Abstract
What is the impact of firm entry regulation on sustained entry into self-employment? How does firm entry regulation influence the performance of long-living entrants? In this paper, I address these questions, exploiting a natural experiment in firm entry regulation. After German reunification, East and West Germany faced different economic conditions, but fell under the same law that imposes a substantial mandatory standard on entrepreneurs who want to start a legally independent firm in one of the regulated occupations. The empirical results suggest that the entry regulation suppresses long-living entrants, not only entrants in general or transient, short-lived entrants. This effect on the number of long-living entrants is not accompanied by a counteracting effect on the performance of long-living entrants, as measured by firm size several years after entry.
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1 Introduction
In recent decades, the regulation of firm entry and entry into self-employment was changed in many countries and industries worldwide. The World Bank’s “Doing Business” reports, for example, document 579 regulatory reforms between June 2007 and May 2009 (World Bank 2008, 2009). The majority of these reforms were aimed at increasing entry and competition in order to foster technological progress, economic growth, and social welfare. While many empirical studies based on micro data show that reducing entry regulation increases entry, more empirical evidence clarifying the specific mechanisms linking entry regulation to technological progress, growth, and welfare is needed.
In this paper, I take one step in that direction by investigating the impact of firm entry regulation on one specific type of entry. The effects of entry regulation on sustained entry into self-employment are investigated, as well as the effects on the performance of long-living entrants that are able to sustain market activity for several years after entry. The empirical analysis is for Germany in the decade after reunification, a country with a strict regulatory setting and a time period when a natural experiment allows for identifying the effects of interest.
Various forms of geographical entry restrictions are relevant to specific product markets in Germany. According to Djankov et al. (2002), entrepreneurs in Germany have to complete numerous time-consuming and costly administrative procedures. The entry regulation under investigation in this paper follows from the German Trade and Crafts Code (Gesetz zur Ordnung des Handwerks). A substantial mandatory standard, the master craftsman certificate (Meistertitel), is imposed on entrepreneurs who want to start a legally independent firm in one of the regulated occupations. Similar standards exist in other European countries, for example, in Austria, The Netherlands, and Sweden, but the related firm entry regulation in Germany is particularly strict (Monopolkommission 1998).
To identify the effects of interest, I exploit the situation after German reunification, when East and West Germany faced very different economic conditions, but fell under the same law regulating entry in some occupations, but not in others. In the East German transition economy new entrepreneurial activities were suddenly needed to an unexpectedly high degree. In addition, the East German pool of individuals fulfilling the mandatory entry standard for regulated occupations depended on decisions taken under the planned economy system of the German Democratic Republic (GDR). Accordingly, the entry regulation in the German Trade and Crafts Code should exert stronger effects on entry in the East German transition economy than in the more stable West German market economy. Building on this conjecture, I estimate average effects of the West–East shift in the regulatory context by comparing the difference between the average outcomes in regulated occupations and unregulated occupations in East Germany after reunification against the corresponding difference in West Germany.
The subsequent empirical analysis builds on empirical studies that indicate less entry due to firm entry regulation when using a general, broad measure of firm entry, or entry into self-employment, as outcome variable. Bruhn (2008), Kaplan et al. (2009), and Mullainathan and Schnabl (2010), for example, present such evidence based on recent micro data for Mexico and Peru. Prantl and Spitz-Oener (2009) show that the entry regulation in the German Trade and Crafts Code lowers a general measure of entry into self-employment more in regulated occupations in the East German transition context after reunification than in the more stable West German context. Empirical evidence for different sets of countries and different time periods is provided by Ciccone and Papaioannou (2007), Fisman and Sarria-Allende (2004), as well as Klapper et al. (2006). Their empirical findings are in line with the view that the effects of country-level entry regulation on entry, again broadly defined, are more negative in industries with naturally high entry or high employment growth than in other industries.Footnote 1
With its focus on sustained entry and the performance of long-living entrants, this paper complements the existing literature on the effects of firm entry regulation. To the best of my knowledge, no other paper identifying regulatory effects from within-country variation in micro data has the same focus.Footnote 2 More common are studies addressing the effects of entry regulation on aggregate employment creation, or productivity growth, in industries or regions (Bertrand and Kramarz 2002; Chari 2009; Sadun 2008; Viviano 2008). Further related work is on the consequences of product market deregulation, or banking deregulation, for industry dynamics (Aghion et al. 2009; Bertrand et al. 2007; Cetorelli and Strahan 2006; Kerr and Nanda 2009).
From the methodological point of view, the empirical analysis presented here is most closely related to Prantl and Spitz-Oener (2009), who implement the same empirical approach. Using a natural experiment in entry regulation and allowing for two types of additive unobserved effects, the approach is similar to standard difference-in-difference setups that exploit data variation across time and regions or industries following from reforms of entry regulation (Bruhn 2008; Kaplan, Piedra and Seira 2009). Ciccone and Papaioannou (2007), Fisman and Sarria-Allende (2004), and Klapper et al. (2006), instead provide empirical estimates identified from data variation across countries and industries along the lines of Rajan and Zingales (1998).
The main results in this paper are twofold. First, the empirical evidence suggests that the entry regulation in the German Trade and Crafts Code reduces sustained entry into self-employment. Due to entry regulation, the probability of being self-employed in 1998/99 with a venture started after reunification and sustained for at least 5 years is lower in regulated occupations in the East German transition context after reunification than in the more stable West German context. Accordingly, the entry regulation suppresses long-living entrants who should have a higher potential of positively impacting technological progress, economic growth, and social welfare than entrants in general or transient, short-lived entrants. Second, this effect on the number of long-living entrants is not accompanied by a counteracting effect on the performance of long-living entrants, as measured by firm size in 1998/99. Altogether, these empirical results provide support for the view that entry regulation may hinder technological progress as well as economic growth, and it may ultimately reduce social welfare.
In the next section, I briefly introduce the firm entry regulation and explain the empirical model for investigating the regulatory effects on sustained entry and entrants’ performance. Then, I summarize related micro data evidence and introduce the research questions addressed here. In Sect. 4, a brief description of the data and the main variables follows. The empirical results are discussed in Sect. 5, and Sect. 6 provides conclusions.
2 Empirical framework and modeling
2.1 Firm entry regulation in the German Trade and Crafts Code
In Germany, the Trade and Crafts Code (Gesetz zur Ordnung des Handwerks, Fassung vom 28.12.1965) imposes a mandatory standard, the master craftsman certificate, on entrants into some, but not all, occupations. Entrepreneurs wanting to start a legally independent business in one of the regulated occupations need a relevant master craftsman certificate.Footnote 3 Regulated occupations are in fields as diverse as metalworking, food, as well as clothing and textiles. In addition, regulated and unregulated occupations can be in similar fields: for example, confectionery, hairdressing or printing and bookbinding are regulated, but ice-cream production, beautician services or copy and paper production are not. The master craftsman certificate is an educational degree that an individual can earn after several stages of training, collecting work experience, and taking several examinations. Typically, the individual first completes 2 or 3 years of apprenticeship (Lehre and Lehrabschluss). Then he has to work in the occupation for several years and has to earn the related journeyman degree (Gesellenzeit and -brief). The journeyman degree certifies a high level of vocational training in all occupation-specific tasks and is the prerequisite for admission to the master examination (Meisterprüfung). In the master examination, a region-specific committee examines the master candidate. The committee consists of five members, three of whom hold a master certificate in the candidates’ occupation, and many candidates do not pass the exam (Deregulierungskommission 1991). Altogether, earning a master craftsman certificate involves not only direct costs, such as fees for preparation courses, but also a substantial time investment.
The German Trade and Crafts Code dates back to the end of the 19th century, when parts of the historic guild system became institutionalized as a first backlash to the introduction of the freedom of trade (Gewerbefreiheit) in the German Reich. The master craftsman certificate was first imposed on individuals who wanted to train apprentices in a regulated occupation (Kleiner Befähigungsnachweis), but in 1935 it gained a substantially different role: all individuals wanting to start a legally independent business in one of the occupations covered by the code needed a master craftsman certificate in a relevant occupation (Großer Befähigungsnachweis). Soon after World War II, the West German Trade and Crafts Code confirmed the master craftsman certificate as an entry requirement in the Federal Republic of Germany (FRG) in West Germany, and it is still relevant to many occupations today. The planned economy system of the German Democratic Republic (GDR) in East Germany enforced strict entry regulation for all occupations and kept, in a rather pro forma manner, an entry regulation that was derived from the German Trade and Crafts Code before World War II as well as the respective educational degrees. Due to their common historical origins, the set of occupations with code-based regulation in East Germany was similar to that in West Germany. As the reunification treaty recognized all educational degrees earned in the GDR, East Germans with a GDR master craftsman certificate met the formal requirement relevant for running a business in the respective regulated occupation immediately after reunification. This is important for the subsequent empirical analysis, as otherwise entry regulation should exert even larger effects on entry than reported below.
Proponents of the entry regulation in the German Trade and Crafts Code name many benefits; among these are higher average product quality in the regulated markets and surplus vocational training relevant to other sectors of the economy. Opponents, including the German Monopolies Commission and several other German or European Union institutions, stress that individuals with a journeyman degree have a similar occupational qualification to those with a master craftsman certificate and they expect various negative consequences of the entry regulation: higher product prices, lower production quantities, less entry, lower competition, slower job creation, and less innovation (Deregulierungskommission 1991; Monopolkommission 1998, 2002).
2.2 Empirical model
In this paper, the main interest is in average effects of the entry regulation in the German Trade and Crafts Code on entry into self-employment that is sustained for several years and on the performance of long-living entrants.
The most straightforward approach to estimating a regulatory effect on such an outcome variable is to compare the respective average outcomes in regulated and unregulated occupations. The difference between these averages would identify the average effect on the chosen outcome variable if the regulated occupations were randomly selected from the population of occupations. The respective estimation equation looks as follows:
In this equation, the dependent variable is the outcome variable Y, a measure of sustained entry or entrants’ performance. Entry regulation is indicated by R. Subscript i indexes individuals, o refers to occupations, and the error term is u. The vector X includes individual characteristics, and the regression coefficients are the parameters β 0, β 1, and δ.
The main problem with this straightforward approach is that systematic, unobserved factors may influence both regulation and an outcome variable of interest, despite the fact that most regulated occupations have been under the German Trade and Crafts Code for many decades or even centuries. Differences between the average outcomes in regulated and unregulated occupations may provide biased estimates of the regulatory effects on sustained entry and entrants performance.
To account for such unobserved factors, I exploit a substantial natural experiment in entry regulation accompanying German reunification (see also Prantl and Spitz-Oener 2009). The natural experiment provides data variation across regions and occupations that allows for taking two types of systematic, unobserved effects into account when estimating the regulatory effects of interest: (1) additive unobserved effects on the outcome variable Y that differ across the groups of regulated and unregulated occupations while being constant across regions, and (2) additive unobserved effects on Y that are common to all occupations but differ across regions.Footnote 4
The chosen empirical approach relies on two core characteristics of German reunification. On the one hand, the West German Trade and Crafts Code was extended to East Germany shortly after reunification, in July 1990, and the entry regulation in the Code was kept essentially unmodified.Footnote 5 Since then, the same regulatory rules have applied to the same set of occupations in both German regions.
On the other hand, both regions differed fundamentally with respect to the economic context during the 1990s. Most important are the following differences: West German market structures were relatively stable after reunification, and opportunities for firm entry opened up on a regular basis due to random exit of incumbents, incremental technological change or other reasons. Moreover, West Germans who held the educational degrees necessary for firm entry in regulated occupations after reunification had chosen their education freely and had access to information on the relevant entry regulation when taking that decision. East Germany, instead, underwent an unanticipated transition from a planned economy to a market economy. After reunification, new entrepreneurial activities, both firm entry as well as industry restructuring, were suddenly predominant. Most East Germans holding master craftsman certificates after reunification had earned their degrees under the GDR’s planned economy system. At that time, training choices were restricted in various respects and German reunification was unforeseeable, including the entrepreneurial opportunities and the regulation of firm entry after reunification.
To illustrate these differences, Tables 1 and 2 provide descriptive statistics calculated from the survey data for the main estimation sample described in greater detail in Sect. 4. In both German regions, the shares of master craftsmen among employed individuals in occupations with entry regulation are at a similar level: the shares are 12% and 13% in East and West Germany, respectively (see Table 1). When aggregating all occupations, the respective shares are 7% and 6%. These results suggest that the master craftsman certificate was assigned to a similar share of the population in the GDR as individuals chose and earned it in West Germany.Footnote 6
Table 2, in contrast, documents substantial differences between potential entrepreneurs in East and West Germany. In regulated occupations, I consider all individuals with the master craftsman certificate of the occupation they are working in as potential entrepreneurs. They fulfill the entry standard that is imposed on those who want to start a legally independent business.Footnote 7 In unregulated occupations, all surveyed individuals are counted instead. In East Germany, 14% of all potential entrepreneurs in unregulated occupations report being self-employed in 1998/99 and having started their venture after reunification. In regulated occupations the corresponding share is 21%, implying a difference of 7 percentage points from the share in unregulated occupations, and a ratio of 1.5. In West Germany, 17% of all potential entrepreneurs in regulated occupations are self-employed in 1998/99 with a venture that they started after reunification, and 6% in unregulated occupations. All shares for West Germany are lower than the corresponding ones for East Germany—a result that is consistent with the expectation of an exceptionally high level of new entrepreneurial activities in a transition economy. The difference in the propensity to start self-employment after reunification among potential entrepreneurs in regulated and unregulated occupations in West Germany is 11 percentage points. The ratio is 2.8 and, thus, about 90% higher than the corresponding ratio of 1.5 in East Germany. Compared with unregulated occupations, potential entrepreneurs in regulated occupations in West Germany are more likely to be self-employed in 1998/99 with a venture that they started after reunification than in East Germany. This pattern is in line with restricted training choices during GDR times and with the fact that German reunification was unforeseeable before 1989.
Given the discussed differences between East and West Germany, my main conjecture is as follows: Entry regulation based on the Trade and Crafts Code is more binding in East than in West Germany. Stronger effects on firm entry should arise in the regulatory context of the East German transition economy than in the more stable West German context.
The regulatory effects estimated below are the average effects of the West–East shift in the regulatory context on the probability of sustained entry into self-employment after reunification and on the size of long-living entrants in the regulated occupations. To estimate such an effect, I compare the difference between the average outcomes of interest in regulated and unregulated occupations in East Germany against the corresponding difference in West Germany after reunification. The estimation equation is as follows:
In this equation, E indicates East Germany, β 2 is the related regression coefficient, and r indexes regions (East and West Germany). All other variables and parameters are defined as above. The following equation provides a more flexible model specification with occupation fixed effects:
The occupation effects, denoted by γ o , account for unobserved occupation-specific determinants of the outcome variable Y and, thus, for systematic variation in the occupational composition of the group of regulated occupations across regions, or of the group of unregulated occupations. The set of occupation effects represents a flexible replacement for β 1 in Eq. 2, the level effect of entry regulation averaging across all the regulated occupations.
The focus in Eqs. 2 and 3 is on β 3, the coefficient of the interaction between entry regulation R and East Germany E. From the exposition above, it follows that β 3 reflects the average effect of the West–East shift in the regulatory context in the regulated occupations on the considered outcome variable.
Equations 1 to 3 are estimated using ordinary least squares, even with discrete dependent variables. There are several reasons for doing so (Angrist and Pischke 2009; Wooldridge 2002), but for each considered discrete dependent variable I also compare linear probability estimates against average marginal effects computed from nonlinear probit estimates (Ai and Norton 2003; Norton et al. 2004). The main findings are robust to the choice of the method.Footnote 8 In all regressions, observations are weighted to account for the sampling design and to readjust to the structure of the population sampled from (Wooldridge 2002). Standard errors allow for correlation between individuals within the same occupation.
3 Existing evidence and research questions
3.1 The effects on entry into self-employment: existing microdata evidence
Microdata evidence on the relation between the entry regulation in the German Trade and Crafts Code and entry into self-employment after German reunification has previously been provided by Prantl and Spitz-Oener (2009). In their study, the effects on a general measure of entry into self-employment are investigated; the measure considers entry decisions taken any time during the first decade after reunification.Footnote 9
The basic empirical analysis indicates that entry regulation reduces this general entry measure more in the regulatory context of the East German transition economy than in the context of the more stable West German economy. Implementing the empirical approach as described above (see Sect. 2.2) gives negative and significant estimates for the coefficient of the interaction between entry regulation and East Germany in equations explaining the probability of being self-employed with a venture that was started at some point during the first decade after reunification. These estimates indicate that the probability is about 5.4–5.7 percentage points lower among employed individuals in regulated occupations in East Germany than in West Germany due to entry regulation.Footnote 10
Prantl and Spitz-Oener (2009) then show that their basic finding is closely linked to the entry costs following from the mandatory standard for entrants in regulated occupations. The regulatory effects on entry into self-employment are stronger among individuals who should be more restricted in their entrepreneurial choices than others as a result of these entry costs. These are individuals who changed their occupation after their initial training and, thus, had ceteris paribus less time to earn the relevant occupation-specific educational degrees than individuals who stayed in the occupation they were initially trained for. In addition, the basic finding is reported to be robust when exploring the relevance of additional factors that vary across occupations and regions. These are, among others, occupation-specific demand shocks in West Germany after reunification, occupation-specific restructuring requirements in East Germany, occupation- and region-specific levels of incumbent self-employment started before reunification, and skill structures that are heterogeneous across industries and regions.
In sum, the empirical results show that entry regulation reduces a general measure of entry into self-employment after reunification more in the regulatory context of the East German transition economy than in the context of the more stable West German economy.
3.2 The effects on sustained entry and entrants’ performance: new questions
The existing evidence on the entry regulation in the German Trade and Crafts Code for the decade after German reunification and the related evidence on various forms of entry regulation in other countries and time periods (see Sect. 1) indicate that entry regulation reduces entry of firms and entry into self-employment. Such evidence is important, but not sufficient for justifying policy reforms that reduce and simplify firm entry regulation in order to foster technological progress, economic growth, and social welfare. Instead, there are many questions regarding the underlying mechanisms that call for further empirical exploration.
Various recent policy-related sources may easily generate the impression that less entry in response to entry regulation unequivocally implies less technological progress, growth, and welfare, but economic theory has long since clarified that this is not the case.Footnote 11 The theoretical literature also suggests that entry regulation limiting entry is more likely to hamper technological progress, growth or welfare if the regulation under investigation inhibits specific types of entrants. These are, for example, entrants that directly increase product variety or charge low prices and successfully attract demand, and entrants or entry threats that are strong enough to trigger advancing reactions in incumbents, including increases in incumbent innovation or productivity (Dixit and Stiglitz 1977; Spence 1976; Foster et al. 2008, 2009; Aghion et al. 2004, 2009; Weinschenk 2010). This provides the starting point for the subsequent empirical analysis. Specifically, I address the following research questions:
-
1.
Does the entry regulation in the German Trade and Crafts Code reduce the entry of firms that are able to sustain their market activity for several years?
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2.
Does this entry regulation influence the performance of these long-living entrants, as measured by firm size several years after entry?
Entrants that are long-living in the sense of sustaining market activity during their initial years after market entry constitute a selective subsample of all entrants; most importantly, entrants with high growth rates after entry are part of this group. This follows from the large empirical literature on entry and entrants’ performance reporting high rates of initial growth for entrants conditional on survival and low survival rates for entrants during their first years after market entry (Audretsch 1995; Caves 1998; Geroski 1995; Sutton 1997). Long-living entrants are more likely than other entrants to be successful in attracting demand and innovating, in creating new jobs, and in exerting competitive pressure, displacing incumbents or fostering innovation and productivity improvements in incumbents.
Entrants that are transient in the sense of exiting the market after only a few periods of economic activity may exit as a consequence of weak entrepreneurial abilities, low product qualities or unfavorable market conditions. They are less likely than other entrants to have proven successful in attracting demand or innovating, in creating new jobs or in exerting competitive pressure. Instead, they are more likely to cause welfare losses that a social planner or regulator may try to reduce. For example, not much can be learned from short-lived entrants’ market experimentation in the case of entrants with similar characteristics displacing one another repeatedly and quickly. In addition, factor allocation to an entrant can always damage other market participants substantially, in particular in case of bankruptcy.
Taken together, entrants sustaining market activity during the initial years after market entry should have a higher potential of positively impacting technological progress, economic growth, and social welfare than do transient entrants. Accordingly, evidence of reduced sustained entry in response to entry regulation is a stronger indication of potentially negative welfare effects than evidence of reduced entry in general or of reduced transient entry.
Entry regulation may, however, not only influence the probability of sustained entry into self-employment and, thus, the number of long-living entrants, but also their average performance. In that case, the composition of the group of long-living entrants is affected, and this may influence the group’s contribution to technological progress, economic growth, and social welfare. To shed light on this matter, I investigate the regulatory effects of the entry regulation in the German Trade and Crafts Code on the employment built up in firms that entered after reunification and sustained their market activity for at least 5 years.
4 Data
The subsequent empirical analysis is based on data from a large survey that has been carried out repeatedly since the 1970s by the German Federal Institute for Vocational Training (Bundesinstitut für Berufsbildung, BIBB) and the Research Institute of the Federal Employment Service (Institut für Arbeitsmarkt- und Berufsforschung, IAB): the “Qualification and Career Survey”. Approximately every 6–7 years, these institutions collect survey data using representative, unlinked cross-sections of about 30,000 employed individuals. For the purpose of this paper, I use the survey wave launched in 1998/99. It covers employed individuals in East and West Germany, including self-employed entrepreneurs who started self-employment after reunification and did so up to 9 years before the survey was taken. Information on the employment in the respective firms at the time of the survey is also available.Footnote 12
In the first part of the empirical analysis, I focus on the impact of entry regulation on sustained entry into self-employment after the fall of the Berlin Wall in November 1989. In order to construct the dependent variable I use data on the current employment status of survey participants at the time of the survey in 1998/99 and, for self-employed individuals, data on the year they started that entrepreneurial activity. The dependent variable indicates individuals who were self-employed in 1998/99 with a venture that they started at least 5 years earlier, but after 1989 (1990–1993). In the second part of the empirical analysis, I investigate the impact of entry regulation on firm size using a categorical measure of employment including working entrepreneurs in 1998/99.Footnote 13 This variable distinguishes six size classes: (1) 1 employed individual, (2) 2 employed individuals, (3) 3 or 4 employed individuals, (4) 5–9 employed individuals, (5) 10–49 employed individuals, and (6) 50 or more employed individuals. Alternatively, I use an indicator that is coded 1 for self-employed entrepreneurs who started between 1990 and 1993 with a venture that has at least one additional employed individual apart from themselves in 1998/99, and 0 otherwise.
The most important explanatory variables are indicators for entry regulation, East Germany, and the interaction of these variables (R, E, and R × E). The indicator for entry regulation is coded 1 for occupations with entry regulation, and 0 otherwise; it is constructed using survey data on the occupation an individual currently works in and information from the German Trade and Crafts Code as enforced during the 1990s. The indicator for East Germany is 1 in case of current residence in East Germany, and 0 otherwise. To capture influences of individual heterogeneity on the dependent variables, I use demographic and educational variables. Table 3 provides the definitions and some descriptive statistics for all the variables used below.
The main estimation sample is for the first part of the empirical analysis. It includes 15,575 individuals participating in the survey of 1998/99 who are 20–59 years old, work between 10 and 75 h per week, have German citizenship, and report all the information of interest here. Excluded are individuals in the public sector, in nonprofit organizations or the mining and quarrying sector, and in all occupations that are not accredited by the Federal Ministry of Education and Research and the BIBB. In accredited occupations, vocational training is based on federal law.Footnote 14 These occupations are the population of interest in my study, since the German Trade and Crafts Code regulates firm entry in some of these, but not in others. In the second part of the empirical analysis, where I focus on explaining firm size, the estimation sample consists of those observations from the main sample that refer to individuals who indicate being self-employed in 1998/99, having started that activity at least 5 years earlier, but after 1989, and owning a firm with fewer than 50 employed individuals.Footnote 15
5 Empirical results
In this section, I first discuss the impact of the entry regulation in the German Trade and Crafts Code on the probability of sustained entry into self-employment after reunification and then the effect on the performance of long-living entrants.
About 38% of all self-employed individuals who started a venture after reunification (in the years 1990–1993) and were surveyed in 1998/99 have then been active with it for at least 5 years. Table 4 shows estimates of linear probability models that explain the probability of this type of sustained entry into self-employment for employed individuals.
Column 1 provides the estimate of Eq. 1 with the entry regulation indicator R as main explanatory variable for the subsample of 3,183 employed individuals residing in East Germany. The other explanatory variables are a constant and measures of individual characteristics (age, gender, education). Column 2 provides the corresponding estimate for the subsample of 12,392 employed individuals residing in West Germany. In both these regressions, I find negative coefficients of the entry regulation indicator R. The one for East Germany (column 1) is statistically significant at the 1% level, in contrast to the one for West Germany (column 2). As discussed in Sect. 2.2, these results may indicate effects of the entry regulation, but they may also reflect systematic, unobserved effects on the probability of being self-employed with a long-lasting venture started after reunification.
The refined model specification in Eq. 2 allows for estimating the average effects of the West–East shift in the regulatory context after reunification while controlling for the following types of additive unobserved effects: those that differ systematically across the groups of regulated and unregulated occupations but are constant across regions, and those that are common to all occupations but differ systematically across regions. Equation 2 includes the indicator of East Germany E and the interaction term between entry regulation and East Germany, besides the indicator of entry regulation R and all other explanatory variables of Eq. 1.
The relevant sample for estimating Eq. 2 covers all 15,575 employed individuals in East and West Germany, and the estimates are shown in column 3 of Table 4. The estimated coefficient of the level term for entry regulation is negative and insignificant, but the coefficient of the interaction term between East Germany and entry regulation is negative and significant. The latter result suggests that entry regulation lowers the probability of self-employment in long-lasting ventures started after reunification by 5.4 percentage points more in regulated occupations in the East than in the West. The coefficient of the level term for East Germany is positive and significant, which is well in line with economic transition triggering unusually high entry and industry restructuring.
As shown in column 4, estimating a flexible model specification with occupation fixed effects (Eq. 3) confirms the negative coefficient of the interaction between East Germany and entry regulation. Accordingly, the main finding holds up if unobserved occupation-specific heterogeneity and, thus, systematic variation in the occupational composition of the groups of regulated and unregulated occupations across regions are allowed for.Footnote 16
All model specifications in Table 4 include further explanatory variables, measuring demographic and educational characteristics, to capture the effects of individual heterogeneity on sustained entry into self-employment. Men are more likely than women to be self-employed in 1998/99 with a long-lasting venture started after reunification. For age, the estimated effects are positive along the whole sample distribution and increasing until an age of 32–38 years in the regressions in columns 2–4; in the regression in column 1, the maximum is attained at 49 years. The estimated effects for the included education indicators are weak.Footnote 17 Migrants with German citizenship who live in East or West Germany but grew up in a foreign country or the part of Germany they do not live in at the time of the survey are less likely to be self-employed with a long-lasting venture started after reunification than nonmigrants.Footnote 18
Altogether, the pattern of empirical findings in Table 4 indicates that entry regulation decreases the probability of sustained entry into self-employment in regulated occupations more during economic transition than in a more stable market environment. This suggests that transient, short-lived entrants are not the only driving force behind regulatory effects on general measures of entry into self-employment, as, for example discussed in footnote 16 and in Prantl and Spitz-Oener (2009). The entry regulation in the German Trade and Crafts Code does not only suppress transient, short-lived entrants that may well cause welfare losses, but also long-living entrants that should have a higher potential of positively impacting technological progress, economic growth, and social welfare.
Having shown that the entry regulation in the German Trade and Crafts Code reduces the probability of sustained entry into self-employment after reunification, I now turn to the effect on entrants’ performance. This is important, as the sustained entry effect lowering the number of long-living entrants is not necessarily the only regulatory effect influencing how the group of long-living entrants contributes to technological progress, economic growth, and social welfare. The effect on the individual performance of the group members can also be relevant. Specifically, I investigate the effect on the long-term average employment built up and reported in the survey of 1998/99 by self-employed individuals who started their ventures after reunification and sustained market activity for at least 5 years. The respective dependent variable is a categorical measure of firm size that distinguishes six employment classes (see Sect. 4).
Column 1 of Table 5 displays the estimates of Eq. 1 for the subsample of 166 self-employed individuals with long-lasting ventures started after reunification in East Germany. Column 2 provides the corresponding estimates for the West German subsample of 241 observations. I find positive coefficients for the indicator of entry regulation R in these regressions. The one for East Germany (column 1) is insignificant; the one for West Germany is significant at the 5% level (column 2). The results for Eq. 2 in column 3 indicate a positive and significant coefficient of the level term for entry regulation and a negative, insignificant coefficient of the interaction term between entry regulation and East Germany. Accordingly, there is no empirical support for differential effects of the entry regulation in the German Trade and Crafts Code on the long-term average employment in long-living entrants started after reunification in regulated occupations in East and West Germany.Footnote 19
The main finding of an insignificant coefficient for the interaction term between East Germany and entry regulation is robust to the following changes of the model specification. First, the coefficient estimate is also insignificant if one uses a flexible model specification with occupation fixed effects as in Eq. 3 (column 4). Second, the result is also confirmed when using a discrete dependent size indicator (coded 1 for self-employed entrepreneurs who employ at least one more individual apart from themselves, and 0 otherwise) instead of the categorical variable of firm size (column 5).
As the chosen measure of entrants’ performance may depend on individual heterogeneity, all model specifications in Table 5 also include measures of demographic and educational characteristics. The coefficient estimates for males are positive, but mostly insignificant. For age, I find a concave relationship with firm size; the coefficient estimates for the age terms are jointly significant in columns 1–4, at least at the 10% level. Education indicators are always insignificant. Migrants employ fewer workers in 1998/99 than nonmigrants; the coefficient estimates in columns 3 and 4 are significant at the 10% level.
In summary, I find no differential effect of the entry regulation in the German Trade and Crafts Code on the long-term average employment of long-living entrants in regulated occupations in East and West Germany. Accordingly, the estimation results in Table 5 provide no indication of an effect on entrants’ performance that would counteract the negative effect on the probability of sustained entry into self-employment after reunification and, thus, the number of long-living entrants.
6 Conclusions
In this paper, I provide empirical evidence on the consequences of entry regulation for sustained entry into self-employment, as opposed to entry in general. In addition, I study the effects on the performance of long-living entrants that are able to sustain market activity for several years after entry. The entry regulation under scrutiny here is a substantial restriction to entry following from the German Trade and Crafts Code. The law imposes a mandatory standard, the master craftsman certificate, on entrepreneurs who want to start a legally independent firm in one of the regulated occupations. In order to identify the effects of interest, I exploit the situation after German reunification when East and West Germany faced different economic conditions, but fell under the same law regulating entry in some occupations, though not in others. In the East German transition economy, entry regulation should exert stronger effects on entry than in the more stable West German market economy. Building on this conjecture, I estimate average effects of the West–East shift in the regulatory context by comparing the difference between the average outcomes in regulated occupations and unregulated occupations in East Germany after reunification against the corresponding difference in West Germany.
The main empirical findings reported in this paper are as follows. First, the entry regulation in the German Trade and Crafts Code reduces sustained entry into self-employment more in regulated occupations in the East German transition context after reunification than in the more stable West German context. Accordingly, the entry regulation suppresses long-living entrants who should have a higher potential of positively impacting technological progress, economic growth, and social welfare than entrants in general or transient, short-lived entrants. Second, this effect on the number of long-living entrants is not accompanied by a counteracting effect on the performance of long-living entrants, as measured by firm size several years after entry. Altogether, these empirical results support the claim that entry regulation may hinder technological progress as well as economic growth, and it may ultimately reduce social welfare.
Notes
Even empirical analyses that have a similar focus and rely entirely on data variation across countries are rare; one exception is Capelleras et al. (2007). To date, several distinctions between different types of entry or entrants have been used in empirical analyses of regulatory effects on entrepreneurship, but no performance-related distinction between sustained and transient entry as considered here. Bruhn (2008), Capelleras et al. (2008), and Kaplan et al. (2009), for example, distinguish between registered and unregistered entrants; Ardagna and Lusardi (2010) compare regulatory effects on entrepreneurs who want to pursue a business opportunity against regulatory effects on those who lack better alternatives.
See Prantl and Spitz-Oener (2009) for further details.
The empirical approach is similar to a standard difference-in-difference approach due to the use of a natural experiment in entry regulation and the consideration of two types of additive unobserved effects (Angrist and Pischke 2009; Blundell and MaCurdy 1999; Blundell and Costa Dias 2009). The average effect of the regulatory change on treated individuals is identified. This average treatment effect on the treated is equivalent to the average effect on the whole population if individuals’ responses to the regulatory change are homogeneous or if individuals with heterogeneous responses are randomly assigned to treatment.
See the Gesetz über die Inkraftsetzung des Gesetzes zur Ordnung des Handwerks (Handwerksordnung) der Bundesrepublik Deutschland in der Deutschen Demokratischen Republik (1990) and the Vertrag zwischen der Bundesrepublik Deutschland und der Deutschen Demokratischen Republik über die Herstellung der Einheit Deutschlands, Anlage I, Kapitel V, Sachgebiet B, Abschnitt III (1990). Note that not only the West German Trade and Crafts Code, but also West German product market regulation more generally, was quickly extended to East Germany after reunification.
Note that the survey data at hand covers employed individuals, but no other individuals in the East or West German labor force and population.
Only about 3% of all other employed individuals in regulated occupations report self-employment started after reunification in East Germany and in West Germany. This is in line with the imposed entry requirement.
The respective estimation results are available upon request, as are all other results discussed in the text but not reported in the tables.
In another part of their study, Prantl and Spitz-Oener (2009) investigate regulatory effects on occupational mobility among workers after reunification: the entry regulation in the German Trade and Crafts Code turns out to reduce occupational mobility more in regulated occupations in East than in West Germany. This result can be explained by entry regulation hampering entry and competition more in regulated occupations in the East than in the West after reunification.
The estimates are for a sample of about 27,000 employed individuals where the weighted average probability of being self-employed with a venture started after 1989 is 4.7%.
Mankiw and Whinston (1986), among others, provide a model of product markets where firms decide freely on entry and must incur entry costs which cannot be recovered upon exiting the market. In this model, equilibrium entry can be excessively high from a welfare perspective (or socially insufficient) instead of socially optimal. See also von Weizsäcker (1980) for an earlier contribution showing that an excessive number of homogeneous firms may produce in the free-entry equilibrium; Belleflamme and Peitz (2010) provide a recent textbook discussion.
See Prantl and Spitz-Oener (2009) and references cited therein for further details on the “Qualification and Career Survey”.
Continuous information on firm-size is not available in the survey data that I use here.
The vocational training in accredited occupations is carried out under the dual system of apprenticeship and, thus, consists of both on-the-job training in companies and training in schools. See Harhoff and Kane (1997) and references cited therein for more details. The empirical results reported in Sect. 4 are robust if re-estimated on a sample with all occupations, including those that are not accredited by the Federal Ministry of Education and Research and the BIBB.
Due to the latter restriction, I exclude two observations with missing firm size and seven observations with firm size of more than 50 employed individuals. The regulatory effect estimates reported in Sect. 5 are, however, not sensitive to this restriction.
For comparison, I re-estimate Eq. 3 with all exogenous variables as in column 4 of Table 4, but a dependent variable as in Prantl and Spitz-Oener (2009). This dependent variable indicates self-employed individuals with a venture started any time after reunification (in the years 1990–1999). The estimation results suggest that entry regulation reduces the probability of these self-employment activities by 7.3 percentage points more in regulated occupations in the East than in the West. In line with expectations, this effect on a general entry measure is higher than the sustained entry effect of 5.4 in column 4 of Table 4 (by about 1.9 percentage points).
In some model specifications, highly educated individuals residing in West Germany and holding a degree from a university or a technical college have a higher probability of being self-employed in 1998/99 with a long-lasting venture started after reunification than individuals with medium education. Medium education indicates a vocational training degree from the dual system of apprenticeship or a vocational school. I find significant coefficient estimates neither for highly educated individuals who reside in East Germany nor for individuals with low education, i.e., those holding neither a vocational training degree nor a higher educational degree.
In contrast, the regression mentioned in footnote 16 shows that migrants do not differ significantly from nonmigrants in an empirical model explaining a general measure of entry. In addition, note that the regulatory effect estimates in Table 4 remain robust if all 1,263 migrants are excluded from the estimation samples.
The coefficient estimate for the level term of East Germany varies across model specifications. It is close to zero and insignificant in column 3, positive and insignificant in column 4, and significantly positive in column 5.
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Acknowledgements
I wish to thank Philippe Aghion, Jan Boone, Richard Blundell, Tomaso Duso, Christoph Engel, Paul Heidhues, Jennifer Hunt, Bernd Fitzenberger, Michael Fritsch, Adam Lederer, Nicola Fuchs-Schündeln, Rachel Griffith, Markus Nöth, Alexandra Spitz-Oener, Philipp Weinschenk, the editor and the anonymous referees for helpful comments and discussions. Brian Cooper and Christoph Wigger provided excellent editorial support and research assistance. All remaining errors are my responsibility. Financial support by the German Research Foundation through the SFB/TR 15 “Governance and the Efficiency of Economic Systems” is gratefully acknowledged. The data used in this paper were obtained from the Zentralarchiv für Empirische Sozialforschung at the University of Cologne (ZA). They were collected by the Bundesinstitut für Berufsbildung (BIBB) and the Institut für Arbeitsmarktund Berufsforschung (IAB) and documented by the ZA. Neither the producers of the data nor the ZA bear any responsibility for the analysis and interpretation of the data.
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Prantl, S. The impact of firm entry regulation on long-living entrants. Small Bus Econ 39, 61–76 (2012). https://doi.org/10.1007/s11187-010-9293-4
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DOI: https://doi.org/10.1007/s11187-010-9293-4