The Fundamental Divergence between the Private and the Social Motive to Use the Legal System

The legal system is an expensive social institution, raising the question of whether the amount of litigation is socially appropriate. The thesis developed here is that it is not—because of fundamental differences between private and social incentives to use the legal system. These differences permeate litigation, affecting decisions about the bringing of suits, settlement versus trial, and trial expenditures. The private-social divergence is attributable to two externalities: when a party makes a litigation decision, he does not take into account the legal costs that he induces others to incur (a negative externality), nor does he recognize associated effects on deterrence and certain other social benefits (a positive externality). Consequently, the privately determined level of litigation can either be socially excessive or inadequate and may call for corrective social policies. A variety of policies are discussed, including taxation versus subsidy of suit, fee-shifting, and promotion versus discouragement of settlement.