Yes, You Can Have Too Few Lawyers! A Quasi-Natural Experiment On the Effect of Lawyers, Yakuza and Zombie Firms on the Japanese Economy.

Anti-lawyer sentiment pervades modern popular culture: ‘What do you call a thousand lawyers chained together at the bottom of the ocean?’ asks the fictional character Andrew Beckett in the 1993 movie Philadelphia. ‘A good start’ is the reply. This negative sentiment reflects a view that lawyers engage in vexatious litigation and are rent seekers.

At the same time, many authors have emphasised the importance of strong institutions in generating economic growth. The idea that the rule of law, with protection for property rights and contracts, is desirable for economic growth is well established. How the size of the legal system affects growth in advanced economies has been a topic of debate amongst economists and lawyers for at least three decades. Scant attention has been paid to the possibility of a scarcity of lawyers in an advanced economy. Our paper 'Lawyers, yakuza and zombie firms: A quasi-natural experiment' addresses two related questions:  Is it possible for advanced economies to have too few lawyers? And what are the consequences of a scarcity of lawyers?

We use Japan as a case study as it offers a unique opportunity to design a quasi-natural experiment. Japan is an advanced economy that underwent a radical reform of its legal system in 2002, which led to a dramatic rise in the number of lawyers, with an effective doubling of numbers within a decade. The reforms gave appearance rights to judicial scriveners (shiho shoshi) and an increased rate of new attorney qualification. In addition, Japan is characterised by the availability of a well-established illegal system of dispute settlement supplied by the yakuza, ie a constellation of Mafia-like organisations that have been operating in the country for more than a century. Our analysis uses panel data regressions of the 47 prefectures of Japan to explain changes in the resolution of financial distress and reductions in the number of ‘zombie’ firms as well as reductions in crimes associated with yakuza involvement in civil dispute resolution.

Broadly speaking, there are three ways in which financial distress is resolved in Japan: (1) through litigation and renegotiation via lawyers as intermediaries; (2) through the extra-legal means of banks suspending transactions; and (3) through ‘dark side’ private ordering, with yakuza as intermediaries. The bursting of the ‘Bubble’ led to financial distress at banks, which together with structural changes in the role of notes payable in inter-firm credit, appears to have resulted in a steep decline in scenario (2), ie the suspension of bank transactions. The opposite trend is detected for the ‘dark side’ resolution of financial distress, with a sustained rise in the number of yakuza between 1997 and 2003. While yakuza may have resolved financial distress in some cases, in others it is likely that they extended financial distress and preyed on creditors and debtors. It seems likely that the threat of yakuza involvement contributed to the creation of ‘zombie’ firms.

The increase in new lawyers post-2002 leads to a statistically and economically significant rise in the dissolution and liquidation of firms and a reduction in the number of these loss-making ‘zombie’ firms, as well as a reduction in crimes associated with yakuza involvement in civil dispute resolution. This finding points to the close interrelation between the availability and effectiveness of legal, extra-legal and illegal forms of dispute resolution. The results are robust to alternative specifications including the financial health of banks, hitherto the primary explanatory factor in the creation of ‘zombie’ firms.

We believe that the results of this study have a wider application than just Japan. Firstly, this work supports moves towards the provision of more and cheaper legal services in advanced economies. Secondly, it clearly shows that the lack of legal services can have serious negative implications for the resolution of financial distress and the wider economy. Thirdly, it lends further support to the view that in countries with weaker institutions, when booms end, there may be a need for legal reforms to promote recovery. Finally, it gives insights into the role played by organised crime in civil disputes and shows that countries in transition with large organised crime sectors can shift to a new equilibrium without ‘dark side’ private ordering.

Paolo Campana is Lecturer in Criminology and Complex Networks at the Institute of Criminology, University of Cambridge. Ken Okamura is Lecturer in Finance at the Saïd Business School, University of Oxford.