Of Torts and Rights

Let there be a factory which makes loud noise. And let there be a hospital next door. Also, let the subsistence of the workers in the factory and that of workers in the hospital depend on the respective enterprises. The hospital, however, needs a silent environment for it to function else the doctors cannot so much as use a stethoscope in the noise that the factory produces. What should be the solution to this problem? Should the factory be allowed to continue functioning and cause the hospital’s shutting down? Or should it be closed to facilitate the hospital’s business? One would usually be inclined to favour the former because the factory’s noise causes inconvenience to the hospital, the functioning of which doesn’t disturb anyone. Let us see how it changes when we add numbers to the problem. Let the shutting down of the factory mean 100 units of utility forgone and let shutting down of the hospital mean 50 units of utility foregone. Now, if we argue that the factory should be allowed to function because we are losing more from shutting down the factory than from shutting down the hospital, what should be the nature of law such that by its uniform application we come to the same conclusion in all such cases? What we have just discussed is a classic problem in the Law of Damages, also called the Tort Law. Though a very old branch of Law, Tort Law historically did not consider the economics of damages in deciding cases. It was only in the second half of the last century that economists started to take interest in law and jurists started to learn and apply the concepts of economics law. And thus was born the cross-disciplinary field of Economic Analysis of Law. And it all began in 1964 with a certain Ronald Coase. But before going any further, a word on efficiency. What is Efficiency? Words don’t mean anything in themselves. It is what we have understood them to be over time that renders them a life of their own. Which also means that their meaning becomes fuzzy and vague. Hence, this attempt to revert to the binary of what efficiency is and what it isn’t. So, what is efficiency after all? In economic terms, efficiency is conventionally defined as a situation where there is no scope for increasing the happiness of the any individual without having to make any other individual unhappy. In that sense, dividing 10 apples as 5 and 5 between A and B is efficient. And so is dividing them as 1 and 9. What is not efficient is dividing 10 apples as 4 and 4 and leaving the remaining 2 in limbo. Coase uses this concept to determine the nature of law that is required for efficient outcomes in the society. The Coaseian Solution Ronald Harry Coase’s contribution to Economics has been just two papers that he wrote in his 102-year life: one on Transaction Costs, which contributed largely to Institutional Economics and Organizational Behaviour; and another on Social Costs, which pioneered the field of Economic Analysis of Law. He was awarded Nobel Prize in 1991 for both these contributions. What is of interest in the current essay is Coase’s argument with regards to the Factory-Hospital Problem. Coase suggests that, for an efficient outcome, all that the government has to do to resolve this problem is assign Property Rights to either the factory or the hospital and leave it. Here’s how it works: If the law assigns a ‘right to no sound’ to the hospital, the hospital and the factory can bargain and the factory can offer to compensate for the lost 50 units and still be earning 50 units for itself. The final total output is 100 units divided equally. Conversely, if the law assigns a ‘right to produce sound’ to the factory, the factory and the hospital can again bargain. In this case, however, the factory has the upper hand in the bargaining. The hospital may not be able to offer a compensation for the 100 units that the factory loses if it were to shut down. Hence, the hospital again shuts down without compensation but the factory is still making 100 units. And the total social output in this case is still 100 units. Do note that both the scenarios lead to an efficient outcome. That is, the maximum of 100 units that can be produced are being distributed among the two actors, even if unequally. The bargain between the individual actors in the above discussed scenario is called Coasian Bargain. In an ideal Coasian Bargain, property rights are clearly defined and enforced by the state, actors are capable of bargaining to achieve maximum possible profit, and there is no cost associated with the bargain. The analysis of Coase has far reaching implications. What this analysis formally proves is that the market is capable functioning efficiently so long as the state defines and enforces Property Rights, which is another way of saying, ‘Capitalism Works’. Coase’s argument has since been used in delivering judgement in many cases in the United States. Of Pauper and Popper Nevertheless, there are some grave shortcomings in the Coase Theorem, what the above analysis has come to be known as. Let us consider the two most important shortcomings. First, the possible inequality that might result from Coasian Bargains. As you might have already noticed and are probably disgruntled about, there is one scenario where the factory gets to earn the full 100 units and the hospital not only closes but isn’t even given a compensation. And that is the nature of the property rights, they are asymmetrical in application. However, one can brush away this argument as normative. But there is another shortcoming which stands from even the instrumentalist standpoint: the costs associated with bargaining. Though not applicable in the Factory-Hospital example, it becomes a problem when a group of people (like residents of city affected by the factory’s pollution) onto the table. The benefits from such an exercise may not be comparable to the costs in terms of travel, forgone work etc. In which case, the government may have to directly intervene as a representative of the citizens. The Common and the Civil All in all, Coase’s Theorem is an important milestone in the history of positive economic analysis. It formalizes the argument for markets at least on paper. And, in emphasizing on the importance of property rights, it provides a foundation for examining the effects of legislation of law on the economic activity. The most important implication of this is the inference that Common Law is efficient. And this argument comes from fact that the common law gives freedom in identifying and reaching that efficient state while Civil Law needs practically infinitely many codes for it to be efficient. Assumptions collapse in the face of reality, but what’s more important is the new perspective a theory adds in analysis and policymaking.

- Sharad Hotha