Products liability through private ordering: notes on a Japanese experiment.

• Author: Ramseyer, J. Mark
• Position: Symposium: Law, Economics, & Norms

INTRODUCTION

We suffer in the law from a failure of imagination. We assume that if we do not ban insider trading, insiders everywhere will trade. We assume that if we do not force firms to disclose their financials, no one will. We assume that if we to not mandate strict products liability, consumers will rarely recover against firms with dangerous products.

Our blindness is the public's loss. In fact, if we followed insider trading, we-have every reason to think that some (perhaps many) firms would ban it anyway to attract investors who preferred firms without the practice.(1) Before 1933, we did not require financial disclosure, but may firms disclosed their financials to court investors who valued the information.(2) And before 1995, Japan did not mandate strict products liability, but many Japanese firms voluntarily subjected themselves to the rule to attract buyers who wanted the protection such a rule gave.

In this short Article, I outline the voluntary products liability regime in Japan: strict liability by private ordering. I begin in Part I by summarizing the dubious case mandatory strict products liability. I explain in Part II how the privately ordered Japanese system worked and in Part III discuss the resulting claim levels.

1. MANDATORY STRICT PRODUCTS LIABILITY

   Modern products liability law may be well-established, but it is notoriously hard to justify.(3) Essentially, it imposes on consumer sales contracts a broad panoply of nonwaivable terms. It forces sellers (or manufacturers) in specified consumer sales contracts to agree to compensate buyers (and specified third parties) for specified damages caused by specified defects in specified products. Restated, it forces sellers to bundle insurance contracts with the goods they sell.(4)

   Basic theory, however, suggests that if some buyers want bundled insurance contracts, then tn unregulated markets some sellers will offer them. When customized sales contracts are feasible, sellers will offer insurance contracts tailored to specific buyers. And when customized contracts are infeasible, market competition will still drive some sellers to bundle some insurance contracts with some products. Consumers who want the products liability protection will buy the bandied insurance-product package. The rest will buy the unbundled product.

   As a result, a legal regime that forces sellers to bundle products-liability coverage with the product sold almost necessarily lowers consumer welfare.(5) Granted, consumers who want the insurance product bundle will still obtain it in the now-regulated market. Those who do not want it, however, will need either (1) to buy insurance worth less to them than the price they must now pay or (2) to do without the product, given the higher bundled price. Again, it is no answer to say that consumers will generally want the insurance. If consumers value it more than it costs, sellers in unregulated markets will still offer it.

   Because of this straight forward case against strict products liability, scholars inclined to justify it turn to a series of questionable empirical claims that given the informational and computational difficulties in determining the risk levels of complex products, consumers wildly miscalculate accident costs; that given cognitive dissonance, consumers systematically underestimate health risks; that given the small value associated with insurance coverage in any one contract, manufacturers will not find the coverage cost-effective; that given the difficulties in distinguishing high- and low-risk consumers, adverse selecting will preclude a private insurance market; or that given the need to deny the risks in their own products, firms will rarely convey realistic information even about the risks of their competitors' products.(6)

   To illustrate some of these arguments, take an entirely hypothetical discussion of disposable cigarette lighters. Suppose, on average, that three in every ten million lighters explode and cause bodily injury of about $150,000 per individual. Even if rational consumers would want to protect themselves against such an injury, argue many observers, they could not correctly calculate the cost given the minuscule adds and the gruesome injuries.

   Moreover, these proponents continue, a firm would earn only a trivial competitive advantage by bundling insurance with its products. After all, the cost of the risk itself is only $150,399 x 0.0000Q03 = $0.045 per lighter. No firm will undertake the managerial costs necessary to design a bundled contract when the returns are so small. And since no firm will want to call attention to the risks associated with its own products, no firm will be able to advertise cost-effectively any liability insurance it did bundle.

   Hence the conclusion: even though consumers prefer insurance against defective lighters, the vagaries of consumer irrationality and imperfect competition will inevitably create a world without it. Accordingly, the law can improve the lot of-both sellers and buyers by forcing sellers to bundle insurance. Strict products liability law does just that, by holding sellers or manufacturers liable for personal injuries caused by defective products. As William M. Landes and Richard A. Posner put it in one of the most sophisticated and articulate justifications for products liability law:

   [W]e take up the fundamental economic puzzle of products

   liability law: the injurer and the victim have a contractual

   relationship, so why shouldn't they be left to work out the

   optimal combination of safety precautions contractually? Why

   isn't no liability optimal?

   The answer is that contracts are costly to make and that the

   costs may well exceed the benefits, relative to regulation by tort

   law, when the contingencies that would be regulated

   by contract-- death or personal injury from using a

   product--are extremely remote. It hardly pays, when buying a

   case of beer, to enter into a contract specifying rights and duties

   in the event that one of the bottles of beer explodes in your

   face.(7)

   Yet, is the empirical premise right? If pop or beer bottles occasionally exploded in consumers' faces, would bottlers really find that contracting for liability did not pay?(8) Consider tentative evidence from Japan.

2. PRODUCTS LIABILITY LAW IN JAPAN

   A. Basic Products Liability

   Until 1995, Japanese consumers bought products in a world governed by a general negligence regime.(9) To sue on an accident involving a product, plaintiffs had to prove not just that the product had been defective but also that its manufacturer had been negligent. Effective July 1, 1995, the Japanese government changed the rule.(10) With enormous hullabaloo, it substituted for negligence a strict liability standard for defective products. In fact, the charge may have been less significant than the hullabaloo would suggest. In some spheres, Japanese courts had imposed standards close to strict liability already," and the concept of "defect" in the new law will probably still incorporate a cost-benefit approach resembling the classic Hand formula.(12)

   Why the Diet enacted the change TS unclear. Some of the pressure for the change came from scholars, journalists, and politicians arguing that consumers had been "exploited" by profit hungry businesses.(13) Some of the pressure came from "public interest" lobbyists determined to maximize their own appeal. Some came from foreign firms claiming that Japanese firms gained an "unfair" advantage by selling in a home market without strict products liability.(14) Elementary public choice analysis suggests that some of the pressure must have come from firms with a cost advantage in safety who could now use products liability law to gain a competitive advantage over their rivals. Whatever the reason--interesting as the issue is, it lies beyond the scope of this short Article--the Diet imposed strict products liability.

   B. The SG System

   Unbeknownst to most Western observers for nearly two decades, many Japanese firms had already subjected themselves--voluntarily--to a strict products liability regime. In 1973, the Diet enacted the Consumer Products Safety Act and through it established the Product Safety Council.(15) The Act itself explicitly authorized only a small mandatory regime. It authorized the Council to establish safety standards for a few hazardous categories of products and to ban those products that did not meet the standards. Within a short time, the Council had designated eight...