A Review of Occupational Licensing

This week the US Supreme Court is hearing arguments in the case of North Carolina Board of Dental Examiners v. Federal Trade Commission, addressing the questions of whether (or under what terms) state occupational licensing boards are immune from antitrust scrutiny. This is the case I referred to last week and linked to the preview of the arguments on SCOTUSblog.

Today I ran across a review of Morris Kleiner’s recent book, Stages of Occupational Regulation: Analysis of Case Studies, on Econ Journal Watch. Uwe Reinhardt (Princeton) provides a great overview of the general issue and Kleiner’s treatment of it. Below is the abstract of Reinhardt’s review:

The licensing of occupations—a very forceful intervention in markets—is pervasive and growing in modern economies. Yet the attention paid to it by economists and economics textbooks has been small. Highly welcome, therefore, has been the extensive and intensive work on this subject by Morris Kleiner. Kleiner’s latest book, titled Stages of Occupational Regulation: Analysis of Case Studies (2013), explores the progression of occupational regulation, from mere registration to certification to outright licensing—three distinct stages. Kleiner carefully selects for his analysis a series of occupations representing the stages of regulation, devoting a chapter to each occupation. He uses a variety of statistical approaches to tease out, from numerous databases, what the impact of mild to heavy regulation on labor markets appears to be.

Kleiner’s work leads him to call for a pervasive review of occupational regulation in the United States, with a view towards replacing occupational licensure, which introduces the most inefficiency and welfare loss, with mere certification of occupations. That recommendation gains plausibility in an age where cheap computation and data mining makes it possible to protect consumers from low-quality and possibly dangerous services by providing robust, user-friendly information on the quality of services delivered by competing occupations, such as doctors and nurse practitioners.

You can access the full article here. I may need to add Kleiner’s book to my list of fun-things-to-read-when-I-get-a-chance.

Occupational Licensing & Antitrust: Legal Licensing or Occupational Cartel?

Occupational licensing is an interesting phenomenon. Governments (state and local) create certification boards (typically made up of industry participants) that set licensing standards and qualifications for persons wanting to work in those occupations. Ostensibly, these restrictions are intended to correct for the information asymmetry between consumers and professionals, where consumers may not be able to assess the quality (or ability) of the professional independently before hiring them. Think medical associations for doctors and bar associations for lawyers at the state level, or licensing for plumbers and electricians at the local level.

But occupational licensing also serves as a way of restricting competition in a profession by limiting the number of people who are able to provide the goods or services under the board’s purview. And as we know, reducing supply in the market increases the prices consumers pay (and the professionals receive). For instance, a medical board may limit the number of doctors who will be “board certified” in a given year. A private investigator licensing board may set standards to reduce the number of licensed (and legal) PIs. Or a state dental board might prohibit non-dentists from performing teeth-whitening services in competition with dentists.

That last one is the basis of a case coming before the US Supreme Court next week. The US Federal Trade Commission (FTC) brought antitrust charges against the North Carolina Board of Dental Examiners for conspiring to restrain competition in the teeth whitening business. The Dental Examiners board asserts they are exempted from antitrust law under the “state action doctrine.” The Supreme Court is being asked to determine if–and under what circumstances–state occupational licensing boards are exempt from antitrust laws. Eric Fraser offers a nice preview of the arguments in the case over on SCOTUSblog.

This could be an important case for licensing boards across the country. It should be fun to watch and interesting to see how the Court delineates the lines of necessary government oversight and the degree to which an overwhelming public interest needs to be justified.

Corporate Control and a New 'Family' for Olive Garden

For years, Olive Garden’s marketing campaign revolved around the theme: “When you’re here, you’re family.” Well it looks like Olive Garden–or more specifically, it’s parent company Darden–has a new family at the helm.

Reports are out that Starboard Value L.P. has successfully routed the entire incumbent board of directors, replacing them with its own slate of 12 new members. This is the culmination of a lengthy dispute about recent strategic decisions and the future direction of Darden Restaurants and its portfolio of restaurants that includes Olive Garden, Longhorn Steakhouse, The Capital Grille, Bahama Breeze, and others.

I don’t have data, but my sense is that such complete board turnover is very rare outside of a change in corporate ownership. I tried to find some evidence on how frequently complete board turnovers happen. The closest thing I found thus far is a report by Equilar looking at board turnover among the Fortune 1500 for the fiscal year ending April 2012. They found only 54% of the 1,445 companies they looked at had any turnover at all. Only 1% had more than 50% of board members turn over. The don’t report whether any firm had 100% turnover. Perhaps someone with out there has numbers handy (or some time to do the digging) to shed light on this?

Outcomes like this certainly reinforce the idea that Lucian Bebchuk and company have been promoting with the Shareholder Rights Project at Harvard Law School; namely, that eliminating staggered boards (i.e., having the full board stand for election every year) can allow for more effective changes in corporate control even without a change in corporate ownership, making companies more responsive to their current shareholders.

Incentives and the SCOTUS Surprise on Same-Sex Marriage

The Supreme Court of the United States (SCOTUS) surprised even veteran court watchers this week by refusing to hear a set of cases involving state-level bans (and reversals of those bans) of same-sex marriage. One lawyer offers a pretty convincing argument on why the Court decided not to weigh in on an issue that has such important consequences for large groups of people (and employers). At its heart, it’s all about individual justices’ incentives and the cost-benefit calculation justices had to make in the face of an uncertain outcome:

So why is the Roberts Court, not normally shy in jumping into controversial issues such as affirmative action or campaign finance law, ducking this one?

The answer may lie in the incentives facing the individual Justices rather than the approach of the Court as a whole. When you look at the choices available from the three different perspectives on this issue – liberals, swing votes, and conservatives – it becomes much easier to see why there weren’t the four votes required (out of the nine Justices) to hear this issue now. With no camp assured of victory if the court decided to hear the cases, the uncertainty may hold the key to the Justices’ thinking.

You can read the full blog post with the details of the explanation here. Regardless your position on the issue, this analysis of the justices’ likely reasoning in passing on the opportunity to settle the issue (at least for a period of time) illustrates how understanding individuals’ incentives helps to explain the expected–and not-so-expected–outcomes that shape the laws and institutions that help structure society at-large.

 

Getting Drunk Rationally–College Life Edition

Let’s just put this up front: Excessive consumption of alcohol and alcohol addiction are bad. It’s even more bad when those involved are underage college students (or even younger). Okay? Okay.

Now, we can debate what the threshold of “underage” is (currently, 21 years in the United States) versus what it could be (18 in most of the rest of the world). If we adopted the global standard, there would be very few US college students who are underage. Problem solved, right? I doubt college administrators would agree (but maybe they should…see below).

While drinking is a hallmark of the US college experience, it is a problem–whether students are underage or not. According to a recent survey of students here at the University of Missouri (MU), 86% drink alcohol regularly; 38% of underage drinkers drink to get drunk, and 68% of Greek students binge drink (ban the Greeks! no, not those Greeks). Binge drinking is defined as 5+ drinks in two hours for men, 4+ for women. Despite these numbers, fewer than 1% of students were arrested for a DUI and almost no students ran afoul of campus administration. But the numbers reflect a lot of irresponsible and illegal drinking, so the University has launched an effort to reduce the incidence of underage drinking and high-risk drinking.

One of the proposals, which has been embraced by other universities, is to increase the number of Friday morning classes. A 2007 study showed MU students with no Friday morning classes drank twice as much on Thursdays as those who had classes. Now, this fact doesn’t take into account the self-selection by students to take Friday morning courses–presumably, those who are less worried about drinking are more likely to choose the Friday courses. But if we take it at face value (as the administration would have us do), it means students are drinking responsibly when they have incentive to do so. Students rationally respond to the expected consequences of getting hammered on Thursday morning and having to be up early (and hung over) for classes on Friday.

I believe the proposal for Friday classes, while it might have some effect, is actually a pretty bad idea. And it’s not because I prefer to teach Tuesday/Thursdays so that I have longer weekends (though it is nice to have the flexibility for traveling and not missing class). Continue reading “Getting Drunk Rationally–College Life Edition”

Costs, Benefits, and Bad Tax Proposals (MO Amendment 7)

One of the most fundamental concepts in modern economics is the idea of marginal analysis. If the marginal benefit of doing something (i.e., the benefit you couldn’t otherwise obtain) is greater than the marginal cost of doing it, then a rational maximizer should do it.

A related idea is that those who benefit (the most) from something should be the ones to pay (the most) for it. Obviously, if you value something less than I do, then my marginal benefits of having or using it are greater and the marginal cost I’m willing to pay are likewise greater.

Herein lies the economic principles behind Missouri’s Amendment 7, which would impose a “temporary” 3/4-cent sales tax to fund road construction: Who should pay for road and transportation infrastructure? Those who drive on the roads (as has been traditionally the case) or consumers who purchase non-food consumables? The economic logic is pretty clear: those who directly benefit from the transportation infrastructure.

Not only does it make sense from a simple benefit perspective, but taxing those who use the roads for road improvements creates more efficient incentives throughout the entire economy. Here’s why:

If you simply slap on a sales tax, then end-consumers are stuck paying those taxes whether the products they purchased used the roads extensively, or just a little bit. Opponents will also argue that the sales tax is more regressive. While that’s true, it’s also a pretty weak argument–even if you care about regressivity. If the cost of driving products to the store goes up, the costs to consumers will go up–and it will still be regressive.

However, this is where taxing the transportation directly is critically important. Taxing road-intensive transportation more for road improvements will change the relative cost of transporting by roads. Higher road transportation costs will encourage shippers to seek alternate, more fuel-efficient means of transportation. Competition at the transportation stage will limit how much of the cost increase gets passed onto consumers, making the cost less regressive. It would also reward consumers (and producers) who choose less road-intensive products.

Taxing consumers at the point of sale does nothing to encourage more efficient use of our transportation system and it eliminates any competitive pressure between modes of transportation that would reduce the costs consumers pay for all the products they consumer. Little wonder the trucking industry is behind this proposal.

But the amendment is even more devious than that. It would prohibit any increases in fuel taxes for the duration of this “temporary tax” and would also prohibit any attempt to move toward toll-roads in the State. Ultimately, toll roads are the most efficient funding mechanism for road construction and improvements, since the road is paid for by the people who actually use it. Prohibiting even an experiment of toll-funded roads anywhere in the state for an indefinite length of time (sure, call it 10 years if you believe it will end then) is cutting off even the chance of a more efficient future that would benefit everyone–except the heavy roads users.

The construction industry (all those “stimulus” jobs!) and the emergency first responders (“we’ll be able to save you better with this tax”) would benefit the same from road construction no matter the funding source. Ultimately, this amendment is a little more than a special interest bone for the trucking industry. If we’re serious about funding roads responsibly, we should demand better of our State legislature than Amendment 7.

RIP Professor Ronald H. Coase, 1910-2013

Professor Ronald H. Coase passed away earlier today at the age of 102 in Chicago, IL (USA). Coase won the Nobel Prize in Economic Science in 1991 for his contributions to the fields of law and economics and his work on transaction costs and property rights.

Professor Coase’s contributions revolutionized economics and law. As profound as his insights was the simple approach with which he encountered reality; challenging the assumptions and conventional wisdom of the established literature by holding up a light to the real world. His seminal paper on transactions costs (The Nature of the Firm, 1937) began with two simple and corollary queries: If markets work so efficiently, why is so much economic activity ‘managed’ outside of the market mechanism under the rubric of “the firm”?  If firms are more efficient means of organizing economic activity, then why not manage all economic activity centrally?

To these questions Coase brought to bear the framework of marginal analysis that characterizes modern economic theory. His answer, that there are costs to using the market mechanism (transaction costs) that can be circumvented up to a point by managerial fiat within the firm, continues to underlie most of the modern theories of organizational economics. The boundary of the firm, Coase explained, is determined by the relative (marginal) cost of organizing one more resource via market transactions versus the (marginal) cost of doing so through managerial control.

The second of the two papers for which Coase was awarded the Nobel Prize focused on the nature of harms in property law cases and its implications for understanding the importance of property rights (The Problem of Social Cost, 1960). Coase highlighted the reciprocal nature of harm in the case of property disputes (and externalities in general): A finding in favor of one party necessarily harms the other, thus raising the question of relative economic efficiency–that is, the solution to the problem should consider the net social cost of finding in support of one party or the other, rather than focusing on some perception of unilateral causation.

In The Problem of Social Cost, Coase explained that if markets were costlessly efficient, parties to an externality/property dispute would be able to negotiate a Pareto superior solution to reallocate property rights to their highest-valued uses. Thus, the initial allocation of property rights would be irrelevant, since parties could arrive at privately negotiated solutions costlessly (or at very low cost). This idea was paraphrased and labeled by George Stigler as “The Coase Theorem,” although this was not at all Coase’s point. Quite the opposite. Coase argued that because transaction costs are positive, one cannot necessarily rely on privately negotiated transactions to achieve Pareto superior reallocations. Therefore, the design and enforcement of property rights is extremely important for economic outcomes. Moreover, Coase argued, one must consider the net social benefits of any attempts to reallocate property rights rather than assuming that any “solution” is necessarily preferable to the status quo–whether it be a market-based solution or a government-imposed solution.

Coase’s career was defined by challenging the common assumptions–and often overlooked assumptions–of economics. If economists are to describe and refer to “firms”, they should have a definition of what is meant by a firm and a reason for its existence in the economic landscape. If economists are going to address externalities, then they should recognize the nature of reciprocal harm in dealing with those externalities and the costs–as well as benefits–or proposed solutions. Assumptions of public goods and natural monopolies were bugaboos Coase dispelled by pointing to counter-examples–exceptions which debunked the rule. The case of The Lighthouse in Economics (1974) is but one example of such. When I last visited with Coase a few years ago, he was still working on another such example in the private water supply system in London in the early 1900s (a utility often argued to be a natural monopoly). Coase also offered a simple, yet profound at the time, understanding of the nature of durable goods monopolies and the way they compete with themselves (Durability and Monopoly, 1972).

I first met Coase as a graduate student at Washington University in St. Louis. I later got to know him much better while working at the University of Pittsburgh and eventually with the creation of the Contracting and Organizations Research Institute at the University of Missouri. Professor Coase generously funded CORI in its early days as we endeavored to create a library of contracts that could be used to study how businesses structure their transactions with one another and to further explore the factors affecting the choice of organizational form. Coase came to Missouri in 2001 and spoke to the need of economics to change. True to his lifelong approach, Coase stated, “We need empirical work which actually changes the way we look at the problem.”

Despite being one of the most cited economists of the 20th Century, I believe the significance of Coase’s work is still under-appreciated. Much of what is written about Coase’s work now still misinterprets, misconstrues or misapplies the fundamental nature of his arguments. In attempt to formalize or integrate pieces of his theories into modern economics, the essence of it is often lost–or simply overlooked. I tried to articulate some of that in a chapter I wrote about Coase’s theoretical contributions to Oliver Williamson’s Transaction Cost Economics, published inThe Elgar Companion to Transaction Cost Economics which I co-edited with Peter Klein. I look forward to doing more work along those lines.

Though I have not had much contact with Professor Coase over the past few years, it was inspirational knowing that even in his advanced years he was attempting to complete several research projects he had laid out. He once told me that it would take him until he was 112 years old to complete everything he had lined out at that point. That work may now never be done.

The economics profession is a bit more dismal with his passing, but his legacy lives on for those who continue to question and to change the way we look at the problem.

Godspeed, Ronald.