A Lose-Lose Proposition

By Matthew D. Mitchell

Do you need a plumber? A door repairman? How about advice on new throw pillows for your apartment? Where will you turn to find the best service providers in your area? A new National Bureau of Economic Research (NBER) study finds that while you are likely to rely on a number of signals of quality, an occupational license is unlikely to be among them. This is merely the latest evidence that a widespread and undoubtedly costly practice is also ineffective.

According to the NBER researchers, “Consumers care about online reviews and prices” and “appear to pay little attention to licensing.” To reach this conclusion, they examined data from an online platform for home improvement projects and found that price, customer reviews, and recommendations all factor into consumer decisions. Fewer than 1 percent of those surveyed listed licensing as a primary reason for hiring a contractor.

In many industries, licensing is a legal barrier to entry for workers: no license, no job. Over 1,000 professions are licensed nationwide and each state licenses dozens of professions—everything from building contractor to cosmetologist. It’s often argued that licensing is necessary because of a market failure known as “asymmetric information.” Producers know their own quality, the thinking goes, but consumers cannot easily tell for themselves whether someone is qualified to provide a certain service.

So some say it’s better to just weed out the unqualified providers before they can open up shop. Adam Smith, the father of modern economics disagreed:

"The patrimony of a poor man lies in the strength and dexterity of his hands; and to hinder him from employing this strength and dexterity in what manner he thinks proper without injury to his neighbor, is a plain violation of this most sacred property. It is a manifest encroachment upon the just liberty both of the workman, and of those who might be disposed to employ him. As it hinders the one from working at what he thinks proper, so it hinders the others from employing whom they think proper."

Although licensing predates Smith, it has only become widespread in the United States in the past few decades. In 1950, for instance, only 5 percent of US workers needed licenses to do their jobs. Now nearly 30 percent must have one. This is unfortunate because the balance of academic research suggests that while licensure does not improve consumer welfare (in terms of price, quantity, or quality), it does harm some particularly vulnerable populations. The good news is that there are ways to protect consumers and improve the quality of goods and services without creating the kinds of unfair barriers to employment that come with licensure.

Price and Quantity

Licensure is a barrier to entry for new workers. According to an Institute for Justice analysis, among 102 low- to moderate-income occupations, the average license requires a $267 fee, one exam, and nearly one year of education. The educational requirement can cost aspiring workers thousands of dollars in direct expenses and tens of thousands in lost income while they spend months in often-useless training instead of earning a living.

Since licensure is costly and time consuming, some workers never make the jump to more lucrative careers. As a result, there are fewer barbers, interior designers, florists, and members of many other professions. The lack of these professionals can create problems not just for workers, but for consumers seeking services, because it can raise prices.

As in most markets, the price and quantity of a service tend to gravitate toward the point where supply and demand intersect. But if there are barriers to entry (such as a requirement to spend six years in training) supply will be restrained and prices will tend to be higher.

These effects don’t just happen on paper. Decades of empirical research show that, just as the theory predicts, licensure raises prices. One study of nurse practitioners finds that stricter licensing is associated with child checkups that are 3 to 16 percent more expensive. Another paper looks at dental hygienists and dental assistants and finds that stricter licensure is associated with 7 to 11 percent more expensive dental visits. Another finds that optometry licensing is associated with 5 to 13 percent more expensive eye care.

Outside of the healthcare field, a study of cosmetologists finds that stricter licensing increases beauty shop prices by 19 percent and decreases the frequency of visits by 14 percent.

Among 19 studies reviewed by scholars at the Mercatus Center at George Mason University, all 19 found evidence that licensure is associated with higher prices. The authors of an Obama administration review reached the same conclusion, writing that “the evidence on licensing’s effects on prices is unequivocal.”

Quality

Some—though by no means all—consumers might be willing to pay these higher prices if it were to mean that the service is of higher quality. Of course, many consumers, especially those with lower incomes, would prefer to pay a lower price for a lower-quality product or service (otherwise, no one would buy used cars or paper plates). And for those consumers who are priced out of a market, it makes no difference whether the quality is improved or not.

According to the advocates of licensure, the process ensures quality in a number of different ways: First, state training, testing, and educational requirements equip providers with the knowledge and expertise to competently perform their jobs. Second, these often-difficult steps weed out low-quality providers. And third, because unhappy patrons can complain to the licensing board, which can then take disciplinary actions, the licensing system creates a quality-assurance process.

In and of itself, there is nothing wrong with this reasoning, especially if regulators were to behave as we all want them to. The problem is that there are other well-supported reasons to believe that licensure might do the opposite and lower quality.

First and foremost, as previously mentioned, the costs and time spent on licensing tend to reduce the number of providers, which in turn reduces competition. Both price theory and experimental evidence suggest that when competition is restricted, quality suffers. Moreover, when providers are sheltered from competition, they tend to be less attentive to cost containment or to customer desires, a phenomenon known as “x-inefficiency.”

Second, because licensure tends to raise prices and to limit the number of service providers, it makes customers more likely to either forgo the service altogether, or to attempt jobs themselves. For example, one early study finds that more stringent licensure of electricians is associated with fewer electricians per capita, greater evidence that homeowners were doing their own electrical work, and—alarmingly—more accidental electrocutions.

So what does the balance of evidence suggest? A majority of 28 studies from the past several decades that we looked at find that licensure has an unclear, mixed, or neutral impact on quality. Of those that do find a clear effect on quality, nearly three times as many find that the impact is negative rather than positive.

Source: https://www.mercatus.org/system/files/figure_1_sources.pdf

Disparate Impact

Even though all potential workers aiming to enter a licensed field face the same requirements, occupational licensure tends to affect certain populations more than others. It is a particularly steep barrier to employment for lower-skilled, lower-educated groups; to immigrants; to non-English speakers; to those with criminal records; and to those who move frequently, such as military spouses. Four of six studies we reviewed find that licensure has a negative, disparate impact on ethnic minorities.

Source: https://www.mercatus.org/system/files/figure_2_sources.pdf

See source belowFor lower-skilled, lower-educated individuals, a low-paying job can be an ideal entry-level position. Work as a barber, landscaper, tree trimmer, childcare provider, or bus driver provides excellent opportunities for people from disadvantaged backgrounds trying to enter the workforce. However, burdensome licensing restrictions make it especially difficult for people with relatively few resources to enter these lines of work, especially considering the education requirements and fees.

Licensure also makes it difficult for immigrants to start working because rules often require domestic experience, ignoring relevant training and experience from outside of the United States. Likewise, licensure can make it much harder for people with past convictions to find work, as about half of the states give licensing boards broad leeway to bar the licensure of those deemed to lack “good character” owing to criminal records, even if the conviction occurred long ago and isn’t relevant to the license. Indeed, the Council of State Governments Justice Center estimates that nationally about 15,000 laws and regulations limit the ability of ex-offenders to obtain state occupational licenses. Among these, 6,000 are blanket or mandatory restrictions.

Another problem with licenses is that they are rarely portable across state lines. This presents a particular obstacle to military spouses, as about 35 percent of these workers are in licensed professions and they are about 10 times more likely than the typical worker to move across state lines. This is one explanation for the high unemployment rate among this population.

In general, when people can’t freely move across state lines and work, it generates inefficiency in the economy. It keeps people from moving to where they are most productive and keeps them from responding to changing economic conditions. An NBER study of 22 licensed occupations found that between-state migration of licensed workers is about 36 percent lower than that of members of other professions.

How Does Licensing Endure?

If licensure clearly raises prices and limits access to services, fails to improve (and may even hamper) quality, and has a disparate impact on vulnerable groups, then why does it persist?

The subfield of economics known as public choice offers some guidance. This field examines the incentives of public decision makers, including elected politicians, bureaucrats, voters, and interest group activists. One of its most important findings is that policymakers will tend to concentrate benefits on small, highly organized groups while spreading the costs out across large and unorganized groups.

That, in fact, seems to be the case with licensure. By limiting competition and raising prices, it benefits well-organized industry insiders at the expense of their would-be competitors and unorganized consumers.

Public choice scholars have long documented the ways in which regulatory bodies tend to act in the interests of the very industries and professions they oversee. One reason for this is that regulators often rely on industry insiders for information since those insiders are often familiar with the technical aspects and governing laws of their professions. This gives them a great advantage in influencing board decisions.

The simplest way for an industry insider to control a licensing board, however, is to sit on the board itself. Nationally, about 85 percent of all occupational licensure boards are dominated by members of the professions they oversee. From these perches, industry members can control entry into their professions, placing limits on competition.

They can also perpetuate the licensure system. Whenever a state legislature considers reform, industry groups line up to testify, imploring policymakers to maintain licensure. And where licensure doesn’t exist, it is typically industry insiders who call for it. In Minnesota, for example, music therapists recently asked officials to license their profession.

Often, established professionals attempt to avoid any new restrictions placed on their newer competitors through “grandfather” clauses that allow existing practitioners to continue without completing licensing requirements. Furthermore, there is evidence that boards fail to actively examine existing licensees’ quality and skill, instead scrutinizing new entrants to the profession.

If Not Licensure, Then What?

The annual costs of licensure are immense. Economists Morris Kleiner and Evgeny Vorotnikov estimate that each year licensure costs the US economy between 1.8 and 1.9 million jobs, results in between $6.2 billion and $7.1 billion in lost output, and leads to a misallocation of resources of between $183.9 billion and $197.3 billion.

In the absence of licensure, what could society do protect consumers? Plenty.

A vast web of both public and private mechanisms govern quality in service markets. As the new NBER study suggests, consumers already favor these mechanisms over licensure, preferring more reliable measures such as consumer ratings. Beyond these, there are private certifications offered by organizations such as Angie’s List and the Better Business Bureau. Insurers incentivize quality by charging higher premiums to providers who are prone to negligence. Social media can also be a powerful regulator, as one unhappy consumer can broadcast frustrations far and wide. And as Adam Smith recognized more than two centuries ago, employers have a strong incentive to employ the best workers they can.

The Institute for Justice has long advocated for policymakers to consider these and other less restrictive means of regulation as alternatives to licensure. But reform is not easy. Industry insiders are quick to mobilize for the status quo, which is perhaps the strongest empirical evidence that licensure protects industry more than it does consumers.

Though special interests have an advantage, history suggests that sometimes broader, less organized groups (such as low-income workers or the general public) are able to prevail in policy reforms. Many states are already drawing on these lessons to reduce the burden of licensure. To see what they are doing, check out Matt’s recent testimony in Ohio.