The central focus of economic analysis of markets is the activity of profit-maximizing business firms in unregulated competitive markets; and such firms are indeed the central players on the supply side of markets in a free-market economy. Analysis of profit maximization is complicated by the fact that large business firms are complex organizations, and persons who compose such a firm, ranging from shareholders to rank and file workers, have conflicting incentives which can blunt profit maximization to an extent. Competition is itself a complex activity, and firms often find it more profitable to collude in price and concentrate on product competition instead. There are also nonprofit enterprises and government producers to complicate the picture.
An important though it seems a diminishing example of a service provider that deviates from the standard model of a profit-maximizing competitive firm is a professional organization such as a law firm or a medical practice. Professionals include besides lawyers and doctors architects, nurses, teachers, engineers, clergy, and military officers (the list is not example), and they constitute an important segment of the economy; there are, for example, a million lawyers and more than 700,000 doctors.
Law and medicine are the oldest professions (other than clergy), the most prestigious and highly remunerated, the most influential, and the most discussed, praised, and criticized. They are also changing at a rapid rate—and in fact changing from professions to businesses, although the change may be reversed in the case of medicine. (I can’t see that happening in law.)
The traditional concept of the profession (the concept that is undergoing change) provides an interesting contrast to the concept of the profit-maximizing business firm. In the business model, the goal is profit maximization in a competitive environment that operates in a basically Darwinian fashion (survival of the fittest); risk is pervasive and both extraordinary profits and devastating losses are real possibilities. Employment and leadership in such an environment attract many and repel many. The people it attracts tend to be aggressive and daring. The ones it repel tend to be cautious and thoughtful.
In the traditional professional model, risk both upside and downside is trimmed by a combination of regulation and ethics both aimed at muting competition. With muted competition the lawyer or doctor can realistically aspire to a safe upper-middle-class income, but he is unlikely to become wealthy. The result, in combination with requiring postgraduate education and qualifying exams for entry into the profession and subjecting members of it to professional discipline, is to attract a type of person quite different from the entrepreneurial type—the latter a type exemplified by such extraordinarily successful college drop-outs as Bill Gates, Steve Jobs, and Mark Zuckerberg. The professional model attracts a more studious, intellectual, risk-averse type of person.
Why does society value such persons and create a comfortable niche for them? The answer is that some goods and services involve a degree of complexity that makes it very difficult for consumers to evaluate the quality of the goods and services. Legal services and medical treatment are important examples. Both involve considerable uncertainty (even the best lawyer loses some cases, even the best doctor fails to cure some patients). When a consumer is unable to determine the quality of a product or service, the provider has to be regulated, either directly as in the case of the regulation of the drug industry by the Food and Drug Administration or indirectly as in the professional model, in which the conditions for becoming a member of a profession encourage self-selection by persons likely to be trustworthy, responsible, and ethical because less inclined to cut corners in order to make a killing.
The professional model in law began to wane in the 1970s, with the beginning of the deregulation movement, which loosened restrictions on competition in legal services. The trend continued in subsequent decades, and was marked by an increased spread in earnings within law firms, an increased dispersion in the size of law firms, and increased turnover—in particular, the tendency of successful lawyers to move from firm to firm (taking their clients with them) in quest of higher incomes. Today, law firms closely resemble business firms. I am speaking mainly of law firms that handle corporate business, not of criminal or tort lawyers, who tend to practice by themselves or in small firms.
Corporate lawyers today don’t want just a comfortable upper-middle-class income; they want to be rich; and one reason is the increased risk they face. Few law firms (remember that I’m talking only about corporate-law firms) any more practice “lockstep” compensation, in which all partners of the same vintage in a firm are paid the same—a risk-minimizing method of compensation that used to be the norm in large law firms. Today a lawyer faces the risk, if his productivity declines, of seeing his income decline, or indeed of being pushed out of the firm altogether; and to cushion that risk, naturally he wants to earn as much as he can while he can.
Once the legal and ethical limits on lawyer competition are relaxed, the underlying riskiness of law firm practice is unchained. That riskiness lies in the fact that, like banks though less dramatically, law firms’ capital is short term but their assets are long term. The principal capital is human capital—the most successful partners and their clients—and that capital is short term; a partner can leave the firm, clients in tow, with little or no notice. This can cause a run on the firm, as happened in the collapse of the previously very successful Dewey LeBoeuf firm, because its assets, including its accounts receivable and future clients (corresponding to a bank’s loans), cannot be liquidated at a moment’s notice to match the firm’s assets to its shrinking capital and its fixed debt.
The market response to the transition of the legal services industry from a profession to a business has been increased vigilance by corporate house counsel, who are expert monitors of legal services, and a related trend toward business firms’ bringing legal business in house, where direct supervision of the lawyers handling it is feasible. Are these adequate substitutes for the ethical and regulatory restraints that define a profession? And if not are the costs offset by increased competitiveness? I don’t know the answer to the first question, but I am skeptical with regard to the second. Even if the business model is more efficient, it is unclear that efficiency in corporate law is a public good. The reason is the adversary nature of corporate law, not only in litigation but also in negotiation of deals, structuring of transactions, and coping with regulation. If there are good lawyers on both sides of a case, the aggregate costs of litigation are higher, and the benefits to judge and jury of a more vigorous and informed adversary process generally quite modest. If private lawyers with a regulatory practice are abler, the regulatory agency needs to hire abler lawyers, and so the cost of regulation increases, though there may be a net gain in the quality of regulation. And do abler lawyer on both sides of a deal negotiate a better deal in a social sense, or simply increase the costs of negotiation?
Turning briefly to medicine, about which I know less: When I was growing up in the 1950s, doctors constituted a highly respected profession, though their capabilities were distinctly inferior to what they are today, after more than half a a century of remarkable progress in medical technology. Like lawyers, doctors in the old could realistically aspire to a comfortable income but not to become wealthy.
Opportunities for wealth developed, not because of significant changes in regulation, as far as I’m aware, but because of the rise of costly though effective specialized treatments and because of the increased availability and generosity of private and governmental health insurance. Most doctors in the old days were general practitioners, or at the higher end specialists in internal medicine, but really they were generalists too; like general practitioners they both diagnosed and treated. With increased specialization, treatment for the rare, complex, debilitating, or lethal diseases gravitated from general practitioners to specialists in particular fields of medicine. These specialists were understood to “deserve” higher incomes because of their more protracted medical education. Moreover, health insurers are more comfortable reimbursing procedures than visits to a general practitioner, because the optimal length of such a visit is impossible to gauge.
As a result specialists now outnumber general practitioners and some specialists, if able through automation or staff to treat a large number of patients in a short span of time, have extremely high incomes. And yet, since medicine more than law has as a career a powerful appeal to a relatively large number of able people, including many foreigners who would be eager to relocate to the United States (in fact a significant fraction of our doctors are foreign-trained), one can imagine a medical system in which doctors were paid somewhat less than they are today yet would be content. This would be some form of “socialized medicine,” such as found in much of the developed world, and it may prove to be the direction of reform of our much-criticized health-care system.
In sum, the professional model is giving way in corporate law to a business model, whether for good or ill, though quite possibly the latter. The professional model is endangered in medicine as well, but there it may actually be on the verge of renewed vitality.