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3 April 1997

 

Parliament of New South Wales

Standing Committee on Law and Justice

 

 

Submission from

John Quiggin

Professor of Economics

James Cook University

The Hilmer process and regulation of the legal profession

 

 

Department of Economics

James Cook University

Communications to John Quiggin at

EMAIL John.Quiggin@anu.edu.au

FAX + 61 77 814149

Phone + 61 77 81 4798

+ 61 77 251269

 

 


Chapter 1

The Hilmer process and regulation of the legal profession

In 1992, an Independent Committee of Inquiry, chaired by Professor Fred Hilmer, was established to examine National Competition Policy. The Committee presented its report in 1993 (Hilmer, Rayner and Taperell 1993, hereafter called the Hilmer Report). Since the release of the Report, the term 'Hilmer and related reforms', or, more simply 'Hilmer', has been used as a shorthand way of referring to that stage of Australian microeconomic reform which focuses on competition policy.

The purpose of this submission is to consider the relevance of the Hilmer process and to critically evaluate the Industry Commission's (1995) estimate that competitive reform in the legal industry would raise GDP by around $1.5 billion a year. It is argued that the standard competitive model cannot be properly applied to the legal profession and that regulation of the profession must balance the competing social interests involved in litigation.

The Hilmer process and its assumptions

Standard economic policy analysis begins with the observation that under certain highly specific conditions, free competition will yield a socially optimal outcome. The basic argument is that competition will ensure the emergence of a set of prices leading to a socially optimal allocation of resources. The conditions required for this argument to hold include:

(i) perfect information;

(ii) absence of externalities;

(iii) absence of scale economies;

(iv) availability of low-cost instruments for income redistribution; and

(v) absence of monopoly power.

If any of these conditions are not satisfied, there is a prima facie case for intervention, since an optimally designed policy intervention could, in principle, improve welfare. Since all cases where the conditions are not satisfied may be characterised as involving the absence of some form of market, violations of the conditions are often described as 'market failures'. For any specific policy proposal designed to address a market failure to be welfare-improving, it must be shown that the benefits generated by the policy exceed the cost. Programs of intervention that fail these condition are sometimes described as involving 'government failure'.

The Hilmer process involves two major departures from the standard policy framework. First, except in cases where market failure arises from the exercise of monopoly power, there is a strong presumption in favour of non-intervention. Second, it is claimed that competition yields benefits not taken into account in standard economic analysis and, in particular, that competition leads to improved technical efficiency in production. This claim is inconsistent with mainstream economic theory and lacks any significant body of supporting evidence.

The Hilmer process and the legal profession

The Hilmer process is based on the assumption that all activities subject to regulation may be described in terms of a market for goods or services. Prima facie, it is assumed that the market conditions are fairly close to the textbook conditions under which a policy of non-intervention leads to an optimal competitive outcome. In this context, it is natural to describe the legal profession and the justice system as parts of the legal services industry.

This description is appropriate for some of the activities of the legal profession, such as conveyancing. In order to complete the sale of a piece of property, it is necessary to purchase the legal or paralegal services involved in conveyancing. The market for these services can be analysed in much the same way as say, the market for oranges. The lower is the cost of providing conveyancing services the greater the benefit to consumers of those services and to society as a whole. A lower cost of conveyancing services means that a greater number of mutually advantageous property transactions can be undertaken.

However, a large proportion of legal work involves various forms of litigation. It is simply not true that more and cheaper litigation will necessarily produce a net social benefit. The basic problem is that litigation is a negative-sum game. A successful piece of litigation involves a transfer from the defendant to the plaintiff. However, since legal costs must be paid the loss to the plaintiff exceeds the benefit to the defendant. Assuming that the legal costs represent the true costs of the provision of legal services, they involve a net loss of productive resources to society as a whole. The situation is even clearer with unsuccessful litigation. Ex post, the resources involved in such litigation are completely wasted.

Within limits, the social costs of litigation are offset by the social benefits of ensuring that the legal rights of individuals and corporations are preserved. Hence, a society can have either too much litigation or too little. However, contrary to the implicit assumption of the Hilmer process, there is no reason for supposing that competitive markets will yield either the optimal aggregate volume of litigation or an optimal allocation of litigation resources across different fields.

In principle, ethical restrictions imposed by the legal profession can be socially beneficial, by ensuring, as far as possible, that socially wasteful litigation does not take place. It is beyond the scope of this submission to assess whether particular restrictions serve this purpose. However, it may be noted that the American profession is relatively unregulated by Australian standards. Most observers agree that the volume of litigation in the United States is grossly excessive.

The Industry Commission

In its study of the benefits of Hilmer and associated reforms, the Industry Commission (1995) considers the removal of a range of regulations considered to impede competition. The removal of these regulations is projected to generate productivity improvements of 50 per cent in the legal profession implying a direct gain in economic welfare equal to 0.1 per cent of GDP or about $500 million per year. When these estimates are incorporated in the ORANI general equilibrium model, they generate a final increase of 0.33 per cent of GDP or about $1.5 billion per year.

The Commission's estimates of productivity gains for the legal profession reflect the misuse of upper bound estimates. The Commission cites evidence showing that the introduction of competition in conveyancing in the United Kingdom was followed by a reduction in conveyancing charges from 0.6 per cent of a property's value in 1984 to 0.4 per cent in 1986. Since the period in question was one of booming property values, the real reduction in charges was, at most, one-third.

In discussing the abolition of the functional separation between solicitors and barristers, the Commission cites the observation of Moran and Burns (1992) that, under functional separation, two lawyers are required where the services of one might be adequate. Moran and Burns conclude that cost reductions of 'up to 50 per cent' might be feasible. This is true only in the trivial sense that, since some lawyers are willing to perform services pro bono publico, savings of 'up to 100 per cent' are feasible. It is surprising that such a casual observation could be regarded as worthy of citation, let alone that it could be regarded as a serious basis for policy formulation. But Moran and Burns' upper bound calculation is exaggerated even further by the Commission. The 'up to 50 per cent' saving suggested by Moran and Burns is converted into of an assumption that competition will generate 50 per cent cost reductions in the cost of all legal services provided by barristers and all conveyancing services. If such a device were used in commercial advertising, it would probably be the subject of charges under the Trade Practices Act.

The Commission's use of the ORANI model to generate large 'second-round' benefits of reform has been criticised on a number of grounds by Quiggin (1996). It should be noted that the large estimated benefits arise from arbitrary technical assumptions made in the course of the Commission's modelling and not from the characteristics of the ORANI model itself. In essence, the choice of assumptions ensures that any reduction in costs within the economy generates a large expansion in the traded goods sector and in particular in the mining industry.

On the basis of the analysis presented above, it seems likely that competitive reform will lead to some reduction in the cost of conveyancing services, but a reduction of even a third seems a very optimistic assessment. The removal of other restrictions may reduce the unit cost of legal services a little, but the reduction is unlikely to be anything like 50 per cent. Such a reduction could easily be offset by an expansion of the volume of socially undesirable forms of litigation. There are no grounds for believing that the Commission's projection of a mining boom arising from legal reform is anything other than an artifact of their modelling procedure.

 

Hilmer, F., Rayner, M., Taperell, G., (1993), National Competition Policy, Report by the Independent Committee of Inquiry

Industry Commission, (1995a), The growth and revenue implications of Hilmer and related reforms, AGPS, Canberra.

Moran, A. J., and Burns, G., (1992), Monopolistic restrictions in the provision of advocacy services, Tasman Economic Research.

Quiggin, J., (1996), The growth consequences of Hilmer and related reforms, James Cook University.



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