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 an upstream national or global firm and improved or distributed by local firms downstream. In this context, heightened products liability may have unintended consequences on product sales and consumer safety. Conventional wisdom holds that an increase in tort liability on the upstream firm will cause that firm to (weakly) increase investment in safety or disclosure. However, this may fail in the real-world, where upstream firms operate in many jurisdictions, so that the actions of a single jurisdiction may not be significant enough to influence upstream firm behavior. Even worse, if liability is shared between upstream and downstream firms, higher upstream liability may mechanically decrease liability of the downstream distributor and encourage more reckless behavior by the downstream firm. 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.