David R. Henderson  

The Gains from Getting Rid of "Run Amok" Occupational Licensing

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In my discussion with Alan B. Krueger on NPR on Wednesday, I pointed out that governments in the United States hamper or prevent entry into many hundreds of occupations. I gave as an example the taxicab monopoly in Monterey and I pointed out that someone who wants to put a sign on his car and operate a cab can't legally do so without government permission and can't easily get permission.

Alan replied:

On some things, David and I do agree. I actually think occupational licensing is a bit run amok. I wouldn't want an unlicensed doctor to touch me. On the other hand, I think there are too many restrictions for entry. But I think that's a small part of the problems that we're facing.

After the show, I wondered why Alan thought that this is a small part of the problem. I recalled that an economist named Morris Kleiner had done some work in which he found occupational licensing to be a huge problem. So I did a search and found by an article by Kleiner titled, "Analyzing the Extent and Influence of Occupational Licensing on the Labor Market." It's NBER Working Paper 14979, May 2009. It's co-authored.

Remember when I said on NPR that about 800 occupations that are licensed? I remembered well. The working paper says, "Governments estimated that more than 800 occupations were licensed in at least one state."

This is from the abstract:

Estimates from the survey indicated that 35 percent of employees were either licensed or certified by the government, and that 29 percent were fully licensed. Another 3 percent stated that all who worked in their job would eventually be required to be certified or licensed, bringing the total that are or eventually must be licensed or certified by government to 38 percent. We find that licensing is associated with about 14 percent higher wages, but the effect of governmental certification on pay is much smaller. Licensing by multiple political jurisdictions is associated with the highest wage gains relative to only local licensing. Specific requirements by the government for a worker to enter an occupation, such as education level and long internships, are positively associated with wages. We find little association between licensing and the variance of wages, in contrast to unions. Overall, our results show that occupational licensing is an important labor market phenomenon that can be measured in labor force surveys.

So these authors are saying that occupational licensing is important.

Of course, they're not saying that it's important for the issue of income inequality. But let's do a back-of-the-envelope calculation.

If licensing causes pay to be about 14 percent higher, how would it do that? I think almost any economist, including the authors, would answer that it does so by restricting entry into those licensed occupations. Indeed, the authors state:

Some evidence suggests that licensing does restrict the supply of workers in regulated occupations. One application focuses on the comparison of occupations that are licensed in some states and not in others. The occupations examined were librarians (licensed in 19 states), respiratory therapists (licensed in 35 states), and dietitians and nutritionists (licensed in 36 states) from 1990 to 2000 using Census data (Kleiner, 2006). Using controls for state characteristics, the multivariate estimates showed that in the states where the occupations were unlicensed there was a 20 percent faster growth rate than in states that did license these occupations. Another study found that the imposition of greater licensing requirements for funeral directors is associated with fewer women holding jobs as funeral directors relative to men by 18 to 24 percent (Cathles, Harrington, and Krynski, 2009).

So what happens to the people who don't get into those occupations? The authors write:
The results of these wage equations are consistent with the interpretation that licensing policy enables the individuals in a licensed job to obtain a degree of monopoly control, or the ability to "fence out" competitors for a service, which results in increased wages for licensed workers.

These other workers presumably choose what they regard as a less-good option and that less-good option will typically pay less, often substantially less. This won't have much effect on the 1% vs. 99% issue, but it could certainly increase income inequality. You could have a plumber who is in the second from-highest plumber and the guy who didn't get to be a plumber being in the middle fifth. You could have a hair braider (an example they mention on page 6) kept out of that occupation by cosmetology barriers so that she is in the bottom fifth rather than the second-from-the bottom fifth. Etc.

With 29 percent of workers being in restricted occupations, that would amount to over 41 million workers earning higher wages. That's good news for them but bad news for two groups: consumers of those goods and services and people who are excluded from those occupations. If the laws kept the number of people in those occupations lower by even ten percent (which, along with a 14% higher wage, would imply an elasticity of demand of only 0.7), then 4 million people are worse off and possibly substantially worse off. With a higher elasticity of demand, you get an even bigger number of people who are worse off.

So, now that I've looked at it, I think Alan B. Krueger was wrong to minimize the effect of occupational licensing. The effect is potentially quite large.

Oh, and by the way, the name of the co-author of the Kleiner piece quoted above? Alan B. Krueger.



COMMENTS (20 to date)
nl7 writes:

Seldom is there occupational licensing whose main effect is to exclude the wealthy and connected but reward the poor or less educated. All of the typical hurdles are in the nature of work experience, no criminal history, formal education, and resources to pursue the licensing process (e.g. exams). All of which selects against poor people, particularly those people most desperate to find employment: convicted felons, unemployed, low skilled, or uneducated.

Some structures, such as a reservation or a caste system, might reserve economic opportunities to poor people while excluding the wealthy. Certain jobs might be ritually unpure, so functionally they all accrue to poor people, or jobs might be controlled by an ethnic/tribal authority within its area of operations. Neither of which purport to help customers or increase quality.

Licensing is not interesting to most economists, but it looms larger to people who have to go through it. It's just another obstacle, before you can get to the costs of locating work space, finding vendors, keeping accounts, paying taxes, withholding for your employees, following the relevant business regulations, suffering audits and inspections, litigation risks, etc. It makes it harder to start and maintain your own business, and offers virtually no appreciable benefit to anybody but your competitors.

Enterprise is an important inter-generational tool for wealth advancement. Lots of the richest families in the US stem from people who started businesses a few generations ago, maybe seeing it grow under a second generation. But even among average wealth families, a small business is a good way to support your family and move them into a better neighborhood and get your kids better educational opportunities.

Making it harder for people without resources or education to join occupations is akin to saying you wish fewer poor people entered that occupation.

MingoV writes:
I wouldn't want an unlicensed doctor to touch me.
I've been a licensed physician in five states. The licensing process does nothing but check the paper trail. Competence isn't assessed. I've run into far too many licensed physicians who were so incompetent that I wouldn't refer people I disliked to them. The same is true throughout the health care professions: nurses, medical technologists, x-ray technicians, pharmacists, pharmacologists, physical therapists, clinical psychologists, etc. Licensing is a way for the state to make money. In some cases (nursing is commonest), professionals lobby for higher qualifications (with their own lower qualifications grandfathered in) to reduce competition and drive up pay.

Since licensing doesn't guarantee quality, it has a negative value to the public: people wrongly think that a license correlates with quality. Licensing should be abolished.

Passing professional boards has a modest correlation with quality. The correlation is strongest when board certificates expire in less than ten years.

If medicine becomes more competitive (not likely for decades due to not enough physicians), it is likely that private quality assessment businesses could rate physicians who pay to participate. This would be superior to board exams, because it would be ongoing.

GabbyD writes:

I think he's refering to inequality.

its not clear how reducing barriers to entry would reduce inequality.

Daniel Klein writes:

Nice post. I agree with you, OL is a huge problem.

Just wanted to add that Krueger also weighed in on OL in NYTimes.

Michael Strong writes:

The role of government licensing in reducing innovation in services, and ipso facto the associated pay premia that would have resulted for the providers of such innovations, seems to be entirely invisible to economists. Innovation in service provision, when permitted, has often resulted in innovative technologies, institutions, and ultimately entirely new industries.

Suppose:

1. Innovation in activities involving human norms, interactions, and ways of doing things typically comes from young people (say, those below the age of 25).

2. Extensive university training acts as a filter that selects for those who accept the established norms of practice taught at the university (as well as the norms inherent in the university model itself).

3. The professional pathways that lead to appointments to government-approved licensing boards and standards-setting bureaucracies further select for those individuals whose attitudes towards licensing standards that are most conformist.

4. Therefore government licensing provides a legal barrier to entry that prevents young, "untrained" individuals and older renegades from obtaining the power to influence or change standards - and to reap the pay premia that might have resulted from such innovations.

The result is that the combination of sociological and legal factors tends to result in extremely conformist, rather than innovative, occupational licensing standards.

In light of this perspective on licensing, consider what would have happened if:

1. Musical performers could only have been licensed by the professional standards of 1850. Consumers would not have access to the diversity of music that they have today, and the vast majority of individuals making a living as professional musicians would not have the incomes or careers that they have today.

2. Theatrical entertainment had been controlled by the establishment professionals of 1900. Would the film industry have been allowed to come into being at all?

3. Software development had been controlled by the professional standards dictated by IBM in 1960. Perhaps they would have required a Masters degree based on "state of the art knowledge" in order to be allowed to develop software. Would Gates, Allen, Jobs, Wozniak, Kapor, etc. have been licensed to create their companies and, if they had forced themselves to jump through the hoops to do so, would they have been the same people who went on to create the same companies? I suspect the entire IT industry would be significantly less well developed and a significant fraction of Silicon Valley wealth creators since 1980 would not have created their companies nor their wealth.

In light of these thought experiments, I'm inclined to believe that the cost of occupational licensing is orders of magnitude larger than can be calculated using traditional economic tools. The most significant costs, to both consumers and producers of new services and new industries, are the invisible costs of restricting innovation. I believe that in long-licensed fields such as medicine, law, and education, these invisible costs are extremely high.

I speak as an educational innovator whose opportunities for innovation have been thwarted by licensing. Even though many states have no licensing requirements for private schools, the fact that roughly 90% of teaching careers are in public schools, combined with the fact that some states do require private school teachers to be licensed, creates a strong incentive for prospective teachers to seek licensing (and thereby undergo a state-mandated indoctrination process). Moreover, because the public school system acts as a dominant monopoly standard (much greater in scale than Microsoft's OS "monopoly" ever was), any non-standard approach to education faces inordinately high development costs and obstacles to adoption.

Occupational licensing provides a morally illegitimate "rent-seeking" pay premia to those who jump through the conformist hoops to obtain a government license. At the same time, it eliminates morally worthy pay premia that should be going to successful innovators that provide higher quality, lower cost, and more customized services had they been allowed to innovate. While we can't say what the net result is in terms of inequality, we do know that both innovators and those who might benefit from the services of such innovators are penalized by the current system. Insofar as creative destruction has typically improved the condition of the ordinary citizen to a greater degree than it has the wealthy citizen (think cheap cotton clothing, washing machines and cell phones for all), we can infer that the thwarting of this process in the realm of services has been more harmful to the ordinary person than it has been to the rich.

Lest someone respond with the notion that "services can't be scaled" consider again my hypothetical examples of occupational licensure freezing music production in 1850, theatrical entertainment in 1900, and software production in 1960. In each case immense industries have evolved based in part on innovations in the services themselves alongside innovations in technology that at times were driven by the innovations in the services themselves. We quite literally cannot imagine the path dependent innovations in law, medicine, and education involving integrations between technology and new ways to structure service provision that might have taken place in the absence of government mandated occupational licensure.

Eric Falkenstein writes:

This is why wisdom is different than knowledge. He acknowledges the detrimental effects of licensing. He thinks this is less important than minimum wage and other progressive initiatives. Indeed, I doubt he would broach the idea over several administrations, so it's hardly different than him saying he hates the idea in practice, though he is immune to criticism on that point.

I just think about all those entry level jobs being removed, and these are stepping stones. Make-shift taxis, hair cutters, child care, are great ways for many to learn discipline and other basic business skills they don't teach in school. Progressives look at all jobs like a guild, but while these are stable and predictable, and can create great things, they aren't dynamic and productive.

It's gotten way beyond ridiculous when the state is spending taxpayer money shutting down little girls' lemonade stands and cupcake businesses

Chloe Stirling may be young, but she's already developed serious culinary and small business skills. She began an enterprise, called “Hey, Cupcake!,” out of her family's kitchen two years ago. According to the St. Louis Post-Dispatch, the sixth grader earns around $200 a month selling her baked goods. Stirling hopes to use her income to one day open her own bakery. Her mother, Heather, also offered to match the money Stirling makes to buy a car when she turns 16. Additionally, “she has donated many to charitable events, including a fundraiser for a student with cancer and, most recently, taking some to residents at a senior care center,” writes the Belleville News-Democrat.

The desserts didn't sit well with the local government, though. The health department called Stirling's parents and demanded that the girl cease operations, because she was violating the Illinois State Food Service Code. Stirling lacked the necessary permit and the kitchen wasn't properly licensed.
"The guy told me I either had to buy her a bakery or put in a second kitchen (in the house),” Stirling's mother said.
Hazel Meade writes:

The way I was putting it to my boyfriend the other day was:
"You should be able to have a vegetable garden in your backyard, and a vegetable stand in your front yard, and anyone who wants to buy your vegetables should have the right to do so at their own risk. "

I cannot fathom how people cannot see how much economic opportunity is destroyed by preventing people from simply engaging in voluntary trade of whatever they can do that is productive.

On a side note:
As someone entering the market for their first home, I'm discovering how perverse the incentives are for first-time home-buyers. Unless you can put 20% down immediately, you are routed into a FHA 30 year mortgage at (at least) 5.5% interest, and told to put as little down as possible. Which seems perversely designed to prevent people in the lowest quintile from accumulating equity. You're basically renting your home from the bank at that point.


Andrew_FL writes:

@GabbyD- "I think that's a small part of the problems that we're facing."

He was clearly implying it's only a small part of more than one problem, indeed possibly one could read that as implying only a small part of every problem, not that it is a small part of one particular problem.

Nick writes:

Alan Krueger was saying that occupational licensing had 'run amok', not 'run a muck', as in: http://en.wikipedia.org/wiki/Running_amok.

GabbyD writes:

@Andrew_Fl

oh, i disagree on the interpretation. inequality creates (or surrounded by) problems(s). he thinks that Licensing is a small part of the problems (caused/accompanied by inequality)

thats why his soon after contribution is the "Wage distribution" which he claims is a major part/cause of inequality.

David R. Henderson writes:

@Nick,
Oops. Thanks. Correction made.

Alex writes:

I'm not a fan of state mandated licensing, which not only restricts entry but--importantly--also crowds out private solutions to the quality certification problem that would likely be superior.

However licensing requirements do have some connection to service quality. So the nature of the entry restriction is that lower quality providers tend to be excluded. I suspect this is why Krueger thinks the losses are small: quantity goes down, but average quality goes up, and the latter effect partially offsets the former. This is wrongheaded, of course. Consumers vary in their tastes for quality, and forcing someone to pay more for unwanted quality is a loss--potentially a big one. Those with a taste for high quality are only benefited if private solutions to quality certification would not otherwise emerge--a demonstrably false premise.

Mark V Anderson writes:

Actually the book I have by Kleiner (Licensing Occupation, 2006) says that most studies do not show an increase in quality for those with licenses. Does his latest book have a different result?

Andrew_FL writes:

@GabbyD-Well, if so, I'm afraid I must still fault him for phrasing what he meant to say poorly.

But neither you nor I know for sure what he meant to say, your interpretation is simply the most charitable one.

This is why people should strive for clarity in their words.

AS writes:

@Michael Strong, brilliant logic. You're right that traditional economic tools don't properly measure the unseen costs of lost innovation. Could it be because to become a licensed PhD economist, one has to learn so much math and statistics, they forget the most powerful tool of all: simple verbal logic.

It's ironic that the one profession that should be most opposed to licensing has its own licensing problem. And how much innovation has been suppressed? Most breakthroughs in economics came in the 18th, 19th and early 20th century from Adam Smith, Friedrich Hayek, Ronald Coase, et. al. I doubt these people would have even made it into a top graduate school today with the math requirements.

David R. Henderson writes:

@AS,
Like you, I found Michael Strong’s comment above powerful. One correction, though: economists are not licensed. I agree that the math hurdle keeps a lot of potentially good economists out. I’ve written about that before. But there is not licensing.

Ian Bertram writes:

The existence of state licensing schemes spills over into other areas. I came across a particularly ridiculous example the other day of a 'Certified Zentangle Teacher'. Zentangle in case you haven't come across it is basically dressed up doodling. The idea of being licensed to teach doodling leaves me almost speechless, but I wonder if it would even have been conceived without the wide spread of state sponsored licensing schemes.

I should add that here in the UK, although some professions are state licensed, in many others the license only applies to the name. For example the title architect is restricted in use to those who meet the terms of the scheme but others can nevertheless do the same sort of work.

I accept that licensing does not necessarily equate to quality. That doesn't however mean we should entirely abandon the pursuit of quality. How, say in the case of medicine, do we ensure quality? A hair braider's error (is that really licensed?) is of a different magnitude to an error by a paediatrician.

Jarod Bona writes:

I published a law review article about these issues a couple years ago after speaking at symposium with Morris Kleiner. You can view it here: http://www.theantitrustattorney.com/?attachment_id=222

Jarod

Jimbino writes:

Licensing is always and everywhere bad, as Milton Friedman showed over and over again. It's the height of stupidity to say, "I wouldn't want an unlicensed physician to touch me." Unlicensed "physicians" have been healing others for years, and the practice is now rampant in Arizona, at least.

A license is usually just a license to steal from the public.

I have participated in the design of nuclear weapons, ICBMs, rockets and tanks without ever having been licensed. HaHa. If the gummint required me to be licensed, I'd go somewhere where my skills were appreciated.

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