Moral Hazard, Adverse Selection, and Tort Liability

"Annual U.S. tort costs account for nearly 2 percent of GDP. As shown in Figure 1, U.S. tort costs (as a percent of GDP) are more than 3 times greater than tort costs in the United Kingdom, and are also significantly higher than tort costs in most other industrialized countries.

Much research has been done concerning the contributing factors behind the expansion of the U.S. tort system. Magee, Brock, and Young (1989) argue that one problem may be that the U.S. has too many lawyers. Their theory is based upon the notion that lawyers do both positive and negative things for the economy. Examples of positive economic contributions include activities such as making property rights clearer, protecting individuals from harm-doers, and facilitating transactions. Examples of negative economic contributions include predatory redistributive conflict, excessive litigation, and the diversion of talent out of productive activity. Thus it seems plausible that there is such a thing as an “optimal” number of lawyers for an economy. Figure 2 provides a conceptual framework for thinking about this problem.

In Figure 2 we are interested in maximizing the economy’s growth prospects. The y axis represents the rate of economic growth, and the x axis represents lawyer density, which is proxied by the ratio of the number of lawyers for every 1,000 white-collar workers. The rising part of the curve represents the effects of the positive economic contributions of the legal system, whereas the declining part of the curve captures the negative effects. The point represented by (g*,L*) shows how economic growth is maximized when there exists an optimal number of lawyers.

Magee, Brock, and Young estimate regression equations from 54 countries over the course of 25 years and find that the optimal value for L* is 23 lawyers for every 1,000 white-collar workers (2.3%). Since the U.S. has more like 38 lawyers for every 1,000 such workers, it would appear that the U.S. has 40% too many lawyers. Furthermore, the economic consequences of having too many lawyers are not “rounding errors.” Magee, Brock, and Young’s equations suggest that these excess lawyers reduce GDP by approximately 10 percent every year. Since 2003 GDP was $11,252.30 trillion, this would imply a 2003 “lawyer tax” on the U.S. economy of $1.125 trillion. On a per-lawyer basis, this comes to $986,842 of forgone GDP.

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"For the United States, it has been estimated that (in the 1980s) 'each additional lawyer who is churned out by American law schools reduces the level of GDP by $2.5 million, a figure far greater than the present discounted value of that lawyer's earnings, substantial though they may be' (Magee et al., 1989, p. 17)" - Kaspar and Streit, 1998, p. 204