Occupations: a hierarchy of regulatory options: policymakers should move beyond the license/no license paradigm.
Hemphill, Thomas A. ; Carpenter, Dick M., II
In July 2015, the Obama administration released a first-of-its-kind
report from any White House: a study on occupational licensing. The
report gained significant attention because of the novelty of its
subject for a White House report, but also for its rather skeptical view
of licensing. Mary Kissel, for example, on her July 29, 2015, WSJ Live
Opinion Journal program, said incredulously: "Stop the presses. The
White House released a report yesterday that says a certain type of
regulation kills jobs. The Obama White House said this?"
For many years, the Institute for Justice, the Cato Institute,
state policy think tanks, and others have worked to reform licensing
laws that amount to little more than a government permission slip to
work. But in recent years, the issue finally caught fire among
Republican and Democrat policymakers, culminating in the White House
report. After reviewing the costs and benefits of licensing--with the
former far outweighing the latter--the report offered a series of
recommendations for how states should reform their occupational
licensing policies and policymaking. The most significant of those
recommendations, and likely the most realistic to implement, is a menu
of regulatory options that are less onerous than licensing, including
"certification (whether private or government-administered),
registration, bonding and insurance, and inspection, among others."
As described in greater detail below, the value and utility of such
a menu is that it provides legislators a range of regulatory options
between either no licensing or full licensing. This article builds upon
that idea by including several private governance options that can
realize the public benefits intended by regulation without imposing
costs that come with full licensure or other forms of restrictive
regulation. Our discussion begins with a presentation of the menu--or
hierarchy--of regulatory options as it has been presented in recent
years, and then considers additional, minimally restrictive options.
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MCGRATH'S HIERARCHY
First conceived by the Institute for Justice's legislative
counsel, Lee McGrath, the hierarchy of regulatory options was designed
to compel legislators and industry representatives to consider
occupational regulation beyond the above-mentioned license/ no license
binary thinking that for years has plagued policymaking. Such thinking
has all too often seen policymakers swayed by the arguments of licensure
proponents, who typically assert both that fencing out
"unqualified" practitioners is necessary to protect public
health and safety, and that licensing promotes higher levels of service
quality.
As the White House report makes clear, however, evidence supporting
safety and quality of service assertions is quite sparse, while evidence
to the contrary abounds. Moreover, anyone who has witnessed committee
hearings on licensing legislation has seen firsthand how little evidence
is actually presented or considered and what a one-sided, pro-licensing
affair they tend to be. Nevertheless, faced with a decision between no
licensing and full licensure, legislators tend to choose the latter in
the hope of protecting against the possibility--no matter how remote or
unsubstantiated--that someone will be harmed by unlicensed practice. In
other words, in a binary world of licensing regulation, better to make a
Type I (false positive) error than a Type II (false negative) error.
Enter McGrath and the hierarchy of occupational regulation. Based
on years of working with legislators, he recognizes two facts: First,
legislators feel compelled to act. They are not, after all, elected on a
promise to do nothing. Second and relatedly, legislators will continue
to opt for licensure unless given a more attractive alternative than
simple inaction. Most occupations, of course, operate just fine with no
government intervention, but from time to time a case may be made for
some form of regulation. With only two options, a license will likely be
created, even if the cost of the intervention outweighs the benefit to
public safety.
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In response to those options, McGrath created the hierarchy of
regulatory options outlined below. In addition to the two options as
before--regulation by markets (at the top of the hierarchy) and
licensure (at the bottom)--the menu includes a series of options that
are increasingly restrictive from top to bottom. In order from least
restrictive to most restrictive, these are:
* Market competition/no government regulation. This option should
be the default starting place for any consideration of regulation. If
and only if empirical evidence indicates a need for government
intervention should legislators move to the next option.
* Private civil action in court to remedy consumer harm. Should
legislators not be satisfied that markets alone are sufficient to
protect consumers, private rights of action are a "light" but
effective regulatory option. Allowing for litigation after injuries,
even in small-claims courts, gives consumers a means to seek
compensation (including court and attorneys' fees if their claims
are successful) and compel providers to adopt standards of quality to
avoid litigation or loss of reputation.
* Deceptive trade practice acts. Legislators should look first to
existing regulations on business processes, not individuals. These
include deceptive trade practice acts that empower state attorneys
general to prosecute fraud. Only if there is an identifiable market
failure should policymakers move to the next level of regulation.
* Inspections. This level of regulation is already used in some
contexts. It could be applied more broadly to other occupations as a
means of consumer protection without full licensure. For example,
municipalities across America use inspection regimes (which involve a
current "permit" allowing commercial operation) to ensure the
cleanliness of restaurants--an option deemed sufficient to protect
consumers-over the more restrictive option of licensing food preparers,
wait-staff, and dishwashers.
* Bonding or insurance. Some occupations carry more risks than
others. Although risks are often used to justify licensure, mandatory
bonding or insurance--which essentially outsources management of risks
to bonding and insurance companies--is a less invasive way to protect
consumers and others. For example, the state interest in regulating tree
trimmers--as California does--is in ensuring that service providers can
pay for the repair to a home or other structure in the event of damage.
Such interest can be met instead through bonding and insurance
requirements that protect consumers from harm, while allowing for
basically free exercise of occupational practice.
* Registration. The option of registration requires providers to
notify the government of their name, address, and a description of their
services, but does not mandate personal credentials. Registration is
often used in combination with a private civil action because it often
includes a requirement that providers indicate where and how they can be
reached by a process server should litigation be initiated.
* Certification. Certification restricts the use of a title. Under
certification, anyone can work in an occupation, but only those who meet
the state's qualifications can use a designated title, such as
certified interior designer, certified financial planner, or certified
mechanic. Although the voluntary nature of this designation seems
contrary to the definition of regulation, it is, in fact, a form of
regulation. Certification sends a signal to potential customers and
employers that practitioners meet the requirements of their certifying
boards and organizations. Certification is less restrictive than
occupational licensing, presents few costs in terms of increased
unemployment and consumer prices, and provides information that levels
the playing field with providers without setting up barriers to entry
that limit opportunity and lead to higher prices.
* Licensure. Finally, licensure is the most restrictive form of
occupational regulation. The underlying law is often referred to as a
"practice act" because it limits the practice of an occupation
only to those who meet the personal credentials established by the state
and remain in good standing. To the extent that licensure is considered,
the need for the creation of new licenses or the continuation of
existing ones should be established through careful study in which
empirical evidence--not mere anecdote--is presented.
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Ideally, policymakers would use this hierarchy to produce
regulations that are proportionate to demonstrable need. The process for
doing so would identify the problem before the solution, quantify the
risks, seek solutions that get as close to the problem as possible,
focus on the outcome (with a specific focus on prioritizing public
safety), use regulation only when necessary, keep things simple, and
check for unintended consequences.
The elegance, utility, and appeal of McGrath's hierarchy is
evident not only by its inclusion in the White House report, but also in
the responses of legislators who have seen it as part of presentations
he and others have given to state legislators on behalf of regulatory
reform. What we propose (with McGrath's blessing) is not a
wholesale change to his hierarchy, but an addition of even more
actionable options, specifically near the top, to give lawmakers a
greater number of alternatives that require either no direct government
intervention or an exceptionally small role for government.
A DIALECTIC APPROACH TO OCCUPATIONAL REGULATION
Our proposed additions are rooted in an innovative public policy
approach developed by Edward Peter Stringham in his recent book, Private
Governance: Creating Order in Economic and Social Life (Oxford
University Press, 2015; see review, Winter 2015-2016). Stringham, the
Davis Professor of Economic Organization and Innovation at Trinity
College (Connecticut), outlines the use of a variety of private ordering
mechanisms, including reputation, assurance, and bonding, all useful for
consumers seeking to mitigate fraud in their commercial transactions.
This "private governance" approach to commercial regulation
(and social ordering) is offered in contrast to "legal
centralism," which is government as the primary arbiter of social
rules and enforcement efforts. Legal centralism assumes that markets do
not function effectively without the strong, efficacious involvement of
government in commercial transactions.
Stringham organizes his mechanism by using a regulatory dialectic
approach that effectively complements McGrath's original hierarchy
of occupational regulation. Stringham's approach begins by asking
the following questions (adapted to the "problem" at hand,
i.e., occupational regulation):
* Do government regulators have the knowledge and ability to solve
the occupational oversight problem in a low-cost way?
* Do government regulators have proper incentive to solve the
occupational oversight problem?
While the legal centralist assumes that the answer to both
questions is "yes," the private governance advocate does not.
And if the answer to either or both of the questions is "no,"
then Stringham would argue that consumer needs remain unmet and a third
question should be asked:
* Will the private sector have the ability, knowledge, and
incentives to solve the occupational oversight needs of consumers?
If there is an affirmative answer to the third question, then
Stringham would recommend the consideration of innovative, private
ordering efforts to solve the occupational oversight needs of consumers.
It is important to note one substantive difference between
Stringham's dialectic and McGrath's hierarchy: Stringham
begins his analysis of governance options with the capacity and
resources of government and proceeds to private governance only in the
event of government shortcomings. McGrath's hierarchy begins with
market competition/private governance and shifts to government
intervention only when necessary. In practice, both approaches will
typically end up at a similar place, but McGrath's approach has the
advantage of starting from an assumed position of freedom rather than
one of government paternalism. As such, the power of inertia favors
freedom rather than paternalism.
What we borrow from Stringham is his dialectic approach, which
illustrates how additional private governance options can be added to
McGrath's hierarchy. Considering Stringham's first two
questions above, the answer to both is "no" as applied to
occupational licensing. As the White House report detailed, a
government-mandated license comes with significant costs, such as lost
jobs, higher consumer prices, lower mobility, and the growth of
government and its trailing costs. Meanwhile, the incentives of
government regulators in occupational licensing are perverse. Regulators
tend to be dominated by the industry being licensed and have financial
incentives to exclude new entrants.
As for the third question, rarely has the answer been so clearly
"yes"; hence the enhancements we propose below.
EXPANDING PRIVATE GOVERNANCE OPTIONS
We argue that actively engaging market-based mechanisms--otherwise
known as "regulation through markets"--should always precede
government regulation as the correct sequence in occupational oversight.
Government regulation has been shown to stifle innovation and
entrepreneurship, thus reducing competition. In contrast, empirical
studies of deregulated, competitive industries show that innovation
creates greater deregulated price reductions, while market-based
incentives lower costs, improve quality, and develop new products and
services.
In an expanded version of the original hierarchy (ranging from
least to most intrusive government intervention), we recognize
opportunities that the market has recently made available, especially
through the widespread availability of the internet and its interactive
capabilities between service vendors and consumers. Our "Hierarchy
of Occupational Regulation Options," shown in Table 1,
significantly enhances the upper portion of McGrath's hierarchy,
identifying and describing several "private governance"
options that consumers can use to evaluate the performance of
individuals in an array of occupations and regulate the behaviors of
goods and services providers.
The options in the middle of our hierarchy represent "public
regulation." They are enforceable only when an individual's
conduct is contrary to established rules and regulations. The lower
portion of the hierarchy also represents "public regulation"
options, but they are command-and-control in nature, requiring
individuals to be formally acknowledged (under varying degrees of
oversight requirements) by a state governmental authority to practice an
occupation.
Our additions to the private governance section include the
following:
* Market forces, alternative dispute resolution, and private
litigation. Alternative dispute resolution, which includes mediation and
arbitration, has gained widespread acceptance among consumers, business
professionals, and the legal community in recent years. Many courts will
require this avenue be utilized before formal litigation can proceed. In
addition, the financial threshold for many small claims courts has risen
appreciably for consumers. These new options provide a lowcost
alternative to formal private litigation for both consumers and
occupational practitioners.
* Consumer service ratings sites. Third-party consumer
organizations such as the Better Business Bureau, Good Housekeeping, and
the Consumers Union have provided consumers with information on the
quality of occupational practitioners for decades. More recently, the
internet has offered consumers greater access to those groups'
information and spawned new sources such as Angie's List, a
feebased service for contractors (and now other services). New
third-party information sources are appearing online all the time, such
as HomeAdvisor.com, Houzz.com, and Porch, com for residential services
contracting, and Yelp and Urban Spoon for restaurants and other
merchants.
* Quality service self-disclosure. This works in conjunction with
the preceding option. With virtually all occupational practitioners
having online websites, the ability to actively link to third-party
evaluation sites will provide consumers with an important competitive
"signal" that the practitioner is open to disclosure regarding
the quality of his or her service. This is a market-based incentive that
helps consumers differentiate highly competent, price-competitive
occupational practitioners from mediocre ones.
* Third-party professional certification and maintenance. The
National Commission for Certifying Agencies was created by the Institute
for Credentialing Excellence in 1987. It has accredited approximately
300 professional and occupational programs from more than 120
organizations over the past three decades. These occupational
certification programs cover, for example, nurses, automotive
occupations, respiratory therapists, counselors, emergency technicians,
and crane operators, to name just a few. Such occupational
certifications, to be maintained, often require continuing education
units. Most importantly, many organizations make such certifications a
requirement for employment.
* Voluntary bonding. Voluntary bonding--a guarantee of job
performance and customer protection against losses from theft or damage
by employees--is most common among general contractors, temporary
personnel agencies, janitorial companies, and companies having
government contracts. For the knowledgeable consumer, voluntary bonding
makes the business more desirable, and potential customers increasingly
demand it.
As this list shows, the market has responded with a myriad of
innovative and still-developing alternatives to public regulation.
Rather than continuing to engage in the binary thinking on occupational
regulation that has so often led to unnecessarily restrictive licensure,
legislators and industry representatives would do far better to clearly
recognize and evaluate the many less onerous, less intrusive
market-based alternatives that can effectively work to protect consumers
and ensure service quality.
THOMAS A. HEMPHILL is professor of strategy, innovation, and public
policy in the School of Management at the University of Michigan, Flint.
DICK M. CARPENTER II is director of strategic research at the
Institute for Justice and professor of leadership, research, and
foundations in the College of Education at the University of Colorado,
Colorado Springs.