Labor Market Entry Restrictions and Crony Capitalism

Many years ago, Adam Smith famously wrote, “[p]eople of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” This quote is often used to warn of the evil tendency of those involved in the world of business to collude against competition. Yet, in many situations, the bigger evil is businesses colluding with government. This has earned the label crony capitalism, in which there is ostensibly free markets but government and politicians tilt the playing field in favor of ‘friends,’ or cronies. Textbooks warn of businesses with market power, with the power to set prices, and in the extreme, monopolies.  But government regulations and restrictions are often the source of market power, and government-granted monopolies are often the most durable form of monopoly. 
Government favoritism for specific business entities is certainly not new.  It takes many forms, including favoring unions, special government contracts or advantages in bidding for certain groups or companies, or subsidies that favor businesses or individuals.  It also takes the form of certain occupational licensing requirements. 
Occupational licensing requirements restrict the entry of workers into certain fields.  Such restrictions reduce the supply of workers to those occupations, leading to higher-than-competitive wages.  Recent headlines have trumpeted the so-called ‘labor shortages’ that seem to have impeded the post-pandemic economic recovery in sectors ranging from cosmetology to transportation.  These complaints have once again put labor market entry restrictions, such as occupational licensing, under scrutiny. 
Many businesses complain that licensing rules have made it increasingly difficult to hire workers, because it takes time and money to obtain the training required to obtain a license.  The time and monetary cost of this training works to restrict potential workers from entering the field.[1]  There are more than 1,100 occupations in the U.S. that are licensed in at least one state, and about a quarter of the U.S. workforce held a license in 2020.[2]  Licenses or certificates are needed for employment as a hair stylist, a teacher, a nurse, a truck driver, a food worker, a day care worker, and many more.
Advocates of occupational licensing typically argue the need to protect consumers from incompetent practitioners. This quality assurance argument may make some sense when it comes to highly skilled occupations that provide goods and services for which quality is critical and yet difficult to ascertain, such as medicine. But for most other occupations, quality of service is readily observable. As a result, market forces can be relied upon to weed out incompetent workers and assure service quality. In fact, studies show that licensing does not increase quality even though it leads to higher prices.[3]      
Labor market entry restrictions reduce competition and cause efficiency losses that are often associated with a monopoly: higher wages and lower employment for the protected profession and higher prices for the consumers of the product or service provided.
Economic studies demonstrate that occupational licensing raises wages of licensed workers by 10% to 15%.[4][5][6]  And yet, these gains for licensed workers are at the expense of consumers and other workers.  There is strong evidence that licensing increases the prices for consumers and reduces employment in the occupation requiring licensing.[3][6][7]         
Moreover, allowing products and services of different levels of quality to coexist may well be an efficient market outcome. For example, some people may prefer to pay a lower price to get a haircut from an unlicensed barber, but the licensing requirements prevent this mutually beneficial transaction from happening.
Additionally, occupational licensing is a major manifestation of crony capitalism. Incumbent workers in the protected occupation gain benefits in the form of higher wages and more secure jobs by fending off competition from other workers through government regulations, whereas the politicians responsible for sustaining the anti-competitive regulations win political support.
Once in place, labor market entry restrictions are difficult to roll back because incumbents with vested interests fight hard to keep them. However, the current labor market shortage provides a catalyst for reconsidering the wisdom of having state licensing requirements for so many occupations when markets and consumer choice can identify workers and establishments that provide high quality services.

[1] “Covid-19 Rekindles Debate over License Requirements for Many Jobs,” by Bryan Mena, The Wall Street Journal, August 24, 2021.
[2] “Occupational Licensing Final Report: Assessing State Policies and Practices,” The Council of State Governments, December 2020.
[3] “Consumer Protection in an Online World: An Analysis of Occupational Licensing,” by Chiara Farronato, Andrey Fradkin, Bradley Larsen and Erik Brynjolfsson, NBER Working Paper 26601, January 2020.
[4] “The Prevalence and Effects of Occupational Licensing,” by Morris M. Kleiner and Alan B. Krueger, British Journal of Industrial Relations, 48 (2010), pp. 676-687.
[5] “Analyzing Occupational Licensing among the States,” by Morris M. Kleiner and Evgeny Vorotnikov, Journal of Regulatory Economics, 52 (2017), pp. 132-158.
[6] “Occupational Licensing Causes a Wage Premium: Evidence from a Natural Experiment in Colorado’s Funeral Services Industry,” by Brandon Pizzola and Alexander Tabarrok, International Review of Law and Economics, 50 (2017), pp. 50-59.
[7] “A Welfare Analysis of Occupational Licensing in U.S. States,” by Morris M. Kleiner and Evan J. Soltas, NBER Working Paper 26383, October 2019.

Posted: October 22, 2021 by Dennis W. Jansen, Liqun Liu, Andrew J. Rettenmaier