Occupational licensing, also called occupational licensure, is a form of government regulation requiring a license to pursue a particular profession or vocation for compensation. Most developed countries require occupational licenses for professions, such as physicians and lawyers. 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 has an impact on the overall quality of services provided to customers by members of the regulated occupation.
Comparison of Unions and Licensing over Time in the United States. (The dashed line shows the value from state estimates of licensing based on the Gallup Survey and PDII Survey results. The union membership estimates are from the Current Population Survey (CPS)).
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 effect 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.
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.
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.
LICENSING THROUGHOUT THE CAREER
In order to obtain a license, workers must first pay the specified fees, undergo required training and education, and satisfy any other state licensing requirements. Depending on the state and occupation, the upfront costs of licensure vary from minimal ($70 and 3 days of training for a school bus driver in Michigan) to very substantial ($1,485 and 6 years of additional education for an interior designer in the District of Columbia).
These upfront costs—including the opportunity cost of lost wages while undergoing training—partially offset any later benefits derived by newly licensed workers in the form of higher wages. Workers already practicing in a profession when it becomes licensed are an exception, as they are often exempted from new licensing requirements. Consequently, the labor market effects of licensing can be delayed, increasing in magnitude as time passes and more workers are required to meet new requirements.
Using nearly two years of new Current Population Survey (CPS) data on worker licenses, previous findings are broadly confirmed: 21 percent of employees aged 25–64 hold a license required for their current job, while 3 percent report a certificate. Workers with licenses earn considerably more than those without: $18.80 per hour for the median unlicensed worker versus $25.00 for the median licensed worker.
While much of this advantage for licensed workers is accounted for by differences in age, human capital, and other variables that typically confer increased wages, some of the licensing wage premium is thought to be caused by the barrier to entry that a license represents. In other words, the difficulty of obtaining a license—in excess of the entry requirements that a market would impose with full information about provider quality—restricts labor supply in the occupation, thereby improving conditions for licensed workers and harming them for the unlicensed. Unlicensed workers see their potential occupational choices diminished, and must crowd into occupations with lower barriers to entry. This transfer to licensed workers is called an “economic rent”, and it generally involves a costly labor market distortion.
Identifying the licensing wage difference that can be deemed an economic rent is a difficult challenge. One common approach is to adjust for observable differences between workers (sometimes including broad occupational categories) and infer that the remaining wage difference—the wage premium—is due to the barrier to entry. Though useful, it is important to note that this approach may under- or over-estimate the rents generated by licensing, particularly if licensed and unlicensed workers are different in unobservable ways or if the need for licensing impels a worker to obtain high-value training, for example.
Estimates of the wage premium that remains after adjustment for observable differences vary depending on the econometric methods and data employed, but in recent CPS data, the estimated hourly wage premium is about 5 to 8 percent. One way to visualize the wage differences between unlicensed and licensed workers is shown in figure 1. The figure contains the median wages of licensed and unlicensed employed workers, shown by age. For unlicensed workers, wages are shown with and without adjustment for observable differences between the groups. Median wages of these groups are quite different throughout workers’ careers. Even after adjustment is made for differences in worker characteristics, licensed individuals are still paid more than the unlicensed at every age, and this gap increases throughout workers’ careers.
LICENSING ACROSS THE WAGE DISTRIBUTION
Estimates of licensing wage premiums are usually expressed in terms of the average worker. However, there is reason to believe that licensing affects wages differently in various parts of the wage distribution. For example, the outlay of time and money required to obtain a cosmetology license in New Mexico—notably including at least 1,600 hours of cosmetology instruction from an approved school—may be a serious impediment for those with limited means and significant family responsibilities, while presenting less of an obstacle for others. Consequently, licensing could be a larger effective barrier to entry for some low-skilled workers, thereby generating larger wage premiums.
Recognizing the possibility that licensing has different effects for different workers, an alternative approach is to calculate the distribution of wages for unlicensed workers, but reweighted to achieve comparability with licensed workers (figure 2). This adjusted distribution can then be contrasted with the wage distribution of licensed workers. Intuitively, this procedure puts additional weight on those unlicensed workers who are comparable with licensed workers in terms of observable variables like education, age, race, and gender, and uses their labor market experiences to formulate a more apples-to-apples comparison. As shown in figure 2, the wage distributions are most different at lower and middle wages, where unlicensed workers are more likely to be found.