Licensing boom: In 1950, 73 occupations required licenses in one or more states. By 1970 that number had grown to more than 500. | Reuters/Athit Perawongmetha
It’s illegal to practice medicine without a license, and that piece of paper is exceedingly hard to come by. Would-be doctors face more than a decade of training and must pass rigorous board exams. Thanks to that high bar and the steep up-front ante, there are almost no quacks in American medicine today. That’s a comforting thought when you’re sick and need to see an unfamiliar physician.
So, naturally, we take it for granted that licensing requirements — now common in skilled professions, including law, architecture, and accounting — exist to protect consumers. Indeed, that’s more or less what Stanford Graduate School of Business professor Jonathan Berk assumed when he began a theoretical study of licensing and certification in the labor market.
Instead, he and coauthor Jules van Binsbergen of the University of Pennsylvania found exactly the opposite. As they report in a new working paper, “Regulation of Charlatans in High-Skill Professions,” their model concludes that licenses enrich the incumbent providers of a service and hurt consumers — not sometimes or in certain scenarios, but every time.
Now, to be sure, if any barber could hang up a shingle and call themself a doctor, and you unwisely decided that would be a good option for hernia surgery, you might wish there’d been more stringent regulations in place. What the analysis says is that consumers as a whole are worse off under licensing — the gains to those who benefit are far outweighed by the burden on the vast majority, who don’t.
“This result was as much a surprise to me as it is to anybody,” says Berk, the A.P. Giannini Professor of Finance. “To be honest, this is not the paper we set out to write.”
More astonishing still, the authors found that if a public agency or trade group simply informs consumers about the quality of practitioners in a field — say, to help you choose a financial advisor — even that hurts consumers. That goes against a strong intuition in economics, Berk says. “We tend to assume that giving someone better information helps them secure a better outcome. Not so here.”
How can this be? Why would consumers be better off without regulation, even if it meant they were more likely to hire a charlatan? “The fundamental point we’ve all missed is that markets adjust to the presence of risk,” Berk says. “When there are charlatans in the market, the price declines to reflect that fact. But imposing standards to force them out reduces competition and raises prices.”
A Boom in Licensing
The second half of the 20th century saw an explosion in the number of fields requiring an official credential to practice, and the impetus for that often came from trade group lobbying. In 1950, 73 occupations were licensed in one or more states. By 1970 that number had grown to more than 500. Many other professions, including mechanics and meteorologists, created voluntary certification programs — even psychics now have a testing and certification board. (A footnote in the paper remarks, “One wonders why a psychic examiner would need to administer an examination to determine whether a candidate is qualified.”)
These credentialing programs serve as a barrier to entry, and as with such barriers in industry, they reduce competition and line the pockets of incumbents. In a way, groups like the American Bar Association are the equivalent of medieval guilds, which were at least open about their intent to fence off and monopolize skilled labor markets.
Prices Adjust
Of course, models are only as good as the assumptions they’re built on, but Berk believes the assumptions they’ve made are quite reasonable. “Our key premise is that consumers aren’t stupid,” he says. “Put yourself in the situation: If you know there are charlatans in a certain field, but you don’t know who they are, you’re not going to pay as much, right? Whatever the odds of getting an incompetent provider are, prices will be forced down to a level at which you’re willing to take that chance.”
Skeptical that anyone would gamble on a doctor? Imagine you need a simple procedure that is wildly overpriced at $10,000 in today’s medical market — but you can also get it done in a country where 1% of the doctors are unqualified. Would you accept a 99% chance of success if it cost only $5,000? How about $1,000? At some point, there’s a risk/price tradeoff that consumers will accept. We do it every day.
So, charlatans lower the price of a service. But if that were the whole story, buyers would come out even. You pay less, and you get less — in the sense of reduced confidence in the outcome. However, there’s a second, supply-side effect, Berk says, and it always goes one way: “When you lift the regulatory barrier, you get more people offering the service. Some are charlatans, but some are just people who trained but failed the licensing exam. Competition increases, and that pushes the price down further. That’s why consumers are better off in a market with charlatans — and skilled workers are worse off.”
To drive the point home, Berk offers an analogy many of us can relate to: the market for used cars. “If I have a really good car I want to sell, but there are others in the market selling lemons, who gets hurt? If buyers can’t tell us apart, they lower their price offers across the board. I get less than my car is worth, and the dishonest sellers get more. So I’m the one who pays the cost, not the buyer.”
Market Discipline
But does that mean the government must step in to protect the interests of honest sellers — or skilled professionals? Not necessarily. Providers have other recourse. After all, it’s in their own interest to energetically convey the quality of their offerings. The person selling the car, say, can have it inspected and share their maintenance records with prospective buyers. And if they don’t, buyers should know that’s a bad sign.
Same in health care. You might not get stats on surgical outcomes, but there are many indirect signals that patients rely on — and physicians invest in. Where did the doctor go to medical school? Do they work with a top hospital? Is the office in a nice building? Is the waiting room clean and bustling? All that translates into higher fees. Legitimacy and success are not that hard to discern.
“The point,” Berk says, “is that qualified providers and consumers are not helpless without regulation. If we stopped licensing doctors — and I’m certainly not advocating that on the basis of this one study — it’s not that everyone then gets charlatan doctors. There is information in the market, and the market imposes standards on its own.”
“Skilled practitioners will always lobby for strong licensing requirements,” he adds. But in the absence of a licensing system, they’ll do everything they can to help us tell the good apples from the bad — in that sense, the accomplished practitioners’ interests are aligned with consumers.
The Continuum of Competence
Does that mean we should scrap licensing requirements? “No, that would be premature,” Berk says. “What we’re suggesting is, if you want to maintain the current policy approach, you need to justify it. You can’t just assume it benefits consumers. What assumption in the model is being violated? The onus should be on you to show, for instance, that consumers are naïve and prices don’t adjust.”
And one simplifying assumption works the other way: In the model, workers are split into two groups — those who are capable of acquiring the talent and others who are incompetent. In the real world, ability is spread on more of a continuum, which means that stringent standards often exclude would-be practitioners who are skilled enough to handle many, but not all, tasks in a profession.
Berk says there’s no guarantee that every single consumer would be better off in a world without regulation. And while aggregate cost-benefit analysis is a standard guide for public policy, some might argue that a caring society should instead aim to minimize the risk for each person — regardless of the cost it imposes on others — especially, as in medicine, where lives are at stake.
But is that what our current system does? “Health care is exceptionally expensive today, and we know that has a terrible human cost,” Berk says. “People aren’t getting the care they need. And there’s no inherent reason it has to be that way. It’s a tough job, but a lot of jobs are tough and pay far less. It’s because we’ve made it so hard to become a doctor and artificially restricted the supply of medical skill. I really believe we should rethink this.”
For media inquiries, visit the Newsroom.
