The Law and Economics of Products Liability

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I. INTRODUCTION

No area of the law is perfect, and this truism certainly applies to products liability. But products liability law has come in for some unusually harsh criticism in the law and economics literature of late, (1) and much of the treatment of this area by economically-oriented legal scholars has been negative for at least a generation. (2)

This Article offers a balanced economic assessment of products liability law. Any reliable assessment of the overall welfare impact of the system will have to depend on empirical work. Economic theory can do no more than offer predictions about the incentives created by the law, hypotheses about the law's welfare effects, and identify the empirical questions that should be addressed.

This Article is largely a positive analysis of products liability law, (3) in the sense that it aims to predict the incentive effects and the welfare consequences of the law, with close regard to its specific legal tests. The other major part of this Article is a normative assessment of the pieces of the law that arguably should be reformed. My overarching goal is to set up a framework that can be used both to understand and to criticize the law.

In contrast to the law and economics literature suggesting that products liability law is one big mistake, and perhaps should be abolished, (4) I argue that the law probably improves social welfare, though it is in need of reform in several areas. For judges and lawyers who have to work within the existing framework, my hope is that a tailored set of reforms would be more useful than the broad-brush critiques that have dominated the law and economics literature on products liability. On the other hand, a strictly positive economic theory would also be less useful to courts because it would suggest that everything could be just fine. To the extent that there are puzzles about the effects and the likely function of the law, a positive theory can provide answers; (5) but the law is so well entrenched, and so often critiqued, that a normative component is clearly desirable in this case.

Products liability law operates largely on products that have observable utility and hidden risks, relative to the safer alternatives available on the market. The observable-utility feature offers an advantage that attracts consumers. The hidden-risk feature leads to injuries. This combination of features is unlikely to be regulated well by the market. The market is likely to fail, for these products, in providing incentives for optimal consumption or for producers to make welfare-enhancing design changes. In contrast, for products with open and obvious risks, the market is likely to regulate optimally, in the sense that where alternative designs exist that offer equivalent utility and less risk, the market will effectively exclude the riskier products.

The law has the potential to correct the market's failures. Moreover, the scope of the market that is regulated by products liability law is so vast that the work of courts cannot be supplanted by government regulatory agencies, even if it were possible to avoid problems such as agency capture and languid public-sector incentives. Even in the absence of capture or dull incentives, courts applying liability rules to producers have an advantage over government regulators because they respond to real injuries rather than breaches of regulatory orders, which may or may not generate serious injuries.

However, there are some glaring inefficiencies in the products liability system. The cost of litigation is passed on, at least in part, to the consumer, in the form of an implicit liability premium substantially greater than the amount required to fund a compensation scheme for injured consumers. Effectively, consumers must pay a tax on products that supports a comparatively inefficient and administratively cumbersome litigation industry. (6) In addition, products liability law fails to send the right signals for precaution and for product search on the part of product buyers, a group that includes businesses as well as ordinary consumers. …

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