Thursday, June 23, 2011

The Wal-Mart Case and the False Promise of Economics in Law

-- Posted by Neil H. Buchanan

Yesterday, Professor Dorf offered an analysis of the Wal-Mart decision, providing a useful summary of why the decision was a radical departure from previous practice, as well as describing how future plaintiffs might get around the ruling to pursue class actions -- most likely with smaller classes. He approvingly quoted a New York Times editorial concluding that the Court's decision would "increas[e] the cost and the stakes of starting a class action." This fits in well with the now-standard critique of the Roberts Court, that its decisions are decidedly friendly to big business, making it more costly (or even impossible) to bring cases against large corporations.

As many commentators have noted, the result in a case like Wal-Mart is that many meritorious cases will never see the light of day, because the stakes in each individual case are simply too low. This is a problem in any system with expensive procedures, a problem that can be handled in various ways, including small-claims courts, special adjudication systems (such as workmen's compensation claims), and so forth. The key is to try to bring the costs of justice into line with the stakes, to allow non-frivolous claims to be heard.

The justifications for keeping the courthouse door open depend upon one's point of view. From a classically legal standpoint, the goal is simply restorative justice: people who are wronged should be made whole, and those who have done wrong should not be allowed to keep their ill-gotten gains. From an economic standpoint, the idea boils down to setting incentives to guide behavior. A system of justice should make wrongdoing unprofitable, so that there is no incentive to do wrong, and it should allow people who have not done wrong to feel comfortable knowing that they can engage in transactions without worrying about being cheated. The system should, in that view, provide signals to all potential wrongdoers, so that they will know that there is nothing to be gained by trying to cheat other people.

Decisions like Wal-Mart, therefore, can be described as distorting the signals that would otherwise have been provided by the legal and economic system. Wal-Mart has essentially been told that it can get away with what it has been doing, because the people who claim to have been wronged have no effective way of gaining redress. Like so many other large enterprises, in so many other situations, Wal-Mart has been told that it can take billions of dollars from people, as long as it can figure out a way to do so in small enough chunks to make it pointless to sue. (As I said in my comment on Professor Dorf's post yesterday, and as his reply confirmed, I find it hard to believe the initial news reports suggesting that there is now no way to bring class actions under similar facts. Even if I am right about that, however, it is still likely that the higher cost of a post-Wal-Mart class action will prevent some meritorious suits from being filed.)

Shortly before I decided to go to law school, in my innocent days as a mere economics professor, I heard about a court decision with similarly perverse incentive effects. Without going into the details, the court held that a health insurance company that wrongly refused to cover medical costs could be held liable for no more than the amount that it would have paid in the first place. From a standard economic perspective, this no-punitives rule created a clear incentive for an insurer simply to deny all claims, on the theory that some fraction of patients would never sue, some would lose their cases for non-meritorious reasons (bad judges or juries, lost evidence, intimidated witnesses, and so on), and only a few would actually win. So long as the cost of in-house counsel was lower than the damages in the suits that should have been brought and won, the company would come out ahead.

Even as an economist who is skeptical of the excessive claims about the value of economic analysis in finding "the right answer," I remember thinking at the time just how crazy this sounded. "Don't lawyers know anything about incentives or efficiency?" I wondered. "How can we have a system that is designed to allow one side of a bargain to get away with what amounts to theft?"

Class actions, punitive damages, and other procedures are, in other words, important devices to allow the legal system to align incentives properly. And given that aligning incentives is the core idea behind economic efficiency, it would be reasonable to assume that people who believe that the legal system should be designed to maximize economic efficiency would want the legal system to allow class actions, punitives, and so on. Given that a commitment to efficiency is closely associated with those at the conservative end of the political scale, why would American conservatives push so hard against class actions and punitives?

One possibility, of course, is that there are different groups of conservatives, one committed to economic efficiency and others committed to other goals (such as originalism, plain meaning, or whatever). Conservatives are not a monolithic bloc, and it might simply be that the Roberts Court and its admirers have no time for efficiency analysis, no matter what their allies on other matters might desire.

Ultimately, however, I think the answer lies in the emptiness of the concept of economic efficiency itself. As I began to discuss in a post last week, the word "efficiency" has been drained of all meaning. Moreover, even the particular (and peculiar) concept of efficiency on which economists rely, usually referred to as either Pareto-efficiency or economic efficiency, is so elastic that it is possible to describe anything and everything as both efficient and inefficient. This is not merely matter of different people using the concept for different purposes in different contexts. In the same context, and for the same purpose, it is possible to specify an economic model that makes anything "efficient." (This is because of the "baseline problem," which I discussed recently here.)

It is possible, therefore, to describe the Wal-Mart decision as both efficiency-enhancing and efficiency-reducing, depending upon the model that one chooses to describe the situation. (The efficiency-enhancing argument could, for example, be bases on an argument to the effect that well-run companies should not be subject to being fleeced by opportunistic plaintiffs with too-easy access to the courts.) One can, therefore, be a big fan of the Roberts Court and think that their pro-business decisions are just dandy for efficiency purposes.

Using efficiency analysis in law ultimately leads nowhere. At best, it simply relocates all of the standard legal arguments inside an argument about model specification -- an argument that can only be understood by those who can navigate economic models. At worst, it leads people to believe that there are objective answers to questions that have no such objective answer. We cannot say whether the Roberts Court's pro-business decisions are increasing or decreasing economic efficiency, because they are doing both and neither. We can only say with certainty that those decisions are very pro-business.


Hashim said...

"Efficiency" isn't an empty concept simply because a given legal rule can have both positive and negative "efficiency" effects. Class-actions have an obvious and undisputed positive effect: they potentially allow the aggregation of meritless claims that are not financially worthwhile individually. But they also have an obvious and undisputed negative effect: they potentially allow the aggregation of frivolous claims with meritorious claim while imposing huge coercive pressure on the defendant to settle all of the claims together. Whether they are "efficient" overall simply requires assessing which effect is larger. But that does not render the concept of "efficiency" incoherent.

To answer your question as to why conservatives who believe in "efficiency" might dislike class-actions, the reason is that there are far easier ways to ensure that small-dollar claims can be litigated: award attys' fees to prevailing parties and, if still necessary, a multiple of damages. On the other hand, there are very few ways to avoid the incredible coercive effect to settle a class that combines meritorious and meritless claims. Rigorous interpretation of Rule 23, however, at least reduces the risk of such extortionate litigation.

Michael C. Dorf said...

Hash: in your first paragraph, I think you mean "aggregation of MERITORIOUS claims". Freudian typo?

egarber said...

One particular irony is that the harder it is for private individuals to bring action, the easier it is politically for legislatures to strenghten regulation in a particular area. In other words, class-action suits -- and the threat of them -- are a form of regulation.

So in pushing for weaker plaintiff power, conservatives are making it easier for politicians to layer on statutory rules of behavior.

Of course, since the media don't typically draw the connection between lawsuits and protecting the public generally (regulatory equivalence), conservatives are typically able to win the narrative on each -- framing conventional regulation and legal actions as separate evils.

Jocelyn said...

I encourage everyone who cares about the ramifications of the Wal-Mart decision to watch the new HBO documentary "Hot Coffee" (trailer and information about the movie's premise here: It shows the other side of the story of the war on "frivolous" lawsuits and the closing of the doors of our civil justice system to ordinary Americans. If for no other reason, please watch this movie to get the facts of the McDonald's Hot Coffee case, especially given that it is touted as the quintessential frivolous legal claim clogging up our court system.

As a public health professional and human rights attorney, I am deeply disturbed by the way that large corporate interests are hijacking one of the best tools to hold corporations to account and protect and promote public safety.

egarber said...

oops. I meant "strengthen". :)

Neil H. Buchanan said...

In response to Hashim: I must have short-handed my argument a bit too much, because I never meant to imply that efficiency is incoherent merely because you have can both positive and negative effects. Simple arithmetic, as Hashim points out, would allow us to determine which effects dominate, if that were the only problem.

My point is two-fold: (1) The decision about what to count in the positive and negative columns is hidden in an economic model, but it drives the result (just as it does in non-efficiency arguments), and more importantly, (2) The choice of economic model determines the numerical values of whatever positive and negative efficiency effects we decide to measure. In other words, it is not an empirical problem. The theory will drive the empirical result, allowing a person to declare that any result is efficient (or not), even if there is no difficulty in gathering or aggregating data.

Hashim's second paragraph is extremely helpful. Although I do not find his argument about "extortionate litigation" persuasive, it at least is a clear and honest argument about which we can have a good discussion. I am likely, in fact, to try to engage that discussion in a near-future post -- contingent on breaking news, etc.

Neil H. Buchanan said...

In response to egarber's comment: I agree that people tend to forget that litigation is another form of regulation. I'm not sure, however, whether cutting back on litigation makes other types of regulation more likely or less likely. (Given his correction, I also can't tell which way egarber thinks it cuts.) It's possible that -- a la the Lily Ledbetter Law -- an anti-plaintiff court decision will lead to better legislation. On the other hand, bad court decisions can feed a general anti-regulatory narrative, making legislative responses less likely. Certainly, there is no reason to think that Congress will reverse Wal-Mart any time soon, for the more simple reason that one house is dominated by pro-business ideologues.

Neil H. Buchanan said...

In response to Jocelyn: Thank you! Even when I teach Tax, I always make sure to find a way to mention how the standard understanding of the Hot Coffee case is completely bogus. One irony is that the Wall Street Journal's original news article on the case treated it as a straightforward tort suit, presenting the facts and outcome fairly. The WSJ editorial page, however, has spent the ensuing 17 years distorting the story. I look forward to seeing the HBO documentary.

michael a. livingston said...

I think part of the problem here is that law and economics mix less well than one might think. A "rule" in law means a normative prescription that one is bound to follow unless there is an applicable exception. A "rule" in economics means at best a general principle with all sorts of possible limitations, exceptions, and so forth. Taking economic "rules" and applying them to law is a classic case of half-knowledge: it tends to be either oversimplified or applied as a rationalization for choices made for other reasons. Ditto for philosophy and other disciplines: but they don't make the claims that economics does.