Self-regulated professions

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1. Economic analysis

In well-functioning markets, unfettered competition is the best means of ensuring that resources are allocated efficiently, that consumers have access to the broadest range of services at the most competitive prices and that producers have the maximum incentive to reduce their costs as much as possible and meet consumer demand. Markets for professional services are particularly vulnerable to factors that prevent them from functioning efficiently, including asymmetric information and externalities, as discussed in detail below. Economic conditions in these markets may therefore suggest that regulation of some sort has the potential to counter these sources of market failure and, as a result, enhance efficiency and improve consumer welfare.

Although regulators in self-regulated professions -comprising provincial and territorial governments and self-regulating organizations- often justify regulation on the basis of countering market failure, it is important to recognize that market failure, while a necessary condition for regulating, is not a sufficient condition for doing so. Ultimately, it is not enough for regulators to identify the existence of market failure as the reason to regulate; they must make a clear case that regulation is likely to improve upon free and open competition. Once they have done so, they must then turn to how best to regulate, including deciding which regulatory instrument (or mix of instruments) to use. The chosen regulatory response should directly target the identified market failure in a way that least restricts competition. (Chapter 2 contains more information on the analysis regulators should do when developing regulatory proposals or reviewing existing regulatory measures.)

This chapter sets out the economic theory behind both the potential anti-competitive effect and the public benefit of regulation in professional services markets, highlighting the need for regulators to balance the two. The chapter starts by reviewing the potential sources of market failure that might lead to the need for regulation. This section is followed by a discussion of the ways in which regulation may adversely affect competition among professional service providers and of the potential effect of regulation on price and service quality. These concepts are then applied to three types of market entry restrictions (restrictions on entering the profession, mobility, and overlapping services and scope of practice) and three types of market conduct restrictions (restrictions on advertising, pricing and compensation, and business structure). In addition, the empirical economics literature on the effect of entry restrictions and advertising on the price and quality of professional services is reviewed. A conclusion follows.

Market failure and the potential benefits of regulation

Markets for professional services are potentially vulnerable to two main sources of market failure: asymmetric information and externalities. In the presence of such market imperfections, free markets may not generate efficient outcomes, which may be a rationale for regulation, based on protecting the public interest.

Asymmetric information

Asymmetric information arises in professional services markets when consumers cannot accurately assess the quality of the services they need because they do not have the information to do so. This divide between buyers and sellers is perhaps the most important source of market failure in professional services markets and is the rationale regulators cite most for imposing restrictions in these markets.

It is useful to distinguish here between search goods, experience goods and credence goods (which in all cases comprise services as well as goods). The terms search , experience and credence refer to the accuracy with which consumers can observe and evaluate a good's characteristics. Search goods are defined as goods whose characteristics and quality consumers are able to evaluate with some degree of certainty before buying them. In contrast, consumers only learn the quality of experience goods upon consumption. The problem of asymmetric information becomes even more pronounced in the case of credence goods, the quality of which consumers are not fully able to assess, even after consumption. It is difficult for consumers to choose goods that suit their preferences from among experience goods, and especially credence goods, a fact that perhaps warrants some regulation to give consumers external quality signals. Eyeglasses frames are an example of search goods, since consumers are able to determine whether the fit and style suit their preferences prior to purchase. The lenses that are made for the frames are likely experience goods: consumers can only determine whether their vision has become clearer by looking through the lenses for some time. Complete eye health exams are credence goods, since consumers would not know with certainty after all the tests whether the resulting diagnosis for poor vision was correct.

Particular characteristics of professional services markets may give rise to problematic information asymmetries. First, the services professionals provide are often complex, such that consumers may be unable to judge their quality until after they have used them, if at all. Moreover, consumers may draw imperfect conclusions about service quality, due to the often tenuous relationship between professionals' abilities and the results they achieve. For example, even the highest quality lawyers lose cases.

The problem of asymmetric information may be amplified by the fact that many consumers do not use professional services often. In contrast, it may be less of a concern for businesses, since they are likely to be more sophisticated or frequent purchasers of professional services and thus over time may be able to discern service quality.

Under certain circumstances, asymmetric information leads to two economic problems: adverse selection and moral hazard.

When quality is difficult for buyers to determine, sellers may have an incentive to offer lower quality services without lowering their prices. When consumers cannot distinguish between high- and low-quality service providers, they may assume that any service offering is of average quality and only be willing to pay as much as they think such service is worth. As a result, providers of the highest quality and highest price services might exit the market because they cannot get the prices they wish for their services. This process of overall quality deterioration driven by asymmetric information is known as adverse selection. ¹ Under this theory, average quality would decrease further over time, until only low-quality, low-price services remain.

Asymmetric information also has the potential to create skewed incentives for service providers to act for their own benefit, contrary to consumers' best interests. This leads to the problem of moral hazard. In well-functioning, competitive markets with informed consumers, the incentives of buyers and sellers align. However, in markets characterized by asymmetric information, these incentives may diverge. When consumers cannot communicate their preferred combination of price and quality, service providers may, for example, oversupply quality in order to charge higher prices, even when lower quality services at more affordable prices would better serve consumers. Hypothetically, if pharmacists were free to receive compensation from drug manufacturers they might have an incentive to dispense more expensive brand name drugs when a lower priced generic might be the better option, unknown to consumers.

Given the risks of adverse selection and moral hazard, regulation in markets exhibiting asymmetric information may enhance consumers' ability to choose their preferred combination of price and quality, and dissuade professionals from exploiting consumers' lack of knowledge.

For example, entry restrictions may correct for adverse selection by preventing low-quality professionals from providing services. Although consumers tend to be harmed when their choices are limited, in circumstances of substantial asymmetric information, consumers may benefit. This is because the lack of choice reduces their uncertainty about quality, thereby ensuring that the prices consumers are willing to pay are high enough to induce high-quality professionals to offer their services.

Moral hazard is likely better addressed through restrictions on conduct than entry. For example, restrictions that set maximum prices may, in theory, reduce the potential for moral hazard by hindering service providers' ability to charge more by supplying higher quality services than consumers require.

Restrictions that ensure a minimum standard of quality to correct for asymmetric information and consequent problems of adverse selection will likely benefit consumers in markets in which consumer demand is low for low-quality services, highly sensitive to quality and relatively insensitive to price. ² However, when consumers prefer a combination of low quality and low price, restrictions on entry may exacerbate the negative impact of moral hazard.

Externalities

Although less prevalent and not cited as often as asymmetric information as a source of market failure, externalities-both negative and positive-potentially provide a justification for regulation in professional services markets.

Negative externalities most commonly appear in markets for professional services as negative effects on third parties that stem from consumers purchasing low-quality services. For example, consider a legal system in which clients hire low-quality lawyers who argue poor or incomplete cases before the courts, leading to substandard decisions. Such a scenario could undoubtedly have negative effects not just on the individuals who hired the low-quality lawyer but also on society as a whole. When buyers and sellers do not take the potential negative effects of their purchasing decisions into account, the market may not function efficiently. As a result, there may be a public benefit to regulating to ensure minimum service quality and reduce as much as possible the potential for negative externalities to arise.

In contrast, positive externalities associated with professional services arise when benefits accrue to third parties as a result of consumers purchasing high-quality services. In this case, such high-quality services may be undersupplied in unregulated markets if purchasers are only willing to pay for the private benefit they receive, not the additional benefit to others. Indeed, some services may even rise to the level of public goods. Economists define public goods as goods or services that are both non-rival and non-excludable. They are non-rival in the sense that one party using them does not preclude other parties from doing so. Non-excludable means that it is not possible to limit the use of the goods or services just to the parties who pay for them: when they are available to some, they are available to all (although different people may value them differently). An example of a positive externality is a pharmaceutical system that works quickly and effectively to distribute medication to those with illnesses. The individual consumer who obtains the appropriate medication swiftly with all side effects explained benefits, as does society because the risk of illness spreading is minimized.

Anticompetitive effects and the potential costs of regulation

In light of asymmetric information, potential externalities and the possibility of some services being akin to public goods, markets for professional services most likely require some form of regulation. However, regulation may inhibit competition beyond what is optimal, which would deprive consumers of the lower prices and high-quality services that result from open competition. Indeed, regulation that protects professionals from the forces of competition may in fact precipitate, rather than correct, market failure by creating, enhancing or preserving the market power of incumbents, which may lead to a lower supply or quality of services at higher prices than in a competitive market.

Specific restrictions that regulators impose may affect competition in several ways:

• by serving as barriers to entry and decreasing the supply of professionals and providers of substitute services;
• by increasing the likelihood of collusion; and
• by raising the costs of members of the profession.

Barriers to entry

Restrictions serve as barriers to entry in two ways. First, they may directly limit entry into the profession by, for example, capping the number of places available in required degree or training programs, or limiting the use of professional titles to qualified professionals. Second, restrictions may deter entry by raising the costs of joining the profession. Restrictions that increase the duration of initial training, for example, impose on those wishing to become members of the profession additional direct costs, such as paying for their training, and opportunity costs, because they forgo earnings during their training.

Barriers to entry may harm competition by reducing the supply of professionals, leading to higher prices and a correspondingly lower quality of service than would otherwise prevail. Since barriers to entry protect incumbents from outsiders, they may also limit competition on the basis of quality: the presence of fewer service providers likely decreases the incentive to develop innovative services.

Collusion

Restrictions may increase the likelihood that members of the profession can successfully collude to raise prices above the competitive level and lower output below it. Such collusion may be explicit, as is the case when the profession sets minimum or mandatory prices, or tacit, which could result from the profession issuing suggested price lists. Because collusive prices are higher than competitive ones (or quality is lower), collusion results in substantial harm to consumers.

The ability of members of the profession to maintain collusive prices depends on the extent to which the profession successfully restricts entry. In the absence of barriers to entry, new entrants would be attracted into the profession by the supra-competitive profits members earn, which would undercut members' ability to maintain the collusion, since they would have to arrange with new entrants to join it.

Raising members' costs

Finally, restrictions may raise the costs of members of the profession, which ultimately hurts competition. Increased costs may result in members reducing their output, since firms generally supply less of a service at a particular price when the cost of providing it increases. The reduction in output, in turn, will cause the price of the service to rise. Increased costs may also deter some prospective members from joining the profession. This will result in price increases, since there will be fewer service providers.

It is important to distinguish between an equal increase in all members' costs, which is not associated with any enhancement of market power, and a disproportionate increase in costs for only some members, since the latter may be anti-competitive. An across-the-board cost increase simply acts as a barrier to entry. In contrast, an increase for only some members hampers their ability to compete effectively.

Examples of restrictions that raise the costs of all members of the profession include restrictions on advertising and restrictions on business structure. Restrictions on advertising force members to compete for consumers' business in more costly ways, resulting in a decreased willingness of members to provide the service at some prices. (Restrictions on advertising may also affect demand for the service by decreasing consumers' responsiveness to changes in price: because providers lack the ability to inform consumers of the lower price, there may be little incentive for them to, in fact, have lower prices.) Restrictions on business structure may decrease the returns associated with engaging in the profession by requiring members to organize their firms in inefficient ways and thereby discouraging prospective members from entering the market (and perhaps protecting high-cost incumbent firms from competition from lower cost rivals).

A new diploma requirement from which incumbents are grandfathered is an example of a restriction that only raises some members' costs. In this case, entrants have higher costs than do incumbents such that entrants are unable to compete as effectively. As a result, prices go up, benefiting the lower cost incumbents.

Restrictions

The remainder of the chapter reviews six types of market restrictions in two categories:

• market entry restrictions: restrictions on entering the profession, mobility, and overlapping services and scope of practice; and
• market conduct restrictions: restrictions on advertising, pricing and compensation, and business structure.

Market entry restrictions

Market entry restrictions include measures that have the effect of limiting the number of professionals able to enter a profession, that may limit professionals from offering their services elsewhere than where they are currently licensed, and that restrict members of related professions from offering similar services. For competition in professional service markets to be vibrant and effective, it is necessary that they be open to new entrants. When it is difficult for consumers to determine service quality, reasonable requirements for professionals to demonstrate competence are likely to be consistent with promoting competition and efficient markets.

Entering the profession

The following are examples of restrictions facing individuals wishing to join a profession:

• educational requirements for certification or licensing;
• quotas on the number of new entrants or limits on the number of educational or training places available; and
• work experience, apprenticeship or practical training requirements for certification or licensing.

Restrictions on entering a profession limit the supply of professionals by affecting either the ability of potential entrants to join the profession or the returns associated with engaging in the profession. Restrictions that limit the number of training places available to entrants, for example, are typical of the former restriction. Lengthening the required training is an example of the latter; such restrictions would indirectly affect the number of entrants into the profession by increasing the cost, both in terms of foregone income (instead of working, potential entrants are in school) and direct educational expenditures.

The principal justification for restrictions on entry is that they protect consumers by increasing the quality of the services professionals provide. Restrictions on entry accomplish this goal by limiting the ability of less qualified individuals to engage in the profession. These restrictions may enhance demand for services when consumers are uncertain about quality-for example, when they are unable to distinguish between low- and high-quality service providers-by assuring them that the service providers meet minimum quality requirements.

While proponents of entry restrictions argue that demand may grow among certain consumers because they are more confident of the quality of the service, the resulting price increase will likely reduce demand among others, including those who prefer lower quality service at a lower price or those who are no longer able to afford the service at the higher, regulated price. This reduction may be viewed as a decrease in service quality for those consumers who no longer choose to purchase the service or who are no longer able to. This can offset the increase in quality consumers who continue to purchase the service enjoy.

Restrictions on entry may also have harmful non-price effects, such as limiting consumers' access to a profession, either because there is an insufficient supply of professionals to meet consumer demand or because geographic access to members (in non-metropolitan areas, for example) is reduced. Additionally, although regulators may argue that these restrictions are intended to enhance quality by setting educational, training or experience requirements, any restrictions that reduce the supply of professionals may also lessen competition among them. This, in turn, may offset the public benefits of these same restrictions by inhibiting quality competition among professionals or hindering their ability to develop innovative services.

Members of a profession may have an incentive to restrict supply more than is strictly necessary to ensure quality, because they would benefit from the higher prices and reduced competition that could result. If this were the case, the harmful effect of the restrictions on competition would outweigh the public benefit gained.

When weighing the consumer protection benefits of restrictions on entering a profession, it is important to consider whether the restrictions necessarily increase service quality. Although professionals with greater education or experience may provide higher quality service, the overall quality of the service may be largely due to unregulated characteristics of the professionals themselves. Similarly, some restrictions on entry, such as limits on the number of places available in training programs (which could serve as de facto quotas), may have little impact on quality and may, in fact, lessen the supply of professionals. A more effective approach then may be to have occupational controls that have the same quality-enhancing effect as entry restrictions but do not limit the supply of professionals. For example, a professional certification administered by the government or another regulatory body could signal quality to consumers while not preventing them from purchasing services from members of the profession who do not have the certification.

Mobility

Restrictions on entry may also include restrictions on the mobility of professionals. When different professional regulators control entry in different jurisdictions, the entry requirements imposed in one jurisdiction may not suffice for entry into another, limiting the ability of existing members to move between them.

Such restrictions on mobility may limit the ability of professionals to respond promptly and effectively to changes in demand, which may lead to a misallocation of service providers.

Overlapping services and scope of practice

Examples of restrictions that reduce the supply of professional services by limiting the ability of members of related professions to offer similar services include the following:

• restrictions on the use of titles by members of the profession;
• restrictions that give certain professionals exclusive rights to offer certain services; and
• restrictions that limit consumers' access to members of other professions offering complementary services.

The foundational concept here is demand substitutability-that is, what services do a sufficient number of consumers view as good substitutes for others, such that suppliers of one service are unlikely to be able to unilaterally raise their prices or otherwise harm competition?

In this context, restrictions on related professionals offering similar or overlapping services may limit the supply of substitute services, potentially allowing members of the profession to raise prices above the competitive level.

The benefits of these restrictions are closely related to the benefits of entry restrictions, discussed above- that is, in the presence of asymmetric information, these restrictions may enhance consumer demand by reducing uncertainty about the quality of the service.

Restrictions on professionals' use of titles may reserve a title for members of the profession who meet certain education, experience or training qualifications. Such titles may act as a quality signal to consumers, which may increase demand or reduce their search costs. Conversely, these restrictions may suggest to consumers that only professionals holding the title are qualified to provide certain services. This may harm competition when, as a result, consumers must purchase higher quality services than they need, at correspondingly higher prices. Restrictions on the number of professionals allowed to use a title may also inhibit price and quality competition among those holding it, resulting in a decline in consumer welfare.

Restrictions that give exclusive rights to members of a profession to offer certain services may protect consumers from low-quality service providers. For example, members of the profession may argue that related professional service providers lack the education or training required to provide the service, cannot provide the complete range of interrelated services, do not hold the malpractice insurance necessary to protect consumers, or are not required to adhere to conflict of interest guidelines that serve to protect consumers. Restrictions of this type may also reduce consumer uncertainty regarding service quality and enhance consumer welfare by limiting negative externalities associated with low-quality service.

At the same time, these restrictions may also pose anti-competitive risks similar to those associated with entry restrictions. In addition, members of the related profession may be able to offer services at lower prices than can members of the profession. This may be because they have a higher degree of specialization or because their costs, including their opportunity costs, are lower. In such cases, consumers benefit from lower prices.

The risk to competition of restrictions that limit the ability of related professions to offer similar services may be particularly acute. Although these restrictions may have some benefits, professions have an incentive to impose them, in the absence of any benefits to consumers, because they foreclose potential competitors and thus increase the returns associated with engaging in the profession. Alternatively, accreditation or registration programs may provide a quality signal to consumers without preventing other professionals from offering services.

Restrictions on overlapping services and scope of practice may also affect members of professions offering complementary services. For example, professions may only permit professionals who offer complementary services to provide those services in conjunction with members. In certain places in Canada, for instance, paralegals must work under the supervision of lawyers. (Conversely, professions may prohibit members from collaborating with members of related professions; see "Restrictions on business structure," below).

These restrictions may mitigate instances of asymmetric information. Since members of the profession may be better able than consumers to judge the quality of the complementary services, they can function as gatekeepers for their customers, ensuring high-quality service. Integration of complementary service providers may also enhance quality by allowing members of the profession to take advantage of any synergies or economies of scope that exist. ³ Integration may also facilitate the development of innovative services. Finally, consumers may benefit from the convenience of being able to purchase complementary services from a single firm or reduce their search costs.

However, the restrictions regulators impose may, in fact, make this integration impossible. First, a profession may be able to dictate the supply of professionals providing complementary services by requiring them to practise in an integrated environment. For example, when entry into the profession is inefficiently low because of entry restrictions, entry into the complementary profession may also be inefficiently low. Second, members of the profession who have been conferred some degree of market power, due to market entry restrictions or market conduct restrictions, may also be able to exercise that market power in the provision of the complementary services. For example, members may require consumers to purchase higher quality complementary services than they otherwise would or may require consumers to pay for access to members of the complementary profession.

Evidence of the effect of market entry restrictions

The following table provides a brief summary of the findings of various empirical studies that sought to determine the effect of market entry restrictions on the price and quality of professional services, as measured primarily by professionals' incomes. Generally, the studies found that the incomes of members of professions with restrictions on entry are higher than those of comparable professionals who do not face restrictions. Kleiner and Ham (2005) also provide an estimate of the effect of entry restrictions on the quality of the service provided, using data on complaints and the cost of malpractice insurance. With one exception, the studies focus on professions in the United States.

Table 1: Empirical studies looking at the effect of market entry restrictions on price and quality of professional services

Author	Profession	Effect on price	Effect on quality
Muzondo and Pazderka (1983)	4,571 professionals randomly chosen from 20 professions in Canada, including dentists, lawyers, optometrists, physicians and pharmacists.	Members of professions in which there are licensing restrictions on advertising, fee setting, and interjurisdictional mobility have their incomes enhanced by 26.9 percent.	n/a
Kleiner (2000)	Dentists, lawyers, barbers and cosmetologists in the United States.	Earnings were higher for those licensed professionals who require more education and training than for those that require less. For dentists, hourly earnings are 30 percent higher than for non-licensed professionals. For lawyers, the hourly earnings are 10 percent higher than for non-licensed professionals.	n/a
Kleiner and Ham (2005)	Doctors, dentists, lawyers, teachers and cosmetologists in the United States.	Licensing has a positive earnings effect for all (except for teachers), relative to their opportunity costs. With regards to universally regulated occupations, the impact of licensing is about 10-12 percent.	The effects on quality are unclear when measured by either complaints or malpractice insurance premiums.
Nicholson (2003)	Physicians in the United States.	Barriers to entry are reducing the number of non-primary care physicians. Results indicated that medical students would be willing to pay the hospital to obtain residency positions in dermatology, general surgery, orthopaedic surgery and radiology rather than receive the mean student salary of $34,000 and continue with primary care medicine. The number of students in those medical categories would increase by an estimated 6 to 30 percent (in the given example) and teaching hospitals would save an additional $0.6 to $1 billion a year in labour costs.	n/a
Pagliero (2005)	Lawyers in the United States.	Professional licensing has a significant effect on entry salaries. On average, licensing increased annual entry salaries by more than $10,000. This implies a total transfer from consumers to lawyers of 19 percent of lawyers' wages and a total welfare loss of more than $3 billion.	n/a
Anderson, Halcoussis, Johnston and Lowenberg (2000)	Physicians in the United States.	Doctors in states with stricter regulations on alternative medicine (e.g. homeopathy) earn higher incomes than those in states with looser regulations.	n/a

Note : Full bibliographic citations for the studies listed in this table may be found at the end of this chapter (see page 35).

Market conduct restrictions

Professions may restrict how members may compete with another when offering professional services. Typical market conduct restrictions include the following:

• restrictions on advertising by members of the profession;
• suggested or mandatory fees for professional services; and
• restrictions on business structure, such as those on ownership, multidisciplinary practices, and firm location and size.

Advertising

Professions frequently restrict their members from engaging in various types of advertising, including comparative advertising, canvassing or soliciting, and offering inducements or discounts. In addition, professions often regulate the size, style and medium of advertising.

Advertising greatly facilitates competition by informing consumers of the characteristics, availability and prices of services. Advertising can also reduce consumers' search costs, ease entry for new professionals and enhance incentives for existing firms to innovate and expand.

Arguments in support of advertising restrictions focus on asymmetric information. When it is difficult for consumers to assess the accuracy of advertising, its information value may be minimal. For instance, advertising may lead consumers to think that one service offering and its alternatives are poor substitutes for one another when they are, in fact, identical or nearly so. Countering this misperception may require service providers to spend more on advertising than they otherwise might. For prospective suppliers, these costs may be a barrier to entry, while existing suppliers may pass them on to consumers. In both cases, consumers may end up paying higher prices without having benefited from the advertising.

Professions may also argue that restrictions on advertising may be necessary to protect consumers from false or misleading advertising, particularly in the face of asymmetric information. In such circumstances, consumers may be unable to assess the accuracy of advertising as it relates to quality, and so advertising may enhance demand for low-quality service providers who choose to advertise, to the detriment of high-quality service providers. Restrictions on advertising designed to protect consumers from false or misleading advertising must be assessed to determine whether they inhibit legitimate advertising to the least extent possible. The Competition Act and, in many instances, provincial and territorial consumer protection laws already prohibit false or misleading advertising, so no additional restrictions are necessary to protect consumers. ⁴ However, given the complexity of many professional services, there are circumstances in which the profession is in a unique position to evaluate what constitutes false or misleading advertising.

Significant risk exists that over-regulation of advertising will deprive both consumers and practitioners of the many benefits of informative advertising. Informative advertising serves to make consumers' demand for services more responsive to changes in price because they have better information about the supply of those services. This enhances competition because professionals have greater incentive to compete by lowering their prices. As a general rule, professionals considering whether to lower their prices must take into account two offsetting effects: first, that the profit from each sale will decrease because the price has fallen and, second, that the number of sales will increase because the price has fallen. Restrictions on advertising may have the effect of muting the demand response to price decreases by making it difficult for professionals to inform enough consumers that their prices have, in fact, gone down. As a result, the increase in sales resulting from the price decrease may not be sufficient to offset the decrease in profitability from each sale, so that the contemplated price decrease is unprofitable.

In addition to enhancing competition by increasing consumers' price responsiveness, advertising may also enhance competition by facilitating the entry of new professionals and by increasing the returns associated with offering high-quality services. Potential entrants may find it difficult to establish a client base of sufficient scale to be financially viable, especially in professions in which consumers rely on experience or word-of-mouth when choosing service providers. Advertising enhances competition by allowing potential entrants to inform consumers of their presence and of the price and quality of their service. Advertising may also enhance competition by providing professionals offering high-quality or innovative services with a mechanism to distinguish themselves from competitors, much as it does for professionals offering lower prices.

Evidence of the effect of advertising restrictions

There is a substantial body of empirical evidence on the effect of advertising restrictions on the price and quality of professional services, as is summarized in the following table. Generally, these studies found that restrictions on advertising increase the price of professional services, increase professionals' incomes and reduce the entry of certain types of firms. Studies of the effect of advertising restrictions on quality show that it is small, except that the restrictions may result in fewer consumers using the service.

Table 2: Empirical studies looking at the effect of market conduct restrictions on price and quality of professional services

Author	Profession	Effect on price	Effect on quality
Muzondo and Pazderka (1980)	Members of 20 professions in 10 Canadian provinces, including dentists, lawyers, optometrists, physicians and pharmacists.	Members of professions that restrict advertising earn 32.8 percent higher incomes than members of similar professions that do not restrict advertising.	n/a
Muzondo and Pazderka (1983)	4,571 professionals randomly chosen from 20 professions in Canada, including dentists, lawyers, optometrists, physicians and pharmacists.	Members of professions where there are advertising restrictions increase their income by 10.8 percent.	n/a
Love and Stephen (1996)	Self-regulating professions (such as lawyers, physicians and optometrists) in North American and Western European markets.	Advertising restrictions were likely to increase professional fees. Results from the studies surveyed indicate that 16 out of 17 reports found that non-restrictive markets had lower average fees than did restrictive ones.	Very little evidence that restricting advertising is likely to raise quality.
Schroeter, Smith and Cox (1987)	Lawyers in the United States.	Fewer advertising restrictions increase competition among sellers in a market and create a more elastic demand curve for a particular firm. The price-cost ratio would fall by approximately 7 percent if market-wide advertising increased by 31 percent from its mean value.	n/a
Haas-Wilson (1989)	Optometrists in the United States.	Employment and price advertising restrictions reduce the total number of chain optical stores in a state. Data indicated that 1.5 to 1.7 fewer chain stores were opened per year by the largest optical firms in fully regulated states versus non-regulated states.	n/a
Benham (1972); Benham and Benham (1975)	Optometrists in the United States.	Results indicate that prices are 25-40 percent higher in the markets with greater professional control (advertising, limiting brand name identification and discouraging public evaluations of other professionals' work).	The higher prices are in turn associated with a reduction in the number of individuals obtaining optometry services. The price elasticity of demand was approximately -1.0.

Note : Full bibliographic citations for the studies listed in this table may be found at the end of this chapter (see page 35).

Pricing and compensation

Professions may regulate the fees their members charge or publish suggested fee schedules. Specific restrictions may set minimum or maximum fees, or prohibit certain types of payments (for example, payment on a contingency basis).

In unregulated markets, price is typically the primary factor on which firms compete, resulting in lower prices and higher output to the benefit of consumers. Price restrictions could inhibit this competition, resulting in prices that are above the competitive level and output that is below it.

Regulators most commonly justify price restrictions as reducing instances of asymmetric information, and thus preventing adverse selection and moral hazard.

In the case of adverse selection-consumers basing decisions on price rather than quality because they cannot assess the quality-fixed prices or a regulated price floor may preserve quality by preventing the exit of high-quality professionals from the market.

Setting maximum fees may assuage the problem of moral hazard (consumers not being able to assess their preferred combination of price and quality due to incomplete information). In such circumstances, a price ceiling may reduce the perverse incentive for professionals to offer higher quality and higher price services than consumers require.

Suggested fee schedules may provide information to consumers about reasonable fees, which may be of particular value when it is difficult or costly for consumers to compare prices. Suggested fee schedules may also benefit members of the profession by guiding new entrants when they set their fees or reducing the transaction costs associated with negotiating fees for complex services.

By contrast, price restrictions can have a significant negative effect on competition, innovation and consumer welfare. The potential anti-competitive effect of minimum price regulations is particularly noticeable. When the minimum price for a service is set above the unregulated market price, the market price rises to the regulated level, which results in reduced output, since consumers are willing to purchase fewer services at the minimum price. In general, price restrictions that fix fees or set a price floor significantly reduce competition between service providers and thus deny consumers the low prices of a freely competitive market.

Conversely, restrictions that set a maximum price may, on their face, seem beneficial to consumers. However, they too have the potential to deny consumers the full benefits of unrestricted price competition. Maximum price restrictions can result in competitive harm by reducing professionals' willingness to supply their services. When the maximum price is set below the unregulated market price, the market price decreases to the regulated level, which results in reduced output, since professionals are willing to supply fewer services at the maximum price. In particular, high-quality service providers who charge higher prices may exit the market, resulting in an overall decrease in service quality. Moreover, prices may end up converging on the maximum price, such that it ends up effectively functioning as a fixed price, thus limiting price competition.

Suggested fee schedules facilitate collusion by helping professionals decide on the prices they will charge. Under tacit collusion, those prices could range from competitive prices to those a monopolist would charge, but agreeing on exact prices could be difficult, particularly when professionals offer multiple services. A suggested price list could serve as a focal point for this determination, resulting in higher prices than would have prevailed in a competitive market.

Many of the consumer protection benefits of price restrictions may be realized through other methods than regulated or suggested fees. For example, publishing survey data on the average prices may reduce asymmetric information and search costs for consumers, provide guidance for new entrants, and reduce transaction costs associated with pricing complex services, without necessarily raising competition concerns. ⁵

Business structure

Restrictions on business structure include limits on the ownership of professional services firms, restrictions on multidisciplinary practices and restrictions on firm location. Regulators typically justify these restrictions as ensuring high-quality service; however, they may also have the anti-competitive effect of lowering the returns associated with engaging in the profession, inhibiting firms from developing innovative services and limiting the locations at which consumers can access services.

Ownership

Restrictions on ownership structure generally comprise requirements that only members of a profession may own businesses engaged in providing certain professional services or that set out whether members may form limited liability partnerships or corporations. Regulators typically justify such restrictions as helping professionals maintain independence and avoid the risk of commercial pressures compromising their conduct.

These restrictions may force owners to bear more of the risks associated with professional malpractice than they otherwise would. For example, in professional service partnerships, partners bear some personal liability for their own negligence and may also be liable for the negligent acts of other partners or employees. The assumption of personal liability may act as an increased deterrent against professional malpractice, although the presence of a market for professional malpractice insurance may limit this.

Pro-competitive benefits may also result from restricted ownership structures, by limiting the conflicts of interest between consumers, professionals and owners that arise when the interests of professionals do not align with consumers'. For example, professionals may recommend higher quality service than consumers actually require. Some firm ownership structures may reduce this misalignment. For example, partnership earnings accrue directly to professional members of the firm rather than to non-employed shareholders, which eliminates shareholder pressure on professionals to provide a level of service that is not in consumers' best interests. (At the same time, such an ownership structure may lead professionals to oversupply their services.)

On the other hand, the same ownership structure may affect the supply of entrants into the profession by changing the returns associated with engaging in the profession and increasing the liability risks, although the effect is likely to be small compared to that of entry restrictions. Restrictions on ownership may also constrain firms from achieving economies of scale and limit the availability of capital to expanding firms. ⁶

Multidisciplinary practices

In multidisciplinary practices, members of different professions can work together and take advantage of economies of scope and scale by allocating overhead or fixed costs across a larger employee base, benefit from a pooled advertising and marketing budget, and share resources and knowledge across professional practice areas.

The economies of scope and scale resulting from inter-professional collaboration can benefit consumers by reducing firms' costs and prices. Moreover, they can enhance the ability of firms to offer high-quality and innovative services. Consumers may also benefit from the convenience of purchasing a range of professional services from a single firm. This convenience may also reduce consumers' search costs and transaction costs. Multidisciplinary practices may also offer lower prices to consumers who buy a number of professional services from a single practice.

Proponents of restricting inter-professional collaboration argue that multidisciplinary practices may produce conflicts of interest to the detriment of consumers. For example, accountants may be more likely to recommend obtaining unnecessary legal opinions on the interpretation of tax law when they work for a firm that also employs lawyers. Regulators also commonly justify restrictions on collaboration as enhancing service quality by requiring all professionals working for the same firm to meet the same professional standards or conduct requirements.

Restrictions that prohibit professionals from being involved in multidisciplinary practices might limit innovative and cost-efficient business structures, to the detriment of consumers, who are deprived of the resulting benefits of lower prices and increased convenience.

Firm location and size

Restrictions on the number of locations at which professionals may offer their services result in pro-competitive benefits when they counter the tendency for service quality at individual branches to standardize downwards across multiple branches, assuming that consumers find it difficult to evaluate service quality. These restrictions may also facilitate entry into the profession by limiting the geographic scope of incumbents' practices, thereby providing new entrants with a greater choice of geographic locations in which to establish their practices.

Restrictions on firm size may enhance competition and, by so doing, ensure that no firm is able to gain market advantage. This may be desirable; however, overly prohibitive restrictions limit the ability of large firms to take advantage of efficiencies associated with their size.

Contrasting with the potential pro-competitive benefits of restrictions on firm size and location are the potential anti-competitive consequences of consumers not having a service provider near them and professionals being unable, when the geographic area they serve is small, to operate near their competitors.

Restrictions on firm size and location likely also affect the returns and risk associated with engaging in the profession: restrictions on additional locations may prohibit profitable expansion that would allow professionals to diversify their risk. A decrease in the supply of professionals as a result of these restrictions would likely lead to an increase in prices, although the effect is likely to be secondary to that of education and training requirements , as was the case with restrictions on ownership structure.

Conclusion

This chapter has reviewed the potential consumer protection and anti-competitive effects of restrictions self-regulated professions impose. Regulators typically justify such restrictions as addressing market imperfections related to asymmetric information or externalities by increasing the quality of the services members of the profession provide.

Restrictions may have anti-competitive effects by serving as barriers to entry, facilitating collusion or raising members' costs, any or all of which could result in consumers paying higher prices for services, and firms reducing the supply of services they provide and being less likely to develop innovative services. Regulators should balance the consumer protection benefits of any restrictions against these potential anti-competitive effects, particularly since professions may have an incentive to impose restrictions that are stricter than is necessary to ensure service quality or protect consumers.

Restrictions may be broadly categorized as market entry restrictions and market conduct restrictions. The former includes restrictions on entering the profession, such as having to meet education and training requirements, restrictions on mobility, and restrictions on the ability of members of other professions to offer overlapping or complementary services. Market conduct restrictions include restrictions on advertising, pricing and compensation, and business structure.

When confronted with an instance of market failure, regulators may be inclined to look to regulation of some sort to address it. In this situation, it must be clear that regulation can improve upon the freely competitive market outcome. Determining this requires regulators to first identify and assess the type and degree of market failure and then look at existing non-regulatory measures that could solve the problem. When regulation is the best solution, then regulators should choose the regulatory tool that directly targets the market failure and has the least effect on competition. A more detailed discussion of a framework for this analysis follows in Chapter 2.

Full bibliographic citations for studies cited in the tables

Table 1

Anderson, G., Halcoussis, D., Johnston, L., and Lowenberg, A., "Regulatory Barriers to Entry in the Health Care Industry: The Case of Alternative Medicine," The Quarterly Review of Economics and Finance 40, 2000, pp. 485-502.

Kleiner, M. and Ham, H., Regulating Occupations: Does Occupational Licensing Increase Earnings and Reduce Employment Growth? prepared for the Federal Trade Commission, Washington D.C., June 2005.

Kleiner, M., "Occupational Licensing," Journal of Economic Perspectives 14(4), Fall 2000, pp. 189-202.

Muzondo, T.R., and Pazderka, B., "The Consumer Costs of Professional Licensing in Canada and Some Policy Alternatives," Journal of Consumer Policy 6, 1983, pp. 55-75.

Nicholson, S., Barriers to Entering Medical Specialties , National Bureau of Economic Research, September 2003.

Pagliero, M., What is the Objective of Professional Licensing? Evidence from the US Market for Lawyers , University of Turin, Italy, March 2005.

Table 2

Benham, L., "The Effects of Advertising on the Prices for Eyeglasses," The Journal of Law and Economics 15(2), 1972, pp. 337-352.

Benham, L., and Benham, A., " Regulating Through the Professions: A Perspective on Information Control," Journal of Law and Economics , 18(2), 1975, pp. 421-427.

Haas-Wilson, D., "Strategic Regulatory Entry Deterrence, An Empirical Test in the Ophthalmic Market," Journal of Health Economics 8, 1989, pp. 339-352.

Love, J., and Stephen, F., "Advertising, Price and Quality in Self-Regulating Professions: A Survey," International Journal of the Economics of Business 3(2), 1996.

Muzondo, T.R., and Pazderka, B., "Occupational Licensing and Professional Incomes in Canada," Canadian Journal of Economics , November 1980.

Muzondo, T.R., and Pazderka, B., "The Consumer Costs of Professional Licensing in Canada and Some Policy Alternatives," Journal of Consumer Policy 6, 1983, pp. 55-75.

Schroeter, J., Smith, S., and Cox, S., "Advertising and Competition in Routine Legal Service Markets: An Empirical Investigation," The Journal of Industrial Economics , September 1987.

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¹ George A. Akerlof, "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," Quarterly Journal of Economics 84(3), 1970, pp. 488-500. Akerlof coined the term adverse selection and won the Nobel Prize in Economics for his efforts in 2001. See www.nobelprize.org/nobel_prizes/economics/articles/akerlof/index.html .

² For more detail on the types of markets that are likely to benefit from this type of regulation, see Hayne E. Leland, "Quacks, Lemons, and Licensing: A Theory of Minimum Quality Standards," The Journal of Political Economy 87(6), December 1979, pp. 1328-1346.

³ Economies of scope occur when the cost of producing two products together is less than the combined costs of producing the two products separately.

⁴ For example, Part VII.1 of the Competition Act prohibits deceptive marketing practices, including "representation[s] to the public that [are] false or misleading in a material respect."

⁵ For example, the Statements of Antitrust Enforcement Policy in Health Care (United States Department of Justice and the Federal Trade Commission, 1996, p. 61, www.usdoj.gov/atr/public/guidelines/0000.pdf ) recognize that the exchange of price information may be pro-competitive under certain conditions (while also recognizing that such an exchange may facilitate collusion): "Participation by competing providers in surveys of prices for health care services, or surveys of salaries, wages or benefits of personnel, does not necessarily raise antitrust concerns. In fact, such surveys can have significant benefits for health care consumers. . Purchasers can use price survey information to make more informed decisions when buying health care services." The Department of Justice and Federal Trade Commission provide a safe harbour for the exchange of price information when the information provided is collected by a third party, is at least three months old and does not allow individual survey participants to be identified.

⁶ Economies of scale occur when, over some interval of output, average total cost decreases.