Simplicity, complexity and variability of legal rules

In addition to pure rent-seeking considerations, another important source of legal costs comes from their complexity and variability. According to this view, the legal system does not create costs because of redistribution. Instead, it is merely the time and effort spent complying with the sheer volume of laws that creates costs, as well as the effort that must be expended when rules are changed.

Quandt (1983) develops a simple model of the welfare effects of complexity and variability of regulations, which we can modify and extend to legal rules. The basic approach is as follows. Suppose there are two types of firms, 1 and 2. Type 1 firms produce a good, the quantity of which (labelled Q ) is consumed. The industry is perfectly competitive. The consumer benefits are u(Q). The price of a unit of output is P. The good is produced with unskilled labour, which receives a wage rate of W. We assume for convenience that the good is produced in fixed proportions, so that Q units of labour produces Q units of output.

Type 2 firms supply legal compliance services, which is also a perfectly competitive market. Now add a crucial further assumption: for Type 1 firms, it takes one unit of labour and z = z(C,V) units of regulatory and legal compliance services to produce one unit of output, where C is a cardinal measure of the complexity of the law, and V is a measure of the variability of legal rules. Let p be the market price of compliance services. Regulatory and legal compliance services are produced with skilled labour, with one unit of skilled labour producing one unit of compliance services. Each unit of skilled labour receives a wage of w.

All else being equal, greater complexity and variability of laws and regulations means that to hire one additional unit of labour and produce an additional unit of output, a Type 1 firm must use more regulatory and legal compliance services. Therefore, we assume that C and V affect z positively, so that:

The competitive equilibrium in this model is straightforward to compute. Since both industries are perfectly competitive, price equals marginal cost in each. Marginal cost in the market for compliance services is w, so in the competitive equilibrium we must have:

Marginal cost in the output market is W + pz = W + wz(C, V), so we must have:

Consumers set marginal benefit equal to price, so the competitive equilibrium quantity obeys:

Let Q* = Q[W, w, z(C, V)] be the quantity that solves (11.29). We have:

From this, we can obtain the equilibrium quantity of legal and regulatory compliance services (and therefore of skilled labour). Recall that each unit of output requires z units of compliance services. Therefore, the quantity of regulatory and compliance services that is purchased in equilibrium is:

The welfare consequences of increasing C and V are fairly straightforward in this model. An marginal increase in legal complexity, for example, increases z, which increases the marginal cost of the Type 1 good, therefore increasing price and reducing welfare by:

A similar analysis applies to an increase in the variability of legal rules and regulations.

Predictions regarding the amount of activity and employment in the market for legal and regulatory compliance services are less straightforward, however. If, for example, C rises, then there are two opposing effects on overall activity in the market for legal services, Qz. On the one hand, z rises, which increases activity and employment in that industry. On the other hand, the increase in z reduces Q, as the above analysis showed. The total effect is given by:

If demand for good Q is inelastic (so that ? > -1), then d(Qz) > 0. An increase in the complexity or variability of legal rules and regulations reduces output of Q , thus increasing the consumer price P and reducing welfare. But activity in the market for compliance services expands.

Equation (11.30) shows that since < 0, expansion of activity and

employment in the market for compliance services can even occur if demand for good Q is elastic - as long as it is not too elastic. If activity in both markets is included as part of GDP, and if the demand function in the market for Q is linear (so that elasticity rises as activity falls as we move up the demand curve for Q), we would expect to observe an inverted 'U' relationship between economic activity and legal complexity and variability. This is again consistent with the argument and evidence presented by Magee (1992).

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