Selection, Heterogeneity, and Entry in Professional Markets

• DOI: http://doi.org/10.1111/jems.12074
• Published date: 01 December 2014
• Author: Marco Alderighi,Claudio A. Piga
• Date: 01 December 2014

Selection, Heterogeneity, and Entry in Professional

Markets

MARCO ALDERIGHI

Universit`

a della Valle d’Aosta

Aosta, Italy

and Universit`

a Bocconi, Milano, Italy

m.alderighi@univda.it

CLAUDIO A. PIGA

Keele University

Newcastle-under-Lyme, UK

and RCEA, Rimini, Italy

c.piga@keele.ac.uk

We analyze two different cases of entry regulation in professional markets: first, when licensing

is a requirement for becoming a professional (lawyers); second, when entry and price restrictions

are applied on a geographical basis (pharmacists). Both cases are investigated within a circular

model of localized competition and heterogeneous players. The analysis reveals that licensing

introduces a selection mechanism which is effective in preventing entry of inefficient players in

markets with large ex ante heterogeneity. Furthermore,because in the second case excessive entry

is reduced as the degree of heterogeneity increases, our analysis lends support to a policy that

simultaneously relaxes entry and price restrictions.

1. Introduction

The degree of efficiency in markets for such liberal professions as lawyers, notaries,

architects, engineers, and pharmacists has been the subject of extensive investigation

in Europe (European Commission, 2004).1The high level of regulation characterizing

the European market, in the form of either State regulation or self-regulation by profes-

sional bodies, has been deemed by some as unnecessary and harmful, while by others

as compelling and vital. For the latter, regulation is usually sustained by arguments

associated with the so called “public interest view” (i.e., regulation addresses market

failures due to asymmetric information, and/or externalities and/or public good pro-

vision). In contrast, those supporting the “private interest approach” claim that, due

to regulatory capture, many regulatory mechanisms may serve the private interests

of professional bodies’ members more than those of the general public (Stigler, 1971;

Posner, 1974; Peltzman, 1976; Becker, 1983; Philipsen, 2009). For instance, in the case of

Wewould like to thank the editor, the coeditor, and two anonymous referees of this journal for their valuable

suggestions and comments. Paul Dobson, Andr`

e de Palma, Francesco Passarelli, Joanna Poyago-Theotoky,

Jacques Thisse, Chris Wilson, and the participants of 2010 IIO Conference in Vancouver, of the 2010 EARIE

Conference in Instanbul, of the CCRP Workshop organizedby The City University, London, and all seminar

participants at CORE (Belgium) and York (UK) also kindly provideduseful feedback.

1. According to the EU Directive on Recognition of Professional Qualifications (2005/36/EC), liberal

professions are “those practised on the basis of relevant professional qualifications in a personal, responsible

and professionally independent capacity by those providing intellectualand conceptual services in the interest

of the client and the public.”

C2014 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume23, Number 4, Winter 2014, 925–951

926 Journal of Economics & Management Strategy

entry restrictions, a requirement to have demonstrated basic competence is clearly jus-

tified where consumers are not well placed to assess the quality of service, as is usually

the case in markets for professional services. This has to be weighed against the risk

that necessary qualification thresholds may be set too high to constrain entry and thus

benefit incumbent producers, who largely control the professional bodies.

Based on the premise that in the real world some degree of firm heterogeneity

is the rule rather than the exception, in this study we deviate from the usual mar-

ket failure versus regulator capture arguments to provide a different and, in some

sense, complementary model for liberal professions, which allows an evaluation of

the welfare properties associated with (1) the entry requirement of licensing, (2) the

entry restrictions capping the maximum number of firms, and (3) fixed or minimum

prices.

Even within the European Union, professional regulation presents significant dif-

ferences among countries and professions, although there are also some important sim-

ilarities worldwide. As far as entry restrictions are concerned, for all professions a

university degree in the relevant field is required; for a subset of them (lawyers) the

exercise of the profession is conditional on the further acquisition of a licence which is

obtained by passing an examination and on spending a period of apprenticeship under

the supervision of a qualified professional (Kleiner, 2000). For other professions, e.g.,

pharmacists, no licensing is needed; in this case, however, rules on entry based on de-

mographic and geographic criteria often make it impossible to open a new outlet in

markets where such criteria are binding (Schaumans and Verboven, 2008).2

Wepropose a set-up that accommodates two main cases based on whether or not a

licence is required for the entry in the liberal profession. When licensing is not required,

entry is modeled as a two-stage game, where prospective entrants incur a set-up sunk

cost before starting production and the related competitive stage. To account for licens-

ing, we introduce a preliminary stage, where prospective professionals have to incur the

licensing sunk cost before deciding whether to start their activity or not. The opportu-

nity cost of the time spent to complete the apprenticeship period largely determines the

magnitude of the licensing cost. Thus, entry in professions where licensing is required

entails a three-stage process and two different sunk costs (i.e., the licensing cost as well

as the production set-up cost as in the no-licensing case).

Both types of entry games (i.e., with licensing and without) are analyzed in this

study by modeling the relevant market as a circular city model of localized competition

with heterogenous costs’ firms (Salop, 1979; Syverson, 2004; Vogel, 2008). To remain

in keeping with the terminology used in the existing literature, we will use the terms

“professional” and “firm” interchangeably.

The two games have different informational structures, which impact on the char-

acteristics of the ensuing equilibrium. In the two-stage game, before moving to the final

stage, players have no information about their own production costs, while in the li-

censing game, a professional learns her own cost after the licensing phase. Thus, this

second model entails a selection mechanism: only those professionals with sufficiently

low production costs will decide to enter the production stage by paying the second

set-up sunk cost.

2. Licensing and quantitative entry restrictions are not always mutually exclusive. For instance in Italy

they are both used to regulate entry into the notary profession,which is generally found to be highly regulated

across Europe (Philipsen, 2009).