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Regulatory State
Wayne State University Law School
Beecher-Monas, Erica

The Regulatory State – Erica Beecher Monas
 
Justifying Regulation When Parties Contract
 
When a risk is imposed by another person, some form of legal response is at least presumptively justified. Even economists agree that, in the case of “negative externalities,” government action is warrantied. The case for government intervention is less obvious when the parties’ relationship is governed by a private contract (i.e. employers and employees). Should the risks associated with the regulation be regulated exclusively by the terms of the parties’ agreement? When, if at all, should legislatures or courts adopt rules that change the allocation of risks found in the parties’ agreement?
 
Legal Responses to The Problem of Allocating Risk                                                         
 
Here we consider a period before the rise of the modern administrative/regulatory state. In the late-nineteenth and early twentieth centuries, risks were managed through common law. The constitution was read as restricting the power of legislatures to alter the allocation of risk in contracts between private parties [a reading since abandoned].
 
Farwell v. The B&W Railroad Corporation, 45 Mass. 49 (1842)
 
I: Facts
 
Farwell was working as a train engineer when his train crashed due to the negligence of another employee working for his employer, the B&W Rail Road Corp. This employee, Whitcomb, was known to Farwell and is described as careful and trustworthy. Farwell was thrown to the ground and his right hand was crushed. 
 
II: Issues
 
Can an employee of a corporation sue that corporation for injuries received in the course of employment resulting from the negligence or carelessness of another employee?  
 
III: Main Analysis
 
–          Blackstone: If a servant, by his negligence, does any damage to a stranger, the master shall be answerable for his neglect (if done while actually employed in master’s service)
o    This presupposes absence of privity b/w the parties; action sounds in tort (the rule of respondeat superior)
o    This doesn’t cover a case where injury results in the course of employment, where all risks that both intend to assume may be regulated by express or implied contract
o    Therefore, this case must be maintained – if at all – on grounds of contract
–          Lacking an express contract, the only possible basis would be an implied contract
–          Farwell fails as a matter of justice
o    No such rule has been established, and the authorities oppose this principle
o    General rule:  When someone becomes an employee, they assume the risks incident to performance of such services and, in prospective consideration of which, can seek to adjust their wages or contracts
o    Injury from another employee is a foreseeable risk & can be guarded against 
–          Farwell fails as a matter of policy
o    “It is competent for [us] to regard consideration of policy and general convenience.” [this is the basis of implied promises – duties legally inferred to promote the benefit of all concerned] o     There are more effective means than liability of employer for securing safety – i.e. observe other employees, report misconduct and neglect, quit, etc.
o    Farwell’s loss resulted from an ordinary injury and must be ruled a pure accident
o    It would be hard to practically separate ‘departments’ within a single employer as a basis of identifying cases where there is and isn’t liability
§ Regardless, the master isn’t exempt because the servant can better provide for his own safety from fellow employees; it is because the implied contract of the master doesn’t extend to indemnify the servant against the negligence of anyone but himself
§ The employee stands toward the master in a contractual relationship of employment rather than of stranger, so no tort liability
§ The rule of respondeat superior rests on different reasons of policy than implied contract, which limit this responsibility only to strangers
o    This rule doesn’t apply to negligence by the corporation or a range of other cases
 
IV: Holding – Fellow Servant Rule … An employer is not liable to an employee for injuries resulting from the negligence of a fellow employee (unless the employer know of such negligence and did nothing to correct it)
Shaw’s Argument:
 
–          Farwell gets wage increase for higher risk. If he feels overexposed, he can quit or demand higher wages. If he stays, we should infer that he is fine with an implied term that allocates risk to him.
 
–          Farwell can see that the job involves both risks and wages, and then choose a package he most desires
o    But could Farwell have really foreseen this beyond a general awareness of risk?
§ Shaw: Farwell had some ability to manage risk by pointing them out or reporting them
§ If Farwell learns that risk is greater than expected, he can quit or demand higher wages
·         However, Farwell can’t properly see people in other departments – doesn’t really have this option … This calls for a chance to a different department’s policy
o    Shaw: Blacksmith Example [where people in different departments can see each other and this rule would quite work] and Ropewalk Example [where people in the same department can’t observe each other] § Shaw: Wages being paid to a contractual employee include the risk
 
–          If Shaw ruled for Farwell, at the next contract renewal, the RR would say “for this wage, bear the risk” or it would pay its employees a lower wage to adjust for this decision
 
o    Farwell would get a huge one-time windfall
o    The railroad would reduce workers’ wages to pay for insurance that covers such major payouts
§ So are workers better off? If we allocate risk to employers, everyone gets paid the same and their subjective valuations of risk aren’t accounted for … so it might actually benefit workers to assume risk b/c they gain the opportunity to state and act upon their evaluation of the risk’s value
§ Either the railroad will buy insurance or the workers each purchase their own
§ It would be better for the railroad to bear risk:
·         The railroad is the incentivized to reduce risk and (b/c of insurance cost)
·         Railroads enjoy the benefits of an economy of scale for insurance
·         Some individuals may not buy insurance. And then really screwed
o    Libertarian: So this is why we have private charity, not government
·         This is the major justification for workers compensation laws
o    Basically equivalent from a purely economic perspective
 
–          Might Shaw be Wrong?
 
o    To be sound, the employee must be able to determine what wage/risk premium to demand
§ What if you work with a hazardous chemical and aren’t aware, but the employer is?
§ This will often be difficult for lots of reasons
§ In some cases, employees will quickly learn about the level of risk and demand wages to match … compare this to cases of long-term gradual risk (i.e. asbestos, carcinogens)
§ This indicates one reason for regulation: Information
·         There are libertarian arguments against requiring even information disclosure
o    Let people pressure companies to disclose by otherwise assuming that, absent information, the risk is high [and demanding high wages] o    Competition among employers with respect to safety information
§ Encourages increased disclosure across time there is a risk that can’t be reduced across the entire industry [then collusion] § This won’t get everything, but can lead to quite a bit of information disclosure by employers
o    Sometimes it might be better to make the workplace safer than to compensate for risk
§ Perhaps some risks are just too high?
§ We may think that you shouldn’t be able to place certain kinds of valuations on certain harms to human bodies
§ A social interest in safety/well-being of employees
o    Maybe the government should protect people from their own desperation?
§ This prevents people from earning high wages for something they greatly value
§ Comes down to supply/demand … Shaw’s argument works only if Farwell can identify better wage/risk packages … if the worker doesn’t have alternatives that sufficiently attractive, that would increase the argument for regulation
§ This regulation, however, can lead to lower wages or fewer available jobs
§ So then, those who lack choice are then furthered denied more choices
 
–          Shaw assumes that, when the contract system functions properly, each party acts on belief re: their subjectively determined best interest. He therefore doesn’t see other societal interests as relevant.
 
Patrick Walters Story
 
Walters knew that he was entering a dangerous situation when he took that plumbing apprenticeship. How isn’t he just like Farwell? He accepted a high risk as part of his investment in job training.   Moeves didn’t comply with OSHA regulations because of COST. If they had complied, Moeves would have gone out of business [and then Walters wouldn’t have had a job] [he also wouldn’t have died]. Why should there be such regulations? Not information-based. Here, the justification seems to turn on a sense of constrained choice due to tough personal situation … ultimately paternalistic.
 
General Comments on Legal Responses to Risk:
 
To say that we have a situation in which risk would be justified is not the same as saying that any given regulation would be justified, or that any regulation at all could fix the issue in a justifiable manner.
 
 
Problem:         Information
 
Description:    The contracting parties may lack sufficient information to form a contract that is beneficial as defined by their own subjective assessment of their well-being (if don’t have adequate information, wage demand will be too low).
 
Remedy:          Provide Information
 
Mechanisms:    On the job learning (says Shaw in Farwell)
                        Competition (among employers or sellers of goods)
                        Mandated provision of information
                        Regulatory Ban (i.e. on a hazardous chemical in the workplace)
                                    Under what circumstances can an information problem justify a regulatory ban? 
A departure from the rational person hypothesis entailing predictable departures from rationality (i.e. we miss risks really close to zero in probability [hyperbolic discounting]; excessively devalue future risks [we know that even from your own point of view, you’ll overly discount risk])
There is inevitable slippage b/w mandates of information and implementation. We want mandates, therefore, to include easy monitoring requirements (i.e. a giant sign). If we can’t easily monitor or solve with information, then we may want to issue a regulatory ban.
 
 
Problem:          Desperation
 
Description:     This job is the only job he could get, or the only one fitting his life plan and the ergo that one that forces him to accept a wage/risk premium he otherwise wouldn’t prefer
 
Remedy:          Subsidy or Regulatory Ban
 
Mechanisms:    Regulatory Ban
Does this really improve things for the worker? Now he might lose the only job that fits his life plan … is this the best outcome from his own perspective? We might want to look at flexibilities of the supply and demand curve to see if the imposition of a regulatory ban would or would not lead to particular economic outcomes.
                        Subsidies or Tax Incentives
The government can offer these to help employers deal with the burden of regulation. Or the government can use these out of the general tax fund to directly remedy employee desperation … maybe, as Rose Ackerman suggests, we should use subsidies to supplement base wages instead of introducing regulatory bans. However, in political reality, bans are typically much easier to achieve.
 
 
Problem:         Negative Externalities
 
Description:     As a society, we may wish to address negative externalities that result from agreements between privately contracting parties [i.e. impacts on the environment, or on families]. Possibly the result of transaction costs that prohibit efficient private contracting.  
 
Remedy:           Legislation and Regulation + Common Law [i.e. public nuisance law, class actions lawsuits]                                     This is often more complicated than it seems.  
                                   
 
 
Problem:         Bad Choices
 
Description:     We think that an employee might be better-off not working under these conditions, even if the relevant set of employees strongly disagrees and even if the alternative might be not working at all. 

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Distributive: Wants to increase the success of some group in the struggle for welfare, expecting and intending that this increase will be at the expense of another group
–          Accept beneficiary’s definition of what will make the beneficiary better off … changes the regime in a way to help one group over another … sees the situation as zero sum
 
Paternalist: Changes a rule in order to improve someone’s welfare by getting them to behave in their “own real interests,” rather than in the fashion they would have adopted under the previous legal regime
–          The issue is false consciousness; believes that under the new regime the objects of his benevolence will end up with set of experience that will be “better for them” … those who have supposedly benefited do not agree that they are better off and would reject the change if given a choice … good or bad consequences for others are seen as side effects
–          Willing to persist even when his contribution is not wanted
 
Efficiency: Changes a rule so as to induce people to reach agreements that correspond to those they would have reached under the previous legal regime had it not been for the existence of transaction costs
–          Accepts the rules of the previous regime as legitimate from the point of view of fairness, morality, rights, distribution, or whatever … modifies one of these rules to make everyone affected better off by their own criteria of better-offness
–          Speculation about what parties would have done had they not been prevented by transaction costs ‘
–          Includes situations where a term is imposed due to belief that, given perfect information, all buyers and all sellers would choose to include it
 
II: The Three Motives in Context
 
It has come to be expected that decision makers will account for distributive but not paternalist consequences. A historical chronology in three parts: (1) free contract provides an exhaustive guide to decision-making, resolving all distributive and paternalist issues; (2) Breakdown of confidence that free contract should be the motive for all legal action; (3) Life “after the fall” (now), comparing efficiency and paternalism with the semi-legitimate status of the distributive motive.
 
A. Freedom of Contract as the Sole Motive in Decision Making
 
There is a view that sees freedom of contract as the sole basis for legitimate decision-making … if this is indeed possible, one might see this as a natural right, or believe that it is immoral to break promises, or that free contracts are presumptively efficient (and that the goal of decision making should be efficiency), or that the people (through their Constitution or otherwise) have expressed a belief that free contract be the rule for decision makers.
 
The test of legitimacy is voluntariness – distributive and paternalist motives are implicit in the constitutive exceptions to free contract (i.e. when we find coercion, fraud, etc.). 
 
B. Critiques of Freedom of Contract
 
Critiques of free contract are motivated by objections to distributive outcomes of 19th/20th CE economic life or by sense that masses under capitalist have used freedom against their best interests.
 
Inequalities around us are unjust, irrational and repulsive, even though we live in a culture produced by a mass of people … also, there is a problem of mass error (as judged against an asserted transcendent standard of the good)
 
Free contract – and its principles, historical practice, common understanding, etc. – fails to tell the decision maker what to do when asked to change or even just to elaborate the existing law … given a choice, the decision maker can readily draw on symmetrical and endlessly-repeated “altruist” or “individualist” arguments, neither of which will therefore be seen as a powerful determinate of his own views. Gaps in the system leave it radically undetermined when viewed as the product of a rational decision process rather than of the brute facts of social, economic, or political power. Within the huge limits available to him, the decision makers choices re: “voluntariness” can have huge distributive effects.
 
C. The Hierarchy of Motives “After the Fall”
The acceptance of distributive motives has never been more than partial and oblique
 
1.     Altruism Does not Equal Egalitarianism
 
Advocates will argue in the rhetorics of altruism and individualism.   Altruism, however, does not equal egalitarianism. Distinguish b/w altruist concerns re: mutual regard, sharing & sacrifice vs. a more equal distribution of income across groups.  
 
People see law as occasionally & dramatically distributive, but otherwise as a mostly invisible, neutral background.
–          Still, a series of dramatic one-shot decisions can have a distributive impact because they enrich underdogs who use their gains to avoid again finding themselves on the bottom
–          However, this will fail is the transfers are small, or if the underdogs don’t know how to use their gains effectively under a regime whose rules are basically unchanged