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In the United States, drugs are jointly regulated by the US Food and Drug Administration, which oversees premarket clinical trials designed to ensure drug safety and efficacy, and the liability system, which allows patients to sue manufacturers for unsafe drugs. In this paper, we examine the potential welfare effects of this dual system to ensure the safety of medical products, and conclude that product liability exemptions for FDA regulated activities could raise economic efficiency. When the safety level mandated by the FDA is binding--in the sense that manufacturers will not conduct additional clinical testing beyond what is mandated by FDA--then product liability may reduce efficiency by raising prices without pushing firms, who are already bound by the FDA's requirements, to invest further in product safety. We consider as a case study the National Vaccine Injury Compensation Program, which sharply reduced vaccine manufacturer's liability in 1988. We find evidence that the program reduced prices without affecting vaccine safety, suggest that liability limits can enhance economic efficiency in the presence of the FDA.

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Tomas J. Philipson is a visiting scholar at AEI. Dana Goldman is in the School Policy, Planning and Development at the University of Southern California. Eric C. Sun is at the University of Chicago.