Regulation of Entry and the Distortion of Industrial Organization

We study the distortions to industrial organization caused by entry regulation. We take advantage of heterogeneity across industries in their natural barriers and growth opportunities to examine whether some industries are differentially affected in countries with high levels of entry regulation. First, we consider the effect of entry regulation on the (static) structure of industry. We find that in industries with high natural barriers to entry, as proxied by firm turnover in the U.S., entry regulation has little impact on the quantity and average size of firms in an industry. By contrast, in industries with low natural entry barriers, countries with high entry regulation have few, large firms, relative to less regulated economies. We find no relation between natural entry barriers and overall industry share of manufacturing, as a function of entry regulation. Second, utilizing firm-level data, we show that operating margins are relatively high in low barrier industries in high entry regulation countries (relative to high ‘natural’ barrier industries). Finally, we examine the impact of entry regulation on industry dynamics, by analyzing the ability of industries to take advantage of shocks to growth opportunities, and find that in countries with high entry regulation, industries respond to growth opportunities through the expansion of existing firms, while in countries with low entry regulation, the response is primarily through the creation of new firms; the total sectoral response is invariant to the level of regulation. We instrument for regulation using a collection of political variables, and find our results unchanged. Overall, our results provide a consistent body of evidence suggesting that regulation distorts the (within) structure of industry, promoting industry concentration, but does not have measurable effects on intersectoral allocations. These results favor the Public Choice view of regulation over the Public Interest view. _____________________ Corresponding Author: 823 Uris Hall, Columbia University, New York, NY 10027. Tel: (212) 854-9157. Fax: (212) 854-9895. Email: [email protected].