Friday, August 23, 2002

In an article in Wednesday's Sydney Morning Herald, Ross Gittins claims that the first principle of the economics of accident law is that liability for the cost of accidents should be assigned to the party that can minimise the risk of accident at the lowest cost. He uses this principle to assert that “in most cases, responsibility for managing the risk of accident should rest with the business supplying the activity, not the people who consume it.”

Gittins criticizes proposed reforms to the Trade Practices Act which would (he claims) allow any business providing a recreational activity involving “significant physical exertion” to ``duck’’ their responsibilities for safety merely by adding clauses to contracts.

As Mark Harrison pointed out to me, Gittins’ application of the economic principles of accident law in this particular context are somewhat problematic. In law and economics, the very first principle -- one that should be observed before we even consider Gittins’ principle -- is due to Nobel Laureate Ronald Coase, of the University of Chicago. The “Coase Theorem” (as fellow Chicagoan and Nobel Laureate George Stigler called it) states that legal rules matter for economic outcomes only when “transactions costs” - the costs of identifying those affected by laws and of negotiating agreements - are sufficiently high.

This result is surprising, but a simple example due to Mitchell Polinksy suffices to illustrate the main issues.

Consider a factory whose smoke could potentially damage laundry hung out by a nearby resident. Suppose that, in the absence of any legal rules, the resident would expect to suffer damage of $375. Suppose that expected smoke damage can be eliminated in either of two ways: a smokescreen can be installed on the factory’s chimney, at a cost of $150; or, the resident can be provided with an electric dryer, at a cost of $250.

The efficient solution in either case is to install a smokescreen, since this is when aggregate costs are lowest. The question asked by Coase was: would the efficient outcome occur if the right to clean air was assigned to the residents, or if the right to pollute was given to the factory?

Suppose first that the residents have the right to clean air. Then the factory could avoid liability at relatively low cost by installing a smokescreen at its own expense.

On the other hand, if the factory has the right to pollute, then the residents could avoid the damage to their clothes by purchasing a smokescreen for the factory.

In either case, the least cost option to either party turns out to be installing the smokescreen, and this solution occurs independently of the legal rule. This is the Coase theorem: if parties are given the opportunity to bargain around legal rules, then efficient solutions will tend to emerge. To the extent that government regulations prevent such mutually advantageous bargaining taking place, the Coase theorem suggests an important corollary: regulations which create artificial impediments to bargaining and contracting should be abolished.

The critical and most relevant part of Coase’s result is that the parties must be able to identify exactly who might be damaged, and the costs involved in negotiating agreements must be sufficiently low. These assumptions are not satisfied in many examples involving potentially harmful accidents, but they do happen to apply to businesses which provide recreational activity involving “significant physical exertion”.

Gittins fails to understand that these conditions move us out of the realm of tort law, and into the realm of contract law.

In the cases that Gittins seems to be concerned about, the businesses and customers can easily identify each other, and the costs of negotiating a contract which allocates risk, would, in the absence of government prohibitions, be relatively low. If parties decide to contract with one another, then the relevant law is contract law, not accident law. Parties to agreements are still protected under this law, and so it simply not true, as Gittins claims, that businesses would be able to avoid legal responsibilities. Businesses and consumers simply take on different legal responsibilities.

Customers would still be free not to sign such contracts or engage in the risky activity, in which case tort laws would still apply. And the proposals for reform, if enacted, would not mean that all such businesses will offer these contracts. But I predict that many businesses will in fact offer these contracts, and that many customers will willingly accept their terms.

Gittins also claims that customers may underestimate risk and so the government should intervene. This is a paternalistic argument regarding the ability of individuals to choose what is or is not best for them. It is an argument that has nothing to do with economic analysis.

On the other hand, the economics of Coase is quite clear in the cases that Gittins’ is concerned about: policy should, to the largest extent possible, strive to remove artificially high transactions costs, in the form of government-imposed bans on contracts between private individuals. This is exactly what the proposed reforms to the Trade Practices Act are designed to achieve.

Remember Cheryl Kernot's talk of the "dream team" when Natasha took over the leadership of the Democrats? I know, I know, it all seems like ancient history now.

At the time of Kernot's remarks, the Australian published this letter of mine (12 April 2001):

CHERYL KERNOT claims that younger voters give ``equal billing to celebrity and policy'' and prefer celebrity and humour to ``boring suits arguing about old politics'', implying that younger voters have only a superficial interest in politics and have difficulty seeing politicians for what they really are.

As a 28-year-old voter, I find Kernot's remarks puzzling. It is not difficult to see that all our political parties -- apart from some minor details -- offer the same nightmare of a social democracy rather than a liberal democracy.

Both major parties have failed to lower the overall tax and spending powers of government, and the alternatives -- the Greens, One Nation, and Democrats -- are even worse, promoting an increased role for government.

Our politicians differ only superficially in their goals but all seem to agree that it should be the government and not the individual that is sovereign. It is not difficult to see that none of Australia's younger leaders (including Stott Despoja and Aden Ridgeway) favour individual liberty, free markets and a limited constitutional democratic government over the destructive politics of envy and wealth redistribution, the promise of bigger government, greater regulation of both private and economic affairs, and higher taxes.

What is difficult to see (apparently, for Ms Kernot) is that younger voters like myself want more economic liberty and personal freedom, not less; more economic reform, not less; more serious debate about the role of government in a free society, not less. What would excite me is a politician -- (yes, just one) -- who was seriously committed to the following ideas: individual liberty and less government regulation, lower taxes and lower government spending via genuine constitutional reform, and an earnest, honest attempt at removing the government-sanctioned obstacles faced by private enterprise.

And if such a libertarian politician or party were to come on the scene, I certainly wouldn't care about their celebrity status, sense of humour or clothing.

Sigh. It seems that the more things change in politics, the more they stay the same.

Tuesday, August 20, 2002

News from the US is that it is not a matter of "if" but "when" the US will attack Iraq. Two recent but different perspectives on this issue by Australian journalists can be found here and here.

For what it's worth, a friend of mine in the US emailed me earlier this week with the following news:

"Our campus is near an air force base, and I have noticed an inordinate amount of activity during the last couple of weeks. I predict an assault on Iraq will commence soon after Labor (no "u") Day"

This seems to be consistent with a recent report from the Cato Institute. (Thanks to Tim Dunlop for this link)

For those of you who don't know, Labor (no "u") Day is the first Monday in September. I don't know if my friend is right, but perhaps September 11 might be a more auspicious day for an attack?

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