Wednesday, March 15, 2006

Understanding Gawker and regulations much better

The legal system of India can be too daunting and leave you gawking but I shall try and unravel it. A legal system exists to decrease transaction costs and provide incentives for appropriate behaviour. The legal system has two parts: the law and judiciary.

Laws are often a mix of government-based legislation (
civil law or legislative regulation) and the decisions made by judges over a long period of time (common law). India has a predominance of of civil law compared to common law. In addition to the civil law in India, you have the criminal law.

Salman Khan running over homeless victims is an example of criminal law. If you are a victim of clinical drug trials with mis-information, that is an example of civil law, especially tort law. A tort law is best exemplified by the famous McDonald's coffee case.

Again, laws in addition to a statutory component have an administrative one. Administrative law (or bureaucratic regulation) consists of government orders, regulations and rules. These, though not part of statutory law, are sanctified and allowed under some statutory law or the other. These gave rise to the much criticised inspector-raj and licence-raj. The statutory component is presided over by the judges. Finally, we have the procedural component of law which is concerned with the facilitation of the movement of a lawsuit through the legal system. This is the functional aspect of the judiciary. Accused languishing in prisons without trials are examples of a poor criminal procedural sytem in action. Cases pending in courts are due to the procedural laws.

Now a few first principles.

My car gets damaged because of your carelessnes. You should pay the damage incurred. This is a liability rule. But then you have the compensation only if a damage happens. What if the car runs into you and you die? For that there is the property rule. This rule tries to set the damages sufficiently high so that there is a reason enough to always deter.

Example. For car accidents you hang the perpetrator. Pretty soon nobody would be driving. And for rapes if you impose a fine of Rs 250, I dare not look at such a society. The difference is crucial. In case of liability rule we are trying to provide compensation. But in the property rule we are trying to provide punishment.

Liability rules function best in a situation of common law (even civil law will do); insurance companies and where tort lawyers have incentives to "prey" on negligence causing harm. Entities soon have incentives to cause least damage (externality) to others, or if they do, then they have to pay the compensation.

When I am asking for a reform in administrative law for clinical trials and that let it be subject to tort law, that is asking for a legal reform in civil law. That is subject to the liability rule. In the case of clinical trials, the insurance company would not "allow" a drug company to carry on such drug-trials. Or the company would have every incentive to try and lower the probability of an adverse result in the drug-trial. It is here that information comes into play for the company will try and make a defense that it gave every possible info to the person. That is why you see doctors in US inundated with info from drug companies. Because the doctors suffer in case of a malpractice, the drug company suffers and the insurance companies involved.

When you are trying to set up a system of deterrence for criminals (criminal law) then you are using the property rule. The government arguably has a role here. This is an application of the liability rule to a criminal activity. I agree. It is not enough to make it work! Unless you have a property rule in implementation in tandem.

There are scenarios where insurance companies can fulfill the role of providing security in a completely free market but that is not crucial to our discussion here. The important part is that there are much efficient ways (
example What should be the punishment for rape?) of providing deterrence to criminals then the present methods, and there can be market-based mechanisms for having the right incentives for liability rule. Part of this efficiency will arise from legal and judiciary reforms: less administrative law; better-designed statutory law and a better procedural law. A more elaborate version is provided in Reforming the Legal System and Judicial reforms - Law and Contract enforcement. I would recommend the latter considering its high IP (Insight/ Pages) ratio. If you are really interested in criminal justice reforms you should read the Malimath report.

Fundamentally, the question is how does the government get to a scenario where it concentrates on the efficient provision of the most important public goods, namely law and order, and defense. The answer is by shedding activities that it is neither efficient nor equitable. And that is where markets help to shed the inefficient economic engagement of the government. We need less inspectors closing shops, destroying cycle rickshaws and muzzling entrepreneurial activity. We need more police personnel, courts and lawyers out there to be a deterrence to the more sinister crimes of murder and violence.

Note: No malice included. Hopefully this will give rise to a better understanding of regulations or atleast a worthwhile debate! For a conceptual overview one can read Law as a Constraint. For judicial reforms read Delays, Costs and Glorious Uncertainity-How Judicial Procedure Hurts the Poor. For understanding the application of liability rule to the state, (yes, why not?) read Tort Law in India.

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