The market for dispute resolution

An economic framework for understanding the judicial system

This is an essay I will share with students in my law and economics class at the University of Chicago Law School to help them understand the economic approach to thinking about the judicial system. I think the essay is useful for anyone trying to understand the demand for litigation, the quantity of litigation over time and space, the role of arbitration, the reason for settlement, and how statutes and regulation affect litigation.

I was prompted to write this essay as prep for a conference in early December on data concerning the judicial system in India. It was organized by Data for India, which is led by Rukmini S, a data journalist, and hosted at the University of Chicago Center in New Delhi, India. At this conference, various groups that gather, analyze and make available data on the judicial system in India were presenting their work. I was asked to give some introductory remarks, and used the chance present my framework. Although I will illustrate the framework using US examples when I teach my law and economics course in the US, it is equally applicable to foreign judicial systems.

I prefer to explore a country’s judicial system using an economic framework rather than a legal one because legal systems and terminology varies across country, but the economic framework does not. For example, while the US has parallel legal systems at the federal level and at the state level, India has a unified legal system that handles both central and state law disputes.¹ These technical details can complicate a legal framework for understanding judicial systems across countries. But my economic framework views many of these details in the same way an economic analysis of the automotive sector would view the differences between how Toyota and Honda produce cars. They are details about the manufacturing process for a good across different producers; it matters for engineers designing products or operating factories, but not for how to evaluate the social value of the output.²

AN ECONOMIC FRAMEWORK

Imagine country with a basic property law, contract law, tort law, and criminal law, and perhaps some government regulatory regimes.

Demand curve for dispute resolution. In any society and its economy, there will be interactions that generate conflicts. I may trespass your property or violate your intellectual property rights. Two business may contract over goods, but find themselves in a dispute not clearly covered by the terms of their agreement. Two car drivers may get into an accident. One individual may murder or assault another. Or a business firm may try to evade taxes. Each of these interactions generates a dispute that needs to be resolved, i.e., demand for dispute resolution.

Government production of dispute resolution. One of the prime producers of dispute resolution will be the government of a society. Dispute resolution is a combination of procedures to register a complaint, adjudicative bodies (courts) to resolve the dispute, and an enforcement system to execute the judgment. In other words, the government is a critical supplier of dispute resolution.

Different governments may have differently organized courts and different legal procedures. As I mentioned earlier, this is akin to different car companies having different methods of producing cars. Some use more robots; others are less vertically integrated. Also, the method of production can change within a country (judicial services) or a company (cars) over time. But these details about the method of production are only important in two respects. First, what is the quantity of disputes resolved and the quality of those resolutions? Second, what is the cost of those resolutions? The answers of these questions help us understand the cost-effectiveness or productivity of each government’s judicial services. Ultimately, those who demand dispute resolution are about the false positives false negatives, and costs of dispute resolution, not the structure or procedures of the court system per se.

Non-governmental production of dispute resolution, including settlement. Most legal data focus on government production of dispute resolution: the number of court cases that are pending, what the nature of these cases are, how many are resolved, how fast they are resolved, how many errors are made, etc. But courts often have a small share of the market for dispute resolution.

The two other producers are (i) private companies that offer arbitration or mediation and (ii) self-production of dispute resolution, i.e., the litigants resolve or settle the dispute themselves. With the caveat that I have far more experience with the US legal system than any other country, I suspect that the private company market is smaller than government share, but the self-production share is perhaps an order of magnitude larger than the government share. I.e., in many legal areas, >90% of disputes are resolved via settlement rather than court judgment.

The reason that private production and especially self-production of dispute resolution is important is that these are in general cheaper than court resolution of legal conflicts. Arbitration often has fewer procedures and proceeds faster. Settlement is even cheaper than arbitration, and far less costly than trial. And both arbitration and settlement are typically more private than government dispute resolution. These are the reasons that non-government producers have a dominant share of dispute resolution in the US, and I suspect in any country where the government does not ban arbitration or settlement.

One reason why the role of arbitration and self-production of conflict resolution is under-appreciated is that there is typically much less data on such resolution than on court cases. Why? First, litigants often want confidentiality, and non-government resolution offers more privacy. Second, there are no incentives or requirements to share data on non-government resolutions. Disclosure is not without costs, and non-government resolution has a lower price if such output is not publicly reported. Third, government resolution of cases serves as precedent for future resolution of disputes, whether by the government or private actors. That is not typically true for non-government resolution of cases: they are not templates for resolution of future cases. Because non-government resolution does serve as precedent, there is little demand by litigants that they are publicly reported.

Unique government role. The value of government dispute resolution as precedent future dispute resolution, regardless of who produces that resolution, highlights the unique role of the government in the dispute resolution market. By unique, I mean that government production in this market has a different role than production by e.g., Toyota plays in the car market. But the unique role of the government is not confined to precedent. I want to discuss the different aspects of the resolution market that make government production unique.

Of course, creating precedent is one of the unique roles of the government. In the narrowest sense, we think the precedential value of a court judgment bind or influences future court cases. But court precedent also impacts non-government dispute resolution, because arbitration and settlement seek to mimic the resolution that parties would obtain in a court proceeding, but perhaps at lower financial or time cost or with privacy. One reason why government resolution is precedent for non-government resolution may be that courts are better able to resolve who has which rights. This could be because they understand what the legislature intended, what the statutory or contract text says, or it estimates majoritarian default rules better than arbitrators or litigants themselves. An alternative reason, however, is that the government retains a monopoly on the use of force and gives litigants the power to appeal arbitration decisions to courts or requires parties to go to the government for legal enforcement of settlements. Under this view, the government sets precedent because it forces people to use the government for precedent. Whether precedent is a voluntary or involuntary, it shows that government production of conflict resolution is a complement to non-government production of conflict resolution.

A second way in which the government plays a unique role is that the government and litigants often jointly produce a settlement. In many cases that settle, the parties partially litigate their dispute in a government court, and then settle their case once they come to agreement on what a court is likely to decide in the case. So, in the US, we often see a spike in settlement after resolution of a motion to dismiss a case or a motion for summary judgment in a case. One reason this occurs is because the court process typically produces disclosure of evidence in a case before summary judgment, and that discovery resolves uncertainty or disagreement about facts among the parties. The other is that the court’s decision in either a motion to dismiss or for summary judgment resolves uncertainty over the legal rule and its application in a case. Reduction of either source of uncertainty helps parties come to some degree of agreement about the likely outcome of a case, a pre-condition to their cooperative resolution of the case without further court process. (It should be noted that arbitration can also play this role vis-à-vis settlement.)

A third way that the government plays a unique role is that it regulates the production of conflict resolution by its competitors. As I mentioned, government courts have the power to revisit arbitration judgments, to interpret settlement agreements, and to authorize (or not) police enforcement of arbitration judgments and settlement agreements. In addition, the government in many places regulates what disputes arbitration can resolve and what procedures arbitration must provide, i.e., how arbitration should be produced. The government also regulates what disputes can be settled, i.e., when litigants can self-produce conflict resolution. The only self-production that the government cannot regulate is whether potential litigants settle cases before filing disputes in courts. The reason is that the government cannot regulate what it cannot see. Of course, if the government is a party to litigation, then even pre-litigation settlements are seen by and thus potentially regulated by the government.

This last point brings us to the final manner in which the government plays a unique role in the market for dispute resolution: the government is frequently a litigant in cases.³

Of course, the government is a large entity and the department that is a party to a litigation is different than the government department (the judiciary) that is resolving the dispute. But the separation is not complete, as it is often argued that courts are biased in cases involving the government.

Often—maybe usually—the bias favors the government litigator. This concern is behind the joke among tax lawyers that a basic rule in specialized tax courts in the US is that “the taxpayer always loses”. Other times, the bias runs against the government. A good example is the recent case, Loper Bright, that overruled a prior case, Chevron, whereby courts gave federal administrative agency interpretation of federal statutes. (Of course, the negative implication is that the law was biased in favor of agencies before Loper.)

Whatever the bias in cases involving the government, it should be noted that the government litigator does not always rely on courts to fully resolve disputes. Often the government settles cases prior to initiating litigation or before courts render judgment in cases. An example of the former is cases that are settled after an agency begins an investigation, but before it files a case against a regulated party. An example of the latter is plea bargains in criminal cases. The defendant pleads guilty to a crime and the government offers a shorter sentence than the potential penalty if the criminal case is found guilty by a court. The implication of government settlement is that courts are complements to self-production, even when self-production is by a government department other than the court.

Let me conclude this section on the unique role of the government in market for dispute resolution is that, although the government is a privileged producer in this market, in a well-functioning legal system, the government producer is trying to put itself out of business. Over time, the judiciary should be trying to clarify legal rights and statutes so that later litigants can resolve conflicts privately, through settlement. Since settlement is a substitute for government resolution of litigation, this means that good judicial decisions reduce demand for judicial supply of dispute resolution. I say this is good because, as I stated previously, settlement is a lower cost form of dispute resolution than court proceedings.

This does not mean that eventually a well-run judiciary will eventually disappear. As long as legislatures or the economy produces new laws or qualitatively different disputes, respectively, courts will have new question that they have not previously resolved. And, of course, a poor-run judiciary will not try to put itself out of business holding laws and economic activity constant. Evidence of a poorly run judiciary is one which does not issue opinions that can guide arbitrators or settlement or one which bars settlement of well-settled legal matters. Often judiciaries are poorly run in this way when their budget depends on court fees, i.e., when judges’ salaries depend on court resolution of cases. After all, judges are humans too.

CONCLUDING REMARKS

I want to return to demand for dispute resolution. This demand is increasing in disputes, obviously. So, to understand how large the dispute resolution market is, we need to see what drives disputes. Here we should consider two different classes of cases and assume, for a moment, that courts quickly clarify legal rules and facilitate settlement. One class of cases is criminal cases. Here, good rules coupled with enforcement should lead to deterrence of crime, i.e., reduction of disputes. This reduces demand for dispute resolution. The other class of cases is commercial cases. Here, good rules should lead to economic growth, i.e., and increase in economic activity. This could lead to more disputes, increasing demand for dispute resolution. In short, good rule should decrease demand for criminal adjudications, and increase demand for commercial adjudications.

But this logic reveals the value of good rules, not the value of efficient production of dispute resolution. We had assumed above that such production was efficient. What happens if dispute resolution is not efficient, i.e., is friction-full and costly? When good rules are burdened by costly dispute resolution, associated costs undermine the effect of good rules. In the criminal context, this means there is less deterrence and more crime, and thus relatively more demand for adjudication. In the commercial context, this means there is less economic activity, and thus relatively less demand for adjudication. (I leave it as an exercise for the reader to think about what happens when the legal rule being adjudicated in court is bad.)

What this discussion reveals is that more efficient dispute resolution has complicated effects on the amount of litigation. In economic terms, an increase in supply may not, as with typical goods, increase quantity. Instead, it could—in certain circumstances—decrease demand to offset the quantity effects of lower cost supply. And in other circumstances, shifting out the supply of dispute resolution could also cause an increase in demand for the same, which in turn would magnify the impact of the supply shift on quantity.

The lesson is that, even though a supply and demand framework can help us map out the role of government courts in dispute resolution, the market for dispute resolution has some non-standard features and dynamics. One is the unusual role that the government plays. The other is the complicated relationship between supply and demand, a relationship that leads to non-standard effects of expansion in supply. So, while there is value in my economic framework, one must be careful when using it to make predictions about the amount of litigation we will observe.

FOLOW-UP QUESTIONS

The following are some questions I will ask students to see if they fully comprehend the framework above. I think the answers are fairly straightforward, but determining whether certain effects are positive or negative would require empirical analysis I do not expect students to do.

1. How would the market for dispute resolution be affected by a law that prohibited settlement of cases?

2. How would the market for dispute resolution change if courts increased or decreased the fees charged for access to courts? What if the time required for a government court to resolve a case increased?

3. How does new, complicated legislation, like the Dodd-Frank bill or the Affordable Care Act, affect the market share of government courts?

4. How does economic growth affect demand for government dispute resolution?

5. How do more stringent laws for jurisdiction or standing affect demand for and market share of government courts?

1. So, while India has High Courts in each state, the US has State Supreme Courts; and while the Indian Supreme Court handles appeals from High Courts, the US Supreme Court does not (in the main) hear appeals from State Supreme Courts for strictly state law disputes between citizens of the same state.

2. I understand that legal scholars may suggest that process is critical to value. I agree. But I frame it differently. Judicial process can affect the quality of judicial services. But more quality is not always better. It depends on the value of quality and the cost of quality. If that were not true, automotive scholars would always conclude that everyone should be trying to produce a Ferrari or Rolls Royce, i.e., the highest quality cars. That is obviously silly.

3. It is helpful to divide cases where the government is a party into two categories. One is criminal matters. In every criminal case, the government is a party because only the government can bring a case, with the justification that only the government should be able to litigate to imprison a person. The other category is civil cases. Most of these are cases where the government is a defendant. Examples include suits to obtain welfare benefits, or the government failed to compensate for taking private property. But there are a lot of cases where the government is a plaintiff. Some are contract cases where a private counterparty breached a contract with the government. But more prominent are cases where the government, as a regulator, brings a suit to enforce a regulation against a private party. These include cases to obtain payment of taxes, antitrust cases, cases to enforce environment regulations, cases of fraud against the government, etc. Occasionally the government is on both sides of a case. These are usually cases where different states litigate against each other or the federal government litigates against states, though such cases are uncommon in the US.