Professors David Gilo and Ehud Guttel recently presented their paper, Liability for Insufficient Risks, at the Law and Economics Workshop. This is a forum where academic working papers are presented and discussed among interested faculty and students.
It's been well documented that a negligence rule may cause people to engage in excessive activity. For example, as long as a train is safely operated (e.g. does not travel too fast), the railroad will not be liable for an accident. However, it still may be socially desirable for the railroad company to limit the number of train rides. There's always some risk of an accident and the benefit from operating a particular train may be less than the risk of harm from accidents this train may cause, no matter how carefully the train is operated. Thus, the railroad may end up operating too many trains, relative to the socially efficient number.
Professors David Gilo and Ehud Guttel argue in their paper, that there may be another systematic deficiency in our tort system causing people to engage in too little activity. Using the previous example, the railroad may be able to put up safety devices to lower the number of accidents. However, such devices will only be cost justified if the volume of traffic through the crossing is sufficiently high. If the traffic is low, these safety devices will not be cost justified and the railroad will not be liable for failing to install them. Thus, a railroad may be in a situation where it is in its best interest to keep its level of activity (number of train rides) low, so that it avoides the need to install safety devices. This may occur even where the most optimal arrangement (not just from the railroad's private perspective) is for the railroad to install the safety devices and keep running a high number of trains. Thus, tort liability based on negligence may cause the railroad to engage in too little activity, rather than excessive activity.
This problem can be resolved by making the railroad strictly liable--the railroad is always liable for an accident, regardless of its safety precautions. The railroad will choose the efficient number of trains to and the efficient level of precaution because the railroad is now forced to internalize all the costs and benefits. Before, the railroad only internalized the cost of the safety devices and none of the benefit from reduced accidents. Thus, the concern that some actors may inefficiently lower their activity level may help courts determine whether negligence or strict liability is a more appropriate rule. Similarly, regulatory agencies, which often focus on fixing the problem of excessive activity (e.g. pollution), may at times need to focus on the problem of too little activity by requiring cost of care expenditures, even when it may not be cost justified from the perspective of the regulated entity.
But, how willing should courts and regulators be to engage in this type of analysis? Should a lawyer be liable for failing to save someone's life because he was dissuaded from going to medical school because of tort liability? Would companies be required to increase the scale of their businesses so that safety regulations apply to them? These extreme examples may have an easy answer--courts shouldn't intervene because the information is too costly for them to process and the chance of a poor decision is too high. Maybe there are easier cases where it would be feasible for courts and regulators to account for insufficient risk taking. The hard part is to separate the two.