Thoughts on sending a political institution in to do a market's job

I've been a little skeptical of claims from people like Jonathan Catalán at Economic Thought that tort law and full legal liability is the best way to prevent disasters like the recent oil spill. So far, my arguments have been along prioritarian/corner solution lines. My point has been that the market trades off costs and benefits. Even if it recognizes the cost of something like an oil spill, it will say "well, that would be bad but I'm willing to risk it for some profits". Normally this is very good. We don't want our resource allocation decisions to be guided by extreme caution and risk aversion, so letting people with skin in the game decide on how to trade off risk and reward is usually the best way to maximize social welfare. But sometimes it isn't. Sometimes we as a society want to prioritize certain concerns.

For example, doctors, above all, "do no harm". The medical profession would be extremely different in its decisions between risk and reward if it didn't have these priorities institutionally built in. Thinking about when markets can and can't assess risk properly often comes down to a question of whether market failures exist. They clearly exist in the medical profession - doctors know considerably more about the product that they are selling than their patients do. That asymmetric information distorts the market. The institutional solution to that asymmetric information problem has been a strict code of conduct that's not negotiable in market optimization decisions (I suppose this suggests that Hippocrates anticipated Stiglitz?).

Another example that I often bring up here is positive or negative externalities. I like working things out in markets, but you can't do that efficiently if the property rights regime keeps the market from incorporating information about certain costs or certain benefits. That is the situation with the oil spill.

One solution that some people propose to the externality problem is tort law. If firms can't pay the costs of their actions in the market, they can at least pay in court - and they'll factor those costs into their decision making (a la Jonathan's post). My objection to this claim so far has been that even if tort law does solve the market failure problem, we still may have social priorities that demand a corner solution that the market may not be able to provide. BP will trade off the costs and benefits of different ways of plugging the hole, while Obama will insist that we simply "plug the damn hole". Before the spill, we might have said that complete risk aversion is inappropriate - we might have wanted to trade off the chances of failure with the prospect of profits. After the spill, profit for most people was no concern. We needed to plug that hole effectively, regardless of the costs. My critique has been that whenever we genuinely have these "regardless of the costs" needs, that's not something that you go to the market to solve.

But that is essentially a question of what we are optimizing. If we are optimizing some sort of prioritarian understanding of social welfare, then the market is inappropriate because the market optimizes a utilitarian understanding of social welfare. But that still assumes, with Jonathan, that tort law and the institution of the courts (if freed from liability limits) would be successful in forcing BP to deal with all costs and all benefits (ie - internalizing the costs and benefits that thus far had been external to the market transaction). I wonder, though, if we need to question this assumption.

Two things I read this morning raised this concern for me. The first is a report that eight people were sentenced to two years in prison in India for the Bhopal gas leak that killed thousands in India in 1984. I was born in 1984. These people have had to wait 26 years for Union Carbide to pay the cost for their decisions. Now, India of course is not the United States (although it took 19 years for Exxon-Valdez to be settled here), but it still raises two obvious questions for me:

1. Even if limited liability were repealed as Jonathan wishes it would be, what makes him think that the courts will impose costs with sufficient fidelity to correct market failures, and

2. Do the courts at all consider discount rates when they reach these conclusions?

The first question is the more obvious one, but I think the second question is more interesting. The people of Bhopal suffered the costs that they suffered 26 years ago, and they were only compensated for those costs 26 years later. For that to fully compensate their costs, it needs to be considerably more than the costs that they suffered in 1984. If this idea of time-preference is confusing for you, think of it this way: if you buy a house the bank that's lending you the money to buy it bears all the costs immediately. But you're only going to compensate them for those costs over the next thirty years. The bank values money in the future less than money in the present, so to compensate them for that delayed restitution you have to pay interest. The same principle should apply in tort law. Maybe it already does - I'm not a lawyer and I just don't know. But it should. And if it doesn't, then that's one more reason to be skeptical of Jonathan's position.

The second problem with sending in the courts to do a market's job is of course the question of whether the courts are impartial in the way that a market is. Recent reports of over half the federal judges in the Gulf recusing themselves because of ties with the oil industry suggests that we should be skeptical of this assumption. This isn't something we should criticize the judges for - it's just an inevitable problem with the institution. There's nothing wrong with having oil interests and being a federal judge. They're allowed to own stock like anyone else. But when the institutional solution that you provide is directed by a certain group of elites, it introduces serious risks of conflicting interest. This is as true of regulatory bodies as it is of courts.

My view on how to address this problem is similar to my view of the political economy aspects of fiscal vs. monetary policy as stimulus (specifically, the political economy reasons for why I prefer fiscal stimulus to quantitative easing): if you have to engage in what is essentially "picking winners" and there is a serious risk of partiality, it's better to do the job in a transparent, deliberative setting where multiple perspectives have a voice and a vote than it is to do it in an opaque setting with fewer voices and votes (like a court or the Fed). There will always be problems with political solutions. Legislatures are not immune to these problems. But they are more accountable and visible than other institutions.

When we can rely on market institutions to make these decisions we should rely on them - but there are many cases where we can't. When we can't, the question is "what is the best political or social institution to remedy the problem"? Since courts impose costs that are not imposed by the market, they're very, very attractive as a market alternative to a lot of people. I think we need to be more critical of that.