PRODUCT SAFETY: LIABILITY LAW AND REGULATION

(1) Overview(2) Social Efficiency Criteria(3) Market Failure Justification-- Imperfect Info(4) Product Liability Law-- “Seller’s Beware”-- The Logic(5) Product Safety Regulations-- Federal Agencies(6) Informed Consumers & Market

Solutions

OVERVIEW

(1) Focus on correcting “wrongs” and reducing risk

(2) Imposes liability burden and standards on producers-- many businesses discontented with present system

(3) Emphasis on consumer protection(4) Imposes costs on producers and

ultimately on consumers(5) Significant changes/reforms

proposed

“CASES IN THE NEWS”

• Tobacco Industry– $500b+ in Lawsuits (Fed, State, Ind.)

• Gun Industry– Law suites from cities

• Bio-engineered Food Products• New Drugs • Motor Vehicle Safety

– GM Pick-up Truck, Min-vans, SUVs• Child Products

– Child restraint seats, Mattresses, Dolls

THE SOCIAL EFFICIENCY CRITERIA (SEC)

• Overall objective of public policy in this area is to: – Strike a balance between the

benefits from injuries prevented and the costs of prevention

• There is a socially optimal level of product injury greater than zero

• Desire is to: minimize:– total cost of injuries + total cost injury

prevention

THE SOCIAL EFFICIENCY CRITERIA (cont.)

• SEC takes a utilitarian perspective• Does not take into account basic

rights (e.g., right not to be injured from product use)

• SEC employed by Dept. of Transportation and other government agencies (e.g., GM pickup truck case)

JUSTIFICATIONS: FOR PRODUCT LIABILITY AND PRODUCT SAFETY REGULATION

• In a perfect market….– private firms would produce the

right (socially efficient) amount of protection from dangerous goods

– the price of dangerous goods would be lower than less dangerous goods with “built-in” protections (e.g. Volvos)

Justifications for Product Liability and Product Safety Regulation (cont.)

However…consumers have imperfect info and

market failure results due to:* relatively infrequent use by consumers* rapid product changes* info asymmetry between producers and consumers

PRODUCT LIABILITY LAW/ COURTS

• Courts most significant institutional arena

• Public safety under common law- set by precedents- varies by state, federal court

• Product liability/ tort law- deciding who should pay for damages?

- include damages & punitive awards- awards often multiple times damages e.g., Chrysler mini-van ...jury in South Carolina awarded $12.5m damages & $250m punitive

PRODUCT LIABILITY LAW(continued)

• Evolution of product liability law- progressively placed more burden on

firms: First, negligence- firms only had to prove that they had taken reasonable cautionThen, strict liability - liability without fault - “sellers beware” (liability on any company that contributes to final product, not just final manufacturer, but also seller)

PRODUCT LIABILITY LAW/ COURTS (cont.)

• Movement towards absolute liability- almost no mitigating circumstance that a firm can use to escape liability

THE LOGIC: PRODUCT LIABILITY AND THE WAY COMMON LAW HAS EVOLVED

• Objectives:- protect product users- serve the general welfare- achieve social efficiency

“THE LOGIC” (CONT.)

• Reasons for placing burden on manufacturers/sellers, include, they:- know the most about the product, e.g., cost of making product more safe- can prevent injuries at least social cost * through product design * consumer info * investment in R&D to improve safety

WHY PLACE “BURDEN ON PRODUCERS CONTINUED

* Product safety law provides $ incentive for private firms to consider public safety

* Placing burden on producers and sellers (e.g., auto recalls) can serve utilitarian interests

Also …private companies

* have deeper pockets* can help those “harmed” * Moral Rights perspective

FLAWS IN THE PRODUCT LIABILITY SYSTEM

• Has turned into a “game” because of potential high payoffs– average award in federal courts is $1.5m+– $105m fine awarded by Atlanta jury against GM

for death of pick-up driver– $262m Chrysler minivan case

• Number of cases have tripled in last decade in federal courts, similar trend in states

• Many cases settled before they go to court, e.g., J&J/Tylenol (should have anticipated negligence case)

FLAWS IN THE PRODUCT LIABILITY SYSTEM (cont.)

• Many frivolous lawsuits• Cost of liability insurance rising

fast– net premiums of $20.b+

• High cost to businesses– majority of firms say product

liability has adverse impact

FLAWS IN THE PRODUCT LIABILITY SYSTEM (cont.)

• Liability issues can be disincentive to innovate & produce new products (e.g., Bio-engineered food)

• High transaction costs– 780,000 lawyers in US (more in CA than Japan)

• Costs of product liability– estimated at $140b (2.5% of GDP)– In contrast… other countries have

comprehensive and more predictable laws (not system based on precedent)

– other countries fewer lawyers/lawsuits, with more reliance on trust & negative views of suing

FLAWSFLAWS IN THE PRODUCT LIABILITY SYSTEM(cont)

• Moral Hazard-liability on sellers and large awards distorts incentives of consumers to be careful with products

PROPOSED REFORMS

• Instigated by private companies lobbying the US Congress and state officials

• Many states have adopted their own reforms, e.g., Texas

• US Congress passed common sense legal reform act in 1995. Proposals included:-- cap punitive damages (to whichever is higher $250k or 3 times damages)-- allow a “state of the art” defense, i.e.,, used best tech/knowledge available at time

PROPOSED REFORMS (cont.)

--Eliminate joint and several liability, avoid deepest pockets phenomenon

--Put more responsibility on consumers for safety

--Put in place “loser pays” to discourage frivolous suits (UK has this and it seems to work)

CONSUMER SAFETY AGENCIES

• Reaction to failures of product liability law• Agencies are a means to:

– prevent injuries from happening– force firms to make safe products

• Instigated by consumer activists and tragedies (e.g., Ford Pinto case)

• Created by Congress, including --the CPSC, FDA, NHTSB and DOA role,

• Agencies mandate safety stds and info dissemination (e.g., ratings) for businesses to follow (command & control regulation)

RATIONALE FOR AGENCIES (OVER COURTS)

• Can reduce transaction costs when many consumers involved

• Address concerns with uncertainty and hidden product risks (e.g., new drugs and food products)

• Moral grounds-when a certain risk is not socially acceptable, -e.g., unsafe cribs and toys and drugs

BENEFITS FROM AGENCIES

• Have contributed to improved safety-fewer people dying in road accidents today than in 1991, even with more cars

• Spreads costs of product testing and monitoring

• Informs & educates public about risks helps to overcome info asymmetry problems

• Can overcome moral hazard problems by setting stds high and protecting people from themselves

PROBLEMS WITH AGENCIES

• Can produce prevention above socially efficient level

• Imposes costs on producers and consumers

• Hard for agencies to accurately assess costs and benefits of preventing injuries

• Hard to keep up with new products (e.g., bio-engineered food products)

PROBLEMS WITH AGENCIES (continued)

• Administrative costs are high• Overuse of uniform standards

– can limit flexibility for firms and consumers to find the cheapest (socially efficient) way for reaching a given level of safety

REFORM OF CONSUMER PRODUCT REGULATORY AGENCIES

• During Reagan Administration-Executive order that no regulation should be permitted if its cost outweighs its benefit, unless there was an express law by US Congress to the contrary-Agency staff and budget cutbacks

MARKET SOLUTIONS TO CONSUMER SAFETY

• Safety a selling point to many consumers• Consumer concern for safety is

increasing• Info dissemination is faster and cheaper

with Internet• Companies are “meeting” consumer

demand for safer products-Volvo-Health food products-Parents buying toys (Mattel replacing Vinyl with Plant based plastics)

MARKET SOLUTIONS TO CONSUMER SAFETY(cont.)

• With better informed consumers market works better and there is less need for government regulation

• Govt might do best by focusing on research, monitoring and info provision

• Industry can work with government on solutions that are mutually beneficial, e.g. handgun child safety locks

ENVIRONMENTAL PROTECTION

• (1) Introduction• (2) Social efficiency criteria

– how its application differences from product safety law and regulation

• (3) Market failures justifying govt intervention– common resource problem– externalities

ENVIRONMENTAL PROTECTION

(4) Government approaches- command and control- emission charges- tradable permits- public ownership

(5) Federal role: Acts & Agencies(6) Market solutions

“CASES IN THE NEWS”

• Global warming• Acid rain • National forests preservation• New England fisheries• Brownfields• “Smart growth” --reduce sprawl• Endangered species • Mail-order catalogs (17B catalogs produced

last year using 3.35m tons of paper, 12% of all paper produced in US)

THE SOCIAL EFFICIENCY CRITERIA

• Similar to product safety discussion• Overall objective for public policy in

this area is to:– strike a balance between the

benefits from environmental damage prevented and the costs of pollution prevention

– there is an optimal level of environmental damage that is greater than zero

THE SOCIAL EFFICIENCY CRITERIA

– T he desire is to: •min (total cost of pollution + total

cost of pollution abatement)

– SEC takes a utilitarian perspective– SEC does not take into account basic

rights & values, e.g., clean air & water at “any cost”

– Utilitarian perspective less accepted in environmental policy than product safety

ENVIRONMENTAL PROTECTION: DIFFERENCES WITH PRODUCT SAFETY

• Who should pay is unresolved, as the liability rules are not set

•not as well defined whether producers or consumers should pay for “preserving the environment”

•who pays has significant distributional consequences

•makes environmental regulation a highly political issue

ENVIRONMENTAL PROTECTION: COMPARISON TO PRODUCT SAFETY

• Less use of courts and more use of government regulation and agencies– because of:

* high transaction costs * high number of parties involved * high uncertainty

* high risk with environmental damage

ENVIRONMENTAL PROTECTION: COMPARISON TO PRODUCT SAFETY

• Broader support for environmental protection--from activists, general public and some industry leaders (e.g., Saturn, Home Depot) --than with product safety regulation

• Less support for deregulation

MARKET FAILURES JUSTIFYING GOVT INTERVENTION

Common resource problem– Consumed collectively– Unlike public goods, dissipates with use,

i.e..,

after one person uses less for others– examples--air, water, land, species– Subject to free rider problem

• use without payment•over time the common resource is

overused & depleted

TRAGEDY OF THE COMMONS

• Businesses and consumers are misled by individual economic incentives to use common property as if it were a free good and inexhaustible– “everyone’s good becomes

nobodies”– the result: non-optimal use from a

society perspective

Solutions: TRAGEDY OF THE COMMONS

• Govt can set rules for use of common property to ensure-- long term sustainability of the resource-- set rules for use of national parks (e.g., ban snowmobiles)--objective is the maximization of the net present value of the use of the resource

* ...Alternatively could privatize common resource, i.e., assign property rights to pollute

TRAGEDY OF THE COMMONS: Privatization “Solution”

-- Main benefit of privatization of resource...lets private market max. npv of resource

-- Problems:* resource no longer common* who should be assigned property

rights?* fairness/equity issues* still hard to avoid free riders and

externalities

EXTERNALITIES --THE 2nd MAIN JUSTIFICATION FOR INTERVENTION

• Degradation of nature harms third parties whose interests are not incorporated in the price system

• Govt can work to minimize the negative externalities-- e.g., firms are made to pay for negative externalities with pollution through effluent charges and process regulations

EXTERNALITIES

Pollution regulations can work.. as firms pass costs on to consumers-- costs then reflect total social costs of

use/production which meets SEC objective

Problem: government failure:-- easier to i.d. need for intervention than to i.d. best intervention approach or appropriate tax or process regulation

COMMAND AND CONTROL(MAINLY USED TO OVERCOME TRAGEDY OF THE COMMONS)

• There are different government regulatory approaches used

• C&C is the most commonly used and significant approach (e.g., clean air and water act, regulated lead content in gasoline)-- Imposes uniform standards, then agency monitors and enforces stds, penalizes offenders with fines

COMMAND AND CONTROL

•BENEFITS OF C&C

-- Can achieve stds. and reduce pollution* more lakes in the US can be used today for fishing and swimming than 20 years ago

-- Creates a market for the pollution abatement equipment mandated

* $115b (2.1% of GDP spent on pollution control)

COMMAND AND CONTROL (cont.)

Problems -- Limited flexibility for producers or

consumers-- Does not achieve social efficiency

**C&C approach does not take into account different costs of firms meeting regulatory standards** ideally want the lowest cost pollutionabaters to abate the most and the highest

cost pollution abaters to abate the least

COMMAND AND CONTROL (problems cont.)

• C&C costly for agencies to implement– Constant monitoring required– Dealing with companies on an

individual, case by case, basis

• High environmental. stds in production could harm competitiveness of US industries (this is an issue in NAFTA)

EMISSIONS CHARGES (MAINLY USED TO INTERNALIZE EXTERNALITIES)

• Taxing externalities

* recall externalities as a market failure which justifies govt intervention

• Benefits -- can lead to prices & costs increasing and output declining which is what is desired for economic efficiency

EMISSIONS CHARGES

»

Benefits -- Costs get passed to consumers which

makes for market efficiency-- Provides incentives for R&D in pollution

control technologiesProblems-- Need to figure out what is correct tax/

emission charge-- Costly to administrate

TRADABLE PERMITS (used to overcome common property problems)

• Assigns property rights to pollute and then allows for private bargaining to achieve social efficiency

• Benefits-- can lead to social efficiency

TRADABLE PERMITS (benefits cont.)

--The firms that can abate most cheaply will do so and sell their rights to pollute to firms which have the highest costs of reducing pollution

-- Environmental interest groups can purchase rights to reduce pollution

TRADABLE PERMITS (cont.)

Problems-- who should get initial rights to pollute?-- “downwind” effect/externalities still an

issue (e.g., NYS and acid rain from midwest polluters)

-- undermines “fundamental” value of environmental protection

and right to breath clean air and swim and fish in clean waters

ALTERNATIVE GOVT. INTERVENTION IN ENVIRONMENT: PUBLIC OWNERSHIP

• e.g., National Parks

• Benefits-- can preserve land/environment

• Problems-- costly to manage-- subject to political swings

U.S. FEDERAL GOVT ACTION & INSTITUTIONAL ARENAS

– Little federal involvement until 1948 & Water Pollution Control Act

– Then 1970s»pesticide hazards»rising incomes»changing tastes»environmental movement (post-

Vietnam protest era)

THE EPATHE EPA--MAIN U.S. FED AGENCY (ENVIRONMENTAL PROTECTION AGENCY)

• Created in 1970• Consolidated 6 environmental acts

under one agency, including Clean Air and Water Quality Acts

• The EPA is an independent executive agency direct reporting to President

-- top administrator nominated by President and confirmed by Senate

THE EPA (continued)

* Influenced by US Congressional: acts, statutes, oversight and budgeting

* Subject to judicial review* National & regional offices and

administration* Sets standards, enforces compliance,

does research* Responsible for air, water, solid waste,

noise

THE EPA (cont.)

* Significant use of command and control to reduce common property problems

* Increased use of other approaches-e.g., 1990 Clean Air Act calls for

greater use of tradable pollution rights

* “Unique” among fed reg agencie-- staff and budget increased in

1980s -- currently +14,000 employees

“OTHER THAN EPA”

– Other Fed agencies involved in environmental protection•DOT, DOE, NPS, Dept. of Interior

State & Local policy- EPA equivalents- zoning- recycling laws

COMMON LAW AND COURTS ALSO USED FOR ENVIRONMENTAL PROTECTION

• Much less use of courts and litigation in environmental area than product safety

• Main reason:- higher transaction costs

* large # of people involved* uncertainty* long term consequences

COMMON LAW AND COURTS (continued)

• Law Suits not as “easy” • Harder to determine in the

environmental arena than product safety• who caused damages??• who is damaged and how much ($)

is damage??

PRIVATE COLLECTIVE ACTION: DIRECT POLITICAL ACTION USED FREQUENTLY TO PROTECT ENVIRONMENT

* Collective Action to stop “projects”:- NIMBY- Greenpeace

* Environment issues influence national, state, and local elections

•Sierra Club, Audobon Society, National Wildlife Federation & Wilderness Society have 7m+ members

International Perspective on Environmental Regulation

* Rest of world in many respects is now catching up with US on environ. reg.

* Developing nations still lag, but do less environ. damage (e.g., use cars less)

* Increasing need for trans-national efforts to address environmental concerns

-- Montreal protocol (1987)-- caps on CFCs

* Difficult to enforce problems with global free riders

PRIVATE MARKET “SOLUTIONS”

• Firms can appeal to people’s ethical sense and feelings for the environment

• Consumers-- as with product safety-- are willing to pay for environmental protection, e.g.,

- voluntary recycling

- purchase of “green products” at

“premium” prices

PRIVATE MARKET “SOLUTIONS”(cont.)

* In New Hampshire environmental industry includes 85 establishments with over 1,500 workers - waste management - pollution abatement equip.

* National firms differentiate products on environmental “friendliness”-- Body Shop, McDonalds (packaging)

PRIVATE MARKET “SOLUTIONS”(cont.)

• Shareholder action -- hold corporations to environ.

stds.* Ceres principles --10 points of

environmental conduct* For some firms... environmental

protection imposes costs * For other firms... it creates market

opportunities -- this is true with most areas of

governmental regulation

ENVIRONMENTAL REGULATION:SUMMARY

• Continued public interest, activism and support

• Increased use of market-based government solutions, e.g., tradable permits

• As with product safety…private market also working as effective regulator, as informed consumers take into consideration environmental factors in their purchasing decisions