The market for legal advice in the UK – competitive market or cozy cartel?

A report in today’s Independent newspaper suggests that the cost of legal advice from one of small number of well known firms in the UK, collectively known as the “Magic Circle”, has risen by around 100% in real terms since 2003.  The market structure for this industry seems to display all the hallmarks of an oligopoly, and one which might tend towards some form of collusion; demand is inelastic, there are a small number of interdependent firms and customers have difficulty collecting good information about substitutes.

In addition, beyond these largest firms a form of price leadership structure may be in operation.  As these large firms ratchet up their charges smaller firms outside the Magic Circle take the opportunity to increase their fees in a clear example of what is commonly referred to as Stackelberg equilibrium.  The economic rents enjoyed by these firms in the form of supernormal profits may be quite considerable.

The question is, as economists should we care, and if so, what can be done?  The availability of good legal advice at a reasonable price may well have positive externalities as it protects the functioning of a market economy and also allows smaller firms to compete in all markets with larger ones as they do not face the barrier to entry in any market of very high legal costs associated with operating in the market.  In short, high legal costs may make a host of markets much less contestable.

This suggests some government action is necessary.  Everyone with a knowledge of economics should be able to recommend lots of policies to make any given market more competitive, and the market for legal advice is no exception.  A reduction of barriers to entry, a requirement for transparency in pricing, an investigation into possible anti-competitive practices and the use of large fines for those found guilty might all be relevant.  However, as we have seen in the energy market action by consumers may also be needed.  A willingness by customers to shift their business to cheaper firms and an attempt to make firms move to a fixed price model by supporting those firms which do will certainly give the Magic Circle something to think about.

Ultimately, a combination of government action and consumer action will be needed but nobody should be under any illusion; the legal profession generally and the “Magic Circle” will fight against it tooth and nail.  Economic history suggests that those enjoying economic rent seldon give it up easily.