Common law efficiency

Tarunya Shankar

Editor’s note:

The common law system revolves around the concept of precedence and deals with laws which require interpretation from a duly appointed authority with requisite knowledge. It seeks to both determine the liability as well as award compensation to parties. This paper deals with the efficiency of such system. Strict liability, for example, although efficient, does not work in a situation where both the injurer and victim were required to take adequate care. This paper examines Posner’s economic theory, which states that the common law system implies the maximization of the societal willingness-to-pay, and Rubin’s hypothesis, who feels that the question is merely whether it is more cost efficient for the parties to negotiate and settle outside of the court or to litigate.


Common law is, simply put the system of litigation that exists in each legal state, an endless loop of cases brought forth by the general body of the nation and decided by a duly appointed authority who holds the requisite knowledge to interpret the existing legal statues, provisions and other related literature. The common law system revolves around the concept of precedence and specifically deals with those laws which require interpretation, for future cases as well of a similar nature. The common law system exists to essentially determine the liability of the parties involved as well as the compensation or damages to be paid to the injured parties. The question then arises as to the efficiency and accuracy of these determinations of the courts as well as the method by which such inefficiencies are to be countered. “The common law method is to allocate responsibilities between people engaged in interacting activities in such a way as to maximize the joint value, or, what amounts to the same thing, minimize the joint cost of the activities”. Posner, in his book, An Economic Analysis of Law, attempted to analyse precisely how the common law efficiency was and is derived. For example, in cases regarding breach of contract, the measurement of expectation damages is a method by which the judiciary calculates the amount to be paid and who shall bear the burden of the costs. Moreover, there is a question of whether settling a matter through private negotiations with the parties or taking the case to court to be decided by a judge is more efficient, efficient meaning properly determining who is in fact the injured party and minimizing the costs to both parties as well as the court, the costs involved being largely termed as transaction costs.

Efficiency of liability rules & transaction costs

The liability rule simply exists to rectify the problem of allocating blame as well as determining the degree of harm between the injured party and the injurer, and under this rule there exist two types of liabilities, strict liability and no liability. Under strict liability rule, the injurer is liable of any and all injuries and expected damages to the victim. This is efficient, perhaps, in most cases as the injurer, for example in an automobile accident where the injurer is the driver, is required to take far more care as the victim is vulnerable to the driver. But in other cases, where there is a need for both the injurer and the victim to take adequate care to avoid risks, such as in a contract to sell an item, where both the consumer and the seller must know all information about the product, thus the existence of the concept of “consumer awareness”, strict liability is not efficient. In cases of no liability, the victim is assumed to bear the burden of all care and preventive measures and thus can claim no compensation from the party that caused his or her injury. Such a case is also highly inefficient and leads to further future cases of similar injuries.

Transaction costs, as explained by Ronald Coase, are simply the costs incurred by the parties, both monetary and social. The logic behind the imposition of exorbitant transaction costs on these parties is to prevent negligence and ensure that the parties involved pay the cost for adequate care-taking measures instead of the high transaction costs that are incurred after the occurrence of the accident or negligent act. However, strict liability and no liability, with zero transaction costs, has also been found to be an efficient decision in cases where there are more than one victim or injurer.

Specifically regarding the efficiency of common law, two theories have been postulated, the first being that of Richard Posner and the second being that of Paul Rubin.

Posner’s economic analysis of law

The essence of Posner’s analysis was that efficiency in the common law system meant maximization of the societal willingness-to-pay. His hypothesis seeks to explain the manner by which economic efficiency is reached during the decision-making process of the judiciary, among other things that the Researcher will not be discussing. Posner begins by analysing the legal system as another form of a common market, with the need for efficient resource allocation, the resources largely being money and power, as well as the need for proper legal regulations. He states:

“A newer view, which draws on economic analysis, argues that the structure of the administrative process is designed to increase political control over the process of legal regulation rather than to, increase efficiency but that within the constraints imposed by the fundamentally political purpose of regulation the evidence is consistent with the hypothesis that the agencies, like most other organizations, are rational utility maximizers.”

This was simply a theory that courts function or perhaps should function in many ways, in manner similar to that of a market, though doing so efficiently would be entirely dependent on the transaction costs being incurred (Harrison, 2002). For example, in Monge v Beebe Rubber Company, the plaintiff allegedly that her at-will employment contract with the defendant was wrongfully terminated upon her refusal to go out with her foreman.[1] The majority rule was in favor of the plaintiff, though one justice dissented.[2] This judgment, though it ensured that at-will employment remained a norm, softened the right granted to employers by the rule significantly. The transactions costs involves thus gain their importance as the higher the transaction costs, the more difficult it becomes for the parties involved to negotiate around the norm at hand (Harrison, 2002).

However, it was hypothesized by Posner that the process of legislative regulation was far less efficient than a legal system that depended on resource allocation. Essentially, Posner’s theory was that, in layman’s terms, the legal system was most efficient because of the part played by the judiciary and individual judges in determining the outcome of cases involving breach of contract, tort law, property law and other fields of litigation that debate the allocation of rights and properties of the involved private parties. His hypothesis, instead of focusing on an analysis of changing preferences and personal relationships, focused instead on the preferences that were given and using those preferences to obtain a pareto-optimal allocation of resources.  With the expectation of such an outcome, Posner argues that common law functions on the basis of the hypothesis that the judges who decide the outcomes of such cases, do so with an objective of promoting efficiency by laying down the norms and regulations that are efficient for any and all cases of similar nature. This hypothesis has been proven effective even in contemporary cases, such as in Escola v. Coca-Cola Bottling Co, where one of the Supreme Court judges, a Justice Traynor, after concurring with the majority judgment for the plaintiff made an additional note to his judgment, with specific reference to future cases of an identical or comparable nature, stating, “…….it should now be recognized that a manufacturer incurs an absolute liability when an article that he has placed on the market, knowing that it is to be used without inspection, proves to have a defect that causes injury to human beings…. public policy demands that responsibility be fixed wherever it will most effectively reduce the hazards to life and health inherent in defective products that reach the market… the manufacturer can anticipate some hazards and guard against the recurrence of others, as the public cannot…. It  is to the public interest to discourage the marketing of products having defects that are a menace to the public.”[3] The justice even went so far as to lay down the allocation of liability in the case of a situation not referred to in the case at hand, stating, “If such [hazardous] products nevertheless find their way into the market it is to the public interest to place the responsibility for whatever injury they may cause upon the manufacturer, who, even if he is not negligent in the manufacture of the product, is responsible for its reaching the market.”[4]

Rubin’s hypothesis

While Posner’s hypothesis states that common law is required to be economically efficient, his argument as to why differs radically from Rubins. Posner attributes the economic efficiency of common law to the judges, who, he claims, decide cases for the purpose of “promoting efficiency”. Rubin, however, attributes the need for efficiency and the strive towards that objective to the participants of the legal systems, the plaintiffs and defendants in each case. It’s simply a question of whether it is more cost efficient for the parties to negotiate and settle outside of the court or to litigate. This particular question is to be analysed in terms of whether or not the legal rule relevant is efficient in itself but not efficient in the particular situation, or is inefficient altogether.  If the rule is efficient, then settling would be the most efficient solution for the parties involved. However, there are two causes for further litigation. The first is the when the rule is efficient but it fails to provide an efficient outcome for a single individual in which case the litigation will continue until the efficient outcome is achieved or until settling out of court becomes more cost-minimizing than litigation. In the second case, the incentive of the participants is not simply a preferable outcome for them but the decision for the judiciary to ensure an efficient rule replaces the old one, thus setting an efficient precedent for all future cases.


In the researcher’s opinion, especially so in contemporary times, Rubin’s theory hold’s steadier as judges are a part of a system that has been found to be incredibly and easily corruptible. Further, judges are, at the end of the day, only human and can make only human decisions and though the assumption is that such decisions are made with rationality, mistakes are inherent in human nature and all humans are susceptible to their human emotions or other factors that Posner’s theory does not fully account for. Rubin’s theory simply says that if a person intends to simply be compensated for a loss or an injury, and the defendant’s aim is to end the case with minimal cost, for example in a case of breach of contract where the defendant can either pay an amount of x as a settlement or take the risk of a going in front of a judge, paying court costs and then being ordered to pay an amount of 6x as compensation, a logical rational and efficient defendant will choose the settlement account. Can this be presumed to be inefficient simply by virtue of the fact that it was not a decision made by a justice. In a similar case of breach, if the defendant is offered the possibility of either paying a settlement value of 6x or being ordered to pay x or not at all by a judge, the efficient solution would be to go to court. However, if the defendant wants to set a precedent, he has many ways by which to appeal the case and get the desired outcome. That is the efficient solution in that case. For Posner’s theory to be efficient in such a manner, the judges would have to be able to instinctively or conclusively know whether a particular participant in a case was looking out for his own interest or looking to set a precedent. And if the judge is already aware of this fact, hypothetically, due to some personal connection with one of the participants, then there is room for bias and thus renders the entire justice system unjust. Further, Posner’s hypothesis is solely based upon the belief that the only way to ensure an efficient outcome is to ensure all cases end up in front of a judge. Such a hypothesis is fundamentally wrong in many ways, as can be, and will be by the researcher, proved by doing an analysis of the various possibilities of solutions of the branches of common law as well as the specific manner in which most efficient solutions are derived, as theorized by Rubin.

Edited by Neerja Gurnani

[1] 114 N.H. 130, 316 A.2d 549 (1974)

[2] Supra Note 1.

[3] 24 Cal. 2d 453, 150 P.2d 436 (1944).

[4] Ibid.

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