Unintended Consequences of Products Liability: Evidence from the Pharmaceutical Market

Abstract

In a complex economy, production is vertical and crosses jurisdictional lines. Goods are often produced by a global or national firm upstream and improved or distributed by local firms downstream. In this context, heightened products liability may have unintended consequences for consumer safety. Conventional wisdom holds that an increase in tort liability on the upstream firm will encourage that firm to improve safety for consumers. However, in the real-world, policy actions in a single jurisdiction may not be significant enough to influence the behavior of an upstream firm that produces for many jurisdictions. Even worse, if liability is shared between upstream and downstream firms, higher upstream liability may decrease the liability of the downstream distributor and encourage it to behave more recklessly. In this manner, higher upstream liability may perversely increase the sales of a risky good. We demonstrate this phenomenon in the context of the pharmaceutical market. We show that higher products liability on upstream pharmaceutical manufacturers reduces the liability faced by downstream doctors, who respond by prescribing more drugs than before.