5.2: English law suffers from a type of ‘market failure’

So far, this report has set out the significant economic benefits that English law brings to the UK, outside the legal services sector, by serving as an essential infrastructure to facilitate transactions in the economy.

Similarly to other types of infrastructure, English law is likely to suffer from ‘market failure’—i.e. a situation where society as a whole can be made better off if provision is not entirely left to private parties within the market (see Box 5.1 for a more detailed explanation). This problem arises because once a private party makes an effort to promote English law, all English law users— including both the legal services sectors, the businesses they serve, and the wider UK economy—will benefit from that effort without having to pay for it. The problem of those who benefit from resources or services of a communal nature^[1]A resource or service of a communal nature is considered a public good if it satisfies two characteristics: non-rivalry (when a good is consumed, it does not reduce the amount available for others), … Continue reading but do not pay for them or under-pay is called the ‘free-rider’ problem.

Box 5.1. The economics of ‘market failure’

Source: Oxera

Another way to look at the market failure that English law exhibits is that there is a positive externality coming from the use of English law—i.e. the benefits enjoyed by the wider UK economy from English law are beyond the benefits for the UK legal services sector.

A free market that works efficiently is expected to result in an optimal level of investment where the marginal cost of the investment equals its marginal benefit for all users. However, due to this positive externality, no private party—in this case, either within or outside the legal services sector—can capture all of the benefits enjoyed by the whole UK economy from the promotion of English law. Indeed, as the legal services sector receives only a part of the benefits generated by English law, the optimal level of investment made by that sector would be likely to fall short of the total benefits. This would then lead to an ‘under-provision’ of English law compared to the outcome without this market failure—i.e. the socially optimal level of investment that is consistent with all of the benefits English law brings to the UK economy.^[2]Superficially, this free-rider problem as described in the case of English law has some similarity with the ‘tragedy of the commons’ concept. However, there are important differences between the … Continue reading)

This ‘under-provision’ problem is particularly relevant when there is large upfront investment required from a private company. The lack of incentives from the free market means that there is economic inefficiency—i.e. investments are not made even when the wider social marginal benefits exceed the marginal cost of the investments.

The economic inefficiency exists here because without sufficient investments to maintain and promote English law, some transactions may move away from English law to other governing laws, reducing the economic benefits that English law can bring to the UK. Perhaps more importantly, increased ‘efficiency’ would allow the UK economy to realise more fully the potential value that is on offer from further opportunities for English law (such as those described in section 4.4).