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My first post discussed one primary impediment to deregulating all the lawyers – which is the current system of legal regulation of lawyers.   Even if one agrees that deregulating all the lawyers may be the ultimate goal, this still leaves the question of how best to achieve this result.  Deregulating all the lawyers may not be the first thing we do.  One plausible candidate is fixing intellectual property protection for law.

This view is based upon the assumption that the best way to achieve the goal of deregulating all the lawyers is to create incentives for entrepreneurs to produce new and innovative legal information products.  As noted in my earlier post, innovation and entry by entrepreneurs into the legal information market can be a powerful force that weakens of the economic and political power of those whose interests are aligned with maintaining the current regulatory regime.  One result of this process is that deregulation becomes more likely.   This dynamic is why I love Virginia wine, even though I never drink it.

Creating incentives for entrepreneurs to innovate and enter requires a mechanism that allows them to appropriate a return to their investments.  Intellectual property rights can be an essential mechanism through which this occurs. Indeed, intellectual property rights can effectively protect many innovative legal information products.  However, in several important cases, legal information is subject to what can be described as a form of legal exceptionalism that results in weakened intellectual property rights.  In general, the availability and scope of intellectual property rights are limited so that the costs of restricting the use of already produced information do not exceed the benefits associated with the marginal incentives to create the information.   Intellectual property rights for law and related works seem to be further limited because of heightened concerns regarding use costs that are specific to legal information.

Perhaps the best example of legal exceptionalism is the legal treatment of the privately produced model building codes in Veeck v. SBCCI, 293 F.3d 791 (5th Cir. 2002, en banc).  In this case, Veeck posted SBCCI’s copyrighted model building codes on a website in violation of a license agreement that prohibited copying or distributing the work. The court held that the copyrighted code text entered the public domain when adopted as law by several local jurisdictions.  Through SBCCI retained copyrights to its model codes, they could not enforce them against Veeck, who identified the posted SBCCI model codes as the building codes of two municipalities.

Current copyright law precludes copyright protection for any work “prepared by an officer or employee of the United States Government as part of that person’s official duties”.  Under this definition, court opinions written by federal judges, congressional bills and statutes, and federal regulations are ineligible for copyright protection.  Courts have applied similar rules to state legal materials, including state judicial opinions, statutes, and regulations.   These rules assume that the use costs of intellectual property protection outweigh gains from improved private incentives to produce model laws.   Copyright law does not explicitly preclude copyright for model codes and other privately produced laws.  However, the court’s holding, by elevating due process concerns with public access to the law over providing economic incentives to produce model codes, effectively extends this prohibition to privately produced model codes and laws that have been adopted as law.

Protecting due process concerns does not require precluding copyright protection for privately produced works adopted as law.  Broad fair use privileges for those bound by the laws or codes could address these concerns while simultaneously protecting model codes from appropriation by competing commercial interests and other jurisdictions.   Restrictive licenses can also serve to appropriately balance the use-creation tradeoff by clarifying parties’ expectations regarding permitted uses and pricing of the copyrighted model law.   As part of these licenses, jurisdictions that adopt privately produced and copyrighted model codes could alleviate due process concerns by authorizing use by citizens bound by the law while preventing reproduction for other purposes.  Courts could require similar licenses to be granted by those wishing to file briefs and other potentially copyrightable documents.

The court’s holding in Veeck unnecessarily limits the ability to use these mechanisms by effectively eliminating copyright protection rather than retaining the protection and using the mechanisms discussed above that would permit limited public use and mitigate any due process concerns.  In doing so, the courts holding, along with other similar forms of legal exceptionalism unnecessarily weakens incentives for legal innovation and can result in less pressure to deregulate all the lawyers.

Innovation and entry by entrepreneurs is a powerful force for change. Joseph Schumpeter saw these forces as the primary engine for long-term growth, even as the process of creative destruction destroyed existing wealth, including monopoly rents associated with established regulatory regimes.  The forces of creative destruction seemingly have their sights squarely on the legal profession, promising greater access to legal services while simultaneously threatening licensed lawyers’ monopoly over legal services.

The traditional market for legal services is breaking down in the face of increased competition from numerous sources.  One of the biggest threats comes from new technologies that enable clients to perform many tasks formerly performed by lawyers.  For example, large clients now use of sophisticated search algorithms to substitute for hours of manual document search and selection formerly performed in large law firms.  As technology improves, it is not hard to imagine the expansion of tasks performed by computers rather than lawyers.  At the low end, legal software products allow unsophisticated consumers competently to perform a wide variety of legal tasks with little or no additional input from legal professionals.  These and other legal information products allow the seller of such information and services to take advantage of technology as well as economies of scale and scope that were not captured by the traditional market.

The speed and extent to which such legal information products transform the supply of law legal services depends upon the extent to which innovation and entry by entrepreneurs, especially by those outside the traditional legal sector, occurs.  In our forthcoming article, Larry Ribstein and I discuss two important impediments to such entry.  The first is the current system of legal regulations, especially those that forbid non-lawyers from practicing law, which directly suppresses legal innovation.

The current system of legal regulation is based upon the assumption that legal advice is conveyed through one-to-one agency relationships in which an uninformed client depends on her lawyer’s judgment and independence.  This assumption supports the system of attorney ethical rules designed to reduce the agency costs of this one-to one relationship by promoting lawyers’ loyalty to clients.  It also supports licensing laws to ensure lawyer quality.

However, these regulations are costly.  They constrain the supply of legal services by suppressing the use of legal information products and services that would directly compete with traditional legal services.  These rules further inhibit innovation by preventing use of private contractual arrangements that limit organizational flexibility and increase the cost of collaboration between lawyers and non-lawyers.  Moreover, it is far from clear that such rules would serve much of a beneficial purpose outside of the traditional model of legal advice.  For example, if consumers of legal services instead could use legal information products traded in a broad and transparent market, the underlying rationale for ethical rules and licensing would be greatly diminished.  Market competition would reduce consumers’ reliance on the traditional agency relationship and market-based mechanisms could help ensure quality.   Thus, one effect of the current system of legal regulations is to suppress the development of a robust market for legal information products that, left unimpeded, would likely threaten both the viability and underlying rationale of the current regulatory system.

How this struggle comes out in equilibrium will depend upon how much pressure is placed on the existing system by the amount of innovation and entrepreneurial entry that occurs.   This in turn will depend upon the returns to such investments, which will in turn depend upon the ability of the entrepreneur to capture the returns from his investment.   This brings us to the second impediment we identify, a system of relatively weak intellectual property right protection for legal information that reduces the incentives for legal innovation.   I will take up this issue in my second post.

kobayashiBruce Kobayashi is a Professor of Law at George Mason Law School.

Dimming the Court’s Brooke Group Bright Line Administrable Rule?

As noted in my earlier post, the Supreme Court’s Brooke Group rule is held out as the primary example of an administrable bright line rule aimed at controlling the costs of type I error. In practice, the Brooke Group above cost rule is not as bright as one might wish. The Achilles heel of the Brooke Group cost based rule is the failure to clarify what the relevant cost is.

Chapter 4 of the Section 2 report for the most part does a nice job of setting out the leading alternatives. The report notes that there is a broad consensus that prices above Average Total Cost (ATC) should be per se legal (Section 2 Report at 61). The report also discusses the measures preferred by Areeda-Turner, Marginal Cost (MC), and Average Variable Cost (AVC) as an administrable proxy for MC, and criticisms of these measures. The Report endorses Average Avoidable Costs (AAC), which includes both the variable and non sunk product-specific fixed costs of producing the incremental output as the preferred measure. AAC is the preferred measure because it correctly measures the avoidable cost of producing the incremental predatory output.

While Chapter 4 of the Section 2 Report provides a very useful review and analysis of the alternative cost measures, I thought the discussion simplified away several important issues. The nature of problems created as a result of this oversimplification can be illustrated by considering the numerical example used to illustrate the difference between the various cost measures (Section 2 report at 64). One problem is that the constant cost of producing the incremental output is constant, so that the AAC is equal to MC. Thus, the example fails to clearly illustrate the differences between the Areeda Turner preferred measure (MC) and the DOJ’s preferred measure (AAC). Moreover, the example suppresses several other important issues. For example, it measures the incremental output relative to the predating firm’s pre-entry output instead of measuring it relative to the but-for post entry output. The simplicity of the example has the advantage of being easier to understand, but it suppresses issues that make use of the AAC measure less administrable than an accounting measure such as AVC.

A more serious issue is the Report’s failure to clearly address the opportunity cost issue, a critical issue in the recent airline cases (U.S. v AMR Corp., 355 F.3d. 1109 (10 Cir. 2003) and Spirit Airlines v. Northwest Airlines, 431 F.3d. 917 (6th Cir. 2005)). In AMR, the DOJ’s position was that when an airplane is shifted from a profitable route (Route S) to expand capacity in the alleged predation route (Route P), avoidable costs for Route P should include the forgone profits from Route S as an opportunity cost. These costs would be added to the flight costs (cost of fuel, crew, passenger costs, etc.). The AMR court rejected inclusion of such forgone profits, but the Spirit court accepted forgone revenues as part of the incremental costs of expanding output (see Areeda & Hovenkamp, 2006 304-11). Continue Reading…

kobayashiBruce Kobayashi is a Professor of Law at George Mason Law School.

One of the most important changes in the antitrust laws over the past 40 years has been the diminished reliance of rules of per se illegality in favor of a rule of reason analysis. With the Court’s recent rulings in Leegin (eliminating per se rule for minimum RPM) and Independent Ink (eliminating the per se rule against intellectual property tying), the evolution of the antitrust laws has left only tying (under a “modified” per se rule) and horizontal price fixing under per se rules of illegality. This movement reflects advances in law and economics that recognize that vertical restraints, once condemned as per se illegal when used by firms with antitrust market power, can be procompetitive. It also reflects the judgment that declaring such practices pre se illegal produced high type I error costs (the false condemnation and deterrence of pro competitive practices).

The widespread use of the rule of reason can be problematic, however, because of the inability of antitrust agencies and courts to reliably differentiate between pro and anticompetitive conduct. Conduct analyzed under Section 2 often has the potential to generate efficiencies and be anticompetitive, and finding a way to reliably differentiate between the two has been described as “one of the most vexing questions in antitrust law” (Section 2 Report, p. 12). Under these conditions, applying a rule of reason analysis on a case by case basis may not substantially reduce error costs and can drastically increase the costs of enforcement. Thus, under the decision theory framework widely used by economists and courts, which teaches that optimal legal standards should minimize the sum of error costs and enforcement costs, “bright line” per se rules of legality and illegality can dominate more nuanced but error prone standards under the rule of reason. Continue Reading…