States’ requirements that lawyers obtain a license to practice law, as well as American Bar Association (ABA) regulations of legal practice, constitute barriers to entry to the legal profession. Specifically, all but a handful of states require would-be lawyers to graduate from ABA-accredited law schools, and every state except Wisconsin requires them to pass a bar exam.[1]

Before the Great Recession, law schools rejected nearly half of all their applicants, and many capable individuals are either unwilling or unable to spend three years in law school and graduate with debts that can easily exceed $150,000.[2] Under ABA requirements, firms that sell legal services must be owned and managed by lawyers who are licensed to practice in the United States, meaning that corporations and foreign law firms cannot compete in this market.

According to many in the legal community, the entry barriers ensure a minimum standard of quality, which is necessary because consumers cannot distinguish between competent and incompetent lawyers. Meanwhile, the exclusion of corporations is justified on the ethical grounds that corporate entities have an incentive to represent their shareholders instead of their clients.

In this paper, we argue that, notwithstanding their intended function, entry barriers in legal services have created inefficiencies that parallel those generated by entry regulations of US network industries (i.e., transportation, communications, and energy). In particular, entry barriers limit competition and raise prices. In the long run, they compound those inefficiencies by impeding operations, innovation, and technological advance. Although network industry regulations were motivated by competitive concerns, rather than ethical considerations, we argue that eliminating entry barriers in legal services would generate benefits that are similar to those resulting from network industry deregulation.

Specifically, prices would fall as competition from incumbent firms and new entrants intensifies; in the long run, competitive forces and operating freedom would incentivize firms to produce innovations that significantly benefit consumers and the broader economy. In the case of network industries, deregulation gained support from experiments that previewed its likely effects.

Although some deregulatory experiments have begun in legal services, more are needed to showcase the potentially large gains from deregulation.

[1] California is the most notable state to have its own law school accreditation process. Wisconsin allows graduates of the state’s two major law schools to practice without taking a bar exam.

[2] Rejection rates among law school applicants fell as the job market for lawyers tightened after the recession.

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The United States has negotiated bilateral open skies agreements to deregulate airline competition on US international routes, but little is known about their effects on travelers’ welfare and the gains from the US negotiating agreements with more countries. We develop a model of international airline competition to estimate the effects of open skies agreements on fares and flight frequency. We find the agreements have generated at least $4 billion in annual gains to travelers and that travelers would gain an additional $4 billion if the US negotiated agreements with other countries that have a significant amount of international passenger traffic.

A passenger jet heads east across the Pacific Ocean at sunrise from Sydney. Australia and the U.S. signed an open skies agreement in 2008. REUTERS/Tim Wimborne

Introduction

Following America’s successful airline deregulation experiment in the late 1970s, many countries deregulated their domestic airline markets. In contrast, deregulation of international airline markets has occurred more slowly. At the 1944 Chicago convention, the United States sought to establish multilateral agreements whereby market forces would primarily determine fares and capacities on international routes. But the effort failed, and ever since, bilateral agreements have provided the framework under which fares and service frequency between two countries are determined. 

The Carter administration promoted the idea of “open skies,” liberal bilateral agreements that freed market forces to be the most important determinants of fares and capacity. Beginning with a successful agreement with the Netherlands in 1992 and a recent one with Japan in late 2010, the United States has tended to consum-mate open skies agreements with one country at a time. Other countries have also taken that approach, while multilateral agreements among countries in Africa, South America, and the European Union have allowed participants to serve each others’ countries, usually without any restrictions on fares.

Generally, open skies agreements are initiated because two countries believe that mutual benefits exist from pricing freedom and having unfettered airline access to each other’s gateway airport(s); such agreements are opposed by countries that seek to protect their flag carrier(s) from competition by closely regulating fares, entry, and flight frequency. It is therefore important to know whether the open skies agreements that have been negotiated to date have increased competition and benefitted air travelers and whether travelers’ welfare would improve significantly if more countries negotiated open skies agreements. Cristea, Hummels, and Roberson (2012) analyzed data from the US Department of Transportation that included only US carriers and international routes flown by those carriers and estimated that open skies agreements have reduced fares, adjusted for changes in flight frequency and new routings, 32 percent compared with fares in markets that remained regulated. Piermartini and Rousová (2013) found that full adoption of open skies agreements would increase passenger traffic worldwide 5 percent, but they did not assess the effects on fares. Finally, Micco and Serebrisky (2006) found that open skies agreements that have been negotiated between 1990 and 2003 and that govern air cargo and passengers have caused a 9 percent drop in the cost of shipping freight by air.

A related literature on international airline competition assesses the effects on travelers of airline alliances where US and foreign carriers have established limited marketing arrangements, such as a reciprocal frequent flier program, or an interna-tional code-share agreement that allows an airline to sell seats on a partner’s planes as if they were its own. Alliances facilitate interline traffic across the networks of the partners, providing “seamless” service in city-pair markets where single-carrier service is not available (Brueckner 2001). Brueckner, Lee, and Singer (2011) provides recent evidence that alliances reduce fares relative to those offered by two nonaligned carriers by eliminating double marginalization of interline fares. Because alliances could account for some of the benefits attributable to open skies agreements, it is important to distinguish between the two policies’ effects on travelers’ welfare.

In this paper, we draw on a large sample of major US and non-US international routes that are served by the world’s leading airlines to explore the effects of open skies agreements on air travelers’ welfare, accounting for changes in fares and flight frequency. We estimate a model of airline market demand, pricing, flight frequency, and market structure and find that open skies agreements have generated at least $4 billion in annual gains to travelers on our sample of US international routes, which includes almost a 15 percent reduction in fares and amounts to roughly 20 percent of carriers’ annual revenues on those routes. Moreover, we find that travelers would reap another $4 billion annually if US policymakers could overcome the political obstacles that have prevented them from negotiating open skies agreements with other countries that have a significant amount of US international passenger traffic. Given that open skies policies have advanced with little publicized evidence of their benefits to travelers, broad dissemination of this (and other) positive  evidence may spur policymakers to eliminate the remaining economic regulations on foreign air-line competition and to enable the world’s airlines to operate efficiently in a fully deregulated environment.

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In this interview with Saïd Business School at the University of Oxford, Clifford Winston discusses the potential benefits of deregulating the legal profession – namely increased competitiveness leading to affordability.

Winston first establishes his view that a need for government regulation indicates some market failure that needs to be addressed. In this case, occupational licensing such as passing a state bar exam is meant to assure a minimal level of quality. Winston argues that such occupational licensing would not be necessary if we could apply crowd-sourced reviews of lawyers, through services such as Angie's List or Yelp. This would offer the opportunity for markets to decide what kind of certification and education is required to provide legal help.

Deregulating the practice of law would drastically increase competition along a spectrum of legal services as the supply of legal-service providers rise as regulations drop; for example, individuals who might require someone with just a background understanding of legal procedures would find approaching a "legal consultant" to be much less expensive than consulting with a bar-licensed lawyer.

The costs of the such deregulation—such as a loss of income for those in the legal professions—would be offset by the consumer benefits of more services provided more cheaply. More economic gains may even be found if third-party review services arise or expand that would help correct any market failures, i.e. review services could weed out individuals providing poor services.

The primary obstacle to such deregulation, though, is getting states to adopt these policies in the face of the tight relationship between policymakers and lawyers. However, if one state successfully pursues a deregulatory policy, it makes it likely for other states to follow, particularly given the success that other countries, such as the United Kingdom, have had in loosening the requirements needed to offer counsel.

The general principle behind legal deregulation is grounded in the idea that there are not serious information problems in determining the quality of a professional service firm. Therefore, whether a firm provides legal advice, accounting advice, or automotive services, Winston feels that markets would determine the credentials and certifications service-providers need to practice. Increasing this supply of service-providers would allow competition to flourish. Additionally, information-providers and guides could offer more resources for consumers who seek quality help. These market forces lead Winston to believe that there is little need for occupational-licensing regulations in many service firms.

      

 

 

Transportation infrastructure significantly contributes to a nation’s prosperity by facilitating workers’ access to employers, consumers’ access to shopping and leisure activities, and firms’ access to capital, labour and potential customers. The public sector has generally provided the vast amount of a nation’s infrastructure – roadways, waterways, railways and airways – and expanded it to satisfy users’ growing demand for transportation. But as demand has increased and ageing infrastructure facilities have required ever-greater funds for maintenance and new construction, capacity has become increasingly strained and travellers and shippers have experienced more congestion and delays. Policymakers have tried to find new sources of money to finance projects to expand capacity; but congestion and delays have persisted.

The public sector’s "strategy" of increasing spending to build its way out of congestion has been entrenched for decades and is unlikely to change for the foreseeable future into a sustainable strategy that could improve infrastructure performance. I therefore consider in this paper three ways that private sector firms could potentially contribute to that goal.

1. They could purchase infrastructure facilities from the government and operate them more efficiently subject to general business laws (privatisation).
2. They could develop technological innovations that the public sector could implement to improve current infrastructure performance.
3. They could make technological advances that greatly improve the operations of transportation modes that use the infrastructure.

In what follows, I explore those possibilities by drawing on evidence based primarily, but not exclusively, on highway and aviation infrastructure services in the United States, which have been the main focus of infrastructure policy discussions. I conclude that: privatisation, while worthy of carefully designed experiments, faces considerable uncertainties as to its long-run success in the United States; technological innovations developed by the private sector are available for the public sector to implement but policymakers have resisted doing so; and, more positively, technological advances in the transportation modes could facilitate significant improvements in infrastructure performance provided its implementation is not impeded by the government.

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June 1 marks the 5-year anniversary of General Motors filing for Chapter 11, which had been preceded by Chrysler Motors’ declaration of bankruptcy. The combination of burdensome labor contracts, a legacy of massive pension and health-care costs, a run-up in fuel prices, falling market shares, and the financial crisis had come to a head by late 2008, leading to financial aid from the government under both the Bush and Obama administrations. Five years later, what are the results of the government’s interventions in the auto industry, and what is the state of manufacturing and manufacturing policy in the United States?

On May 21, the Economic Studies program at Brookings explored these questions. Keynote speakers included Sergio Marchionne, chairman and CEO of Chrysler, and former National Economic Council Director Larry Summers. In addition, one panel focused on the implications of the government’s intervention in the auto industry, and the second on the broader question of the state of manufacturing and manufacturing policy in the United States.

Video

• Was the Auto Bailout Worth It?
• Four Reasons the Auto Bailout Was Not a Mistake
• Foreign Cars Are Better than U.S. Cars
• 50-Year Decline in U.S. Manufacturing
• U.S. Manufacturing Jobs Pay Poorly and Cost Much to Create
• There Were No Alternatives to the Auto Bailout
• Question and Answer Session One: Inside the Decision-Making
• Panel One: Implications of the Government Rescue on the Auto Industry
• Panel Two: U.S. Manufacturing and Manufacturing Policy
• Question and Answer Session Two: Inside the Bail-Out

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• Recovery Road? An Assessment of the Auto Bailout and the State of U.S. Manufacturing

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This view may be surprising given the usual rhetoric that infrastructure spending is a good thing because roads, bridges, airports, and the like significantly contribute to America’s prosperity by facilitating our access to the workplace, shopping, and leisure activities, as well as giving employers easy access to labor, capital, and potential consumers. But in practice, transportation policy is so inefficient that infrastructure spending fails to generate the large promised benefits.

There are clear ways to know what new infrastructure is actually needed. Every time Americans use a road, airport, or even cross a bridge, we don’t actually pay for the congestion we cause. That gives policy makers the misleading impression that it is necessary to build new roads, airports, urban transit — and even a high-speed rail system! — to reduce delays. But public officials would likely arrive at a different conclusion if we users were charged congestion tolls, especially during peak travel periods. Demand would fall, transmitting a more accurate signal. Supply and demand would then do its job nicely.

Politics rears its ugly head in at least two ways. First, transportation funds are allocated to the states through a politically devised formula and then within states to satisfy metropolitan planning organizations’ wish lists. Thus “bridges to nowhere” get built, and roads and airports with little traffic get a large share of federal transportation dollars. Second, so-called demonstration projects really only demonstrate the ability of elected officials to garner pork-barrel spending for their home districts.

Moreover, infrastructure costs are inflated by inefficient investments and burdensome regulations. For example, if roads were built with thicker pavement to better withstand the damage inflicted by heavy trucks, both highway authorities and motorists could save billions of dollars annually on maintenance and repair costs.

An 80-year-old labor law (“Davis-Bacon” — the same law that undoubtedly contributed to Boston’s Big Dig coming in at four times over projections) stipulates that prevailing wages, interpreted in practice as “union wages,” be paid on any construction project receiving federal funds. And the cost of constructing runways — at Boston’s Logan Airport, for one — has turned into a task measured in billions of dollars because it takes decades to meet regulations, especially environmental impact standards.

The United States has been extremely slow to implement the latest technological advances in infrastructure. In recent testimony before Congress, the Inspector General of the US Department of Transportation reported the latest tale of woe: the Federal Aviation Administration’s completion of the advanced satellite-based air traffic control system could be delayed by at least a decade, and its cost could triple.

As my own peer-reviewed research shows, this myriad of policy inefficiencies is reflected in returns to highway investments during the past decade of a mere 1 percent. And for every $1 in government highway spending, motorists have saved a measly three cents in travel time and operating costs. Other research indicates that the transportation spending component of the American Recovery and Reinvestment Act of 2009 — the stimulus — did little to either improve the highway system or add highway worker jobs.

Fortunately, transportation has continued to advance with the help of private sector throughout history. Recent developments, such as driver-less cars and aircraft that rely on on-board navigation equipment, raise the possibility of an entirely new era of highway and air transportation. Such innovations, all driven by private sector innovation, provide another compelling reason for public policy makers to think twice before significantly increasing infrastructure spending.

If the government does want to spend a large sum to raise employment levels, it should encourage industries and corporations to hire additional workers through direct subsidies, targeting especially those industries with high social returns and that would easily absorb more workers. Yes, this risks political concerns by forcing the government to pick winners. But this route is far preferable to the more politically expedient route — continuing to sink taxpayer money into scattered infrastructure projects that lead the greater economy nowhere.

      

 

 

While the government is looking to mandate private sector auto technology – vehicle-to-vehicle (v2v) communication – it is doing little to allow technology that would improve the nation’s public highways, according to a new paper by Clifford Winston, Searle Freedom Trust Fellow at Brookings and Fred Mannering at Purdue University published in The Economics of Transportation.

Winston and Mannering compare the nation’s highways to a blocked artery of the U.S. economy, noting that the indispensable road system is valued at $3 trillion, with 75 percent of goods transported on roads by truck and 93 percent of all commutes by cars and busses. The private-sector auto industry has implemented substantial technological improvement in terms of performance, safety and comfort, whereas technological improvements on highways have been meager, they write.

The authors list many beneficial policies that could be facilitated by existing technologies that the government could and should implement:

• Pricing (congestion pricing for car and truck lanes and for shoulders for cars; real-time pricing and information about on-street parking; pavement-wear and bridge-wear pricing for trucks)
• More flexible truck size and weight limits
• Investments (adjusting the number of traffic lanes in response to volume; new pavement designs to increase durability)
• Safety operations (variable speed limits; re-timing and optimizing traffic signals; using photo-enforcement technology; expediting response to incidents)

Those technologies have not been implemented, they posit, due to status-quo bias, agency imitations, regulatory constraints, political forces as well as lack of expertise; they note that the Federal Highway Administration spends only about 0.5 percent of its budget on promising research and development – or 10 times less than administrative spending.

Because policymakers have not implemented those existing technologies, the authors believe the driverless car will have to leapfrog ahead of the technology on government-run highways to improve highway performance. They note that the technology, with a 10 percent adoption rate, would reduce fatalities and injuries, save travel time and fuel – and save $40 billion annually. At a 50 percent adoption rate, it would save $200 billion per year. The promise of the cars will allow virtually all of the benefits of the above-listed technologies to come to fruition in spite of government foot-dragging.

“Our discussion of policymakers’ failure to implement this technology has culminated in the eternal debate over whether the public or the private sector is better able to spur technological change that contributes to growth,” they write. “In the case of highways, we conclude that it is likely that the private sector will eventually implement driverless car technologies, and that those technologies will benefit motorists by leap frogging the technological advance that the public sector has put on hold. If this innovation is not impeded by government regulations and does succeed, social welfare could possibly increase further by exploring privatization of the road system so that it could operate at the same level of technological sophistication as the vehicles that are driven on it.”

“Research has found that over the course of the day individuals’ commutes are the leading activity for which their dominant emotion is negative. Motorists would probably feel even worse if they were aware of the evidence summarized here—that policymakers could implement available technology on the road system that would reduce much of the congestion and delays that make road travel so onerous and would also improve safety,” they conclude.

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President Obama could have provided a more accurate assessment of the state of the union by acknowledging the state of our economic knowledge, particularly related to my area: transportation.

First off, the president stated that:

When we rescued our automakers, for example, we worked with them to set higher fuel efficiency standards for our cars. In the coming months, I’ll build on that success by setting new standards for our trucks, so we can keep driving down oil imports and what we pay at the pump.

The success of our rescue, at a cost of $10 billion and generous tax benefits to GM, and the Corporate Fuel Efficiency (CAFE) Standards are far from confirmed as successes. First, there is the unresolved debate about whether a carefully managed bankruptcy of Chrysler and GM would have been a less costly solution than a bailout in both the short and long run. Bear in mind that those companies have been declining for decades and foreign competitors have more than picked up the slack. Second, CAFE has nothing to do with the bailout as it raises auto prices in return for higher fuel efficiency. The justification for CAFE depends on the extent that consumers accurately value savings in fuel economy. The literature has not yet sorted out that issue.

Later, he discussed infrastructure:

Moreover, we can take the money we save with this transition to tax reform to create jobs rebuilding our roads, upgrading our ports, unclogging our commutes – because in today’s global economy, first-class jobs gravitate to first-class infrastructure. We’ll need Congress to protect more than three million jobs by finishing transportation and waterways bills this summer. But I will act on my own to slash bureaucracy and streamline the permitting process for key projects, so we can get more construction workers on the job as fast as possible.

No one is opposed to eliminating red tape and streamlining transportation projects. The problem is that the president did not indicate how that would be done. Moreover, since he was on the subject of efficiency, he failed to mention well-known reforms based on established economic literature that could improve pricing, investment, production, and technical change in infrastructure services. 

As I recently wrote in the Journal of Economic Literature, inefficiencies in the transportation sector from poor public policies have continued to grow over time and currently cost more than $100 billion per year and that does not include the costs in employment because of poor commuter access, the lower benefits from trade because of delays and congestion, and the like. The solution is not to spend significantly more taxpayer dollars. There is a lot that we could do to fix our transportation woes by applying market practices, combined with better policies, but not necessarily more government.  For example

• Base user prices on actual costs:
  • Charge people tolls for congestion, not just road use via the gas tax.  By substantially reducing delays and sprawl because the out-of-pocket cost of commuting would no longer be underpriced, such tolls could generate annual gains of $40 billion, accounting for the travel time savings, lower costs of public services from greater residential density, and revenues to the government;
  • Charge for street parking with real-time prices – charge more for crowded streets and less for others;
  • Charge trucks for the damage their weight does to the roads and bridges instead of a gas tax; and
  • Charge planes more to take-off and land in high-volume times, which could save $6.3 billion in time and money to passengers and the airlines.  Also charge passengers for air traffic control based on the plane’s use of congested airspace as opposed to a set per ticket tax.
• Improve federal investments in infrastructure:
  • Improve highway design by increasing the number of lanes and shrinking the lane width in high volume traffic when people drive slower;
  • Use thicker pavement to keep maintenance costs down and  lessen wear-and-tear of drivers’ vehicles; and
  • Fund projects based on cost-benefit analysis, not earmarks and underpriced estimates (aka Boston’s big dig).
• Streamline regulations so that highway projects do not distort wages and raise project prices:
  • Reduce the number of federal and state employees who focus on contractors meeting regulations (200,000 employees);
  • Expedite environmental reviews -- EPA reviews end up costing billions and decades to create new runways.  New runways could save $16 billion;
  • Change labor regulations which make it hard to fire transit workers – it can cost $400,000 per severance package.
• Open the skies and seas by liberalizing international airline routes and shipping lanes
• Privatize a city bus service to see if it can be better operated than the public bus company and be more responsive to travelers’ preferences.
• Privatize highways so that the federal government and states could explore whether it leads to lower costs of highway services and better service to motorists.

Efficiency and equity do not have to conflict because any distributional concerns of higher prices for certain groups could be addressed through vouchers and other mechanisms.

      

 

 

The most extensive and contentious recent government intervention in Americans’ lives is undoubtedly the 2010 Affordable Care Act (ACA). In light of the federal government’s failure to successfully launch its website, www.HealthCare.gov, to implement the Act, it is useful to step back and broadly assess government’s efforts to implement and manage large projects.

In my testimony, I first discuss the conceptual justification for the government taking on large projects and what its objective should be. I then provide an overview of the available empirical evidence on the economic effects of government’s management of a range of projects and offer possible explanations for the findings. I conclude by drawing some implications that pertain to the government’s delay in launching the ACA website.

Theory

Two reasons exist to justify government implementation of large projects. The first is to correct a market failure, which could arise when a socially desirable service (that is, one whose social benefits exceed social costs) is not privately offered because it is unprofitable or requires enormous financial capital that may be unavailable in private markets. Public bus transit systems are often alleged as an example of the former and the interstate highway system is alleged as an example of the latter. Market failure also occurs when a service is undersupplied because it is a public good and susceptible to the free rider problem. National defense is a classic example of a pure public good. Innovative activity by firms may also result in free riders by creating positive spillovers to competitors.

The government can increase the nation’s welfare by financing socially desirable projects and services, including public goods, which would not be supplied by the private sector. In practice, the government can provide the service or negotiate a contract with a private firm to provide the service. In the ideal case, the government corrects a market failure and maximizes economic efficiency by setting efficient user charges, financing investments that equate marginal benefits and marginal costs, and minimizing production costs. Note that the projects and services requiring the largest investments constitute the nation’s physical infrastructure. Government has tried to spur innovation in several ways, including the establishment of a patent system and an array of subsidies for firms.

The second reason that could justify government implementation of large projects is to pursue social goals—that is, American society, like any society, seeks to solve other social problems in addition to correcting market failures and promoting economic efficiency. Those goals can be categorized broadly as attempting to reduce poverty, ensure fairness in labor markets, and provide merit goods—goods that American society believes every citizen is entitled to regardless of whether he or she can afford them, including an education, insurance against certain events that could dramatically lower the quality of life (social insurance), and protection from criminals, hostile countries and terrorists, and natural disasters.

Generally, policies to achieve those goals redistribute resources from one group of people for the benefit of another group of people, but government should nonetheless attempt to achieve those goals at minimum cost to society. The ACA arguably tries to provide a merit good and to some extent correct a market failure.

Evidence

What does the empirical evidence indicate about government’s involvement in projects and services to correct market failures and achieve social goals? My 2006 Brookings book, Government Failure Versus Market Failure, indicated government’s efforts generally resulted in substantial losses in economic efficiency and missed opportunities to benefit society in a cost-efficient manner. Here I provide a brief overview and update of my findings.

The federal government, sometimes in collaboration with state and local governments, is responsible for financing and managing highways, airports, air traffic control, inland waterways, urban transit, and intercity passenger rail.  In the appendix, I present a table that summarizes the economic inefficiencies and annual welfare costs from public provision of infrastructure and urban transit that appeared in my Journal of Economic Literature, September 2013 survey of the performance of the US transportation system. The total annual cost of the economic efficiencies exceeds $100 billion. The inefficiencies are attributable to the fact that government’s provision and management of transportation services has not been guided by economic principles: prices do not reflect social marginal costs, especially a user’s contribution to congestion and delays; investments are not based on cost-benefit analysis and on accurate forecasts of costs and benefits and have therefore failed to maximize net benefits; and operating costs are significantly inflated by regulations.

The vast inefficiencies have important implications for transportation-related policies to strengthen the economy. For example, the stimulus program and ongoing calls to increase infrastructure spending must recognize that potential improvements in the nation’s productivity and employment are lessened by policy failures in the current transportation system. Similarly, the Obama administration’s vision of a high-speed passenger rail network as a transformative investment must consider costs and benefits that have traditionally been overlooked by government. Indeed, Edward Glaeser performed a series of cost-benefit calculations that were published in his 2009 New York Times column and consistently found that building such a network would not be socially desirable.  

The evidence that I report in Government Failure casts strong doubt on whether federal programs to spur innovation have supported socially beneficial programs that would have been undertaken without federal assistance. Moreover, some federal support has resulted in no accomplishments and cost taxpayers billions. The recent Solyndra fiasco harkens back to the Clinton administration’s failed effort to produce a high-gas-mileage car using a hybrid propulsion system.

Still other large-scale government projects and services have experienced serious problems including the U.S. postal system and the government’s allocation and management of public land for grazing, natural conservation, and recreational activities. The former has continued to struggle financially, with ongoing threats to discontinue Saturday service, and the latter has come under attack after the government shutdown forced national parks to close.

Finally, although I am much less familiar with empirical assessments of government services and programs to pursue social goals, such services and programs are undoubtedly not being provided at minimum social cost and are wasting a vast amount of resources.     

Explaining Government Failure

Agency limitations, regulatory constraints, and political forces combine to cause and maintain inefficient policies and to impede efficient reforms. For example, the Federal Aviation Administration (FAA) is at the heart of airport and air traffic control inefficiencies because it lacks organizational independence and is prevented to a significant extent by both the U.S. Department of Transportation and Congress from using its resources—and from encouraging airports to use theirs—more efficiently. Given that it faces opposition from two powerful branches of government, it is not surprising that the FAA finds it so difficult to reform its policies.

Government agencies do little to assess whether their vast public expenditures have been spent efficiently. Transportation officials have told the GAO (GAO-05-172) that little incentive exists for them to direct available funding to performing outcome evaluations, but they have also said that potential risks do exist from finding out that a project is not providing the intended benefits. Thus, because government measures inputs instead of outputs in many venues, transportation agencies tend to declare that a project is a success once it is operating.

Agencies are likely to have status quo bias because they may lack the technical expertise to ensure that new technologies are implemented effectively and efficiently. For example, the Federal Highway Administration has not placed a priority on using advances in information technology to improve highway travel. At the same time, FAA’s well-publicized delays in implementing new technology have tarnished its reputation to manage air traffic control effectively.

Of course, special interest politics is transparent in several areas of policy. In transportation, state and local government officials lobby for increased federal assistance for surface transportation grants and increased flexibility on how they use those funds; the American Automobile Association and the American Trucking Association have opposed efficient congestion tolls and axle-weight charges; labor unions have opposed removing Davis-Bacon regulations; and urban transit subsidies have largely been accrued by powerful interests—higher wages to labor and higher profits to suppliers of transit capital. Finally, powerful interest groups are supporting federal funding of a national high-speed rail system.

Implications for ACA Website

The potential for government failure in implementing and managing a large project should be foremost in the mind of the officials of a government agency and department when it takes responsibility for a new project. Accordingly, it is vital for those officials to take steps to anticipate and address potential failure. Based on my preceding discussion, the potential problems facing the government’s launching of the ACA website include but are not limited to:

• Limited technical expertise and an over-reliance on contractors;
• Little, if any, rigorous and transparent ongoing assessment because of a fear of exposing problems;
• Status-quo bias and an inflexibility and inability to make important changes in managing a project;
• Constraints that may affect budgeting and adoption of state-of-the-art technology.

The unfortunate result of the functionality problems and delay in launching the federal ACA website is not that the desirability of the social goal of universal coverage is necessarily reduced—the pursuit of that goal is a democratic decision that must be determined by our political system—but that the social costs of achieving this goal are already, and will continue to be, inflated. Indeed, it is my understanding that some states that produced effective ACA websites have also negotiated lower rates with insurance companies for their consumers as compared with the rates obtained by states that are using the federal website and thus did not benefit from rate negotiations. It is also possible that a state that did not produce its own website could reduce the future efficiency costs of using the federal website by arranging to pay a fee to a state that produced an effective ACA enrollment website to expand that website so people from a different state could also use its services to sign up for their insurance.

In sum, the controversy surrounding the Act should not blind policymakers to their obligation to implement the Act at minimum social costs and, if necessary, to explore alternative ways of doing so.

Appendix

Inefficiencies from the Public Provision of Infrastructure and Urban Transit

     

 

 

Transportation is a vital sector of the U.S. economy based on consumers’, firms’, and government’s enormous expenditures in money and time and on its effect on virtually all other sectors in the economy. I assess the performance of the transportation system and consider how it could be improved by analyzing whether the United States has the optimal mix of public and private provision. The empirical evidence indicates that our hugely important transportation system has been compromised by various government policies and the significant welfare costs motivate either vastly improving public provision or expanding the role of the private sector.

Introduction

Transportation is a friction—a cost in both money and time—that must be incurred by individuals and firms to complete almost any market transaction. An efficient and extensive transportation system greatly enriches the standard of living in modern society by reducing the cost of nearly everything in the economy; expanding individuals’ access to and choices of employers and employers’ choices of workers; enabling firms and urban residents to benefit from the spatial concentration of economic activities, referred to as agglomeration economies; reducing trade costs and allowing firms to realize efficiency gains from specialization, comparative advantage, and increasing returns; and limiting firms’ ability to obtain market power by locating in geographically isolated markets with no competition. By increasing frictions, however, an inefficient transportation system, just like poorly functioning financial institutions (Hall 2010), can cause all sorts of economic activity to collapse.

Transportation is also important because it can be thought of as a merit good—that is, societies generally believe that citizens are entitled to accessible transportation to experience a decent quality of life no matter where they live, even if the cost of their service must be subsidized. To this end, both the public and private sector have provided and managed transportation throughout U.S. history and government policy has redistributed transportation resources across households with different incomes, between residents of urban and rural areas, across residents of different states, and between users of a specific service and general taxpayers.

Americans’ annual expenditures in both money and time on transportation are enormous. As reported in 2007 dollars by Winston (2010), consumers spent $1.1 trillion on gasoline and vehicles commuting to work, traveling to perform household chores and to access entertainment, and traveling for business and vacations, and spent an astronomical 175 billion hours in transit, which averages out to about 100 minutes per day for each and every American, valued at some $760 billion. Firms spent $1 trillion shipping products using their own and for-hire transportation, while the commodities that were shipped absorbed 25 billion ton-days in transit, valued at roughly $2.2 trillion.1 Local, state, and federal government spending on transportation infrastructure and services contributed an additional $260 billion, bringing total pecuniary spending on transportation up to 2.4 trillion, or 17 percent of GDP in 2007, which is as much as Americans spent on health care, and total annual money and time expenditures to more than $5 trillion! Finally, transportation looms large in American life because both the public and private sector have made huge investments in the transportation capital stock, which (after deducting depreciation) is valued by the U.S. Department of Commerce at nearly $4 trillion (2009 dollars).

The fact that this sector is so large and simultaneously so intertwined with virtually all other sectors in the economy suggests it is vital to assess the performance of the transportation system and to consider how it could be improved. At first blush, this appears to be a daunting task given the system’s size and complexity. However, because the government is so heavily involved in the system’s performance through its management of public infrastructure and services, regulation of private sector competition and externalities, and subsidies for travelers and private carriers, my view is that a constructive assessment can by performed in this paper by analyzing whether the United States has the optimal mix of public and private provision of transportation. And while I focus on the U.S. transportation system, my discussion is relevant to all transportation systems that must consider this issue.

In what follows, I outline the theory of efficient provision of transportation, describe how public–private provision in the United States has evolved historically, and summarize the salient features of the current system. I then survey the empirical literature on the public sector’s performance, which indicates that our hugely important transportation system has been compromised by policies that have resulted in inefficient pricing, suboptimal investments, and inflated production costs that are manifested in congestion, delays, budget deficits, and excessive money and time costs to users and excessive government expenditures on transportation.

The hundreds of billions of dollars in welfare costs motivate either improving public provision or expanding the role of the private sector. I point out that political forces and limitations of transportation agencies strongly contribute to inefficient policies and, in my view, constrain efficient improvements in public provision. Thus, for example, policymakers have called for a significant increase in spending on the nation’s transportation infrastructure, but they have not considered how inefficient pricing policies have prevented travelers and shippers from making efficient use of existing infrastructure and how mispricing has distorted signals for investments in new capacity.

An alternative policy—privatization and deregulation—calls for fundamental institutional change to rid the system of its shortcomings that are attributable to current government policies and to rely on market competition to allocate transportation resources efficiently. Theoretical arguments and empirical evidence based on international experiences and simulations of the effects of privatizing certain parts of the U.S. system provide some support for this approach but they do not resolve all of the important uncertainties about its effects in practice. I therefore call for modest, localized experiments that would give economists and other analysts the opportunity to develop crucial empirical evidence based on actual U.S. experiences to help guide policymakers’ decisions on what parts of the transportation system, if any, should be privatized and deregulated to improve its performance.

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• On the Performance of the U.S. Transportation System: Caution Ahead

     

 

 

In the aftermath of last month’s air traffic control fiasco, many people are probably wondering how there could be a budget pinch since travelers pay for air traffic control every time they buy an airline ticket. Current fees amount to a 7.5% ticket tax per flight and $3.90 per flight segment, which generates some $10 billion in annual revenues. Assuming that user fees fund the service, it made no sense that the sequester would affect air traffic control. But that assumption is wrong.

What Americans experienced in April was a classic example of how federal transportation deficits can reduce the nation’s productivity. Millions of man-hours were wasted on planes that were delayed, and hundreds of thousands of travelers postponed or canceled trips that generate work for people at their destinations. Unfortunately, the United States will experience more costly disruptions to its transportation system unless its deficits are curbed by efficient policy reforms or by privatization.

Travelers’ user fees do not bear a close relationship to an aircraft’s contribution to the cost of air traffic control. Why? Because there is no variation in price for airspace congestion that increases traffic control’s workload. The gap between passengers’ user fees and the cost of air traffic control is even greater for unscheduled general aviation (corporate jets and other private flights). General aviation causes unpredictable peaks in demand for airspace, and their preferred altitude approaches create additional complexity and cost for controllers. Overall, revenues from user fees do not cover costs, and the difference is covered by a subsidy from the general federal fund.

The Federal Aviation Administration has been unable to figure out the real costs of air traffic control services and thus has underpriced it since its founding in 1958 as the Federal Aviation Agency. The inadequacy of the ticket tax to cover costs over time has been compounded by the intensity of airline competition that has driven down real airline fares. The costs of air traffic control also have undoubtedly been inflated by the delays and cost overruns attributable to the FAA’s inability to adopt new technology to upgrade and modernize the system. The long-anticipated next generation satellite-based air traffic control system, known as NextGen, is billions over budget and years behind schedule. It may need to be renamed PastGen at the rate of its deployment.

FAA’s involvement with public airports is also characterized by pricing and cost inefficiencies. The charge that an aircraft pays public airports to land—they are not charged to take off—is based on weight and generally does not vary by time of day. But the time at which an airplane lands clearly affects airport congestion and an airport’s capacity to reduce delays. Building new runways has turned into multiyear projects with a price tag in the billions of dollars due to various regulations that can take decades to meet, especially Environmental Protection Agency environmental impact standards.

As part of a federal agency that depends on taxpayer funds to cover a deficit caused by its inefficiencies, air traffic control is at the mercy of Congress. So when the sequester hit, the FAA’s already troubled budget was cut—including funding for air traffic control.

To be sure, the 10% cut in air traffic control was politically efficient from the White House’s perspective, because it delayed more than one-third of all flights and drew the immediate attention of the public and Congress. But FAA’s pricing and operating inefficiencies led to the deficits that rendered air traffic control operations subject to manipulation.

Air traffic control is not an isolated case. Evidence in my forthcoming Journal of Economic Literature paper indicates that the nation’s highways, ports, urban bus and rail transit systems are also characterized by prices that are below costs and by inefficiencies that inflate operating costs, which have resulted in large and growing budget deficits that make those services vulnerable to politics. Cuts in their funding could adversely affect the nation’s productivity by, among other things, increasing commuting and shipping delays.

One way to insulate the nation’s transportation system from the threat of costly political shocks is to efficiently reform its pricing policies so services are financially supported by real, cost-based user charges. Alternatively, the U.S. could follow the lead of countries such as Canada, England, Australia and New Zealand and explore privatizing its transportation services.

All of America’s transportation modes and infrastructure services were initially developed and operated by the private sector. Over the past centuries, they were brought into the public sector by financial crises—some that the government arguably helped create by interfering in the market. Now that the government’s political crises are becoming ever more disruptive, it may be time to return the transportation system back to where it started.

     

 

 

A crisis is a terrible thing to waste, so the saying goes. So is a mind – a keen scholarly legal mind. Fewer students seem to be interested in entering law school as can be seen by the 50% decline in applications. But the crisis in legal education may have a silver lining: as most law schools are cutting their student enrollments, Chicago, Vanderbilt, and Yale law schools are attracting students to new legal doctoral programs. Despite what one might think, PhD lawyers could be a good thing for the economy: they will be trained to produce research that could help eliminate costly inefficiencies caused by public policies—ironically, especially those that increase the demand for lawyers. Indeed, if economics research is correct that an economy’s growth slows as more lawyers comprise its workforce, then the payoff from such research could be substantial.

Last year, the University of Chicago established the Coase-Sandor Institute for Law and Economics and is currently developing a joint J.D./Ph.D. in law and economics. Vanderbilt Law School will welcome students to its new Ph.D. program in law and economics in 2014. And this fall, Yale Law School will welcome students to its new Ph.D. program in law. Other major law schools are likely to follow, offering similar doctoral programs in the coming years.

Law is at the core of public policy and indeed is the bedrock of democratic government; thus, doctoral programs in law will require graduates to apply analytical tools that produce original contributions to knowledge about the causes and effects of a vast array of public policies. As a result, these newly minted PhDs will develop powerful, empirically testable findings that could significantly benefit society by maximizing the benefits and reducing the costs of government intervention in our economics lives.

Since the late 1950s and early 1960s, when faculty at Chicago and Harvard first used quantitative methods to analyze whether economic regulations of various industries were having their intended effects of controlling monopoly pricing, scholars have assessed countless public policies. However, we have little knowledge of the quantitative—and even qualitative—effects of many important policies, especially those where lawyers may benefit at the expense of society at large. Those laws and regulations would therefore be ripe for analysis by law doctoral students due to their in-depth knowledge of the legal system and the various roles that lawyers play in it.

For example, lawyers are central to the resolution of intellectual property disputes. Indeed, lawyers are routinely called upon to write patent applications because applicant companies know that the validity of most patents will eventually be determined in a federal court. While lawyers benefit from a patent system that generates demand for their services, there is little evidence on whether the lawyer-rich patent system provides benefits that outweigh its costs.

There’s also America’s expensive liability system. Lawyers are generally paid on a contingency-fee basis, and because the cost of defending a suit is high, defendants often pay the plaintiffs (and their lawyers) to settle before trial. The cost of the U.S. tort system has been estimated by Towers Perrin to be at least two percent of GDP, but there is little evidence on whether the benefits of this system exceed its cost. Thus policymakers have little guidance on how the system should be reformed to reduce its costs without compromising any incentives it may provide for individuals and firms to behave in a socially desirable manner.

Another example: financial regulation reform in the wake of the Great Recession. Highly-paid lawyers representing various interests have engaged intensely with federal regulatory agencies to shape the implementation of the Dodd-Frank Act. Unfortunately, little scholarly knowledge is available to guide how, if at all, financial regulation should be reformed and how best to prevent a repeat of the events that led to the financial crisis. As a result, the merits of the Act are being strongly questioned and certain policymakers and industry executives are calling for its repeal even before it is fully implemented.

Finally, reform of health care has emerged as one of the most important policy issues of our time. And while research has yet to find a “magic bullet” to lower the costs of the health-care delivery system without significantly reducing the quality of care, lawyers are fully engaged in opposing any measures that would limit their fees or impose caps on damages in medical malpractice cases.

Graduates and faculty of the new doctoral programs in law have an opportunity to fill many gaps in our understanding of the effects of policies that are at the center of their expertise and to explain how the symbiotic relationship between private-sector lawyers and policymakers, who often come from legal backgrounds, have adversely affected policy outcomes.

If lawyers are truly a drag on the nation’s growth in the course of influencing and benefiting from inefficient public policies, then doctoral programs in law have come at just the right time.

     

 

 

Introduction

In a 1995 book, The Evolution of the Airline Industry, Steven A. Morrison and I assessed the effects of various hypothetical changes in airline competition on air travelers’ fares. An extreme scenario that we considered was that Alaska, Continental, America West, Northwest, TWA, and USAir exited the industry, leaving Southwest, United, American, and Delta as the only major carriers in the U.S. domestic market. At the time, we thought this large scale exit would be a tremendous shock to industry competition—note, we did not assume that the carriers exited by merging with other carriers. We found, however, that fares increased modestly, about 8 percent, which preserved most of the decline in fares due to deregulation. We attributed our finding to the ability of Southwest to enter additional markets and discipline fares.

Today, this extreme scenario no longer seems so extreme because if American’s proposed merger with US Airways is approved, then, with the exception of Alaska, all the carriers that we assumed would exit the industry would have done so. My testimony provides some perspective on this scenario, indicates why its effects on fares would differ from the prediction that we reported in our book, and assesses U.S. airlines’ merger activity in the broader context of the industry’s eventual evolution to a highly competitive, global airline industry.

The Scenario and Reality

The scenario we posited in our book differs from an actual post American-US Airways merger environment because we assumed that carriers would simply exit the industry and would not merge and because we accounted for competition among only four remaining carriers.

In our scenario, when a carrier was assumed to exit a market, all of its assets exited with it. This assumption ignored the potential benefits of a merger and overstated the exiting carrier’s effect in raising fares because its assets could have been put to more effective use if that carrier merged with another carrier, thereby creating a more efficient competitor. Indeed, retrospective empirical assessments of airline mergers have generally found that the presence of a merged air carrier in a market does not lead to higher fares. At the same time, travelers benefit from the merged carrier’s more extensive network and from more opportunities to use frequent flier miles.

Our scenario also did not account for the fact that in addition to American, Delta, United, and Southwest, the carriers that would still compete in the industry include Alaska, JetBlue, Spirit, Frontier, Virgin America, Allegiant, and Hawaiian Air among others.

Accordingly, even though for the last decade or so the U.S. airline industry has been evolving in a way that is consistent with the extreme scenario in our book, as shown in Borenstein and Rose’s recent paper reporting U.S. airline industry operating characteristics through 2011, real yields have continued to decline since deregulation in 1978; real yields have been consistently below the Standard Industry Fare Level (SIFL) that was used by the Civil Aeronautics Board to determine regulated fares; low-cost carriers’ market share has steadily increased; route level concentration on hub and non-hub routes has stabilized during the past ten years; and the industry average load factor (the percentage of seats filled by paying passengers) has steadily increased. And, as reported in Tomer, Puentes, and Neal’s Brookings study, travel in U.S. international markets has more than doubled between 1990 and 2011 as U.S. carriers have taken advantage of open skies agreements to expand their international networks and increase flight frequency.

Similar to the mergers that preceded it, the merger of American Airlines and US Airways would preserve those positive long run trends. Carrier competition would continue to be intense and low-cost carriers would continue to put downward pressure on fares. Entry and exit would continue to be fluid in airline markets as a merged American and US Airways would optimize its network by exiting some routes and entering others, while other carriers would adjust their networks by entering some of the routes that American exited and exiting some of the routes that they entered. The merged American and US Airways would also strengthen its international network and benefit travelers by serving more foreign destinations.

In retrospect, the extreme scenario depicted in our book previewed a natural evolution of the industry in response to deregulation with the critical caveat that instead of completely exiting the industry, certain carriers have merged with others, which has enabled the industry’s capital stock to become more productive as, for example, merged carriers have been able to retire their least efficient aircraft more quickly and has enabled the merged carriers to strengthen their international networks.

Toward a Global Airline Industry

A proposed merger between large firms is often accompanied by concerns that the consolidation would reduce competition and raise prices. If policymakers are concerned that the proposed American-US Airways merger may have anti-competitive effects, notwithstanding any gains in operating efficiency, then an effective way to address those concerns, obtain the efficiency gains, and significantly benefit travelers would be to take steps to stimulate additional competition by creating a deregulated global airline industry.   

In fact, U.S. and foreign policymakers have already begun that process by negotiating open skies agreements, which give U.S. and foreign carriers the freedom to enter and set fares in U.S. international markets. As expected, air travelers have benefited. In a recent paper, Jia Yan and I estimated that the reduction in fares and increase in flight frequencies in markets that are governed by open skies agreements has raised travelers’ welfare $5 billion annually. If the United States negotiated agreements with foreign countries so that all U.S. international routes were governed by open skies, we estimate that travelers would gain an additional $5 billion annually.

The final step to create a highly competitive global airline industry would be for the United States to allow foreign airlines to serve U.S. domestic markets. (Other countries should also allow foreign carriers, including U.S. carriers, to serve their domestic markets.) Clearly, competition would be even more intense in U.S. markets and travelers would benefit from lower fares and service improvements if their choice of carriers were expanded to include discount carriers like Ryanair and global players like Qantas and British Airways. Such airlines have never posed a threat to national security or to the safety of air travelers.

Whether it was part of their grand design, U.S. carriers have been preparing for decades for a truly competitive global airline industry. As part of this process, they decided that mergers would help them develop more efficient operations and networks. No evidence exists to question the effectiveness of that strategy; hence, policymakers have been wise to allow consolidation to move forward and they should allow American Airlines and US Airways to continue the process. Policymakers should also accelerate the airline industry’s contribution to globalization by creating a truly competitive deregulated environment that would benefit travelers in the United States and throughout the world.

     

 

 

As the holiday season approaches, the major airlines are signaling to some passengers to take a hike. At least that’s what travelers might infer from the smaller number of flights being scheduled at many of the nation’s airports.

Between 2007 and 2012, airlines cut the number of domestic passenger flights by 14 percent, according to the Department of Transportation—with the biggest drops occurring at midsize and smaller regional airports. The five heartland hubs of Cincinnati, Cleveland, Memphis, Pittsburgh and St. Louis have lost a stunning 40 percent of their scheduled flights.

The reason is simple: airlines have decided that the best way to earn a healthy return on their investment is to maintain tight discipline on capacity. That’s a fancy way of saying they want their planes to fly as full as sardine cans. And the way they’ve been accomplishing this is by concentrating service on the big domestic and international markets and by cutting flights in smaller, less traveled ones.

That’s smart business, of course. Why expend the same dollars on jet fuel, pilots and Sun Chips on a flight that’s likely to leave half-empty from Memphis when you can trim the number of scheduled departures from the same airport and really pack them in on each flight?

But this, of course, leaves Aunt Sally in Sarasota, Fla., with fewer options to visit family during the holidays; it leaves millions of us with longer boarding and exiting delays on our planes — and, yes, it helps drive up fare prices, too. It’s that old rule of supply and demand. Travelocity, an online booking site, has found airline ticket prices for this pre-Thanksgiving period to be 10 percent higher on average than last year.

Unfortunately for travelers, this situation is unlikely to change anytime soon. With five airlines now serving 85 percent of the domestic market—four, if American Airlines and US Airways merge, as industry analysts expect—the major carriers are worrying less about the one factor that could disrupt their cozy, cram-’em-in strategy: competition.

That is, unless policy makers do what they should have done a long time ago and allow foreign airlines, including discount carriers like Ryanair and global players like Qantas and British Airways, to serve domestic routes in the United States. Why, after all, should an industry that has ingeniously used free-market principles to squeeze the most revenue out of each middle seat be protected from competing in a real free market?

As things stand now, the United States allows foreign airlines to serve its major cities as part of international agreements — conventions that have been around for decades. Foreign airlines have never posed a threat to national security or to the safety of air travelers; there’s no indication that such carriers have resisted American security measures in the past or any reason to think they’d violate any protocols required for domestic routes either.

Competition from foreign airlines would put downward pressure on wages, something that union workers may object to. But by reducing fares and expanding service, it would also increase the demand for air travel and related services — thus, presumably, creating additional jobs during a time of persistently high unemployment.

Airline travelers, in fact, have already benefited significantly from increased competition among international carriers. Beginning with a successful agreement with the Netherlands in 1992, the United States has pressed for liberal free-trade pacts, called “open skies” agreements, with several nations.

In collaboration with Jia Yan of Washington State University, I have estimated that travelers have gained at least $5 billion annually as a result of lower international fares and additional flights generated by open skies agreements.

By allowing foreign airlines to serve American domestic markets, the process of creating a truly free market in airline services here would be complete and, as in the case of international markets, would provide travelers the benefit of more flight choices and lower fares.

Naturally, domestic airlines are likely to oppose such a policy. But they should realize that their current strategy to maximize profits — reducing flights and raising fares — runs the danger of alienating the American flying public and spawning new regulation.

One possible solution is to take a half-step toward opening up domestic markets and allow foreign carriers to serve any midsize and regional airport in the United States that has lost service in the past few years. New entrants would be able to integrate those markets with their international routes, something that could put many smaller American cities on the global business map.

Soon, Aunt Sally might enjoy the service on Singapore Airlines en route to Cincinnati. It’s a short flight from Sarasota — but the hot face towels are a dream.

     

 

 

California's proposed bullet train between Los Angeles and San Francisco—which Gov. Jerry Brown is likely to sign off on soon—has been characterized by the Obama administration and its other supporters as an effective way to reduce highway congestion. These costs amount to more than $100 billion annually in wasted time and higher fuel expenses.

In fact, a much better technological solution is on the horizon, if we pave the way by getting rid of obsolete highway design. It is already possible to imagine a world in which you could predict exactly how long it would take to drive in your car from one point to another. No worries about rush hour, vacation congestion, bad drivers, speed traps and accidents. You could also text while you drive with no safety implications.

All this may be possible thanks to a "driverless" car that does a human driver's normal job and much more. The car is operated by a computer that obtains information 10 times per second from short-range transmitters on surrounding road conditions, including where other cars are and what they are doing.

That's exponentially faster than the human mind can process the same information. By gathering and reacting immediately to real-time information, the technology can drastically reduce highway fatalities by preventing collisions. It also can significantly reduce delays by creating a smoother traffic flow and rerouting drivers who have programmed their destinations.

Google's version is being piloted in Nevada, and it could prove that faster, reliable and safer road travel is within reach. But one stumbling block would remain: the government-run roads this innovation must use. Auto makers have made one technological improvement after another since the car was introduced to consumers more than a century ago. Unfortunately, the paved road systems on which cars travel have not advanced much in comparison. Without reimagining the way we design and maintain highways, the driverless car will achieve little of its potential.

Despite the frustratingly frequent lane closures for repairs, about one-third of the nation's highways are still in poor or mediocre condition. Driving on damaged roads is hard on vehicles and is estimated to cost motorists billions of dollars annually. Those potholes could also defeat the purpose of the driverless car because it would be unable to avoid them, or succeed in doing so only by significantly disturbing the traffic flow.

Most highways in major metropolitan areas operate under congested conditions during much of the day. Yet highways are designed around standards based on higher free-flow travel speeds that call for wider but fewer lanes. Driverless cars don't need the same wide lanes, which would allow highway authorities to reconfigure roads to allow travel speeds to be raised during peak travel periods. All that is needed would be illuminated lane dividers that can increase the number of lanes available. Driverless cars could take advantage of the extra lane capacity to reduce congestion and delays.

Another design flaw is that highways have been built in terms of width and thickness to accommodate both cars and trucks. The smaller volume of trucks should be handled with one or two wide lanes with a road surface about a foot thick, to withstand trucks' weight and axle pressure. But the much larger volume of cars—which apply much less axle pressure that damages pavement—need more and narrower lanes that are only a few inches thick.

Building highways that separate cars and trucks by directing them to lanes with the appropriate thickness would save taxpayers a bundle. It would also favor the technology of driverless cars because they would not have to distinguish between cars and trucks and to adjust speeds and positions accordingly.

Traffic management also suffers from obsolete technology that could hinder implementing the driverless car. On local streets, signal timing contributes to hundreds of millions of vehicle hours of annual delay because it is based on out-of-date historical data that inaccurately measure relative traffic volumes at intersections. Without signals based on real-time traffic flows, driverless vehicles may not be able to accurately align their speeds with them.

The future also holds the promise of new communications technologies that could let road authorities use electronic tolls to charge motorists for their contribution to congestion, based on actual traffic conditions, and thus encourage them to travel during off-peak periods, use alternate routes, or switch to public transit. Driverless cars would significantly help motorists respond to congestion tolls because their technology can balance the cost of a toll with its travel time savings to optimize motorists' route choices.

The driverless car represents one of the most amazing breakthroughs in safety and quality of life in recent history. Instead of focusing on enormously expensive high-speed rail as our transportation future, the government would do well to stop hindering driverless cars by its obsolete thinking about our nation's roads.

One promising approach that would not require taxpayer funds would be to turn to innovative private highway companies, which have leased the Indiana toll road, Chicago Skyway and Dulles Greenway. By working closely with auto makers, they could significantly shorten the time that motorists must wait before they fully realize the benefits of driverless technology.

     

 

 

On Monday night the century-old law firm of Dewey & LeBoeuf filed for bankruptcy—following in the footsteps of other venerable firms such as Howrey & Simon, Heller Ehrman, Coudert Brothers, and Brobeck, Phelger and Harrison. It is easy to think that greedy lawyers are getting their just desserts. But this should not blind us from seeing that there is a better way for America's law firms to do business.

The problems these firms face today are twofold: Large clients are increasingly using in-house counsel to reduce costs, and the public is increasingly taking the do-it-yourself route given the growing access to a variety of legal services and documents on the Internet. The rational response would be for new, low-cost legal firms to start up, and for incumbents to reduce costs and attract new clients by providing innovative services.

But that is happening only to a limited extent because of state licensing requirements and American Bar Association (ABA) rules. Deregulation could open the market and transform the legal industry for the better.

Regulatory barriers have hamstrung other sectors of the economy in the past until the arrival of deregulation. For example, Interstate Commerce Commission (ICC) regulations raised railroad rates for decades after its inception in 1887. But with the proliferation of motor vehicles, trucks began to capture a large share of rail freight traffic.

Then trucks were included under the ICC's regulatory umbrella in 1935, to prevent railroads' freight market share from continuing to erode. But by raising trucking rates, the ICC induced some shippers to buy and operate their own trucks, exacerbating rail's woes. Similarly, Civil Aeronautics Board regulations elevated airline fares, and by the late 1950s—when interstate highway travel was possible—the high fares limited the percentage of seats filled with paying passengers.

The deregulation of transportation that began during the late 1970s enabled motor, air and rail carriers to reduce costs and, particularly in the case of railroads and airlines, to regain market share by offering consumers lower prices and better service.

How have regulations caused the demise of long-established "white-shoe" law firms? Much legal work is performed by associates, who in most states must graduate from a law school accredited by the ABA and pass a state bar examination. This form of licensing significantly limits the flow of new legal practitioners. It also means would-be lawyers must make a substantial upfront educational investment in money and time that must be recouped in high salaries later.

Such salaries can be and are paid because licensing limits competition in the legal profession, and because partners derive much of their own inflated earnings from associates' work.

But when law firms are under pressure to reduce costs, it is difficult for the partners to significantly reduce their reliance on associates without severely affecting their ability to serve clients. Efforts to outsource some tasks have met with only limited success.

While law firms can and do get bank loans, ABA regulations prohibit banks, private-equity firms or other corporations from owning or having an ownership stake in a law firm. This limits a law firm's financing options and raises its capital costs. Dewey's collapse has been attributed to the firm being highly leveraged and unable to attract investment from businesses outside the legal profession.

Law firms are aware of the value that professional business managers can add to their operations. But regulations that prohibit the ownership of law firms by nonlawyers prevent those firms from fully realizing the value of managerial skills and oversight that professional management could bring.

Finally, because regulations prevent corporations from providing legal services other than their own legal counsel, a law firm today cannot realize efficiencies or make more money by merging with a firm outside the legal profession to provide financial and accounting services, for example, along with legal services.

Eliminating regulations on who may provide legal services and who may own and operate a law firm could result in substantial efficiencies. Deregulated firms and new legal entities could reduce costs by hiring a variety of people to provide legal services—some who have completed three years of law school and some who have not.

Such firms would be better positioned to explore the substitution of capital for labor—for example, by accelerating the use of sophisticated Web searches as a substitute for manual document searches, and by using other information technology to ensure that corporate clients comply with government regulations.

New firms not necessarily owned by lawyers would bring new ideas, new technologies, new talents, and new operating procedures into the practice of law. This process has certainly happened elsewhere, the way Freddie Laker and Southwest Airlines brought new operating efficiencies to the airline industry, or the way satellite and cable brought a multitude of new programming to a once-stagnant television industry controlled by three broadcast networks.

As legal fees fell and services improved and expanded, many corporate clients would begin to downsize their internal legal departments. They would go back to relying principally on outside legal help, much as shippers have returned to deregulated for-hire trucking companies and less-regulated railroads. American businesses would reap the economies of specialization and technical progress that a rejuvenated legal-services industry could provide.

     

 

 

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.