Academic journal article The Cato Journal

Occupational Licensing and Asymmetric Information: Post-Hurricane Evidence from Florida

Academic journal article The Cato Journal

Occupational Licensing and Asymmetric Information: Post-Hurricane Evidence from Florida

Article excerpt

Federal, state, and county governments accept the argument that occupational licensing protects consumers and improves their welfare. This argument stands in stark contrast to the apparent rent seeking that occurs with licensing. In return for gains from state-created barriers to entry, coalitions built along occupational lines support politicians (Stigler 1971: 3-21).

This article will show that government action in times of crisis is often inconsistent with its rhetoric, Licensing is typically justified on the grounds that market mechanisms will not mitigate the problems associated with asymmetric information. In the wake of Hurricanes Frances and Katrina, Florida reduced restrictions on construction contractors, yet in times of crises informational asymmetries are more likely to be problematic. By examining the volume of work completed, I find little evidence of significant detrimental effects from the policy change. Given the relative success of reducing restrictions and the government's explicit recognition of licensing's limiting effect on the availability of roofers, reform of licensing, at least to the extent done in crisis, should be adopted permanently.

Why Occupational Licensing?

The dominant position in economics is that licensing restricts supply, increases prices, and transfers wealth from consumers to producers. This position extends as far back as Adam Smith's warning of the monopolistic tendencies of licensing in The Wealth of Nations (1994: 136-37) where he wrote, "The exclusive privilege of an incorporated trade necessarily restrains the competition, in the town where it is established, to those who are free of the trade." In the 20th century, Friedman and Kuznets (1945), Friedman (1962: 137-60), and Kleiner (2006), among many others, reiterated and expanded the argument that licensing is monopolistic and is intended to secure rents to practitioners.

On the other hand, many economists argue that information asymmetries justify licensing laws. Akerlof's "lemons model" (1970) demonstrates that markets may be thin or nonexistent when buyers and sellers cannot adequately convey information about product quality. If average quality dictates price, then higher quality products would not receive acceptable remuneration and would be withheld from the market. Poor quality products, in contrast, receive greater remuneration than if the market has perfect information; individuals are thus encouraged to dilute the market with more lemons. The result is that exchanges do not take place.

Leland (1979) applies Akerlof's framework to occupational licensing laws and finds that a minimum quality standard can improve welfare. However, he notes that this conclusion does not consider alternative methods of reducing the problems associated with asymmetric information; other policies may achieve this end more effectively. Law and Kim (2005) discuss the historical development of licensing laws during the Progressive Era and examine what they consider the dominant view among economists--that licensing restricts entry and reduces competition. They argue informational asymmetries, which were exacerbated due to increasing urbanization and advances in knowledge, explain the enactment of many of these laws and provide justification for them on economic grounds.

There are many market mechanisms in place that mitigate the problems associated with asymmetric information. As Akerlof himself suggested, sellers often offer warranties and establish a brand name in order to provide information to buyers about product quality (Akerlof 1970). The desire for repeat business gives producers an incentive to provide true information about the quality of goods. Certification from third parties, such as the Better Business Bureau or Consumer Reports, provides another means for buyers to obtain assurances about product quality (Klein 2001).

Govermnent's justification for licensing is generally not as sophisticated or explicit as the explanations put forth by economists; however, the language used to indicate legislative intent does suggest the presumption of information asymmetry problems. …

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