Monday, February 18, 2008
Kyle D. Logue (Michigna) presents Overlapping Sanctions at Northwestern today as part of its Law & Economics Workshop Series. Here is the abstract:
Legal sanctions are often used to deter behavior. Economists sometimes refer to this function of law as “cost-internalization.” The idea is that to the extent the law can cause an individual or a firm to bear all the costs and benefits of their activities, including the “external” costs and benefits, those parties will make decisions that are efficient. Not only will they maximize their own expected utility or profits; they will maximize social welfare. Any list of paradigmatic cost-internalizing legal sanctions would include such legal sanctions as the proverbial Pigovian tax, damages awarded in civil litigation, as well as ex post government fines. In addition to legal sanctions, scholars in recent years have focused a great deal of attention on the existence of nonlegal sanctions, such as the reputational penalties that are imposed by a community when a nonlegal norm is violated. Such nonlegal sanctions are sometimes said to produce “order without law,” at least under certain conditions.
Surprisingly little has been written about what should be done when various types of cost-internalizing sanctions overlap. For example, what if a particular activity is subject not only to an ex ante Pigovian tax but also to an ex post sanction such as tort liability or a regulatory fine for the same harm? Should the one be offset by the other? Likewise, should tort damages or Pigovian taxes be adjusted to take account of existing nonlegal sanctions? Moreover, just as legal sanctions can be used to internalize negative externalities, policymakers must also consider the possibility of positive externalities. What should be done, then, if an activity that is subject to potential ex post civil liability happens also to produce external societal benefits as well? How should such benefits be taken in account, if at all, in the policymaker’s decision concerning the appropriate amount of cost-internalizing legal sanction? And how should an ex ante Pigovian subsidy be coordinated with an ex post damage award? To what extent is this sort of coordination of various types of sanctions done in the real world?
This essay explores these questions. The goal of the paper is not to provide definitive answers, but to offer a framework for analysis and an agenda for future work. The initially adopts a set of highly restrictive assumptions, including an assumption of perfect rationality and complete information and that the sole function of legal sanctions is to internalize costs (or deterrence). Under these extreme assumptions, the paper’s overall conclusion is this: Policymakers should adopt a legal regime and accompanying system of legal sanctions (whether ex ante, ex post, or some combination of the two) that, when combined with the nonlegal sanctions (as they exist after the adoption of the legal rule and legal sanctions, taking into account whatever dynamic causal effects there may be between legal and nonlegal sanctions), produces an overall ex ante marginal cost to the potential injurer equal to the ex ante expected value of the external harm associated with the potential injurers’ activity. This conclusion, which becomes more complicated as the assumptions are relaxed, is contrary to the conventional wisdom among economists regarding the appropriate way of coordinating legal and nonlegal sanctions, which holds that nonlegal sanctions are separate and distinct social costs that should not be offset against legal sanctions (unless the nonlegal sanctions produce positive externalities.)