How To Regulate the Legal Services Market? Starting From First Principles.

Christopher Decker & George Yarrow, Understanding the Economic Rationale for Legal Services Regulation, A Report for the Legal Services Board (Regulatory Policy Institute, 2010).

Dr. Christopher Decker and Professor George Yarrow are economists at the Regulatory Policy Institute, Oxford, who were commissioned to consider the “case for regulation” and the role of professions in the legal services market in the UK. Their report appears at a time when the professions in England and Wales are in the midst of a quiet revolution, precipitated by the Legal Services Act 2007 (LSA). The Act places a range of professional groups, from the mainstream solicitors and barristers to the more esoteric trade marks and patent agents, under the purview of the Legal Services Board (LSB), an “oversight regulator.” This means that the professions retain a large measure of regulatory control, over ethics and education for example, but that they, and the LSB, must pursue statutory objectives.

While much of the theory that Decker and Yarrow refer to is familiar to scholars of the legal professions, in Rick Abel’s work for example, it is valuable for scholars of professions and legal services to see the argument through the prism of another discipline. The report is accessible to those without an economics background and might therefore provide a better foundation for dialogue between lawyers, economists and others than presently exists. This potential to stimulate debate is not purely parochial. Although the report uses examples of the practices of the English professions, the general approach is an “in principle” analysis of the rationale for regulation. Such a study might undermine the basis of legal professionalism, but it might also doubt the rationale for regulation per se, even public regulation by an oversight regulator. Decker and Yarrow do not disappoint in this regard, but also point to the limits of economic analysis in answering the questions they were posed.

The LSB has statutory duties that appear to compete, for example promoting consumer interests and a strong and independent legal profession. In the two years it has been operating, the LSB has worked hard to navigate this difficult terrain. While economics informs other analyses of legal services provisions in England and Wales, it is unusual for regulators to fund theoretical projects. Commissioning a report that examines the economic rationale for regulation, that questions fundamental assumptions, is symptomatic of its open approach.

A particularly impressive feature of the report is a willingness to concede ambiguities and limits of economic analysis. Early in the report Decker and Yarrow concede that most of the economic analysis of legal professions and legal markets is in the tradition of modern neo-classical economics (MNC). This approach theorizes an efficient market equilibrium achieved by perfect competition. One of the features of the model is that any situation that does not conform to the unrealistic assumptions of the model is labelled a “market failure.” This, the authors suggest, is a common analytic misunderstanding. Rather, because MNC is an abstract theory, scarcely applicable to concrete situations, it has limited explanatory power.

While MNC has severe limitations, it is the foundation of public interest theories of regulation, which assumes capacity to correct market failures. In fact, it cannot. Decker and Yarrow argue that “market failures” such as information asymmetries between suppliers and consumers are too difficult or expensive to eradicate completely. In fact, they suggest reputation, one of the main priorities of professions and professional firms, is one of the most effective means of mitigating the impact of information asymmetry. Therefore, distinctions such as Queen’s Counsel (QC), awarded to elite advocates, are ambiguous. Challenged by the UK competition authorities as a restrictive practice, the QC fudge could also be seen as a reputational indicator helpful to consumers. For example, see Joel Poldony’s  sociological study of market competition.

Decker and Yarrow’s report suggests that the regulatory experiment in the UK is largely built on political conviction rather than economic facts. In fact although they find no evidence of cartelization or other anticompetitive practices among UK lawyers, the assumption of regulatory policy in the UK is that professions, left to their own devices, will favor their own members over members of the public. Indeed, Decker and Yarrow point out that changing regulation is often a way of shifting market advantage from one group to another.

The rights or wrongs of government intervention in the legal services market may not be the main point of Decker and Yarrow’s report. Rather they are considering whether any regulation of the market is necessary. Their starting point for an affirmative answer is that the provision of legal aid points to legal services being a necessary “social good,” and therefore, like public utilities, worthy of regulatory effort. This analogy, however immediately breaks down. Legal services, unlike gas or electricity, are not capable, for example, of being organized so as to facilitate cross subsidy. Large commercial firms at one end of the market make huge profits while legal aid firms at the other, are, increasingly, going out of business.
The decline of the legal aid sector in the UK points to the central problem in legal services regulation. Government no longer trusts that legal services suppliers (lawyers, as we used to call them), will take enough from transactions with consumers to ensure efficient supply. Therefore, although there is scant economic evidence that they do take more than they need to run an efficient service, it is assumed that lawyers do so, contrary to consumer interests. The regulatory oversight attempted by the Legal Services Act will either ensure that they are “more efficient,” or admit others (non-lawyers) to the market. This is the entry point for Alternative Business Structures, also to be introduced under the LSA, but not a phenomenon dealt with at length by Decker and Yarrow.

Those who are interested to read the report should note the availability of a supplementary collection of essays, many of which make valuable points on, or contribute important perspectives about, the report. The great value of Decker and Yarrow’s report is that it authoritatively supports and questions many of the economic assumptions on which the emerging regulatory philosophy, based on ideal competition, is based. As it is, a strong possibility is that legal services in the UK will become progressively de-regulated, albeit with a transitional period of public regulation. This, as Decker and Yarrow show, would be to replace one flawed system of regulation with another. Before that happens, other, more nuanced and empirical studies will, it is to be hoped, test the assumptions of the economic model, illuminating the theoretical shadows identified in this report.