Occupational licensing, also called occupational licensure, is a form of government regulation requiring a license to pursue a particular profession or vocation for compensation. Professions that can have a large negative effect on individuals, like physicians and lawyers, require occupational licenses in most developed countries, but many jurisdictions also require licenses for professions without that possibility, like plumbers, taxi drivers, and electricians. Licensing creates a regulatory barrier to entry into licensed occupations, and this results in higher income for those with licenses and usually higher costs for consumers.
Licensing advocates argue that it protects the public interest by keeping incompetent and unscrupulous individuals from working with the public. However, there is little evidence that it affects the overall quality of services provided to customers by members of the regulated occupation.
Licensing has been among the fastest growing labor market institutions in the United States. The figure shows the growth of occupational licensing relative to the decline of union membership since the 1950s.
By 2008 occupational licensing in the U.S. had grown to 29 percent of the workforce, up from below five per cent in the 1950s. In contrast, unions represented as much as 33 percent of the U.S. workforce in the 1950s, but declined to less than 12 percent of the U.S. workforce by 2008.
One simple theory of occupational licensing envisions a costless supply of unbiased, capable gatekeepers and enforcers. The gatekeepers screen entrants to the occupation, barring those whose skills or character suggest a tendency toward low-quality output. The enforcers monitor incumbents and discipline those whose performance is below standard with punishments that may include revocation of the license needed to practise. Assuming that entry and performance are controlled in these ways, the quality of service in the profession will almost automatically be maintained at or above standards that are set by the gatekeeper to the profession. Within this approach only those who have the funds to invest in training and the ability to do the work are able to enter the occupation.
Introducing economics to this otherwise mechanical model by noting that a key discipline on incumbents—the threat of revoking one’s license—may not mean much if incumbents can easily re-enter the profession, such as by moving to a new firm, or by shifting to an alternative occupation with little loss of income. Since grandfathering (i.e., allowing current workers to bypass the new requirements) is the norm when occupations seek to become licensed, incumbent workers are usually supportive of the regulation process. In the absence of grandfathering, lower skilled workers in the occupation may have to seek alternative employment. For example, if sales skills are the key to both providing licensed sales of heart monitors and the non-licensed selling of shoes or cars, then individuals may shift between these lines of work with little loss of income.
Under these circumstances, meaningful discipline for license holders may require deliberate steps to ensure that loss of license entails significant financial loss. Such additional steps could include imposition of fines, improved screening to prevent expelled practitioners from re-entering the occupation, or requiring all incumbents to put up capital that would be forfeited upon loss of the license. To offset the possibility that incumbents could shift to other occupations with little loss of income, entry requirements could be tightened to limit supply and create monopoly rents within the licensed occupation. The threat of losing these monopoly rents could, in principle, give incentives to incumbents to maintain quality standards. This may also result in some increases in human capital investments in order to attain the additional requirements. The rents could also motivate potential entrants to invest in high levels of training in order to gain admittance. This suggests that licensing can raise quality within an industry by restricting supply, raising labor wages, and raising output prices. Increasing prices may signal either enhanced quality due to perceived or actual skill enhancements or restrictions on the supply of regulated workers.
State-regulated occupations can use political institutions to restrict supply and raise the wages of licensed practitioners. There is assumed to be a once-and-for-all income gain that accrues to current members of the occupation who are “grandfathered” in, and do not have to meet the newly established standard. Generally, workers who are “grandfathered” are not required to ever meet the standards of the new entrants. Individuals who attempt to enter the occupation in the future will need to balance the economic rents of the field’s increased monopoly power against the greater difficulty of meeting the entrance requirements.
Once an occupation is regulated, members of that occupation in a geographic or political jurisdiction can implement tougher statutes or examination pass rates and may gain relative to those who have easier requirements by further restricting the supply of labor and obtaining economic rents for incumbents. Restrictions would include lowering the pass rate on licensing exams, imposing higher general and specific requirements, and implementing tougher residency requirements that limit new arrivals in the area from qualifying for a license. Moreover, individuals who have finished schooling in the occupation may decide not to go to a particular political jurisdiction where the pass rate is low because both the economic and shame costs may be high.
One additional effect of licensing is that individuals who are not allowed to practice at all in an occupation as a consequence of regulation may then enter a non-licensed occupation, shifting the supply curve outward and driving down wages in these unregulated occupations. If licensing requirements contain elements of required general human capital, then it is possible that these workers may raise the average skill level in their new occupation.
Evidence on the effects of occupational licensing
It is well understood that occupational licensing can serve as a barrier to occupational entry resulting in reduced employment, monopoly rents for workers in the occupation, and higher prices for consumers (Friedman, 1962).
Kleiner and Krueger (2010 and 2013) show that after controlling for education, labor market experience, occupation, and other controls, licensing is associated with a 15 to 18 percent wage premium in the labor market. This estimate may partially reflect a premium for higher unmeasured human capital, but it is also consistent and likely in large part due to rents.
The empirical work on the effects of licensing on employment levels or growth rates, but the existing estimates suggests that they could be large. Kleiner (2006) examined employment growth rates in states and occupations with stronger versus weaker occupational licensing requirements. Specifically, he compares employment growth between 1990 and 2000 of occupations that are licensed in some states to the same occupations that are not licensed in other states. In order to account for differential growth rates between states, he also compared the growth rate of occupations that are either fully licensed or fully unlicensed in both sets of states. Using a “difference-in-difference” regression analysis, Kleiner found that partially licensed occupations had a 20 percent lower growth rate in states with licensing relative to states without licensing and relative to the difference in growth rates between these sets of states of fully licensed and fully unlicensed occupations. This estimate implies that a licensed occupation that grew at a 10 percent rate between 1990 and 2000 would have grown at a 12 percent rate if it were unregulated.
With occupational licensing varying by state, another channel through which licensing can affect employment is through reduced mobility. The patchwork of regulations raises the cost of cross-state mobility for workers in these occupations. This will result in slower adjustment costs to regional economic shocks which can result in higher unemployment.
Because it restricts employment, licensing can also lead to higher prices for services faced by consumers. This has been documented in a number of studies including Shepard (1978), Bond, et al. (1980) Cox and Foster (1990), and Kleiner and Todd (2009).
While it is not possible to precisely estimate the effects of substantially reducing occupational licensing at the present time, both theory and the available evidence suggest that such a reduction could translate into significantly higher employment, better job matches and improved customer satisfaction. Low-income consumers, in particular, would benefit because reduced barriers to entry would reduce the prices of services provided (Shapiro, 1986 and Cox and Foster, 1990).
Without doing a detailed analysis at the occupation-by-occupation and state level, economists cannot say which occupations can be justified based on quality-consideration, though studies have been conducted they have found at least in a number of cases at different stages of licensing reduces employment, but does not result in better services (Kleiner, 2013). For example, Kleiner and Kudrle (2000) find that occupational licensing of dentists does not lead to improved measured dental outcomes of patients, but is associated with higher prices of certain services, likely because there are fewer dentists.
A study from the Mercatus Center showed that occupational licensing can lead to greater income inequality, with each step needed to open a business leading to an additional 1.4% of national income going to the top 10% of earners.
To distinguish various forms of regulation, there are three forms of government regulation of occupations:
- Licensing: Licensing refers to situations in which it is unlawful to carry out a specified range of activities for pay without first having obtained a license. This confirms that the license holder meets prescribed standards of competence. Workers who require such licenses to practice include doctors, lawyers, nurses, civil engineers, and surveyors.
- State Certification: is generally necessary in order to obtain a license to practice an occupation. The certification requirements include passing of a standardized, state-administered test and proof of minimum experience working under the supervision of a licensed practitioner. New entrants to the occupation can start working as trainees such as "journeyman electrician". Some workers in an occupation may never get certified and licensed but can continue working under the supervision of a licensed person indefinitely.
- Registration: Registration refers to situations in which one can register one’s name and address and qualifications with the appropriate regulatory body. Registration provides a standard for being on the list, but complaints from consumers or improper listing of credentials can result in removal from the list.
In contrast to government regulation, voluntary professional certification can be used to demonstrate competence without the harmful economic effects of legalized occupational barriers. Examples of professional associations and trade associations that provide voluntary professional certification in various fields include:
- National Institute for Automotive Service Excellence
- Project Management Institute
- American Meteorological Society
- Employment protection legislation
- Labor economics
- Labour market flexibility
- Law and economics
- Loss aversion
- Professional certification
- Regulatory capture
- Regulatory state
- McGrath, Lee (April 2008). "A Primer on Occupational Licensing". Institute for Justice. Retrieved June 16, 2014.
- Jenni Bergal (2015-01-30). "A License to Braid Hair? Critics Say State Licensing Rules Have Gone Too Far". The Pew Charitable Trusts. Retrieved 2015-02-01.
- Friedman, Milton. 1962. Capitalism and Freedom. Chicago: University of Chicago Press.
- Kleiner, Morris M., and Alan B. Krueger. 2010. "The Prevalence and Effects of Occupational Licensing." British Journal of Industrial Relations 48(4): 676–687.
- Kleiner, Morris M., and Alan B. Krueger. 2013. "Analyzing the Extent and Influence of Occupational Licensing on the Labor Market." Journal of Labor Economics 31(2): S173–202.
- Kleiner, Morris M. 2006. Licensing Occupations: Ensuring Quality or Restricting Competition? Kalamazoo, MI: W.E. Upjohn Institute for Employment Research. ISBN 978-0-88099284-8.
- The partially licensed occupations he considers are librarians, respiratory therapists, and dieticians and nutritionists. The fully licensed occupations are lawyers, dentists, and cosmetologists. The fully unlicensed occupations are economists, computer programmers, and glaziers.
- Note that this estimate only reflects the differential growth rate between licensed and unlicensed occupations, not levels.
- Shepard, Lawrence. 1978. "Licensing Restrictions and the Cost of Dental Care." Journal of Law and Economics 21(1): 187–201.
- Bond, Ronald S., John E. Kwoka Jr., John J. Phelan, and Ira Taylor Whitten. 1980. Effects of Restrictions on Advertising and Commercial Practice in the Professions: The Case of Optometry. Washington, DC: Federal Trade Commission, Bureau of Economics.
- Cox, Carolyn, and Susan Foster. 1990. The Costs and Benefits of Occupational Regulation. Washington, DC: U.S. Federal Trade Commission, Bureau of Economics.
- Kleiner, Morris M.; Todd, Richard M. (2009). "Mortgage Broker Regulations That Matter: Analyzing Earnings, Employment, and Outcomes for Consumers". In Autor, David H. Studies of Labor Market Intermediation. Chicago: University of Chicago Press. pp. 183–231. ISBN 0-226-03288-4.
- Shapiro, Carl. 1986. "Investment, Moral Hazard, and Occupational Licensing." Review of Economic Studies 53(5): 843–862.
- Cox, Carolyn, and Susan Foster. 1990. The Costs and Benefits of Occupational Regulation. Washington, DC: U.S. Federal Trade Commission, Bureau of Economics.
- Kleiner, Morris M. 2013. Stages of Occupational Regulation: Analysis of Case Studies. Kalamazoo, MI: W.E. Upjohn Institute for Employment Research. ISBN 978-0-88099-459-0.
- Kleiner, Morris M., and Robert T. Kudrle. 2000. "Does Regulation Affect Economic Outcomes? The Case of Dentistry." Journal of Law and Economics 43(2): 547–582.
- For additional examples see Carroll and Gaston (1981).
- Carroll, Sidney L., and Robert J. Gaston. 1981. "Occupational Restrictions and the Quality of Service Received: Some Evidence." Southern Economic Journal 47(4): 959–976.
- "Do Entry Regulations Promote Income Inequality?". RegBlog. Retrieved 19 April 2016.
- McLaughlin, Patrick; Stanley, Laura. "Regulation and Income Inequality The Regressive Effects of Entry Regulations" (PDF). Mercatus Center. Mercatus Center. Retrieved 19 April 2016.
- Friedman, Milton (1962). "Occupational Licensure". Capitalism and Freedom. ISBN 978-0226264219.
- Kleiner, Morris M. (2006). Licensing Occupations: Ensuring Quality or Restricting Competition?. ISBN 978-0880992848.
- Kleiner, Morris M. (2013) Stages of Occupational Regulation: Analysis of Case Studies ISBN 978-0-88099-459-0
- Young, S. David (2002). "Occupational Licensing". The Concise Encyclopedia of Economics. The Library of Economics and Liberty.
- Reinhardt, Uwe E. (October 11, 2013). "The Dubious Case for Professional Licensing". The New York Times.
- Stangler, Dane (April 2, 2012). "Occupational Licensing: How A New Guild Mentality Thwarts Innovation" (PDF). Progressive Policy Institute.
- de Rugy, Veronique (Mar 25, 2014). "Occupational Licensing: Bad for Competition, Bad for Low-Income Workers". The Mercatus Center at George Mason University.
- Hood, John (November 1, 1992). "Does Occupational Licensing Protect Consumers?". The Freeman. Foundation for Economic Education.