Is deregulating firm entry good for the workers? And if so, which workers?

While it is generally agreed that deregulating firm entry is good for firms there is another question of, Is it good for their workers? A VoxEU.org column presents new research on the deregulation of firm entry and how it affects different types of workers. Using a natural experiment from Portugal, the evidence suggests that deregulating firm entry appears to boost competition and employment (and possibly aggregate income) but its gains seem largely to be reaped by better-off, better-educated workers.

The column, by Ana P Fernandes, Priscila Ferreira and L Alan Winters, looks at a natural experiment in Portugal.

Prior to 2005, starting a business in Portugal took 11 procedures, 20 forms and 78 days, and cost around 13.5 % of GDP per capita. In May 2005, however, a new government introduced the ‘On the Spot Firm’ (‘Empresa na Hora’) programme by which entrepreneurs could register a company at a one-stop shop within an hour, receiving the company identification card, the corporate taxpayer number and the social-security number in the same day and at a cost of 3% of GDP per capita. Even better, the programme was largely unanticipated and was rolled out across districts more or less randomly over a four year period, making it a good quasi-natural experiment for research [ ... ] and extensive data are available on firms and their workers before and during the roll out.

The questions in the study have to do with the effects of the 'On the Spot Firm' programme on competition and wages.

We focus on private firms in the manufacturing and services sectors covering over the period 2002-09, which gives us a sample of 431,000 firms and 3.9 million workers. Having established that the skill premium (the difference between skilled and unskilled wages) appears to be greater where competition is greater, we look directly at the effects of the ‘On the Spot Firm’ programme. Working with the 308 municipalities in Portugal, we treat each as joining the programme from the year in which it gets its first ‘one-stop shop’ for conducting registrations. We find that the ‘On the Spot Firm’ programme significantly increased the number of firm registrations even after allowing for differences between municipalities, sectors and years. [ ... ]

We then consider how the wages of workers with different skill levels are affected by this entry, making use of the different timing of the introduction of ‘one-stop shops’ across municipalities to identify the effect. That is, we ask whether the returns to skill or to education vary between included and excluded municipalities and over the periods before and after the deregulation reform was introduced. Our rich data allow us to identify the characteristics of the worker and the firm employing her, the industry and the municipality and so we are able to allow for most of the other factors that may affect wages. This increases our confidence that the programme effects we identify are genuine.

Our regression results [ ... ] show the effects of inclusion in the ‘On the Spot Firm’ programme on workers with different levels of education.

The conclusions?

The results are highly significant statistically, strongly consistent and rather striking:

• Wages in general appear to be 1% lower in municipalities with an ‘On the Spot Firm’ one-stop shop.

This might be because the increased entry of marginal firms increases competition for the outputs that less-educated workers can provide (since we do not have data on firms with no employees – i.e. with only owners – we will miss any returns that such owners receive).

• On top of this negative effect, secondary educated workers receive slightly over 1% extra, restoring them to parity between included and excluded districts.
• Upper-secondary and Higher-educated workers receive stronger stimuli – over 2% and nearly 5% respectively.

The results for skill levels – as defined by workers’ occupations – are similar to those for education, except that low and medium skilled workers appear to gain little (and possibly to lose) while the premium to more skilled occupations is about 3% higher in ‘On the Spot Firm’ municipalities.

Recalling all the effects we have allowed for in making these comparisons, the 3% and 5% premium for skills and higher education are economically important.

• Deregulating firm entry appears to boost competition and employment (and possibly aggregate income, although this has not been investigated) but its gains seem largely to be reaped by the better-off.

This may be quite acceptable to policymakers – and after all it increases the incentives for people to obtain education, which presumably helps Portugal’s competitiveness relative to other countries. However, in these days of sensitivity to inequality, it is not something which governments should be ignorant of.

What we see here is a common pattern these days in the distribution of the gains from economic change. That is, there are better returns to the better educated. These results show an education premium, which should provide an incentive for people to obtain higher levels of skills and education.