The Milken Institute Review

Deregulate the Lawyers

Is it time to discard the requirement that a lawyer obtain a license to practice the profession? A dumb question, you say? Read on, preferably with an open mind.

The widely accepted justification for licensing lawyers is that consumers don’t have the knowledge to distinguish the competent from the incompetent until it is too late. But it has not always been thus. In the 19th century, the standards for admission to the bar in the United States were minimal — the norm was an oral exam, administered under the jurisdiction of a local court without any guidelines. Though he never went to law school, Abe Lincoln served as a bar examiner — and, you may remember, went on to dazzle in the courtroom.

The licensing of lawyers became more restrictive only when the American Bar Association, which was formed in 1878, began to participate in the process. The ABA’s first inroad was its initiative to accredit law schools. In 1921, it adopted a statement of minimum standards of legal education and began publishing a list of schools that complied with those standards. The organization met considerable resistance from state legislators, though. As late as the mid-1950s, only about half of the states had enacted education requirements based on ABA standards.

In his signature tome, Capitalism and Freedom, Milton Friedman suggested that the other states had not gone along because many legislators were graduates of unaccredited law schools. Friedman predicted that as more were trained at accredited schools, the ABA standards would be more broadly accepted. His forecast has proved correct: today, all but a handful of states — the notable exception being California — require bar applicants to be graduates of ABA-accredited law schools. And every state except Wisconsin (which grants free passes to graduates of the state’s two major law schools) then requires them to pass a bar exam.

State governments (and state appellate courts) have also gone along with the ABA’s wish to prohibit businesses from selling legal services unless they are owned and managed by lawyers. And not surprisingly, the group’s definition of the practice of law is expansive, including nearly every conceivable legal service, including the sale of simple standardform wills.

All this deserves a fresh look. In what follows, I draw on my 2011 book with Robert W. Crandall and Vikram Maheshri, First Thing We Do, Let’s Deregulate All the Lawyers, which argues that licensing restrictions for the legal profession cannot be justified on cost-benefit grounds. We would be better off deregulating entry into the legal profession, thereby forcing lawyers to compete more intensely both with other lawyers and other providers of legal services.

In the marketplace we envision, lawyers would still be welcome to attend traditional three-year law schools and to acquire other credentials that signal their competence and quality. At the same time, though, individuals ought to be able to learn what they need to practice law from less expensive and less time-consuming sources. Allowing the lawyers’ trade association to enjoy a monopoly on law school accreditation and forcing lawyers to pass licensing exams generates huge costs, direct and indirect, yet adds little protection against unscrupulous and incompetent providers of legal services.

The market for lawyers

Approximately one million lawyers are currently working in U.S. law firms, government offices and the legal departments of private corporations. This figure may confirm the conventional view that the nation has too many lawyers. But licensing requirements have, in fact, constrained the supply.

As noted, a would-be lawyer must run the gantlet of completing a degree at an accredited law school and passing a state bar examination. (The ABA has yet to consider online law schools and foreign law schools for accreditation.) Since law school applicants are generally required to take the Law School Admissions Test, the numbers who take the test represent a lower bound on the number of people in the United States interested in entering the legal profession.

According to data from the Law School Admission Council (the nonprofit group that administers the LSAT), roughly half of the 800,000 applicants to law school during 1997- 2004 were not admitted anywhere. And since 95 percent of people who enroll in an ABAaccredited law school do eventually pass a state bar examination, the primary factor that limits the supply of lawyers in the United States is plainly the number of available spaces in these law schools. Note here, too, the supply distortion created by the reality that some of the most worthy applicants never attend because they are unwilling or unable to spend three years and as much as $150,000 on tuition and fees.

Yet, even as the supply of lawyers has been artificially constrained, the demand for legal services has experienced continual growth — thanks largely to government policies that compel businesses to retain legal counsel or that encourage them to engage in litigation.

Part of that growth in demand is linked to the promulgation and enforcement of government regulations encouraged by legal lobbies. For instance, attorneys from some 20 law firms met with commissioners from the Commodity Futures Trading Commission to shape the new financial regulations in the Dodd-Frank Wall Street Reform and Consumer Protection Act. And the CFTC is just one of many agencies involved in fleshing out the rules for Dodd-Frank.

Legal lobbies, moreover, are ever vigilant in the pursuit of new regulatory territories to conquer: they managed to block measures in the health care reform law that would limit attorneys’ fees or would impose caps on damages in medical malpractice cases. All told, the nation is spending some $200 billion annually on lawyers — a significant share of which reflects windfall profits or sheer waste.

Desperately seeking surplus

In our book, we offer estimates of the “earnings premiums” for lawyers — the portion of their income exceeding the opportunity cost of their services. The figures fluctuated a bit from year to year for the sample period (1975- 2004). But the premium has clearly increased with time; it hovered around 25 percent during the latter part of the 1970s but has risen to about 50 percent in more recent years.

In 2004, the total premium amounted to $64 billion — or an eye-popping $71,000 per practicing lawyer. We found lawyers at all income levels — not just the highest earners and not just those at the largest firms — were receiving substantial and growing premiums.

Now, this is an unusual market. On the one hand, increasing the supply of legal service providers ought to create competition that eliminates some of the surplus. On the other, adding lawyers to the rolls gives them more collective clout to influence public policy in ways that increase premiums. Indeed, our analysis suggests that, for the moment, the marginal lawyer has a positive effect on these earnings premiums.

The impact of licensing on lawyers’ earnings is magnified by government policies that generate ever-growing demand for legal services by private firms and government agencies even as the supply of lawyers remains constrained. We found that (a) economic and social regulations, as measured by federal non-defense government agency employment, (b) the real costs of the tort system, and (c) the number of patent awards were all associated with increased lawyers’ earnings premiums. In fact, all told, those factors accounted for most of the increase.

Of course, greater demand for lawyers, and higher expenditures on them, could be justified if regulatory, intellectual property and liability policies were actually raising social welfare. But the available evidence indicates that those policies do not have that effect.

Let them be free

The straightforward way to reduce the cost of restrictions on the market for legal services would be to deregulate entry, removing barriers that prevent individuals and/or firms from providing legal services without satisfying occupational licensing or other ABA regulatory requirements. State bar associations would still be free to certify that lawyers had passed competency exams, and the ABA (or any other association) would still be able to award seals of approval to law schools, leaving it to the free market to determine the value of such certification.

Along with driving down the price of legal services toward the cost of providing them, deregulation could be expected to accelerate the adoption of cost-cutting technologies as well as the introduction of new services. The potential benefits of new technologies can already be seen as clients have started to perform many tasks offered by lawyers. For example, large businesses now use sophisticated Web search technology as a substitute for manual document search and selection formerly performed by entry-level lawyers and paralegals in large law firms. Note, too, that new software is enabling many consumers to manage legal tasks with little or no input from legal professionals — and no harm to themselves or others.

Deregulation that reduced the range of tasks requiring the imprimatur of a certified professional would presumably stimulate the introduction of information technology that substituted for legal services altogether. For example, corporations could use IT to ensure that they complied with regulations and to help manage litigation decisions.

It is difficult to predict the change in structure induced by deregulation in any particular industry. But the historical record offers insights: new entrants challenge incumbent firms with both innovative ideas and efficient operating strategies, forcing the incumbents to adapt or perish.

In the case of the legal industry, solo practitioners and traditional law firms could expect new forms of competition from nonlawyers and untraditional service providers along the lines of LegalZoom, which sells do-it-yourself wills, leases and other standard documents online. And different corporate models could emerge to exploit economies of scale and scope — say, large “legal retail” suppliers, Wal- Marts for legal services. Moving up-market, more streamlined low-cost law firms, like Axiom, would compete for corporate clients. Such firms employ lawyers, but charge lower fees (especially for the services of novices) and operate with very low overhead.

Finally, new businesses could compete with incumbents by investing in lawyersaving technology and by packaging legal services with other business services. The potential for such competition is suggested by innovative firms like Novus Law and Clearspire, and by big companies that are increasingly supporting their in-house lawyers’ use of sophisticated information technology.

The abundance of legal service suppliers would also generate demand for information about service quality. Because of resistance from lawyers themselves, strong competition has not yet developed in the market for this information. But that would certainly change in a deregulated market. In addition, legal clinics would help clients find legal practitioners who provide useful, low-cost services.

We estimate that the annual gain in “economic welfare,” the difference between consumers’ benefits and lawyers’ losses from eliminating inflated prices for legal services, would be at least $10 billion. This would also help to address the “justice gap” — the reality that some litigants cannot afford lawyers, yet do not qualify for legal aid or don’t have lawyers assigned to them because of dwindling public budgets. Free entry would enhance the proposal by Stephen Schulhofer of NYU and David Friedman of Santa Clara University for a free market in criminal defense services, which would enable indigent defendants to choose their own legal representation. Surely, many of the currently unrepresented litigants would be better off even if they gained access only to uncredentialed legal advocates.

Deregulation would also spur innovations that reduced costs and resulted in new products. Because the pace and nature of innovation are unpredictable, it is difficult to quantify their prospective benefits. But I believe they could easily amount to billions of dollars.

Consider, too, another source of inefficiency in the regulated system that could be pared by deregulation. There is little doubt that some people who become attorneys would have chosen to work in other occupations — and possibly made greater contributions to society — if they were not attracted to law by the prospect of inflated salaries.

In all likelihood, lawyers’ earnings premiums are shared with law school administrators and faculty members because the premiums enable law schools to raise tuition. Entry deregulation would be likely to reduce law school tuition at some institutions because the demand for traditional three-year law schools would fall as some students shifted to untraditional training.

The arrival of new forms of legal education would also be a constructive response to recent concerns that law schools are not adequately preparing students for actual practice, and would encourage traditional law schools to be more responsive to the interests of prospective students and employers. One would expect legal education to be streamlined, with some colleges offering undergraduate law degrees and some law schools offering one- or two-year courses for students seeking careers in less demanding specialties. At the other end of the spectrum, elite law schools would probably continue three-year programs that produced the highly trained lawyers required for complex litigation in areas ranging from corporate finance to intellectual property protection.

Après deregulation, a déluge of regret?

Most potential objections to deregulation are based on what economists somewhat euphemistically call “distributional” grounds — who wins and who loses. And even those objections probably overstate the downside because they overlook the reality that deregulation would create opportunities for profit as well as cutting salary premiums. Some lawyers could be more productive and innovative if they worked more closely with nonlawyers and corporations, and some law firms could be more profitable if they were managed by nonlawyers and were allowed to raise outside capital.

Recent law school graduates and current law students would presumably object that deregulation would allow new legal service providers to enter the profession at a time that many newly credentialed lawyers are unemployed. Surely, though, legal regulation can’t be justified as a make-work program. As Roger Noll of Stanford quipped in a Washington Post article, the government might just as well outlaw tractors to create more jobs for people working in the fields.

In any case, deregulation would cause demand for legal practitioners to increase and lead to more jobs because the price of legal services would fall. In the short run, established law schools would still try to fill their seats. So the shift in demand for alternative sources of legal training would lower tuition at traditional law schools, and the number of students attending those schools and gaining employment would remain relatively constant. In the long run, established law schools would contract or possibly develop strategies to expand into new programs that made their graduates more employable.

But there are other efficiencyoriented issues here. One reasonable fear is that, without the licensing of lawyers, incidents of incompetence and/or dishonesty would rise.

That fear is based on the assumption that current regulations raise the quality of practitioners. But the American Bar Association’s own Survey on Lawyer Discipline Systems reported that, in 2009, some 125,000 complaints were logged by state disciplinary agencies — one complaint for every eight lawyers practicing in the United States. Note that this figure is a lower bound on client dissatisfaction because it includes only those individuals who took the time to file a complaint.

Although many of those complaints were dismissed, their volume suggests that clients are far from satisfied with the quality of service they are now receiving from the legal profession. Indeed, Deborah Rhode, director of the Stanford Center on the Legal Profession, concluded in her book, Access to Justice, that, on balance, the ABA and state bar associations have done little to discipline lawyers’ conduct or improve the quality of legal service.

Client dissatisfaction may increase or decrease in a deregulated environment; there’s no way to know with certainty. But it is worth remembering that deregulation would increase access to information about lawyers’ quality. Today, lawyers are judged by reputation and licensing requirements — customers do not enjoy the benefits of warranties, industry-sponsored voluntary disclosure, third-party disclosure or even government-mandated disclosure. The American Bar Association has vigorously opposed third-party ratings of law schools, lawyers and law firms. In addition, several states have resisted the initiatives of a leading legalinformation provider, Avvo, threatening lawsuits and not cooperating with Avvo’s requests for information about attorneys’ licensing and disciplinary records.

With deregulation, occupational licensing would no longer create a false sense of security about a lawyer’s quality, and buyers of legal services would be much more inclined to shop around. Legal service providers, especially non-lawyers and firms that employ them, would respond to customers’ wishes by providing extensive and credible information about their capabilities and performance — and perhaps by offering warranties. Thirdparty evaluations of legal practitioners by private firms like Avvo and by law clinics would also drive information disclosure. Finally, all legal practitioners would be subject to general business laws against dishonest practices.

Doubts about whether markets are up to the challenge have been raised in previous debates about regulatory reform. Critics of proposals to deregulate the airline and trucking industries argued that carriers would skimp on maintenance to increase profits, thereby compromising safety. In fact, safety has improved in both industries since deregulation, in part because carriers are no longer protected from competition and can ill afford to have their reputations damaged by accidents.

From here to there

The reality that deregulation of the market for legal services is socially desirable does not, of course, make it more palatable to the potential losers. And any fundamental change in regulatory policy would have to go through state legislatures or courts, whose sentiments are likely to be aligned with incumbents. But the deregulation of other industries suggests that experimentation offers a possible end run around the opposition.

Airline deregulation was spurred by its success in California and Texas — two states large enough to support regional carriers and intrastate routes. One state — perhaps Arizona, whose legislature has declined to re-enact its unauthorized practice statute, or California, whose bar indicated it would not initiate actions under its statute — may realize benefits that build support elsewhere. And perhaps England’s and Australia’s recent efforts to liberalize regulation of their legal services will attract attention here.

No matter how much it is justified, deregulating legal services in a nation whose politics and policy are largely dominated by lawyers seems unlikely on its face. But there were similar grounds for pessimism before the economic regulation of airlines, trucking, railroads and natural gas eroded and finally crumbled in the 1970s and 1980s. It really could happen here, too.