Applying Economic Analysis to Tort Law
This article was originally published in the summer 1998 issue of the Expert Witness.
Economists have made important contributions to the analysis of many areas of the law – particularly competition law, labour law, regulation, and international trade – during the last 200 years. It is only in the last quarter century, however, that economists – and legal scholars using economics – have turned their attention in a systematic way to the analysis of torts, contracts, and criminal law. In spite of the youth of the sub-discipline that investigates these branches of the law, it has quickly become a major force within U.S. and, to a lesser extent, Canadian and European law schools. All of the major U.S. law schools – Harvard, Yale, Princeton, Chicago, Stanford, and Berkeley among them – now offer courses in the Economic Analysis of Law and have professors with Ph.D.s in Economics on faculty. (Only the University of Toronto, among Canadian schools, has followed suit.)
Those reading this newsletter will be familiar with some elements of the economic analysis of personal injury damages – for example, through my textbook Assessment of Personal Injury Damages (Butterworths, 1992). But economics, being the imperialistic science that it is, has not stopped there. Economic models have been applied to virtually every aspect of tort law – negligence rules, causation, onus of proof, intentional torts, informed consent, volenti, to name only a few. I do not wish to claim that the economic analysis of these doctrines should supplant the traditional legal analysis. However, I do think that there may be situations in which practitioners may find it useful to consider some of these issues from a different angle.
In this article, and a number of others to follow it, I would like to provide some insight into one such angle – the economic analysis of torts. In this introductory article, I begin by identifying the primary characteristics that distinguish the economic approach from more traditional methods of legal analysis. I then use this approach to discuss collateral benefits and negligence rules.
Characterising the Economic Analysis of Torts
Two fundamental characteristics distinguish the "economic" analysis of torts from other approaches to the study of tort law.
First, economists take a "positive," or "scientific" approach to the identification of legal doctrines. Instead of trying to determine what the law "should be," economic analysts attempt to determine what the law "is." That is, they use the deductive approach to derive hypotheses about the principles which underlie judges’ reasoning and then test those hypotheses by comparing their predictions against the decisions which judges have made. As a simple example, economic analysis can be used to "predict" that the courts will, under most circumstances, reject the defence of "custom." That prediction can be "tested" by observing whether the courts do or do not accept that defence.
Second, all economic analysis of tort law begins from the working hypothesis that judges behave as if they were attempting to devise legal rules which would encourage individuals to maximise social benefits net of social costs. (For example, if there is some accident-avoiding behaviour whose cost is less than the resulting saving in accident costs, the courts are predicted to adopt rules which will encourage adoption of that behaviour.) It is not argued that judges consciously act in this way; simply that the doctrines that have been selected by the common law courts have developed as though this was the goal of the courts.
This view of the functioning of the courts suggests that the courts will behave as if they were employing an ex ante (or "forward-looking") approach to decision-making. In this approach, the courts recognise that any decision they make in the current case may influence the behavior of parties in similar, future cases. Hence, it becomes important to set a precedent which will direct future parties to behave in the socially desirable manner.
This approach can be contrasted with the traditional view of the court’s decision-making process, which I call the ex post (or "backward-looking") approach. In this approach the court is assumed to take the position that, as the tortious act has already occurred, that act cannot be undone. Rather, all the legal system can do is to ensure that the victims are restored, as well as possible, to the position they would have been in had the act not occurred. Contrary to the economic assumption, no thought is given to the impact which decisions will have on future behaviour.
The ex post view is common to most textbooks and was given its most famous expression by the Supreme Court of Canada in Ratych v. Bloomer. There, Justice McLachlan concluded that the function of damages in tort law was to "restore the plaintiff to his pre-accident position." Further, she emphasised that
[t]he law of tort is intended to restore the individual to the position he enjoyed prior to the injury rather than to punish the tortfeasor whose only wrong may have been a moment of inadvertence. [Emphasis added]
That is, the Court has said that tort damages are intended strictly to compensate harms that occurred in the past, not to deter negligent behavior that might occur in the future.
The response which those who rely on "positive" analysis of the law make to this argument is that the most reliable way to determine what someone thinks is to observe what they do, not what they say. In short, the best way to identify the underlying principles of tort law is to review the courts’ decisions, not their arguments. What I propose to argue in the following sections is that the courts’ decisions can often be more easily understood if it is assumed that they are trying to influence future behavior than if it is assumed they are attempting to "right past wrongs."
The Collateral Benefits Rule
A clear example of the courts saying one thing and doing another arises in their interpretation of the "collateral benefits rule." On the one hand, the Supreme Court has made it clear that it prefers the ex post approach. On the other hand, the trial courts have consistently adopted the ex ante approach.
1. Orphaned Children: Consider for example the situation in which orphaned children have been taken into the care of relatives.* Although Ratych would appear to suggest that the children’s claim for loss of dependency was thereby extinguished, most of the decided cases have rejected this view. The trial courts have recognised that the plaintiffs would be "double compensated" but have argued that to deny compensation would be to establish a dangerous precedent for future cases.
The leading statements of the latter view appear in Tompkins (Guardian ad litem of) v. Byspalko (1993) 16 C.C.L.T. (2d) 179 and Ratansi v. Abery  5 B.C.L.R. (3d) 88. In both cases, the trial judges argued that if Ratych was followed, the risk would be created that
… in some cases, family members who would otherwise take orphaned children into their care may decline to do so until or unless an award has been made in the children’s favour.
And in Tompkins, Spencer, J. went further, arguing that "… a surviving parent may refrain from remarriage, advantageous from the children’s point of view, because the presence of a new spouse who replaces services to the children may reduce their award"
2. Charitable Donations: Similarly, the rationale that is commonly given for the "charity exception" is that to deny a plaintiff compensatory damages because he or she had received a charitable donation would discourage individuals from making those donations. A clear example of this principle was stated in the Northern Ireland case of Redpath v. County Down Railway  N.I.L.R. 167 where Andrews L.C.J. noted that if
the proposition contended by the defendants is sound the inevitable consequence in the case of future disasters of similar character would be that the springs of private charity would be found to be largely if not entirely dried up.
Surprisingly, further confirmation of this view comes from the author of Ratych, Madam Justice McLachlan. In her dissent in Cunningham v. Wheeler (1994) 113 D.L.R. (4th) 1 she argued that "… people should not be discouraged from aiding those in trouble."
3. Implications: The common thread running through all of these decisions, I would argue, is that the courts will often consider the impact that their current rulings can be expected to have on individuals’ future behavior. In this view, the function of torts is not merely to compensate particular plaintiffs for past wrongs, but is also to protect potential plaintiffs from future harmful behavior. Children whose parents have been killed are to be protected against the possibility that their relatives may delay the adoption process; and victims of catastrophic events are to be protected against the possibility that donors may be discouraged from providing assistance.
This view opens a number of interesting possibilities for argument in similar future cases. For example, the practice has been to assume that a widow(er)’s loss of dependency comes to an end once she (he) remarries (assuming that the new spouse has a similar income to the first spouse). It could be argued, however, that this rule may encourage widow(er)s to postpone any relationships with the opposite sex until after the fatal accident case has been settled. As it cannot be in the public interest to discourage dating and marriage, a legal rule which has the effect of providing that discouragement may well be contrary to public policy.
In each case, economic analysts of the law would argue that the courts were behaving as if their goals were to encourage (socially) desirable behaviour and to discourage (socially) undesirable behaviour. In the next section, I will argue that it is rules of negligence which distinguish desirable from undesirable behaviour.
Assume the following facts:
- One of the stop signs at the intersection of two country roads is knocked over sometime on Saturday evening.
- The County responsible for those roads becomes aware of this on Sunday morning but decides to wait until Monday morning to replace the sign, in order to save $1,500 overtime pay to its road crew.
- Sunday evening, Mr. A, unaware that the sign is missing, assumes that he has the right-of-way, enters the intersection without slowing, and collides with Ms. B’s car.
- The two cars and their occupants suffer damages which total $5,000.
- At trial, the court accepts the evidence of a traffic expert that the probability, per day, that such an accident will occur is 3/10 if there is no stop sign in place and 1/10 if there is a stop sign.
Was the county negligent? Traditional, ex post legal analysis has difficulty answering this question definitively. On the one hand, ex post analysis holds that the function of tort law is to compensate "worthy" victims, creating a presumption that the county should be found responsible. On the other hand, that analysis also argues that a defendant should only be found liable if he or she failed to take those actions that would have been taken by a "reasonable" person. But what actions would have been reasonable in this case? I will argue that the answer the courts will usually give to this question is consistent with the ex ante, or economic, analysis of the law.
In particular, if the function of the law is to encourage behaviour that maximises social benefits minus social costs (the economic prediction), a "reasonable" action will be one for which the benefits exceed the costs. That is, economic analysis predicts that the county will be found negligent only if the cost of ensuring that the stop sign was re-erected exceeded the benefit of doing so. In this section, I will show that the factors that enter the determination of those costs and benefits are the same as those that the courts usually take into account when determining negligence.
Assume that rural stop signs are frequently knocked down on Saturday evenings. If the relevant counties wait until Monday to replace their stop signs, there will be three accidents every 10 times a sign is knocked down. Hence, there will be $15,000 damages for every 10 such occurrences. ($15,000 = 3 x $5,000.) If the counties replace the stop signs immediately, the number of accidents will fall to one in every 10 occurrences, reducing the accident costs to $5,000, a saving of $10,000. But, in order to obtain that "saving," counties will have to send out 10 repair crews at an overtime cost of $1,500 each, or $15,000 in total. The $10,000 "saving" will have cost $15,000. Put another way, the average cost of precautions per event (knocked over stop sign) will be $1,500 and the average benefit of those precautions (measured in terms of accident costs saved) will be (2/10) x $5,000, or $1,000. (Note: the reduction in the probability of an accident, when the county sends out a repair crew, is only 2/10 because the crew does not reduce the probability of an accident to zero.) As the economic model predicts that the court will only encourage behaviour whose cost is less than the benefit, the economic prediction is that the court will not find the county to be negligent in this case.
It can be seen from this example that three factors were predicted to enter the court’s calculations:
- the cost to the defendant of taking an additional precaution to avoid the accident, (here, $1,500);
- the probability that an additional precaution would have prevented the accident, (here 2/10); and
- the expected cost of the accident, (here, $5,000).
In the U.S., this prediction was confirmed in one of the leading cases on negligence, U.S. v. Carroll Towing. In that case, Justice Learned Hand concluded that negligence was to be found only if the burden (cost) of precautions was less than the probability of the accident multiplied by the gravity (cost) of the accident – precisely the formulation which was derived from the economic model.
In British/Canadian jurisprudence, confirmation of the prediction is less direct, but persuasive nevertheless – sufficiently persuasive that in recent editions of Canadian Tort Law Allen Linden has organised his discussion of the rules of negligence around the "Learned Hand rule." In Wagon Mound No. 2, for example, the court concluded that a party could be found negligent even if the probability of an accident was low as long as the cost of the accident was high. Arguably, it was the court’s view that the cost of the accident multiplied by the probability that it could be avoided should be weighed against the cost of avoidance in order to determine negligence – again, precisely the prediction made by economic reasoning. Other leading cases which are consistent with the economic model include Bolton v. Stone, Priestman v. Colangelo, and Reibl v. Hughes.
Economists often define their discipline to be the analysis of "the allocation of scarce resources among competing ends." When this approach is applied to common law, it suggests that one of the functions of torts might be to establish rules that encourage individuals to use resources effectively. Common law precedents should not discourage relatives from adopting orphans, for example. Nor should they find defendants to be liable if they have taken all precautions for which the benefits (of those precautions) exceed the costs.
In this article, I have argued that this "law and economics" method of analysing the common law predicts that
- the courts will employ the ex ante approach when resolving tort disputes; and
- they will base the determination of negligence on: the probability of an accident occuring, the costs of the accident, and the costs of avoiding the accident.
I have also provided evidence that, at least in some cases, the Canadian courts have followed this approach.
I do not wish to conclude from this that the courts should follow the economic approach, nor that they will always adopt it. I merely offer it as another tool for those who are looking for an underlying rationale to the courts’ behaviour. Perhaps in some cases, the advocate and the court will find it of value to think explicitly in terms of the signal which the decision in the current case will send to others in situations similar to those in which the plaintiff and defendant found themselves. In future articles in this series I will discuss the economic analysis of such doctrines as custom, causation, duty of care, volenti, and restitutio in integrum.
* The foregoing analysis is based on an article that I wrote for The Lawyers Weekly (April 24, 1998). This article is also available, as "Duty to Care for Orphaned Minors," on this website. [back to text of article]