Scales Skewed

How America's legal system strangles progress

Risk & Progress explores risk, human progress, and your potential. My mission is to educate, inspire, and invest in concepts that promote a better future for all. Subscriptions are free. Paid subscribers gain access to the full archive and Pathways of Progress.

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Recently, the The Boyd Institute posed an expansive, but thought-provoking question: How can America improve its problem-solving capacity? Indeed, it is undeniable that many Americans, rightly or wrongly, feel that the country’s best days are behind it. It’s as if the chilly waters of uncertainty continue to build and rise, because our ability to manage them, the metaphorical spillway, isn’t working as it used to. Inevitably, the dam will burst, and the resulting torrential flood of unsolved challenges will inundate the nation. But there is hope. America has been in dire straits before and recovered. The waters may be rising, but with some oil on the spillway valves, we can manage our problems once again.

Problem-Solving Capacity?

When asked how we can improve America’s problem-solving capacity, most will probably seek to optimize Federal government policy and its institutional operations, perhaps even extending those optimizations to the state or local level. While beneficial, these moves would aid only at the margins; the reality is that the vast majority of “problem-solving” doesn’t involve the government. Problem-solving is the college student debating a startup with his roommate. Problem-solving is the family considering whether to buy a local food franchise. Problem-solving is the corporation deciding which project to allocate billions of dollars in research and development. Human problem-solving capacity is the vast decentralized coordination of human brains, linked together by social and market forces, which I call the “social supercomputer.”

Yet, despite our collective cognitive prowess, our problem-solving capacity is inherently limited. The human brain perceives reality through what I call the “reality distortion field,” in which cognitive fallacies color and distort our perception. Perhaps no fallacy plays a greater role than loss aversion. Studies have repeatedly shown that our brains place greater emotional weight on losses than on gains. Losing $20 in a bet, for example, impacts us more than gaining $20 in the same bet. This is probably an evolutionary development that once made sense; for our ancestors, picking the wrong kind of berries, for example, could mean the difference between life and death. Today, however, because all problem-solving involves some risk of loss, we are naturally, perhaps irrationally, wired against trying new things. Every new startup risks failure, every career path risks being wrong, and every dollar allocated to one project might have been better spent elsewhere.

A Presumption of Guilt

We have spawned entire social institutions and industries to manage loss aversion. We have convened courts to adjudicate disputes and created insurance companies, where, in exchange for a premium, we can shift the risk of loss to a third party that specializes in managing it. In America, however, these institutions are no longer working as they should, with significant consequences to our aggregate problem-solving capacity. Instead of managing loss aversion, the legal system now feeds off it, driving up costs for families and businesses. Gary Winslett of The Rebuild, called this the “litigation tax,” which Americans pay in insurance premiums, legal fees, or baked directly into the prices of the goods and services they buy. The U.S. Chamber of Commerce’s Institute for Legal Reform (ILR) estimates that, in 2022, litigation costs and compensation in the U.S. tort system totaled 2.1% of GDP, or $529 billion, that’s $4,207 per household. A separate analysis by ATRA estimates that Americans are paying $367 billion annually in “excessive” litigation costs. Indeed, litigation costs rose 7.1% annually from 2016 to 2022, outpacing both GDP growth and inflation.

America’s litigious exceptionalism comes from the dysfunctional way in which it handles disputes. America has 50 states, each with its own statutes, licensure requirements, and case law, requiring highly compensated professionals to navigate. America’s common law/jury trial tradition is also a factor, as jury trials move more slowly and cost more to prepare for and hear. But the issues facing America’s legal woes are deeper: the plaintiffs’ bar heavily funds political campaigns, creating a legal environment that favors plaintiffs over defendants. For example, unlike most countries, in America, plaintiff’s lawyers can advertise their services to the public, and are allowed to work for “free” (on contingency), taking 30-40 percent of the final settlement or judgment. At the same time, the United States lacks a strong “loser pays” rule, so plaintiffs often have nothing to lose and everything to gain by filing a lawsuit.

For the defendants, on the other hand, even a “win” at trial can be a pyrrhic victory if they spent hundreds of thousands of dollars to get there. The plaintiff’s bar has helped cultivate a system where the cost of defending oneself from a lawsuit is so onerous that the system now operates as if there is no presumption of innocence, but instead a de facto presumption of guilt. Defendants will only risk the expense of a trial when they feel certain they can “prove” their innocence to a jury. Plaintiffs’ attorneys know that all they need to do is slow walk the case, make it expensive, and muddy the waters just enough to raise the spectre of doubt; to play upon the defendant’s loss aversion and force them into settlement, if only to stop paying their defense staff $550 an hour. But this, in turn, encourages more litigation because plaintiffs’ attorneys know that even the most frivolous lawsuits will receive payments. In short, America’s legal system has become a shakedown racket, at the expense of its businesses.

America’s civil legal environment has become so dysfunctional that the insurers can no longer manage it either. In many states, defendants are legally required to provide a copy of their insurance policy to the party suing them. This helps the plaintiff craft their complaint to ensure it gets covered by insurance. It also gives them extreme leverage because many states have adopted laws that allow plaintiffs to uncap the insurance limits. Say, for example, a business has a $1 million liability policy. Armed with this knowledge, plaintiff’s attorneys will almost always demand the full $1 million right away, no matter how small the case is. This is because the law holds that if the insurer doesn’t immediately settle for that number and the plaintiff goes to court and prevails for more than $1 million from a jury (leaving the insured liable for excess exposure), the court will have deemed the insurer to have “gambled” with its insured’s money. This leaves the insurer an impossible situation: tender $1 million right now, often knowing little about the case’s true value, or risk a multi-million dollar verdict two years from now.

The insurers, the companies we rely on to manage losses, now operate under loss aversion themselves. I have personally witnessed the consequences of this unequal playing field. I have been ordered to pay half a million dollars to a plaintiff who claimed injuries after falling into a “hole” in the floor of his apartment. It didn’t matter that he purjered himself during his deposition about not being able to work. It didn’t matter that, days before the alleged shoulder surgery, we had video of him benching weights at a gym and dancing at a club. I’ve been forced to pay $1 million to a plaintiff who claimed she injured her back when a stair step collapsed as she was running up it. It didn’t matter that the mechanism of injury was impossible, that the step in question had been tampered with, and that the CT scans of her back showed zero evidence of acute injury whatsoever. In both cases, the fear of a jury “going nuclear” against the landlord and the insurance policy limits being potentially uncapped was all that mattered.

The true cost here isn’t limited to insurance premiums and higher prices. At the end of the day, America’s businesses are problem-solving mechanisms. Google was formed to solve the internet search problem, Tesla to solve fossil fuel dependence, SpaceX to solve space access, etc. But even small businesses solve problems; from the mom and pop corner grocery store to the local barber, even the in-house daycare that allows parents to work. How many businesses, startups, and otherwise good ideas never materialized or reached the market out of fear of being sued or simply because the insurance premiums were prohibitively expensive? How many landlords elected not to build a new property because their last tenant never paid rent and sued them upon eviction? How many doctors ended their practice because they could no longer afford the malpractice premiums? How many startups elected not to launch a product for fear that it would inadvertently infringe on a patent?

Without risk, we can have no progress. Our dysfunctional legal system has cultivated systemic loss aversion, making it difficult for entrepreneurs and innovators, our problem solvers, to survive in the market, let alone try anything new. Unsurprisingly, US business vitality, measured by new business formation rates, entrepreneurial activity, and business dynamism, has declined since the 1970s, a trend that accelerated after 2000. Indeed, while many pin the blame on the rise of the “precautionary principle” in legislation and among regulators, most have ignored the exacerbating role of the legal system. Americans often quip that the European Union has strangled innovation through overregulation, but the US finds its own innovative spirits tempered by overlitigation. Both civilizations are on different paths to the same destination: stagnation.

Balancing the Scale

Solving America’s legal woes requires curbing the incentives to file lawsuits and the cost of defending them. We could, for instance, make greater use of bench trials. A 2005 study of US state-level trials found that bench trials reached a verdict about six months faster and cost 30-50% less than comparable jury trials. Attorneys typically bill by the hour; a faster turnaround time means fewer billable hours. Moreover, the streamlined nature of bench trials makes them more cost-effective. Without a jury, there is no need to hire a jury consultant, engage in jury selection, prepare jury instructions, and less time and money must be devoted to hiring experts who can clarify complex evidence for laypeople. Importantly, bench trial judgments also tend to be more predictable, ameliorating fears of so-called “nuclear verdicts.”

Faster, cheaper, and more predictable trials would certainly help defendants and their insurers manage risk and loss, but most cases shouldn’t need to proceed to trial in the first place. In the US, a typical civil case takes between 400 and 800 days to resolve, but many countries could handle those cases in about 200 days. Partly, this is because most countries have a mandatory mediation requirement, which is currently voluntary in the US, but resolves about 70 percent of cases ahead of trial. If the US were also to widely adopt a mandatory mediation rule, it would further reduce the cost of lawsuits (for both sides) and ease the strain on the broader legal system, allowing resources to be devoted to the most valuable and contentious of cases.

Going further, the US should adopt the “loser pays” doctrine widely used abroad. In a “loser pays” regime, the party that loses at trial must pay the reasonable attorney’s fees of the prevailing party. This is meant to deter frivolous lawsuits by giving the plaintiff “skin in the game.” Additionally, we should reform the “collateral source rule,” which prohibits the introduction of evidence that a plaintiff received compensation from other sources, allowing the plaintiff to “double dip.” Currently, in many US states, the damages awarded by a jury cannot be reduced by amounts the plaintiff has already recovered from “collateral” sources. For example, if a plaintiff incurs $100,000 in medical bills from a car accident but their health insurance covers $80,000, the defendant could still be liable for the full $100,000, because the jury wouldn’t be allowed to know about the insurance payment.

The effect of this is more consequential than it appears because American medical providers bill at higher rates than they actually charge. For example, an MRI might be billed at $5,000, charged at $1,500, and then paid by the plaintiff’s health insurance, meaning the plaintiff owes nothing. The jury, however, only hears about the $5,000 bill. This creates a strong incentive to file lawsuits and to inflate billing. In the US, there is an entire industry of doctors and lawyers who cooperate to inflate billing. These doctors will, free of charge, perform unnecessary treatments, including surgeries, then bill at 10 times the usual rate in exchange for a cut of the final settlement or verdict. This “legal voodoo” allows them to transform $50,000 in actual medical procedures into $500,000 of fictitious billing that can be shown to a jury. The jurors are falsely led to believe that, if they rule against the plaintiff, they will leave him or her saddled with the $500,000 in debt. In reality, however, the plaintiff owes nothing. They didn’t pay for the treatments or the lawyer and never will, but the jury is kept in the dark.

Gavels and Sledgehammers

Everything I have described in this essay comes from years of personal observation, directly from the battle-weary trenches of the litigation and finance world. But in the process of writing this, I learned that I am not alone in my assessment that America’s litigation environment is holding the nation back by making it difficult to do anything. Dan Wang has even written a book about it, called Breakneck, where he argues that the rise of China as a rival superpower owes to the fact that, “China is an engineering state, which brings a sledgehammer to problems both physical and social, in contrast with America’s lawyerly society, which brings a gavel to block almost everything, good and bad.” Indeed, from my own experience living in China, I am inclined to agree. China’s society is more pragmatic and focused on outcomes, whereas America gets tied up in process. This is perhaps a reflection of their respective governments. China’s political elite is dominated by engineers, while America’s is dominated by lawyers. Engineers solve problems, lawyers argue problems.

As a consequence of America’s lawyer dominance, however, the deck is stacked against the problem solvers. Millions of American businesses and innovators now operate in an environment of fear. They fear introducing new products. They fear laying off employees. They fear making any moves that might trigger a lawsuit and years of expensive litigation that they have no hope of truly winning. This fear imposes a cost that goes beyond insurance premiums; the cost is progress itself. New ideas, especially the kind of breakthrough innovations that help Americans collectively solve problems, arrive more slowly, if at all, and their benefits are spread more unevenly. To accelerate progress, America must rebalance the scale of its legal system and restore its role as the blind arbiter of truth. Only then will its entrepreneurs and innovators be able to build the future we wish to see.

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