Evan Soltas
May 23, 2012

Open to Business

SAIC Ribbon Cutting
This post is a response to Matt Yglesias' excellent article in Slate, "Licensed to Decorate," which discussed the expansion of barriers to entry in entrepreneurship -- in particular, occupational licensing requirements which are unreasonable and serve to protect firms and employees from competition.

Yglesias is right, but he seems to neglect to show us actual data of the extent to which these barriers to entrepreneurship matter.

Looking into this, I found that the business environment is an important determinant of entrepreneurship, according to research published by the World Bank in 2010. Countries which ranked in the quintile of lowest cost of starting a business had more than 10 times the entry density, or number of newly-registered firms per capita, than do countries which ranked in the top quintile of startup costs. Countries which were in the quintile of the fewest procedures to start a business had roughly 5 times the entry density of countries in the quintile of the most procedures for firm creation.

(Incidentally, the wonderful work of the Kauffman Foundation has showed just how important startups are -- they are just about the only source of net new jobs, and firm creation has been relatively constant for decades.)

Entry regulation is more than just a simple "barrier to entrepreneurship," according to this paper co-authored by Raghuram Rajan -- using data from European countries, the authors found that such barriers box out small firms in particular, reduce the competitive pressures on incumbent firms, and thus slow the long-term rate of productivity growth.

Yglesias also cited a paper by Morris Kleiner, a professor at the University of Minnesota, but another of Kleiner's papers written for the Federal Trade Commission and available here reveals the magnitude of the effects of occupational licensing:

For the occupations examined we find the impact of being licensed to be about 10 to 12 percent [of hourly earnings]...[T]he impact of being in a state that licenses an occupation relative to ones that do not...is about a four percent hourly earnings premium...[W]e find that occupational licensing reduces employment growth in states that are licensed relative to those that are not regulated. Comparing three occupations that are approximately evenly divided between licensed and unregulated we find that employment growth is higher in the unregulated states by approximately 20 percent over the decade from 1990 to 2000.
It's not just obtaining credentials as an employee which can serve as an entry barrier -- registering one's firm is also a significant obstacle. A program introduced in Mexico in the 2000s to facilitate and speed up firm registration procedures increased firm registration by 4 percent, although follow up research found this effect was "temporary and of relatively modest magnitude...not liv[ing] up to the lofty expectations of some." Another study found this increased employment in the registered businesses by 2.2 percent.