Do Entry Regulations Promote Income Inequality?

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Think-tank study finds correlation between income disparity and regulations affecting new businesses.

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In some states, florists, hair-braiders, and even animal-massagers must obtain a license to work in those fields. But according to a working paper recently released by the Mercatus Center, a think-tank affiliated with George Mason University, these licenses and other so-called “entry regulations” may contribute to income inequality.

Patrick McLaughlin and Laura Stanley, researchers at the Center, examine whether the difficulty of starting a business affects a nation’s income distribution. They theorize that citizens who want to work in regulated professions but cannot afford to pay for required licenses often choose lower paying jobs instead. They also claim that entry-regulations allow licensed workers to charge higher prices for their services.

McLaughlin and Stanley use the World Bank’s “Doing Business” dataset to measure the impact of entry regulations. That dataset scores the ease of doing business by measuring the average cost, time, and number of steps needed to start a business in a country. The authors use two different methods to measure income inequality: the Gini coefficient , and the share of income going to top earners. The Gini coefficient is a measure of how far a country is from perfect income equality, and is represented by a number between 0 and 100 with, 0 being complete equality and 100 being maximum inequality. For example, the United States has a Gini coefficient of 41.1.

Because the 175 countries examined are so different, McLaughlin and Stanley attempt to control for other variables, including economic development, openness to trade, ethnic divisions, credit development, and democratization. They found that after accounting for those differences between countries, each additional step required before opening a business correlates to an additional 1.59% of national income going to the top 10% of earners, or a .44 increase in the Gini coefficient.

Although entry regulations may increase inequality, the cost may be justified by other goals such as safety or consumer protection.

Nevertheless, McLaughlin and Stanley recommend three broad strategies for regulators to follow that might mitigate the negative effects of entry regulations while still obtaining social benefits.

First, they suggest requiring entry regulations be tied to specific, widespread social problems. For example, the potential social harms of unqualified physicians necessitate medical licenses. However, unqualified florists present far less serious concerns, and licenses are unnecessary.

Second, they argue that regulators should consider alternatives to licensing. In some cases, private certification by a professional association can achieve many consumer protection goals without limiting market participation. Mandatory labels can also disseminate information and protect consumers.

Third, McLaughlin and Staley stress that policymakers should study whether old entry regulations are still solving the problems that led to their creation. If they are no longer needed, they should be removed.

Occupational licensing regulation has become a surprising point of agreement for some conservatives and liberals. Although the McLaughlin and Stanley study is the first direct attempt to study the effects of entry regulation on income inequality, the Obama Administration issued a report last July, covered on The Regulatory Review, which also noted the potential costs of licensing regulations. Some of these costs include a reduction in social mobility, an increase in prices for consumers, and the introduction of suboptimal barriers to professionals moving across state lines.

The Obama Administration report appears to agree with the three suggestions offered by McLaughlin and Stanley to mitigate the effects of entry regulations. The report also highlights the importance of harmonizing state law to help licensed professionals be able to change their residence more easily, thereby facilitating labor mobility needed to improve national employment and economic growth.

Another recent paper issued by the Hamilton Project at the Brookings Institution estimates that the total cost of the increased prices for consumers caused by entry regulations, excluding any economic costs from associated reduced employment, is more than $100 billion annually. Both the McLaughlin and Stanley paper and the Obama Administration report accept that entry regulations can raise prices for consumers.

That paper also found that the percentage workers who need a license for their job grew from less than 5% in the early 1950’s to nearly 29% today. This increase not only increases the price of some goods and services , it also affects employment. They argue that occupational licensing restrictions can lead to up to 2.85 million fewer jobs nationally.

Although some professions are licensed by every state and are not controversial, others are only licensed by a small minority of states. Professions that only a few states license provide an opportunity to study the benefits of licensing a profession. For example, only one state requires florists to be licensed, and a study comparing florists in that state to others found no difference in quality. When such licenses do not affect public safety or improve quality of services, the higher prices and reduced employment associated with licensing may not be justified.

Additionally, the Hamilton Project paper found that such license requirements can affect international migration as well. For example, some states have English language proficiency requirements to be a licensed manicurist, which disproportionately affects the 42% of all manicurists who are Vietnamese. Those regulations were associated with a 5.7% reduction in the likelihood of a manicurist being Vietnamese, with questionable benefits to the public interest.

Some groups are seeking to change occupational license laws through the courts. The Institute for Justice has challenged numerous state occupational licensing laws. One successful suit in the Supreme Court of Texas overruled a state law requiring eyebrow threaders to obtain cosmetology licenses. Because the licensing exam did not require knowledge of eyebrow threading, that court held that the law imposed a burden that violated substantive due process rights under the state constitution.

Some conservative commentators, such as George Will, have argued that the US Constitution also prohibits these occupational licensing requirements because they present an impermissible restriction on the individuals’ freedom to contract. Similarly, Senator Rand Paul has argued in favor of federal courts taking a more active role in striking down such economic regulations. However, the question has divided conservative legal thought. Chief Justice John Roberts and the late Justice Antonin Scalia have argued that striking down democratically passed economic regulations is an impermissible form of judicial activism.