Free Our Markets

by Howard Baetjer Jr

  The Constitution protects the right to earn an honest living without arbitrary and unreasonable government interference.

  But if you want to braid hair for a living in Utah, you must submit yourself to a completely irrational licensing scheme to get permission from the government before you are allowed to work.

  Jestina Clayton, a college graduate, wife, mother of two and refugee from Sierra Leone’s civil war has been braiding hair for most of her life. Now she wants to use her considerable skills to help provide for her family while her husband finishes his education. But the state of Utah says she may not be paid to braid unless she first spends thousands of dollars on 2,000 hours of government-mandated cosmetology training—not one hour of which actually teaches her how to braid hair. In the same number of class hours, a person also could qualify to be an armed security guard, mortgage loan originator, real estate sales agent, EMT and lawyer—combined.

  By the way, I checked with the Institute for Justice about what looks like a misprint in this last sentence, but those numbers are accurate.

  Increased Harm from Stricter Electrician Licensing

  As these examples show, the capture of occupational licensing by established members of a regulated industry allows the privileged insiders to exclude would-be competitors. That denies those would-be competitors their right to earn an honest living, it forces customers to pay more, and it restricts their choices. These ill effects are substantial on their own, but sometimes there are additional, more insidiously harmful effects. Ironically, licensing can reduce the public health and safety it is supposed to promote. Economists Sidney Carroll and Robert Gaston did a study of the effect of licensing of electricians. The strictness of electrician licensing requirements differs substantially from state to state. In some states the requirements are quite strict, so it costs a would-be electrician a lot of time, effort, and money to gain a license. In other states the requirements are less strict, so qualifying is much less costly. To judge the effect of licensing on public health and safety, the authors correlated the strictness of licensing requirements in various states with the states’ rates of death by electrocution. They found a significant relationship. Before reading on, try to figure out what they found and try to explain the findings you expect in terms of the incentives of the affected groups. Remember that in all fields subject to licensing, those already licensed have an incentive to keep others out, so they can charge more for their services.

  * * * * *

  If we don’t take incentives into account, and consider only the apparent intention of the regulation, we might expect to find that rates of death by electrocution are lower in states where electricians are very strictly licensed and vice versa. After all, the more strictly licensed electricians are, the more competent electricians should be and consequently the fewer problems we should have with bad wiring and electrocutions. At the other extreme, where it is so easy to get an electrician’s license that almost anyone can do so, we might expect incompetents to practice, wiring buildings badly and causing more deaths by electrocution. But that is not what Carroll and Gaston found.

  They found rates of death by electrocution to be significantly higher in states with stricter licensing of electricians. A large portion of those electrocuted were amateurs—homeowners—trying to do their electrical work for themselves. In their inexperience, they made fatal mistakes. Why do such fatalities occur at higher rates in states where electrician licensing is more strict? Because in those states the comparatively fewer electricians don’t have to compete as hard on price, so their services are more expensive, and hence incompetent homeowners have a stronger incentive to do the work themselves.

  The intentions of regulation don’t determine its outcomes; incentives do.

  Occupational licensing is spreading. According to the Institute for Justice, “Fifty years ago, one in 20 Americans needed a government license to work in their occupation. Today that number is close to one in three. In 1981, there were roughly 80 occupations that required a license in at least one state. Today there are 1,100.”

  Capture of Other Kinds of Regulation

  Not just occupational licensing but all kinds of government regulation are liable to be captured by special interest groups. The coercion that backs government regulation always offers special interest groups the possibility of a short cut to higher profits. If they can just find a way to use that legal coercion to advantage, they can bypass the free market’s relentless requirement that they actually serve their customers as well or better than their competitors do. Humans are resourceful beings. When regulatory authority offers us the possibility of getting what we want by force rather than by creating value, many of us fall prey to the temptation. Here are two more examples.

  Airline Routes and Fares

  Before air travel was largely deregulated, the Civil Aeronautics Board (CAB) controlled which airlines could operate, the routes that airlines could fly, and the prices they could charge. The special interest group most immediately affected was the established airlines themselves; they had a strong incentive to influence that regulation to their own advantage. They did so, at great expense to consumers. The CAB held airfares high enough to keep the existing airlines in business and denied would-be airlines the freedom to compete. What little competition occurred among existing carriers was along such lines as the quality of meals. Under this regulation, consumers paid high prices for a limited choice of carriers and routes.

  Airline deregulation was long opposed by the major airlines, but it improved air travel dramatically for most consumers. By allowing new entrants to compete, and to do so by offering lower fares, deregulation spawned a variety of new airlines, new service to more destinations, and substantially lower fares on routes between major cities. “Deregulation also allowed existing airlines to enter new routes without having to get the government’s permission. [For example], Southwest started as an intrastate airline in Texas and could only expand because of deregulation.” The profit-and-loss feedback that resulted from deregulation drove into bankruptcy many of the airlines that regulation had kept artificially profitable, such as Eastern, TWA, and Pan Am. It rewarded lower-cost, more efficient carriers such as Southwest.

  Mexican Trucking Companies in the U.S.

  The Teamsters’ Union and other American trucking interests have largely captured safety and environmental regulations as applied to trucking, using regulations to block competition from Mexican trucking companies and their Mexican drivers. The consequence is higher wages for U.S. truckers and trucking companies, higher shipping costs in both the U.S. and Mexico, and increased pollution.

  Under the North American Free Trade Agreement (NAFTA), trucks and drivers that met both nations’ safety and licensing requirements were to be free to operate on both sides of the border. There was to be no discrimination based on national origin. The resulting competition would be good for everyone in either country who buys goods that have been shipped by truck. (That’s all of us.)

  NAFTA went into effect in 1994. Dan Griswold, former director of the Herbert A. Stiefel Center for Trade Policy Studies at the Cato Institute, reports that President Clinton “unilaterally suspended implementation of [its U.S.-Mexico] trucking provisions in 1995, citing safety concerns.” Mexican trucks already had to meet all the safety requirements of American trucks to operate in the U.S., but nevertheless Clinton treated Mexican trucks as unsafe. Mexico officially objected in 1998, claiming correctly that the U.S. was violating NAFTA by discriminating against Mexican trucking firms. In 2001 a NAFTA dispute-resolution panel unanimously agreed, and forbade the U.S. to assume that all Mexican trucks and drivers are unsafe.

  Nevertheless, the American trucking interests kept using “safety” restrictions to block the Mexican competition. They persuaded Congress to pass twenty-two new safety requirements that Mexican trucks must meet in addition to the safety requirements for all trucks on American roads, before they would be allowed to go outside “commercial zones” near th
e border. The U.S. Department of Transportation duly implemented the twenty-two new requirements in 2002 and prepared to issue licenses to complying Mexican trucks.

  To prevent that, the American trucking interests then turned to environmental restrictions. With the help of environmental activists they complained in court that the new trucking regulations violated environmental laws. (This argument looks particularly insincere because forbidding Mexican trucks from delivering cargo directly to destinations in the U.S. means diverting cargo to warehouses in “commercial zones” near the border, where it is reloaded onto American trucks. The extra truck mileage and delays result in needless air pollution.) The 9th U.S. Circuit Court of Appeals upheld the American truckers’ complaint in 2003 (thereby banning Mexican trucks from the U.S.), but the Supreme Court unanimously rejected it in 2004 (thereby allowing the Mexican trucks into the U.S.).

  Denied the use of environmental regulation to block Mexican competition, the American trucking interests fell back on licensing, which they have held captive with Congress’s help. As of 2007, the Federal Motor Carrier Safety Administration had developed a “pilot program” under which (only) fifty-five Mexican trucks were allowed to deliver goods deeper than twenty miles into the U.S. (and fifty-five American trucks were allowed to deliver goods deeper than twenty miles into Mexico). In a world not manipulated by special interests, this pilot would have been expanded to allow all safe Mexican trucks to operate in the U.S. But Mexican trucks need licenses to operate on American roads, and safety inspections cost money. So what did Congress do, at the behest of American trucking interests? They simply declined to fund the pilot program any longer, or to appropriate any money for licensing and inspecting Mexican trucks.

  To risk belaboring the point lest it be missed: Licensing trucks to operate on American roads is supposed to protect Americans from unsafe trucks and untrained drivers, but it is not used that way. According to Dan Griswold, “the Mexican trucks that have been allowed to operate in the United States under the pilot program have actually had a better safety record than U.S. trucks.” Instead of protecting the American public’s safety, the licensing protects American trucking interests from competition. The consequence for the American public is less choice and higher prices.

  Regulations Captured by Indirectly Affected Groups

  In the standard theory, as in the examples we have considered so far in this chapter, capture of regulation occurs by the regulated group. But the regulatory process can be captured by groups other than those regulated. Often some group that is affected only indirectly will have strong interests at stake in the regulation. In such cases that group usually tries to gain control of the regulation, or at least influence it to their advantage. The general principle is the same as in capture of regulation by the regulated group: Wherever governments intervene in the economy, using force to restrict people’s freedom or use of their property, special interest groups will have an incentive to use that governmental force to their own advantage, even to the detriment of others. In this section we consider two such cases.

  Minimum Wage Laws

  Here is a quick refresher on the effects of minimum wage laws:

  In a free market for labor services of any sort, the wages or salaries paid will be determined, as all market prices are determined, by the interaction of suppliers and demanders in that market. Employers who need (“demand”) workers will try to outbid one another to the extent they must, in order to attract the number of workers they would like. This competition among employers holds wages up. Workers who want jobs (“suppliers” of labor services) will try to underbid one another to the extent they must, in order to win the available positions. This competition among workers holds wages down. The market wage is determined “at the margin”: It will be right around the level negotiated by the last (or “marginal”) employer willing to pay at least that much and the last (marginal) worker willing to accept that little. To put it another way, the wage will be in the narrow range in which the number of workers employers are willing to hire (at that wage) just equals the number of workers who are willing to work (at that wage). The crucial point about the going market wage at any time is that if it were any higher, some employers would not be willing to pay that much and would lay off workers or hire fewer in the first place.

  It follows, sadly, that when legislatures set a legal minimum wage high enough to make a difference—higher than the freely-negotiated market wage—they cause unemployment. For the marginal employers—the ones barely able to pay so much—that higher wage they are required to pay means they’ll make losses instead of profits, so they don’t hire them. The immediate consequences of minimum wage laws are therefore twofold: 1) some low-skilled workers—those who keep their jobs—earn higher wages and higher incomes, and 2) some other low-skilled workers—those who lose their jobs—earn no wages at all and thus lower incomes. How much lower depends on their other options, including relying on family, public or private charity, or work in the black market.

  Thus, while minimum wage laws are intended by their well-intentioned supporters to hold up wages and hence incomes for all low-skilled workers, the laws must have the opposite consequence for some low-skilled workers, usually the lowest-skilled, if they have any effect at all.

  With that refresher of price theory in mind, let us return to an investigation of why certain groups try to capture the process of setting minimum wages. Use the public-choice framework for analysis as we have in earlier examples:

  Of any policy, ask two questions:

  1. What groups are primarily affected?

  2. What are their incentives?

  Those incentives will determine (or strongly influence) the outcomes.

  What groups are significantly affected by the minimum wage? What are their incentives? Of course low-skilled workers whose market-determined wages would be at or below the legal minimum are affected (for better or worse, depending on whether they keep or lose their jobs). And we have also discussed the incentive for employers: When forced by law to pay higher wages, they have an incentive to lay off workers who earn for the enterprise less than what paying them costs the employer in total. (In addition to wages, that includes unemployment insurance tax, Social Security tax, workmen’s compensation tax, and any other contractual or mandated benefits.) With minimum wage regulation, there is one other broadly-defined group with a significant financial interest. Before reading on, try to figure out what group that is and what incentive they have with respect to the minimum wage.

  If you don’t see it right away, try a much more cynical approach: Who benefits when the low-skilled and disadvantaged become too expensive to hire? Be warned: Public choice analysis of public policy can be disillusioning.

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  Lower-skilled workers compete with higher-skilled workers who can accomplish the same results. Accordingly, higher-skilled workers who can accomplish results now achieved by lower-skilled workers have an interest in minimum wage laws. Why? When minimum wage laws make lower-skilled workers more expensive, employers have an incentive to turn to higher-skilled workers whose services have now become a relatively better bargain.

  What are the organized associations of higher-skilled workers? Unions. Even unions whose members earn far more than minimum wage have a financial interest in higher minimum wages because their higher-paid members compete with lower-skilled workers. Thus it should be no surprise that unions frequently back higher minimum wages.

  A thought experiment will clarify the arithmetic of the minimum wage: Suppose you are a general contractor on a construction site and among the many tasks to be done, you need to get a ditch dug. You have two options for digging it. One is a group of five men with strong backs, picks and shovels, and little education. They are willing (and we’ll assume legally allowed) to work for five dollars an hour each; together, the five will get the ditch dug in one hour. Your other option is a single backhoe operator with his own backhoe and the training to use it well. He is prepar
ed to work for union wage of twenty-seven dollars an hour; he, too, will get the ditch dug in one hour.

  Whom will you hire? On what reasoning?

  If you hire the five unskilled workers, the cost of getting the ditch dug is

  5 men x $5/hour x 1 hour = $25.

  If you hire the backhoe operator, the cost is

  1 man x $27/hour x 1 hour = $27.

  Probably you’ll hire the unskilled workers if you and they are free to deal with one another on those terms, because they will accomplish the same results for less.

  But suppose, with union support, the government imposes a minimum wage of six dollars an hour. Now whom will you hire?

  If you hire the five unskilled workers, your cost is no longer $25, but

  5 men x $5 $6/hour x 1 hour = $25 $30.

  If you hire the backhoe operator, your cost is

  1 man x $27 $29/hour x 1 hour = $27 $29.

  You’ll hire the unionized backhoe operator, even if the unions have taken this favorable opportunity to increase the wages they demand, because the union worker will do the job for less. In this case, the minimum wage would mean that the five unskilled workers would lose a job they otherwise would have had, the union worker would be able to charge more than he previously could, and your customers would have to pay more for their building.

  This conclusion applies to unions and minimum wages generally. By pricing low-skilled labor services out of the market, minimum wages increase employers’ demand for the services of higher-skilled (often unionized) labor services that are the alternative. Though union workers earn far more than minimum wage, higher minimum wages can benefit union workers.

  Based on unions’ incentive to achieve higher minimum wages, the outcome we observe is understandable—steady pressure by unions, and year after year, bills introduced in Congress by the unions’ politicians to raise the minimum.