Sunday, May 20, 2007

Justice vs Efficiency: An Example

One way in which a legal system discourages people from doing things that inflict costs on others is by fining them. Roughly speaking, there are two alternative approaches. Under criminal law, the fine goes to the state. Under civil law, it is called a damage payment and goes to the victim.

A variety of arguments can be made for one approach or another; interested readers may want to look at the chapter of my webbed Law's Order devoted to the general question. One interesting feature of the analysis is that the straightforward argument based on justice gives the opposite answer from the straightforward argument based on economic efficiency.

The justice argument is that the money should go to the victim, in order to compensate him for his loss. Indeed, the standard rule in tort law is that the damage owed are enough to "make whole" the victim.

For many, although not all, cases the argument from efficiency goes just the other way. The reason is that, even if the victim is not morally responsible for the loss, in most cases he makes decisions that affect how likely it is to occur and how large it is if it occurs. There is nothing inherently immoral about driving an expensive car, but the more expensive your car is, the larger the damages if my negligent driving results in my running into it. There is nothing inherently immoral about walking after dark in bad neighborhoods, but doing so can substantially increase the chance of being a crime victim.

From the standpoint of economic efficiency--loosely speaking, maximizing the size of the pie--we would like people to reduce the likelihood and cost of their being victims whenever the savings are larger than the cost of doing so. But if victims were fully compensated, as in theory under tort law they are, they would have no incentive at all to take precautions. Hence the efficient rule, for a wide range of cases, is that the money should go to anyone but the victim (or the perpetrator).

[I've linked to the HTML version of a late draft of my book. There is another version that consists of page images of the book as published with virtual footnotes--links to icons in the margin.]


Perry E. Metzger said...

Even when people are "fully" compensated for a loss, it is rarely the case that they are compensated for the enormous trouble that the entire event caused them. There is also the issue that frequently, the perpetrator of a tort is never identified -- the person who steals your car or hit it in the parking lot is never caught at all.

However, even assuming that victims could be made indifferent in the economic sense, is the ideal overall result really with the victim minimizing possible exposure? That is certainly the most efficient result within the framework of the tort system taken by itself, but what of the impact on the whole economy if people are afraid of buying, say, an expensive but important piece of equipment for fear that it might be stolen?

It would seem to me that the argument from efficiency would be for the situation in which market forces decide how to allocate risk and restitution based on everyone's revealed preferences in the market. In an insurance based security scheme, for example, we would expect the overall economic result to be maximally efficient even if in particular segments taken alone it did not appear to be optimal.

Anonymous said...

And if the fine goes to the state, you get bureaucracies and enforcement units addicted to the proceeds and more than happy to ratchet up enforcement beyond what is efficient (or just).

That's why my (semi-)facetious suggestion is that the judgment from a tort case (or fine in a criminal case) should be collected in cash from the perpetrator, put in a large pile, and burned.

Theoretically, everybody else's dollars should become more valuable through deflation, distributing the benefit to all moneyholders.

The practical problems with this plan include the cost of printing money in the first place, the uneven distribution based on ownership of dollar-denominated assets, the unhelpfulness of linking the money supply to tort judgments, and the just plain silliness of it all.

But I keep proposing it because there's something about the idea as the least corrupting way to take from the perpetrator.

jimbino said...

What about this:

Suppose you drive a Mercedes and I a Kia. There's an accident in which only the left front turn-signal lens of each car is broken.

The question is, who's responsible and for how much in damages? If I am responsible, I owe you $350 for a Mercedes lens; if you are, you owe me $50 for a Kia lens.

Huh? Fairness would dictate that the guilty party should be liable for, say, $150 in damages, the average cost of a lens. The implication is that the Kia owner, if not responsible, would come out $100 ahead!

Folks who drive an expensive gold-plated Mercedes, as well as the pregnant woman who ventures forth from her house, thus putting her fetus at risk, should bear partial responsibility for damage to what she has put at risk of loss in an accident.

Our current law, which is an ass of course, does not countenance that. Instead it compensates folks who die in terrorist attacks in proportion to their familial complications and financial worth.

Anonymous said...

I'd say a better arrangement would be that your insurance company pays you for the damages you suffer with an agreement that you give them any damage payment you'd collect.
Then it is up to the insurance to handle the moral hazard the best way by equilibrating justice and cautiousness incentives.

Hurray, justice and efficiency are safe once again.

Anonymous said...

My reaction is similar to Peter's: why exactly do we want people taking precautions? Yes, it will deter some torts and crime. But buying locks, burglar alarms, or driving around a neighborhood instead of walking through it have their own costs.

The argument hinges on the aggregate cost of all the precautions people take being less than the aggregate cost of some additional malfeasance that occurs when people don't bother taking precautions. But how do we know it's less?

Michael Roberts said...

I would suggest that the precautions people take to avoid injury (of all kinds) are VASTLY in excess of the real danger.

I think there have been some books written about that... percieved versus actual risk and all.

It's safer to walk than to drive, and worse for the general good to burn the gas and make the noise, and worse for the individual to miss the excercise, and yet people continually say that driving is safer. Humans aren't very good at evaluating risk in the current rather strange surroundings common to modern western civilization.

Fear is bad. Retributive justice is bad too, but now I'm getting off topic.

Alex Perrone said...

"But if victims were fully compensated, as in theory under tort law they are, they would have no incentive at all to take precautions."

Sure, except for court costs, taking time off work, undergoing the stress of the crime, etc. I mean do you really think someone would believe, "oh walking around this bad neighborhood at night? that's fine, i will get compensated in court if anything happens." the far more rational thing to break even is to leave.