Reassessing Aggregate Welfare under Professional Licensing and Certification∗

I compare the welfare effects of professional licensing and certification in Shapiro’s (1986) moral hazard model of services. Shapiro (1986) shows that licensing can dominate certification, assuming that certification reveals a provider’s human capital investment exactly. This occurs if certification leads to excessive investment in human capital as a signaling device. I consider an alternative form of certification that reveals only whether providers’ investment exceeds some threshold. I show that this form of certification weakly dominates licensing when it sends the same information as licensing about providers’ human capital investments. Although this certification policy limits consumers’ capability to distinguish providers, it also limits the cost of signaling in equilibrium. ∗I am indebted to my advisors Joe Altonji, Björn Brügemann, and Fabian Lange for their guidance and support. I also thank Dirk Bergemann, Rick Mansfield, and seminar participants at Yale University. All errors are my own. †Department of Economics, Yale University, Box 208264, New Haven, CT 06520-8264. Email : [email protected]