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Litigation in the Public Interest?

 


America needs billions of masks to protect against the Coronavirus, particularly high-grade N95 masks for healthcare workers. Nonetheless, fear of litigation delayed delivery of millions of construction masks to healthcare workers. Should the law be slowing our emergency response?

America’s largest mask producer, 3M, will soon be producing 100 million a month. The company

normally produces more construction than medical masks; while similarly effective, the medical masks must meet more stringent standards. The construction masks would certainly protect better than bandanas.

As reported by the Washington Post, 3M executives feared potential liability. Even with protective equipment, some healthcare workers will get sick. The performance differences could provide grounds for lawsuits. 3M would not ship the masks without a Federal liability waiver, which Congress approved in mid-March.

Who is to blame for the delay? A professor of bioethics quoted in the Post article states, “Don’t talk to your lawyers if you’re making masks or gowns or ventilators.” Yet 3M executives and lawyers have a duty not to expose the company to potentially ruinous litigation. The Federal government could have acted quicker, as mask makers raised the liability issue in early February.

Many might blame the lawyers who might file such lawsuits. Suing a company helping out in a crisis is hardly praise-worthy. But this misses the more significant question: Why should plaintiffs have any chance of winning such a suit?

Plaintiffs’ lawyers commonly take cases on a contingency fee basis. As the ads say, “We don’t get paid unless you get paid.” Consequently, these lawyers must carefully evaluate whether they can win a case and would only sue 3M if they thought they could win.

Plaintiffs should be able to sue and win when companies have done wrong. Litigation helps us learn about corporate misbehavior. I frequently discuss the decentralized nature of knowledge. In a world of decentralized knowledge, we rarely know enough to call new lawsuits frivolous. Once the legal process discovers the relevant facts, we might conclude that the plaintiffs should not win.

If plaintiffs can win when we believe they should not, this is a problem with the law. We should fix the underlying problem instead of hoping lawyers will not file winnable cases.

My interest is not in narrow questions like why liability arises in this specific instance. The difference between law and legislation provides perspective on why law today can produce injustice. Today we think these are the same thing, but historically they differed.

Congress, state legislatures, and city councils pass laws today. But as economist Friedrich Hayek observed, law used to differ from government legislation. This was most apparent with England’s common law.

Common law emerged and developed as freedom increased, providing rules to order peoples’ business and personal affairs. Rules help us anticipate how others will act, because people usually follow the rules. Starting a business would be impossibly risky unless an entrepreneur knew the meaning of leasing a building, purchasing supplies, and hiring workers.

The rules emerged out of a common understanding, not acts of Parliament. A relevant analogy today is the difference between a company’s employee handbook and the informal ways to get things done.

The common law evolved as judges decided cases involving new issues. There were multiple judges who were not bound by precedent; they could adopt or modify other judges’ rulings. If a party to a case did not like a judge’s ruling, they could argue their next similar case before a different judge. Through trial and error, decisions were fine-tuned into rules satisfying most parties.

In the 1800s, governments decided to write the common law into legislation. This sounds reasonable: any person could read the text of any law. Yet this also let legislatures change laws, sometimes to advantage special interests.

The law helps people deal with each other in peaceful, socially beneficial ways and should protect us from charlatans who break the rules. And our laws should assist us in responding to emergencies, not create unnecessary obstacles.

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The Stimulus and Moral Hazard

Congress passed the $2.3 trillion CARES

(Coronavirus Aid, Relief, and Economic Stimulus) Act and Washington passed two measures providing relief and economic stimulus after the financial crisis. Many economists feared that the financial bailouts set bad precedent for the future. Could the CARES Act possibly have similar effects?

Accidents happen less often when people exercise care. Taking out insurance can increase the probability of the accident or loss, what is called moral hazard. The response involved is straight forward: insurance lowers the return to being careful, so on average people are less careful.

Government bailouts after the financial crisis could easily produce moral hazard by contributing to expectations of future bailouts. Once financial institutions know that Uncle Sam considers them “too big to fail,” they will not fear getting in a bad spot. The expectation of bailouts creates a “Heads I win, tails you lose” scenario and banks will naturally take more risks.

Bailouts also help bad managers keep their jobs. In markets, profits reward good investments and decisions while losses penalize bad decisions. Fairness demands that if investors get the profits from good investments, they should bear the losses from bad investments. When investors take losses, they force the replacement of the executives responsible.

Taking the latter point first, I do not think that the managers of airlines, hotels, and department stores should have anticipated recent events. By contrast, the financial institutions, which made or invested in subprime mortgages and mortgage-backed securities, should have known the risks involved. The CARES Act is not allowing bad managers to avoid the axe.

Nor am I worried that this assistance will lead to future carelessness. I suspect we will all now be aware of how a pandemic can disrupt life. Individuals and businesses will likely save more going forward. But if COVID-19 is a once in a century event, we do not need to worry about undermining incentives to prepare for the next such catastrophe.

A factor favoring assistance here is the impact on businesses of governments’ actions to mitigate the pandemic. The businesses ordered closed by governors or mayors arguably should be compensated for their losses. This does not mean that closing businesses is unwise, merely that compensation for the ensuing losses is deserved.

It is not completely true that businesses could not have done anything to avoid financial losses. Companies can get business interruption insurance coverage for lost revenue. Whether existing interruption coverage will pay for pandemic-related losses is a question likely heading for a courtroom.

Insurance, however, would not have saved us. Prior to this pandemic, neither business executives nor insurance companies could have imagined the potential losses or reasonably estimated the likelihood of this type of pandemic. The coverage would not have been priced properly, leaving insurance companies facing bankruptcy and unable to pay claims. Business interruption coverage would simply mean we would be bailing out insurance companies.

The primary downside of the CARES Act is its impact on the national debt, which is currently $23 trillion. The Congressional Budget Office was forecasting a $1 trillion deficit this year before the pandemic. The COVID recession will reduce tax revenues sharply even without any additional spending. The U.S. may be on the verge of a debt spiral, where interest on the debt drives us further and further into debt. COVID and CARES may push us off the fiscal cliff.

If so, the blame would fall on Washington’s unwillingness to live within its means. The deficits of the past five years have been irresponsible, not the response to the pandemic. Our leaders may have left us with insufficient credit to address a true national emergency.

The border between science fiction and reality is fuzzy. Our minds can imagine many cataclysmic events, and it would be folly to prepare for them all. We will always be unprepared for events we do not think could really happen. So it is unlikely that the CARES Act sets a bad precedent.

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Is this a Recession?

We have experienced unprecedented economic effects of the COVID-19 pandemic and social distancing policies. Twenty two million Americans lost jobs in four weeks. The Federal Reserve Bank of St. Louis projects potentially 30 percent unemployment and a 50 percent decline in GDP by June. This looks like a depression, but is it really?

A recession or depression is visible – idle factories, reduced investment, and unemployed workers – but the causes are typically numerous and elusive. An economy in a depression is like a motor that has stopped working. Economists also note that recessions extend across most of the economy, as opposed to being a slump in one sector. The oil bust of the mid-1980s, for example, did not produce a recession.

Our current slump meets the breadth requirement. While sectors like tourism and entertainment have been particularly hard hit, the 30 percent decline in global oil demand demonstrates widely reduced economic activity. The stock market tumbled over 30 percent as well, consistent with a broad slump.

Yet in a very important way, the COVID-19 slump, dubbed by some the Great Suppression, differs from recessions and depressions; the decline has resulted from closing businesses to stem the virus’ spread. Christmas Day, when GDP craters as most factories, stores and restaurants close, perhaps provides a more appropriate economic analogy. The Christmas shutdown is intentional; people do not want to work and businesses oblige. Is the COVID-19 slump a lengthy Christmas break?

If so, we could expect a vigorous rebound when we end government closures, just as on December 26 (or perhaps January 2). We do not fear the economy not returning to normal after the Christmas shutdown.

The aftermath of World War II provides another hopeful example. Many of America’s factories produced tanks, planes, ships, and munitions for the war. Measured GDP was high but consumption of goods and services was modest. Economists were unsure the economy would transition to peacetime production after fifteen years of limited consumer production due to the Depression and the War, but it did.

One important difference exists between the COVID slump and the Christmas crash: we plan and prepare for Christmas. The COVID crash was unanticipated and of uncertain duration. Households did not stock up on supplies or accumulate extra savings. The Federal government did not run budget surpluses ahead of the crisis.

In addition to Christmas, small businesses often close when the owner goes on vacation, and seasonal businesses survive months-long closures. How and when will the Great Suppression turn into a recession? Most likely when currently shuttered companies go out of business, or their employees take other jobs.

Closed businesses have no revenue to pay employees, their rent, or for leased equipment. They may potentially hibernate and come back to life. Laid-off employees may have few other job options and landlords may lack new paying tenants. The Payroll Protection Plan and supplemented unemployment will hopefully help businesses hibernate and not go bankrupt.

The pandemic has two distinct components: reduced economic activity as people try to stay safe, and government closure of non-essential businesses. These two actions occurred nearly simultaneously and now complicate business owners’ calculations. When states lift stay-at-home orders, will customers return to restaurants and gyms? The existence of COVID-19 will significantly alter our economy. Previously successful business may be unprofitable until we have a vaccine or cure.

Business owners must also evaluate a political uncertainty. In March we chose public health over the economy. If COVID-19 cases increase after states ease restrictions, will we choose public health again? If so, then owners may squander their savings reopening businesses, which get closed a second time.

Business failures will have ripple effects. Landlords will feel financial hardship as businesses and tenants are unable to pay rent. Loans made to these businesses will go unpaid. The ensuing rounds of spending reductions will not be directly connected to the closed businesses. The shutdown will have become a recession or depression and it will be too late to “reopen” the economy.

 

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