Thoughts on the Economics of Lawyer Licensing

Josh Wright —  10 May 2006

Larry Ribstein and Jonathan Wilson have an interesting exchange going regarding the merits of lawyer licensing. Larry actually has several posts on the subject (see, e.g., here, here, and a paper here). WSJ Law Blog has picked up the exchange, and offers a poll which asks the question: “Is Lawyer Licensing Necessary?” (Perhaps unsurprisingly for a poll in which a large proportion of voters are most likely lawyers, 60% are in favor of licensing.)

Wilson’s basic point is that informational asymmetry prevents efficient outcomes in the market for legal services. This asymmetry plagues individual consumers and unsophisticated buyers but not corporate clients who have the tools necessary to evaluate price and quality at the time of purchase. Wilson’s problem is that this informational asymmetry results in market failure which justifies licensing:

Consumers are generally ill-equipped to evaluate their own legal needs and are generally unable to evaluate the merits of competing producers. Consumers cannot evaluate competing price proposals (and in many consumer decisions their is no realistic price competition) and consumers are often left to the tender mercies of their lawyers when it comes to price and service levels.

Wilson’s two main points seem to be: (1) an inability to detect product quality pre-purchase means that consumers cannot evaluate competing offers and are harmed; and; (2) there is insufficient price competition in the market for legal services offered to unsophisticated consumers.

I offer a few economic points in response to Wilson’s thoughtful reply below the fold.
First, the real world is full of markets in which pre-purchase quality detection costs are substantial. It is only in textbooks that consumers have perfect information about product availability, attributes, quality, and alternative prices. Surely this cannot be a sufficient condition for market failure. In these markets, consumers rely on brand names and the reputation of sellers to assure quality. The theoretical mechanism behind this reliance was introduced by Klein and Leffler twenty five years ago. Fortunately, many markets where consumers know very little about product quality operate efficiently. The only “failure” in these markets is relative to an unattainable world of perfect competition. Consumers of the type Wilson is concerned with know they are not perfectly informed and may rationally rely on brand names as an efficient source of information. In turn, because consumers are willing to pay for such information, firms have the incentives to establish and maintain those relationships by supplying quality services (or products). These incentives are sufficient to produce efficient outcomes despite “imperfect information” in many markets.

We often see a great deal of variance in brand name investment across firms within the same industry. For example, Klein offers the example of aspirin, which may come in a brand-name form, generic, or a “mid-level” brand name such as aspirin carrying the name of the chain drugstore. Consumers quite naturally have heterogeneous values for “brand name quality assurance,” and varying demands for this form of information. The fact that not all consumers demand the highest brand name and some prefer generics (or vice versa) does not mean that consumers are exploited. Larry points to Milton Friedman’s statement that lawyer licensing is very much like requiring consumers desiring an automobile to purchase a Cadillac. The essential economic point is that brand names and reputation are a powerful tool that facilitates performance in markets where consumers have imperfect information. There are also incentives for others to collect and disseminate this valuable information. In Capitalism and Freedom, Friedman noted that certification could also solve many informational problems:

The usual arguments for licensure, and in particular, the paternalistic arguments, are satisfied almost entirely by certification alone. If the argument is that we are too ignorant to judge good practicioners, all that is needed is to make the relevant information available. If, in full knowledge, we still want to go to someone who is not certified, that is our business; we cannt complaint that we did not have the information.

Second, Wilson is concerned with the level of price (and presumably, other forms of) competition in the market for legal services. The basic economic point here is that lawyer licensing and unauthorized practice of law statutes (UPLs) decrease the intensity of competition. Posner wrote the following in his 1993 Indiana Law Journal article describing the legal profession to a medieval guild:

“[The legal profession] was an intricately and ingeniously reticulated, though imperfect, cartel. Government regulations designed to secure the cartel against competition and new entry from without, and centrifugal, disintegrative competition pressures within, held the cartel together against the dangers that beset and ordinarily would destroy a cartel of so many members.”

I will take on faith for the moment that we can agree that increased competition produces desirable results for consumers as a general matter. I have not read all of the empirical studies on the subject, but I know that at least some work has been done suggesting that consumer welfare has increased in jurisdictions that have relaxed licensing requirements or experimented with life without UPL statutes. This result would not be surprising. Further, it is persons with lower incomes, as Larry’s post recognizes, that are most immediately harmed by licensing entry barriers that raise the costs of legal services.

In sum, the “imperfect information” story is insufficient to justify licensing requirements imposing significant economic costs to the very consumers they purport to protect.

UPDATE: As I was writing this post, Larry announced that he and Wilson will be debating this issue on Point of Law in a few weeks. I will be looking forward to it.

6 responses to Thoughts on the Economics of Lawyer Licensing

  1. 

    I wonder why I didn’t see it in my post!

  2. 

    I would argue that licensing (for virually any profession proves next to nothing). Would you trust a freshly minted doctor with your heart bypass surgery? Perhaps some recent law school graduate can handle your complex commercial lawsuit?

    Or, perhaps, people are smarter than that and look to other factors (like board certification, lots of practice in a given specialty, etc.). A license provides none of this information.

    For pete’s sake, Louisiana requires licensing for florists. What are we protecting the public from? Don’t most licensing laws get their initial push from those to be licensed, as a way to restrict competition?

    Peter

  3. 

    Taavi, I agree whole heartedly that empirical data should take center stage in this debate. As I refer to in the post, there are some empirical studies exploiting state variation in UPL laws and licensing requirements. I will try to track down some cites and take a look at these. I would not be surprised if, as you allude to, there were interesting international data as well.

  4. 

    I wonder why those discussions rarely (if ever) refer to empirical studies on what the consequences of having no lawyer licensing actually are (as opposed to what the consequences might be). There must be both historical and comparative information out there. Lawyer licensing has not been out there forever in the U.S.? Comparatively, Estonia, for example, had a very relaxed lawyer licensing system for a very long time after getting independence in 1990s: you could call yourself an “advokaat” only if you had passed an exam administered by the body of other “advokaats”; but you could still practice law (including offer legal advice, appear in court) without this exam, or actually without any legal background such as law school whatsoever. You just had to call yourself a “legal consultant” or similar. The theoretical arguments are interesting, but they would be much more interesting if empirical information was attached to it.

  5. 

    Congrats John!

  6. 
    John Jenkins 10 May 2006 at 5:41 pm

    As someone who just completed his last law school final, I would like to say, “Yay barriers to entry!”