1.1 Economic Damages
Like a number of sub-fields of economics, forensic economics is comprised of both theory and application. More precisely, forensic economics applies economic theories, methods, and measurements to economic damages issues in civil litigation. The field of forensic economics in the USA first developed in the 1970s as various courts began allowing expert testimony from an ever-expanding array of specialists in a wide variety of disciplines. 1 The National Association of Forensic Economists [later, Economics] (NAFE) was formed in 1987, bringing together for the first time dozens of individuals from across the country who had been involved separately in calculating economic losses. One of the driving motivations of NAFEâs creation was to systematize and improve the quality of forensic economist (FE)âs work. A detailed history of the creation and development of NAFE is presented in Brookshire (2003) with additional history given by Rodgers and Weinstein (2014).
In federal and state courts in the USA, as well as in other nations, when one party sues another based on allegations that harm was done as a result of the actions of the other party, the suing party is required not only to prove that the harm was, indeed, caused by the other party but also to claim and demonstrate that a specified dollar value represents just compensation for the harm. Economic damages or losses are claimed within a wide array of civil law cases. Civil law is subdivided into sub-fields such as death and injury, breach of contract, lost profits, employment discrimination, and the like. Each of these types of cases is governed both by legislated rules (statutes) and the findings of case law. Further, the rules and cases differ among the states. For example, economic losses in New Jersey civil cases must ultimately be reduced to present value, whereas in New York cases the jury determines the total, undiscounted value which, in turn, is then subject to a Series of post-trial calculations governed by statute. Numerous other differences in methods and scope form the legal landscape from state to state. Chapters 7, 12, and 16 of this volume explore some of the key differences.
In addition, civil cases may be filed in accordance with various federal laws such as those against gender or racial discrimination. Federal courts have their own rules, some of which are completely independent of state statutes, and require experts to provide more disclosure than is expected in a number of state courts.
All civil cases may be viewed as consisting of two parts: proving liability for the egregious act of one or more named parties, and proving the extent of economic damages, if any. The major focus of forensic economics is with respect to economic loss calculations. But such calculations cannot be carried out irrespective of the legal parameters affecting both the scope and methodologies permitted to be used. Thus, effective FEs are those who have familiarized themselves with case law and those statutes dealing with the calculation of economic damages.
Sometimes the harm is non-economic in nature, for example, emotional distress, but in most cases economic damages are claimed. 2 While FEs would not typically be involved in the proof-of-causation stage of a litigated matter, they are often called upon to evaluate, measure, and opine on the degree of economic loss that is alleged to have occurred. According to part of the definition promulgated by NAFE (www.ânafe.ânet), forensic economics deals with the following:
- 1.The calculation of pecuniary damages in personal and commercial litigation.
- 2.The analysis of liability, such as the statistical analysis of discrimination, the analysis of market power in antitrust disputes, and fraud detection.
- 3.Other matters subject to legal review, such as public policy analysis, and business, property, and asset valuation.
It is in these areas that we find economists bringing to bear their knowledge of theory, data sources, and methods of analysis to assess economic damages or losses. This is not to say that all civil claims require or make use of FEs. On the contrary, most claims involve relatively modest dollar amounts, and are satisfied via private insurance companies or government regulations that cover losses due to automobile, residential, and/or employment accidents and injuries. But when the amounts being claimed are substantial, or when the claims are strongly contested, economic damages experts are often called upon to analyze and measure the losses. In contrast, many nations permit neither litigation nor expert testimony to determine the magnitude of economic losses. A detailed examination is provided in Chap. 19 of this volume.
Some caveats are in order at this point regarding the second activity listed above, that is, the analysis of liability (as opposed to damages) in discrimination and personal employment litigation. This is a more limited area for economists, for two reasons. First, the number of such cases is much smaller than damages claims arising from personal injuries and commercial disputes. Second, the laws against wrongful discrimination do not always require proof of discrimination, in the form of statistical analysis, when the facts are such that there is a prima facie presumption of adverse behavior on the part of defendants. Nevertheless, if statistical analysis is needed, economists skilled in the statistical arts, especially analysis of small numbers, may play a role in the proof-of-liability stage of a case.
Turning to antitrust disputes, these are much less common than everyday personal and business litigated claims, and they require a significantly different and specialized set of skills and knowledge, quite different from the methods used in personal and commercial cases. There exist numerous articles and books in the field of antitrust. Given the scope and methodological differences, this volume will eschew inclusion of the topic.
1.2 Role of the Economist
What exactly, then, do FEs do? Experienced experts in the field are sometimes consulted by lawyers for advice on the scope and magnitude of potential damages, well before litigation gets under way. By far and away, however, is what may be described as the typical or standard engagement that consists of review by the economist of the documents and information provided by the retaining attorney, analysis of the facts to determine the scope and types of economic damages, calculation of numerical values, and an opinion offered on the value of all economic losses. The process usually culminates in the issuance of a signed report that becomes part of the documentation in the law suit. When shared with the adversary, it could trigger a response by the opposing side who may engage its own economist to opine on the value of economic damages, or to comment on and critique the otherâs side report.
Valuation of personal claims involves methods that differ from the methodology used in valuing commercial claims. Due to the higher level of risk in operating a business, the discount rate used to convert future projected values to present value incorporates a number of elements of risk. Not so for personal injury, wrongful death, and employment discrimination torts. In such matters, the analyst will make adjustments to the expected earnings figures, and then apply a âsafe and secureâ interest rate for discounting to present value. Let us first consider personal litigation.
The process by which the expert arrives at an opinion of loss is not particularly complicated. But it does require careful consideration of various facts and assumptions that touch upon every aspect of the expertâs work. For example, had an alleged incident not occurred, the analyst would need to determine what would have been the likely annual earnings in subsequent years. If the plaintiffâs earnings history over the past five years were provided, would it be appropriate for the analyst to average the five values to establish a reasonable base earnings as the foundation for projecting future yearsâ earnings? Or would it be better to use the preceding two or three years? If there had been a dip in the earnings rate in the second and third years, but the dip had occurred during a recession, how would the analyst treat these values for purposes of making projections? Alternatively, the earnings history may have exhibited annual increases, year after year, for the past five years. In that case, taking an average of past, lower-earnings years would likely yield an unwarranted lower figure.
Another possible complication would involve projecting earnings for a person with no track record of past earnings, such as a student, who has been injured. In such cases, the analyst must project expected earnings or the earnings capacity of the individual. This generally entails consideration of the individualâs potential educational attainment, the personâs grade-point average, the educational attainment of the personâs parents, and other related factors. Chapter 2 addresses the meaning and measurement of earning capacity, and Chap. 5 deals with earnings estimation in cases of impairment of a child.
Given this brief sketch of the issues involved in determining a reasonable figure for projecting future earnings, it must be reiterated that the forensic economics methodology, though not complicated, requires consideration of numerous elements of each particular case. Choices must be made by the analyst at nearly every turn. Assumptions are unavoidable. And, over time, as knowledge expands, the expertâs assumptions may change to reflect current research and statistical sources. Chapter 13 reviews the evolving viewpoints of FEs.
However, all of this rests on a basic, underlying approach used in every analysis. The FE is being asked to create a picture of what would have occurred absent the injury or incident. This is often referred to as the âbut forâ scenario. In other words, the analyst must examine the available information, consider relevant microeconomic and macroeconomic forces that might have a bearing on the case, make assumptions regarding numerical values needed for projecting future values, undertake research related to the assumptions, and carefully make the calculations necessary to arrive at an opinion of economic loss. The economic loss opinion represents what most likely would have occurred but for the incident. It is an alternative universe, but one grounded as best as possible on known facts and known economic and statistical trends.
1.3 Other Considerations
We have touched on the determination of a base earnings figure as the starting point in the analystâs calculations. An important and related question involves determining the number of years over which such losses would likely occur. When would the individual have retired? During the entire time period until retirement, would the individual have been in the labor force every month and every year? Chapter 3 examines the concept and measurement of worklife expectancy. Further, even when a person participates in the labor force, would there likely have occurred periods of layoffs or unemployment that would have adversely impacted annual earnings?
These important questions, and others like them, have led to the development of an extensive literature in forensic economics. Several academic journals regularly publish research related to the questions encountered by FEs. Two well-regarded publications, among others, 3 are the Journal of Forensic Economics and the Journal of Legal Economics, published, respectively, by NAFE and the American Academy of Economic and Financial Experts (AAEFE). In their pages over the past three decades may be found articles about numerous topics including studies of statistical years to retirement and worklife expectancy. Many of the statistical-based articles rely on US government data and, as such, have been accepted by state and federal courts in civil litigation.
Because the research in forensic economics covers a wide variety of topics touching on all aspects of the calculation of economic losses, there is no single âtheoryâ that underpins forensic economics. Rather, FEs use theories and methods based on numerous microeconomic and macroeconomic foundations. Publishers of the Journal of Economic Literature classify the sub-field of forensic economics within the broad Law and Economics category. Other sub-fields such as antitrust, environmental, health, sports, and many other economics specialties are assigned separate classification categories. And like these others, forensic economics dips into labor economics, statistics, and welfare analysis, to name a few. In some unusual situations, economists may venture into environmental economics, foreign exchange rate theory, and even international cost-of-living differences.
And, as in o...