The regulation of quality in the market for legal services: taking the heterogeneity of legal services seriously.

• Author: Chaserant, Camille
• Position: Special issue on: "The comparative economics of regulated professions"

Introduction

During the last decade, the DG Competition of the European Commission (EC) has promoted the "need to modernise the professions in Europe" within Member States (EC, 2005, p. 11), including lawyers' services (1). Such modernisation of legal services involves enhancing competition in this market "usually characterised by a high level of regulation" (EC, 2004, p. 3). Indeed, in all European countries, the provision of legal services is regulated by a mix of governmental regulation and self-regulation by a professional body. Although applicable rules and their scope may vary across countries, in all of them, becoming a lawyer requires to fulfil education and training obligations and to comply with rules of professional conduct. Most of these rules consist of exclusive rights to perform specified services, of limitations on the pricing of services, on advertising, and on forms of business organization.

Now, the EC (2004, p. 7) observes that "in countries with low degrees of regulation, there are proportionally higher numbers of practising professionals generating a relatively higher overall turnover". It then considers that "[a] light regulation is not a hindrance but rather a spur to overall wealth creation", consequently urging Member States "to reform or eliminate those rules which are unjustified" (ibid., p. 4). A greater competition is expected "to lower prices, to increase quality or to offer innovative services" (ibid., p. 7), and to improve "the availability of better and more varied professional services, [that] could increase the demand, which in turn would have a positive impact on job creation" (EC, 2005, p. 4). The OECD (2007) adopts a similar point of view, stating that "the quality and the competitiveness of professional services have important spill-over effects since they affect the costs of necessary inputs for the economy and business" (OECD, 2007, p. 17).

These reports both rest on and result in an abundant economic literature on legal services (2). Using the traditional law and economics analyses of regulation, they build upon two main approaches, respectively the public interest and private interest approaches to regulation (Den Hertog, 2000; Ogus, 2004). First, following up the public interest point of view, both reports underline that "certain regulations are in the public interest as a remedy to market failures". Second, they next embrace the private interest line, stressing that "regulation and self-regulation at times appear to serve mainly the private interests of the profession" (OECD, 2007, p. 10). Recalling that competition law applies to professions, they consequently deplore rules on fees, advertising and business structures, as well as the existence of exclusive rights and entry regulations.

This article criticizes this way of analyzing the regulation of legal services. Indeed, the public and the private interest approaches do not only lead to opposite theoretical propositions but also to policy recommendations that are limited to the sole debate between regulation and deregulation. Such a debate may nevertheless be endless. Indeed, according to the public interest view, market failures justify regulation in the market for legal services. Now, according to the private interest approach, regulation may be captured by private interests. Furthermore, the public interest analysis usually pays little attention to asymmetric information between regulator and regulatees. It thus fails to analyze its consequences on the efficiency of regulation. Besides, the private interest approach does not explain how the market for legal services, once deregulated, could mitigate market failures and achieve efficiency. Finally, "the public interest approach, which assumes that law is made exclusively to generate aggregate social welfare is too naive; and the private interest theory which relates it entirely to the furtherance of personal and group welfare is excessively cynical" (Ogus, 2004, p. 42). In other words, because the public and private approaches mainly endorse standard tools that have been developed for the study of other goods and services markets in the fields of public and industrial economics, they also fail to account for the specificity of legal services.

Indeed, legal services are usually characterized as credence goods, that is, goods for which consumers are unable to assess quality either ex ante or ex post (Darby and Karni, 1973). As shown by Dulleck and Kerschbamer (2006), market mechanisms thus perform poorly, and regulation may be required to guarantee quality. In the market for legal services, a client may not be able to ascertain that a lawyer has provided him or her with the optimal service, making it necessary to regulate the provision of legal services. Now, not all the legal services fall within the category of credence good but some of them rather exhibit search or experience characteristics. Considering the ontological diversity of legal services (Karpik, 2010), we suggest that different governance structures should be associated with different types of legal services, calling for a pluralistic regulation of the market for legal services. Hence, we argue that "one-sizefits-all" deregulatory recommendations may not be relevant in the legal market, but various types of institutional arrangements governing the regulation of dissimilar legal services should rather be distinguished. This, we think, should be taken into account when discussing the deregulation of legal services in the EU.

The article is organized as follows. The first section presents the public and the private interest approaches to the regulation of legal services successively and discusses some of their empirical and theoretical caveats. The second section first introduces the distinction between legal services with credence, experience and search characteristics, and compares it with the distinction commonly made in the law and economics literature between occasional and regular consumers. It then argues that market mechanisms like individual reputation may perform well with search or experience legal services, whereas services with credence characteristics may require a higher level of regulatory protection. The third section argues that the degree of asymmetric information between the regulatory authorities and lawyers partly may determine the choice of the best institutional arrangement.

1. The traditional approaches to the regulation of the market for legal services

   Traditionally, the public interest approach explains the regulation of legal services by market failures (1.1). By contrast, the private interest approach sees the legal profession as a producers' cartel oriented towards the promotion and defence of its members' interests (1.2). Empirical studies are inconclusive and do not help to decide between incompatible regulatory recommendations (1.3).

   1.1 The public interest approach

   The public interest approach focuses on asymmetric information between lawyers and clients (1.1.1), externalities, and public goods (1.1.2). Following up that line, it accounts for most regulations that currently apply in European countries (1.1.3).

   1.1.1 Asymmetric information between lawyers and clients

   Since Arrow (1962), legal services are considered to fall within the scope of "the knowledge economy". Indeed, lawyers are experts whose specialized skills and knowledge result from formal learning and the use of abstract concepts (Freidson, 1986). Consumers do not have such skills and are thus less informed than lawyers. Consequently, the lawyer-client relationship is flawed by information asymmetries. First, a moral hazard problem arises from the client's lack of information about the type of service that is required for his or her case. Second, adverse selection occurs since the client also lacks information about the quality of the legal service.

   More precisely, the client can observe the action of the lawyer but does not know whether this action is appropriate to his or her case. Hence, the lawyer may engage in opportunistic behaviour and may not deliver the optimal service to the client. He or she may encourage clients to purchase more services than necessary, generating a supplierinduced demand. (S)he may also overtreat the case at hand in order to charge a high price, thereby delivering excess quality to a client whose interests would have actually required a simpler service. Moral hazard is increased by the fact that a lawyer performs two functions (Quinn, 1982). (S)he first performs an agency function when making a diagnosis, i.e. when defining the client's needs and determining the required legal services. Second, (s)he also performs a service function by providing the previously determined services (3). Hence, the problem is here to grant lawyers with the incentives to behave in the best interest of their clients at both stages.

   Furthermore, because consumers are not able to assess the quality of legal services ex ante, adverse selection also occurs. Lawyers providing low-quality services are able to charge low prices, whereas lawyers supplying high quality charge high prices. However, consumers are not willing to pay high prices for unobservable quality. According to the well-known "lemons" problem (Akerlof, 1970), the "good" lawyers are driven out of the market by the "bad" ones.

   Hence, adverse selection occurs because of consumers' lack of information ex ante on the quality of legal services, and moral hazard occurs because they still lack information ex post: they are not able to assess whether the price they have paid matches the quality they have purchased. Asymmetric information therefore yields market inefficiencies, which justifies regulations intended to improve and guarantee the quality of services.

   1.1.2. Other public interest motives: external effects and public goods

   The lawyer-client relationship also creates externalities that are at the root of further market...