RDP 2024-06: Examining the Macroeconomic Costs of Occupational Entry Regulations 2 OER have costs and benefits

OER have costs and benefits, that may need to be weighed up when creating them. The main benefits largely stem from the potential to improve or maintain minimum quality standards. This can help provide consumers greater confidence to engage services and protect them, and workers, from direct harms.

The costs of OER include the direct costs to workers in needing to pay for the additional licensing. In addition, OER also impose indirect costs that can lead to higher prices and less choice for consumers. This can stem from reduced competition as it is more difficult for new firms to enter and expand, and for workers to move to where there are opportunities. For similar reasons, OER can also make it harder for the economy, businesses, and workers to respond to shifts in demand or technological change. The NSW Productivity Commission and NSW Innovation and Productivity Council (2022) also found that overly stringent OER can perversely incentivise consumers to use unlicensed services. These economic costs are fairly indirect and diffuse, relative to the benefits. As a result, they may be hard to assess when setting OER.

2.1 OER help maintain minimum quality standards

OER are intended to ensure goods and services meet a minimum quality, by ensuring that the workers producing them meet a minimum standard in terms of skills and training (Leland 1979). As consumers are sure that goods and services will be of a high quality, it will inspire greater confidence, benefiting both consumers and producers. Workers may also benefit from OER by ensuring that only qualified individuals can perform certain tasks that may pose a risk to worker safety.

These benefits are likely to be particularly large where the consumer cannot effectively assess the quality of the goods or services due to a lack of expert knowledge. That is, where there are informational asymmetries between the consumer and the provider. While some of these information asymmetries can be overcome by repeated interactions, or reputational mechanisms (e.g. online reviews), this is not always the case, nor is it always appropriate. For example, in some cases it may not be obvious whether the goods or services were of high quality for some time (e.g. the workmanship of a builder). Similarly, where poor-quality goods and services could lead to significant harm for consumers, relying on repeated interactions and reviews may not be desirable.

Not all OER are necessarily effective in maintaining or improving quality standards. Minimum qualification requirements do not guarantee that a practitioner will meet standards or deliver high quality services. And numerous studies looking at the effects of lowering OER failed to find evidence of a subsequent reduction in the quality of goods and services (see Bambalaite et al. 2020, annex C for a detailed summary of this literature).

That said, the lack of evidence of a benefit does not indicate that OER serve no purpose as quality is inherently difficult to measure (Commonwealth Productivity Commission 2023). In addition, it can be difficult to extrapolate findings from incremental changes, which are more common and tend to be used in assessing benefits, to more substantive changes in OER, particularly given the incremental changes that occur are likely to be relatively ‘safe’.

2.2 But OER can also work against consumer interests

OER create barriers to entry for workers and businesses looking to enter a profession or industry. This can have several direct and indirect costs.

First, by creating barriers to entry into professions, OER can create and exacerbate skill shortages. Differences in licensing regulation across jurisdictions makes it difficult (and costly) for individuals to move between states, countries, or professions: a study in the United States found state-specific licensing reduced interstate mobility of workers by 36 per cent (Johnson and Kleiner 2017). And within jurisdictions, OER can make it harder for people to change occupations. Both sets of frictions make it harder for the economy to adjust to economic shocks or structural changes. This can potentially contribute to higher levels of skills shortages and structural unemployment (i.e. workers can't find jobs because their skills do not match the jobs available).

Second, OER can also lower the overall number of providers, which can reduce competition leading to higher prices for consumers. For example, in the United States, licensing is estimated to have reduced labour supply by an average of 17 to 27 per cent across several occupations (Blair and Chung 2018). Similarly, across a broad range of countries more stringent OER are correlated with lower rates of business entry and exit – or dynamism, the sum of the two (Figure 1).

Third, occupational licensing can also have implications for productivity growth as businesses may have reduced incentives to innovate. As discussed in Bambalaite et al. (2020), occupational licensing could cause individual businesses to be more or less productive. By ensuring that the average worker is better trained, it could raise the productivity of existing businesses. But at the same time, barriers to entry could weaken competitive pressures which can weaken businesses' incentives to improve (Andrews et al. 2022, Andrews and Hansell 2021). Bambalaite et al. (2020) find that firms' productivity growth tends to be lower where OER are more stringent, suggesting that the reduced incentive to innovate is the dominant channel.

Fourth, occupational licensing could also affect productivity by influencing the allocation of resources in the economy – that is, the extent to which resources such as labour are attached to the most productive businesses. One of the key drivers of productivity is the reallocation of resources from low- to high-productivity businesses, as high-productivity businesses thrive and grow and attract resources from lower-productivity businesses. Stringent OER could slow this process by making it harder for skilled professionals to move between industries or businesses, and by weakening competitive pressures and therefore the impetus for low-productivity firms to shrink and exit (e.g. De Loecker et al. 2021, Hambur 2023). Bambalaite et al. (2020) find evidence of such effects, with the flow of labour from low- to high-productivity firms tending to be slower in jurisdictions and occupations with more stringent OER.

Fifth, occupational licensing may affect productivity by limiting the ability of occupations to change and evolve as technology and consumer demand changes. Previous overseas research has demonstrated that the tasks required by narrowly defined occupations have changed significantly over time (Atalay et al. 2020). For example, bank tellers in the past primarily handled cash transactions but their role has shifted to include customer service, sales of financial products, and troubleshooting digital banking issues. By tightly defining the boundaries of occupations we may limit this natural transformation, which limits new and innovative industries and ways of working.