Occupational Licensing and Entrepreneurship
Agnieszka Kwapisz, Ph.D., M.S., Assistant Professor, Jake Jabs College of Business and Entrepreneurship
This research investigates the link between success of nascent entrepreneurial firms and the states’ occupational licensing policies. We conjecture that individuals are more likely to start a new firm, and do it faster, in states and industries where there are fewer, cheaper, and easier to obtain licensing requirements. Moreover, we will investigate the moderating effect of education, income, industry, sex, race, age, and necessity entrepreneurship.
This project investigates the effect of occupational licensing on success of nascent entrepreneurs. An occupational license is a credential that government requires a person to hold to practice in a given occupation. To earn the license, an individual must clear various hurdles, such as paying fees, attaining a certain level of education or training, or passing an exam. Some occupations are universally licensed but many are licensed only in a specific state. There is a good reason to suspect that many licensing schemes are very arbitrary, as evidenced by the variability in the manner and burden of licensing across states (Kleiner, 2015; Broughman et al., 2012). Few would support a system in which anybody could be a doctor or a lawyer but overly extensive regulations hamper productive entrepreneurship (Henrekson & Stenkula, 2010; Thornton & Timmons, 2015). The most regulated state in the nation is California, which requires licenses for 177 job categories (Summers, 2007). Over 1,100 occupations are regulated in at least one state, but fewer than 60 are regulated in all 50 States (The White House, 2015). Some states regulate occupations with no self-evident rationale for licensure, such as shampooers (5 states; Tennessee requires 70 days of training, 2 exams, and $140 fee), florists (only in Louisiana, 1 exam and $225 fee), or funeral attendants (9 states including Montana). Licensure burdens vary considerably. For example, manicurists must have 3 days of training in Alaska, 9 days in Iowa, but 4 or more months in 10 other states (Carpenter et al., 2012). Such inconsistencies give good reasons to doubt that having so many licensing schemes is necessary.
Most of the licensed occupations offer a possibility of entrepreneurship, suggesting that these laws may hinder both job attainment and creation. In fact, there are claims that licensing may be a contributing factor to the decline in entrepreneurship in the recent years (Davis & Haltiwanger, 2014). Nascent entrepreneurs are individuals who initiate activities (e.g. writing a business plan, talking to customers, seeking financial support) that are intended to culminate in a viable new firm (Reynolds, 1994; Davidson, 2004; 2005). Therefore, nascent entrepreneurs are at the very early stages of starting a new venture when they determine the profitability as well as regulatory requirements of their ideas. Licensing may either delay the startup process or halt the efforts altogether. In fact, data from the Panel Study of Entrepreneurial Dynamics (used in this study) show that many entrepreneurs cite “licensing” as the main problem involved in starting a new business.
The study will proceed in 3 steps. First, we will determine characteristics of startups whose owners specifically answered that government licensing and regulation were the biggest problems in starting their business. Second, we will test a set of hypotheses (set 1 below) to determine the effect of licensing on the probability and the time it takes to start a new firm. Finally (set 2), we will determine the effects of the specific licensing requirements (fees, education, experience, exams, minimum age, and minimum education). Since previous literature suggest that licensing requirement may affect poor, un-educated, females, or minorities differently, we will test the possible moderating effects explained in the hypotheses statements below.
Set 1. The effects of a license requirement:
H1a/b: Occupational licensing laws decrease the probability that nascent entrepreneurs form a new viable firm and increase the time it takes for nascent entrepreneurs to form a new viable firm.
H2-4 a/b: The level of education/experience in industry/income moderates the effects hypothesized above in such a way that having more years of education, experience, and higher income increase the probability (and decrease the time) that nascent entrepreneurs form a new viable firm in industries and states that require licensing.
H5-8a/b: Being female/racial minority/younger age/necessity entrepreneur moderates the effects hypothesized above in such a way that these populations have lower probability (and longer time) to form a new viable firm in industries and states that require licensing.
Set 2. The effects of difficulty of obtaining an occupational license:
H1-3a/b: Higher fees/more days of education or experience/more exams required to obtain an occupational license decrease the probability that nascent entrepreneurs form a new viable firm and increase the time it takes for entrepreneurs to form a new viable firm.
Moderating hypotheses: As above, education, experience, income, sex, race, age, and necessity entrepreneurship are expected to moderate the above effects of fees, days, and exams (in a similar way as in the first set of hypotheses).
Additionally, the effect of minimum age and grade required to obtain the license will be investigated but these are not expected to be significant since the requirements are usually very low.
The rationale and economic basis
The study of regulation of the occupations has a long tradition in economics, going back to Adam Smith’s Wealth of Nations and Milton Friedman, but has received relatively little attention in modern days until very recently (Kleiner, 2000). The reason for the renewed interest in licensing is its widespread and fast growth (Kleiner and Krueger, 2010; Kleiner, 2015; Larkin, 2016). The proportion of the workforce required to obtain a license to work was 4.5% in the 1950s, 18% in the 1980s, 20% in 2000, 29% in 2008, and this number is expected to grow (Kleiner & Krueger, 2010). According to Kleiner (2000), licensing directly affects more workers than either the minimum wage (10%) or unionization (15%). On one side, licensing is designed to protect the public’s safety and well-being by mandating training and experience for certain professional practices. It creates greater incentives for individuals to invest in more occupation-specific human capital, as they will not face low-quality substitutes for their services (Akerlof, 1970; Shapiro, 1986). It is intended to reduce customers’ uncertainty over the quality and potentially create more demand for the service. On the other side, many scholars report that “many occupational licensing schemes are the product of the political equivalent of bribery and extortion, rather than a considered attempt to improve the public welfare” (Larkin, 2016, p.4). Research shows that licensing requirements raise the price of goods and services (3-16%), restrict employment opportunities, make it more difficult for workers to take their skills across state lines, and often do not increase the quality of goods and services (The White House, 2015; Kleiner & Kudrle, 2000; Kleiner, 2015). One could argue that licensing is a vehicle to protect incumbent businesses and workers from competition, especially from younger, less educated workers and entrepreneurs (Davis and Haltiwanger, 2014; Konczal, 2013; Zapletal, 2017).
Significance of the Project
Entrepreneurs are thought to play a vital role in the economy. They are touted as a primary driving force behind employment creation, technological advancement, innovation, creating change, intensifying competition, and overall economic growth (Wennekers & Thurik, 1999; Carree & Thurik, 2003). Entrepreneurship occupies an iconic place in American public policy debate, and political leaders of both parties routinely voice their support for the sector (Gale & Brown, 2013). Economists propose that the key obstacle to economic growth is the insufficient level of entrepreneurship and see entrepreneurship as having some public good characteristics (Hausmann & Rodrik, 2003; Iyigun & Rodrik, 2004). But partially because of US regulatory overreach, US ranks 47th out of 189 countries in the ease of starting a new business (World Bank, 2014; Davis, 2015).
The proposed project will evaluate the effect of licensing requirements enacted by state legislatures on the success of startups. According to Kleiner and Krueger (2010) “one of the fastest-growing yet least understood institutions in the US labor market is occupational licensing” (p. 676). For a subset of low- and medium-skilled jobs, the average license required: $209 in fees, one exam, and about nine months of education and training (Carpenter et al., 2012). Therefore, licenses may slow down or halt early stage ventures but their effects on entrepreneurship is not fully understood.
How the research project will improve our knowledge regarding the regulatory/policy issues
Despite the fact that occupational licensing is one of the fastest-growing forms of labor market regulation, it is the least studied and understood (Kleiner and Krueger, 2010). This study will extend existing research by examining the impact of licensing on the probability of formation of a new firm and the time required. Additionally, this study will investigate the effects of specific licensing requirements: fees, days of education and experience, and number of exams. We will also see how licensing laws may differently affect certain populations: low income, low education, females, or racial minorities. This research will highlight the importance of licensing as an under-studied phenomenon with significant public policy implications. The panel data analyzed will allow us to study how licensing directly affects startups. This approach avoids many econometric problems discussed in the literature on the topic of firm formation.
How the research could potentially help policy makers addressing the regulatory/policy issue
In the light of what seems to be excessive growth in licensing, this research will quantify the extent to which these legislations slow or halt startup efforts. The effect of fees, required education and experience, and number of exams have not been studied before and, in order to make informed decisions, states need to know their impact on entrepreneurship. Nascent entrepreneurs usually struggle with resources, and an excessive licensing fee may stop or slow them down in the startup process. Our results would provide state policymakers with a rationale to review current and proposed licensure schemes and to determine whether they truly serve the public or merely fence out competition. If significant result are documented, lowering licensing fees may be justified. Low income, low education, and minority populations are hypothesized to be more affected by licensing laws. Also, females are known to start their businesses in more service oriented industries which tend to require more licensing. If occupational licensing laws affect some demographic groups or sectors differently, economic regulation has to be fine-tuned accordingly.