Carrots, sticks, and the multiplication effect

Although a punishment can be applied only once, the threat to punish (also referred to as stick) can be reiterated several times, because when parties obey, the punishment is not applied and thus the threat can be repeated. The same is not possible with promises to reward (also known as carrots), since they need to be carried on every time a party complies, and hence at each round a new reward is needed. We show that the multipliability of sticks has pervasive consequences in economics and law and provides a unified explanation for seemingly unrelated phenomena such as the dynamics of riots and revolutions, the divide-and-conquer strategy, comparative negligence, the anticommons problem, the use of property rules in markets, the most-favored nation clause, legal restrictions on penalties in employment contracts, and legal aid

Limiting Limited Liability

Limited liability may result in inefficient accident prevention, because a relevant portion of the expected harm is externalized on victims. This paper shows that under some restrictive conditions further limiting liability by means of a liability cap can improve caretaking.insolvency; judgment proof; liability; bankruptcy; liability cap

Uncertainty of Law and the Legal Process

There is extensive literature on whether courts or legislators produce efficient rules, but which of them produces rules efficiently? The law is subject to uncertainty ex ante; uncertainty makes the outcomes of trials difficult to predict and deters parties from settling disputes out of court. In contrast, the law is certain ex post: litigation fosters the creation of precedents that reduce uncertainty. We postulate that there is a natural balance between the degree of uncertainty of a legal system (kept under control by litigation) and its litigation rate (sustained by uncertainty). We describe such equilibrium rates in a model of tort litigation, study how they are affected by different policies, and compare the costs and benefits of the legislative and the judicial process of lawmaking. This discussion paper has resulted in a publication in the Journal of Institutional and Theoretical Economics , 2007, 163(4), 627-56.incompleteness of law; complexity of law; litigation; judgemade law; legislation

The Core of Pure Economic Loss

Should loss of earnings be compensated? The established law and economics wisdom considers pure economic loss as a transfer of wealth from the victim to a third party, whose earnings increase as a consequence of the accident. Such transfers do not amount to a social loss and, hence, should not be compensated. We revisit these arguments and show that the social loss should be calculated by taking into account that: (a) pure economic loss often involves impairment costs resulting from the fact that valuable resources cannot be temporarily used; and (b) the third-party earnings come at the cost of increased capacity. This increased capacity mitigates the expected harm and, hence, is a form of precaution. By taking into account these factors, we show that most pure economic loss cases do result in a socially relevant loss. In addition, we argue that the absence of a social loss is a necessary, but not sufficient, condition for the denial of compensation. The victim (or a third party) may have actually paid for protection against purely private losses. Thus, compensation should be awarded irrespective of whether national law treats the case under tort or contract (where compensation is undisputed). Finally, we offer considerations on the optimal design of liability rules.economic loss; financial loss; tort; damage; compensation

Seeking Rents in the Shadow of Coase

Trade opportunities are generally seen as valuable instruments to improve the allocation of resources in society. However, when the traded rights are secured through unproductive rent-seeking contests, the tradeability of the rents may provide stronger incentives to invest in rent-seeking activities, exacerbating rent-dissipation losses. In some cases the increase in rent dissipation may exceed the benefits of trade, rendering the opportunity to transfer rents socially undesirable. We consider a two-stage game in which the contestants have different valuations of the sought-after rent. In the first stage, parties invest to secure rights by participating in a rent-seeking contest. In the second stage, parties decide whether to reallocate the rights by entering in a Coasean exchange. We show that an opportunity for an ex post reallocation of the rights may have perverse ex ante effects. We consider the effect that such trading opportunities have on the parties’ payoffs and evaluate the final outcome in terms of dissipation and misallocation costs, comparing our scenario with tradeable rents to the conventional case of non-tradeable rents.Rent-seeking; asymmetric rent valuations; misallocation costs; rent dissipation