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EUROPEAN JOURNAL OF LAW AND ECONOMICS

Volume 28, Number 3, 257-287, DOI: 10.1007/s10657-009-9104-z

Scope of liability: the vanishing distinction between negligence and strict liability

Pablo Salvador-Coderch, Nuno Garoupa and Carlos Gmez-Ligerre

B

USINESS AND ECONOMICSPRECAUTION INCENTIVES IN ACCIDENT SETTINGS

2008, 7-63, DOI: 10.1007/978-3-8349-8127-1_2

The Economics ofTort Law:Basics and Selected Core Themes

Economic Analysis of Alternative Standards of Liability in

Accident Law[*]

The body of scholarship using the various tools of economics to assess alternative standards of liability for accidents is enormous. The purpose of thefollowing essay is neither to provide a comprehensive map of all of the articles and books on the subject nor to resolve the raging debate concerningthe relative merits of negligence and strict liability. The goal, rather, is to ill ustrate how economists tend to think about the issue of tort liability and tooutline a few of the major arguments they have developed.

Driving a car, operating a nuclear power plant, or using a hair dryer are all activities that produce risk. Almost everything we do produces a risk of somesort accident or harm, and we quite naturally take precautions against many of those harms. Some precautions, like those taken in nuclear powerplants, are expensive; others, like not leaving a hairdryer on when we are fi nished using it, are relatively inexpensive. In deciding what level ofprecautions to take, we sometimes weigh the cost of the precaution against the benefit (in terms of reduced accident cost) that it wi ll provide. Supposethat I own a house with a fireplace, and the probability (P) of a spark from my chimney setting the roof my house on fire in the foreseeable future is .01.(In other words, there is a one percent chance that a spark will start a fire). If my roof is set on fire, I would suffer a loss (L) of $10,000 in damage. Theexpected cost of the fire would be its cost if it occurs ($10,000) times the probability that it will occur (.01), that is $100. Assume that I am risk

neutral, and that a spark-catching device on my chimney will cost $80 toinstall.

Clearly, installation of the device would be both wise from my standpointandsocially efficient(its benefits outweigh its costs). Suppose, instead, thatthe device cost $200. In that case, installation would be both unwise frommy standpoint (because its cost exceeds its expected benefits) andsociallyinefficient. (I would be better off -- and society would be better off -- ifinstead of purchasing the device, I bought fire insurance.) Because, in bothof these cases, the self-interest of the affected person and the collectiveinterest of society at large coincide, it may not be necessary for the law tointervene. At least if I am fully informed and attentive (an assumption we willreturn to later), I will (without any guidance from the state) voluntarily takethe socially optimal level of precautions.

What if (because of prevailing winds in my community) any sparks issuingfrom my chimney would land, not on my roof, but on my neighbor's?Suppose that the loss to the neighbor in such a case would be $10,000; theprobability of the calamity occurring is .01; and the cost (to me) of the spark-catching device would be $80. Here, self-interest and the interests of societydiverge. Plainly, it would be socially efficient for me to install the device. Butif I am not obliged to pay for the injury sustained by my neighbor, I will not

take the efficient precaution. In such situations, legal intervention may be necessary. It is cases of this sort that prompt many economists to think of tortlaw primarily as a system for inducing people to behave in socially efficient ways -- specifically, in ways the minimize the sum of the costs associated

with injuries and precautions taken to avoid injuries.

What standard of liability is most likely to achieve that effect? There are many possible standards lawmakers might choose from, but the two mostprominent are negligence rules, under which defendants pay for harms caused by theirunreasonable activity, and strict liabilityrules, under whichdefendants pay for all of the harms caused by their activities, whether or not that activity was reasonable.Which is best from a deterrent standpoint?Let's consider them in turn.

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I. Negligence

The most common economic definition of negligence can be seen in operation in Judge Learned Hand's famous opinion, U.S. v. Carroll Towing Co.,159 F.2d 169, 174 (2nd Circuit 1947).[3] The event that gave rise to the case were as follows: Several barges owned by the Connors Marine Co. weretied together off a busy Manhattan Pier. The defendant's tug boat, "Carroll ," removed one of the lines connecting the barges to the pier. When theremaining lines broke, the barges were washed down-river and sank. No one was aboard the barges when they broke away, and the evidenceindicated that had Connors' barge operator (the "bargee") been on board, the barges could have been saved. The question for the Court was whetherConnors was liable for fai ling to have its "bargee" remain aboard. Judge Learned Hand wrote that Connor's liabili ty for the lost barge depended on:

(1) The probability that she will break away;(2) the gravity of the resulting injury, if she does;(3) the burden of adequate precautions. Possibly it servesto bring this notion into relief to state it in algebraic terms: if the probability be calledP; the injury, L; and the burden,B; liability depends uponwhetherB is less than L multiplied byP: i.e., whetherB less than PL.

A defendant is negligent if and only ifB < PL.[4] This formulation of the negligence rule has come to be known as the Hand Formula. Judge LearnedHand went on to conclude that, taking into account the surrounding circumstances (there were strong winds, the harbor was busy, and the ship's cargovaluable), the risk (PL) outweighed the burden of prevention (B). Consequently, he held Connors liable.[5]

Graphically, the Hand Formula looks like this:

The X-axis depicts the amount of care taken by the defendant. The Y-axis represents the cost in dollars -- of taking precautions (lineB) or of theexpected loss resulting from failing to take precautions (line PL). The upward slope of line B indicates that the marginal cost of prevention increases asmore care is taken. The downward slope of line PL indicates that the marginal expected cost of an accident declines as more care is taken.[6] Thepoint at which the combined cost of precautions and accident are minimized is c*, the optimal level of care.

In determining what level of care the courts should require, two points should be kept in mind. First, courts should not merely examine the cost of theaccident that occurs without taking into account the probability of such a loss occurring. Returning to our initi al example, if my neighbor's house catcheson fire at the cost of $10,000, then my failure to take a precaution costing $9,999 will appear negligent if the court looks only at the loss that actuallyoccurred.[7] Yet the expected cost of the accident was only $100.Unless the court considers both the probability of the loss and its magnitude, it willprescribe a level of care that above the optimal level, producing an inefficient result.

Second, the court must consider the marginalcost and benefits of additional precautions, not the total costs and benefits of al l precautions. Supposethat spark-catching devices were prohibitively expensive, but an alternative set of precautions were available to me: I could paint my roof (or myneighbor's roof) with fireproof paint -- thereby reducing the expected cost of a spark accident from $100 to $10 -- for a cost of only $30. A second coatof fireproof paint could reduce the expected cost of a spark accident to zero for another $30. If a court looked at the total cost and benefits of two coatsof fireproof paint, the total precautions would appear efficient because the total cost ($60 of paint and labor) is less than the total benefit ($100 inreduced risk). However, if we separate the two decisions -- the choice to apply a first coat and the choice to apply a second cost -- it becomes apparent

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that the latter is inefficient; it provides only a $10 marginal benefit for a $30 marginal cost. The general point: courts concerned with economic efficiencyshould look at the marginalcostof each level of precaution.

[For two contemporary applications of the Hand Formula, see Judge Posner's decisions in U. S. Fidelity & Guaranty Co. v. Plovidba, 683 F.2d1022 (7

thCir 1982) (involving the reasonableness of boat owner's unloading procedures resulting in the accidental death of a longshoreman)

and McCarty v. Pheasant Run, Inc., 826 F.2d 1554 (7th Cir 1987) (involving the reasonableness of hotel security precautions where woman sufferedbeating and attempted rape)].

What action will the parties take if the court uses a negligence rule?[9] Assuming that the level of care required by the courts is equal to the optimallevel of care, the defendant will naturally take the optimal level of care to avoid liability. What about the plaintiff? Will he become careless, knowing thatthe defendant must either take optimal precautions or pay for any injuries caused by his failure to do so? Probably not. Not all losses can be readilycompensated with money. For example, no amount of money can offset the utility losses a plaintiff suffers from his own death. The loss of a loved oneor the pain and suffering from bodily injury are other examples of non-compensable losses. In addition, plaintiffs are often risk averse with respect torelatively large losses and tend to prefer uniform levels of utility over time. A risk averse individual would prefer a constant utility of 10 over time to autility of -5 (due to injury) in one period and a utility of 25 (including compensation for the previous injury) at a later time. For these reasons, in anegligence regime, plaintiffs, as well as defendants, are likely to continue to take care -- although whether the levelof care they take is optimal has yetto be determined.

So far, the negligence standard is looking pretty good from an economic perspective. On further reflection, however, negligence rules prove vulnerableto some serious economic criticisms. See Guido Calabresi & Jon Hirschoff's Toward a Test for Strict Liability in Torts, 81 Yale L.J. 1055 (1972). Fourare especially strong:

1. The administrative costs of a negligence rule are higher than those of a strict liability rule. To apply a negligence rule, a court must firstdetermine the level of care that would have been optimal under all of the circumstances, and then whether the parties met that level of care.To apply a strict liability rule, all a court must determine is whether or not the defendant caused the plaintiff's injuries. The latter is muchsimpler -- and thus cheaper -- for the parties as well as the court.

2. Another argument against the use of the negligence rule is that, because of the increased expense of bringing a suit, more plaintiffs willchoose not to file suit. This could result in underdeterrence because the defendant will not bear the full cost of his risky activity. Suppose,for example, that a defendant's factory pollutes a stream and causes a loss of $10 to be suffered by each of 100 residents who l ive downstream. The pollution can be prevented by a filter that costs $750. The total cost of the defendant's activity is $1000. Plainly, installation ofthe filter would be efficient. Because PL exceeds B, a court applying a negligence standard would find the defendant liable for failure toinstall the filter. To avoid that liability, we would expect the defendant to engage in the socially optimal behavior -- i.e., install the filter.However, what if the defendant knows that, if he continues to spill, only sixty percent of the residents can afford to bring suit? Under thosecircumstances, the defendant's expected liability will be only $600. Paying that judgment would be cheaper than installing the filter.Consequently, he is likely to fail to take the optimal level of precautions.

3. Courts may err in determining the level of proscribed care. If courts set the level of proscribed care too high (and force defendants toobserve it, instead of allowing them to "punch and pay"), efficient activity will be deterred. If courts set the proscribed level of care too low,inefficient injuries will occur. For a detailed discussion of the problems of over- and underdeterrence, see Craswell, Deterrence andUncertain Legal Standards 2 J. Law, Econ & Organization 279 (1986). The parties may also err in predicting the level of proscribed carethat will be required by the courts. See Mark F. Grady'sA New Positive Economic Theory of Negligence, 92 Yale L.J. 799 (1983). Sucherrors by either the court or the parties will result in an inefficient outcome.

4. Finally, a pure negligence rule may not address cases where theplaintiffis the least cost avoiderof the accident. For example, if theplaintiff can avoid a loss of $10 by taking a precaution which costs only $2, and the defendant can prevent the same loss by taking aprecaution that costs $9, we would prefer the plaintiff to take the $2 precaution rather than have the defendant take the relatively inefficient$9 precaution. This last problem can, however, be addressed through the use of a properly formulated contributory negligence doctrine.Question: will the contributory negligence doctrine currently in force in most American jurisdictions have this effect?

II. Strict Liability

Under a strict liability rule, the defendant pays for the injury his conduct causes the plaintiff regardless of whether the defendant was negligent. That is,the defendant pays for both negligent and non-negligent injuries. Famous cases employing strict liability rules include Rylands v. Fletcher, L.R. 3 H.L.330 (1868), Ploof v. Putnam, 81 Vt . 471 (1908), Vincent v. Lake Erie Transp. Co., 109 Minn. 456 (1910) and Bolton v. Stone, 1 K.B. 201 (1950)[providelinks to all].

As with a negligence rule, a defendant who is held strictly liable will take the optimal level of care to minimize his expenses. If a precaution costs lessthan the expected cost of the injury it will prevent (i.e., the cost of the injury times the probability it will occur), the defendant will take the precautionrather than pay for the injury. The defendant will not take an inefficient precaution, because if the cost of the precaution is more than the benefit itwould provide in terms of i njury prevention, it is cheaper for the defendant to pay for the resulting injury than to take the precaution. Thus under either astrict liability or a negligence rule, the defendant will take the optimal level of care.

One advantage of a strict liability rule -- as mentioned above -- is that it reduces administrative costs. The courts need not determine what level of careshould be required of defendants nor whether defendants have met the prescribed level of care. A strict liability rule thus can produce an efficient resultin a situation in which a court would be unable to determine what precautions should be taken by the parties. A strict liability rule also reduces litigationcosts to parties and may encourage settlement of lawsui ts by reducing uncertainty about probable judgements. The cost savings of each trial under astrict liability rule may be offset, however, by an increased number of suits brought. Thus it is not necessarily the case that a strict liability rule willalways be cheaper to administer than a negligence rule.

A third advantage of a strict liability rule is what has been described as the "insurance function" of strict liability. Holding a company strictly liable for theinjuries created by its products permi ts the company to spread risk to all the consumers who purchase the product. If a product wi ll injure oneconsumer in a thousand, a strict liability rule will impose upon every consumer of the product 1/1000 of the resultant loss (in the form of slightly higherprices), rather throwing the burden entirely upon the person who is non-negligently injured. An ancillary benefit of such a regime is that the prices of

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products will fully reflect all of the costs associated with the harms the products cause, rather than only those costs due to the manufacturer'snegligence. The resultant pattern of product prices will encourage consumers to select safer products and avoid dangerous ones.

There are several potential arguments against the use of strict liability in torts:

1. Strict liability has also been criticized on moral grounds by Richard Epstein inA Theory of Strict Liability, 2 J. Leg. Stud. 151 (1972) andRonald Dworkin in Is Wealth Value?, 9 J. Leg. Stud. 191 (1980).

2. Some economics have criticized strict-liability regimes on the ground that they will overdeter risky behavior. The risk of overdeterrence maybe particularly strong in areas of new or developing technology. If companies bear the ri sk of all foreseeable and unforeseeable harms, theymay be deterred from pursuing innovations whose risks are relatively unknown. This, in turn, may result in under-investment in newtechnology. For a more discussion of overdeterrence, see Richard Posner's Strict Liability: A Comment, 2 J. Legal Stud. 205 (1973).

3. Strict liability rules may also provide incentives for strategic behavior by plaintiffs. Consider the case of a farmer who knows a railroad willbe held strictly liable for all livestock its trains run over. The farmer may let more of his livestock wander near the tracks rather than incurthe expense of keeping them penned. In situations where both the plaintiff and the defendant should take care, a pure strict l iability rule isinefficient. The danger of encouraging strategic behavior may be mitigated by risk aversion on the part of the plaintiff, especially if theplaintiff may suffer physical injury. In addition, a comparative or contributory negligence rule, used in conjunction with a strict-liabilitystandard, can largely remove the incentive for strategic behavior -- although it will also increase the costs of administering the regime.Finally, stric t liability rules may have regressive effects in practice. When the victim of a non-negligent injury receives compensation under astrict liability rule, the cost of the liability award typically is borne ultimately by two groups: those who must pay a higher price for the productand those who can no longer afford the product and must chose substitute goods. The increase in the price of a product due to strict liabilityis borne equally by all those who use the product regardless of their income. A fixed increase in the price of a product affects people withlow incomes disproportionately more than it does people with higher incomes. For this reason the "price effect" of strict liability issometimes considered a regressive tax.

III. The Effects ofLiability Rules on Activity Levels

The probability that an injury of a particular sort will occur is affected, not just by the degrees of care exercised by defendants and plaintiffs, but also bythe frequency with which they engage in their respective behaviors. For example, the likelihood that a hiker will be shot by a hunter is affected, not justby hunters' care in shooting and hikers' wi llingness to wear orange vests, but also by the frequency with which hunters hunt and hikers hike duringhunting season. In principle, there is no reason why courts should not consider activity levels of plaintiffs and defendants when assessing thereasonableness of their conduct -- i.e., when applying a negligence or contributory negligence standard. In practice, however, courts rarely do so --largely because they are unable to determine the optimal level of any activity.

Even though, in general, the courts do not examine the activity levels of parties, the standard of liability they select will indirectly affect those activitylevels. Suppose, to illustrate the point, that cars and 18-wheel trucks sometimes collide at intersections (perhaps because of bad weather ormechanical defects) even though the drivers of both vehicles take optimal precautions and that in such collisions only the cars (and their drivers) areinjured. If a negligence standard is used to determine liability arising out of such collisions, both car and truck drivers will of course have an incentive totake optimal care -- to observe speed limits, watch for other vehicles, stop at stop signs, etc. In such a system, risk averse car drivers will also have anincentive to reduce their activity levels -- i.e., to drive less in hopes of avoiding uncompensated (because nonnegligent) injuries. Under a negligencerule, truck drivers, however, will have an incentive to maintain high activity levels even when, from a social-welfare standpoint, those levels areinefficient. Knowing that they can escape liability altogether by taking the prescribed level of care, the truck drivers will continue driving as long as themarginal benefits of additional trips exceeds their marginal costs -- excluding the costs associated with the resultant injuries.[10]

A strict liability rule, by contrast, will discourage excessive activity levels by truck drivers. Forced to pay for all injuries they "cause," they will decline totake trips whenever the resultant savings (in terms of decreased liability) outweighs the potential profit. However, ri sk averse truck drivers may reducetheir activity levels more than is socially desirable. Under a strict liability rule, on the other hand, car drivers may drive more than optimal amounts.Knowing that the truck drivers will have to pay for all injuries, they may undertake socially wasteful trips. However, this effect is likely to be mitigated bycar drivers' desire to avoid pain and other non-compensable losses.

The care and activity level effects of various rules are summarized on the following table:

Is There An

Optimal

Level of:

No Liability Strict Liability Negligence

Strict Liability

with Contributory

Negligence

Care by

Truck Driver?.

Truck Activity? . .

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Care by Car Driver? . .

Car Activity? . .

Note that a "no liability rule" operates as a strict liability rule pointed against the plaintiff rather than the defendant.

The general lesson on this comparison is that -- from the standpoint of activity-level effects -- whether a negligence standard or a strict-liability standardwould be better depends on (a) the relative risk aversion of the parties and (b) who is most likely to be the best activity-level modulator. If defendantscan best adjust the level of their activities, we might wish to use a strict liability rule. If plaintiffs are the best activity-level modulators, we would tend toprefer a negligence rule. For further discussion of the effects of legal rules on care and activity levels in unilateral and bilateral accidents, see StevenShavall's Strict Liability versus Negligence 9 J. Legal Stud. 1, 2-3 (1980).

http://cyber.law.harvard.edu/bridge/LawEconomics/neg-liab.htm