This paper investigates empirically the role of Portuguese deregulation in shaping the structure of local markets for driving instruction and competition among driving schools. We develop a framework that integrates quality and price competition among horizontally and vertically differentiated driving schools. We estimate the model using detailed data on the market structure, firm attributes and prices, and consumer preferences for 593 schools in 117 local markets. We use the estimated parameters of our model to predict the effect that the 1998 easing of price and entry restrictions governing the sector had on firm profits and consumer welfare. We also explore the effect of new regulations currently being considered

Seim, Katja

Vitorino, Maria Ana

English

ScholarlyCommons@Penn

University of PennsylvaniaScholarlyCommonsMarketing Papers Wharton Faculty Research4-2011Efficiency Gains from Removing Entry and PriceControls: Evidence from a Change in RegulationKatja SeimUniversity of PennsylvaniaMaria Ana VitorinoFollow this and additional works at: https://repository.upenn.edu/marketing_papersPart of the Business Administration, Management, and Operations Commons, Business Law,Public Responsibility, and Ethics Commons, Economic Policy Commons, Marketing Commons,Organizational Behavior and Theory Commons, and the Taxation CommonsThis is an unpublished manuscript.This paper is posted at ScholarlyCommons. https://repository.upenn.edu/marketing_papers/335For more information, please contact repository@pobox.upenn.edu.Recommended CitationSeim, K., & Vitorino, M. A. (2011). Efficiency Gains from Removing Entry and Price Controls: Evidence from a Change inRegulation. Retrieved from https://repository.upenn.edu/marketing_papers/335Efficiency Gains from Removing Entry and Price Controls: Evidence froma Change in RegulationAbstractThis paper investigates empirically the role of Portuguese deregulation in shaping the structure of localmarkets for driving instruction and competition among driving schools. We develop a framework thatintegrates quality and price competition among horizontally and vertically differentiated driving schools. Weestimate the model using detailed data on the market structure, firm attributes and prices, and consumerpreferences for 593 schools in 117 local markets. We use the estimated parameters of our model to predict theeffect that the 1998 easing of price and entry restrictions governing the sector had on firm profits andconsumer welfare. We also explore the effect of new regulations currently being considered.Keywordsquality competition, professional services, regulationDisciplinesBusiness | Business Administration, Management, and Operations | Business Law, Public Responsibility, andEthics | Economic Policy | Marketing | Organizational Behavior and Theory | TaxationCommentsThis is an unpublished manuscript.This working paper is available at ScholarlyCommons: https://repository.upenn.edu/marketing_papers/335Efficiency Gains from Removing Entry and PriceControls: Evidence from a Change in Regulation∗Preliminary & Incomplete. Please do not circulate or quote.Katja Seim†Wharton SchoolUniversity of PennsylvaniaMaria Ana Vitorino‡Wharton SchoolUniversity of PennsylvaniaApril 2011AbstractThis paper investigates empirically the role of Portuguese deregulation in shapingthe structure of local markets for driving instruction and competition among drivingschools. We develop a framework that integrates quality and price competition amonghorizontally and vertically differentiated driving schools. We estimate the model usingdetailed data on the market structure, firm attributes and prices, and consumer pref-erences for 593 schools in 117 local markets. We use the estimated parameters of ourmodel to predict the effect that the 1998 easing of price and entry restrictions governingthe sector had on firm profits and consumer welfare. We also explore the effect of newregulations currently being considered.Keywords: quality competition, professional services, regulationJEL Classification: L10, L43∗The authors thank the Global Initiatives Research Program and the Dean’s Research Fund at theWharton School for financial support and David Muir for excellent research assistance. The authors wouldalso like to thank Susana Paulino, from IMTT, for sharing with us data and valuable insights on the DrivingSchool Industry, and João Filipe Belo, Susana Belo and Paulo Sopa for assisting with local data collection.†Philadelphia, PA 19104-6372, U.S.A., kseim@wharton.upenn.edu.‡Philadelphia, PA 19104-6340, U.S.A., vitorino@wharton.upenn.edu.SummaryThe regulatory oversight of professional services industries, ranging from accountants, no-taries, and lawyers to pharmacies, continues to be substantial in many countries. Theseregulations typically govern entry into the profession via minimum competency or licens-ing requirements or geographic entry restrictions and restrict firms’ organizational structureand size. Some industries also experience conduct regulations, including price restraints andbans or limits on advertising. The goal of these restrictions typically lies in addressing mar-ket failures, such as information asymmetries, externalities, and insufficient entry. Concernshave been raised, however, that such regulation has the effect of limiting competition inthe market for professional services. This has resulted in liberalization and an increasingapplication of antitrust laws to the sector.1In this paper, we study the outcomes of one such liberalization effort, the deregulationof Portuguese driving schools. Similar to other European countries, Portugal mandatesthat students take a minimum number of theoretical and practical driving lessons at alicensed private driving school prior to taking a driving exam and ultimately obtaining adriver’s license. Prior to 1998, the sector was subject to both entry and conduct regulations.The number of awarded licenses was tied to the population size of the markets the firmsserved and the firms’ spatial locations within a market were subject to minimum distancerequirements from competitors. Simultaneously, the government employed ceilings on theprices schools could charge for a course. While the government continues to use a licensingprocess to oversee entry and requires schools to post their price schedules locally, the strictentry restraints and price ceilings were fully lifted in 1998. This had the immediate effectof a significant expansion in the number of competitors in local markets, with an overallincrease in the number of schools of 116% from 1998 to 2010.We develop an empirical model of firms’ pricing and quality provision decisions. We beginwith a discrete-choice model of student demand for the driving instruction services offeredby differentiated driving schools. We allow consumer preferences to vary with horizontalschool attributes such as the types of driving licenses offered by the school, its size, andthe attributes of its fleet of instruction vehicles. Consumer demand also depends on schoolquality. In the case of driving schools, an important school attribute is the quality of thetraining that the student receives and the extent to which the school prepares the student forthe driving exam. We initially assume that students are aware of the quality that each schoolprovides. In an extension, we then allow for asymmetric information whereby the school1In the EU, the European Commission intensified its liberalization and harmonization efforts in the early2000s; see e.g. Paterson, Fink & Ogus (2003)’s assessment of professional regulations across Member Statesand the subsequent EC Communication (Commission of the European Communities 2004). In the U.S., a1975 Supreme Court decision resulted in the application of U.S. antitrust principles and law to professionalservices (Biggar & Wise 2000).1has better information about its quality than the students. Such information asymmetriesare one motivation for regulatory intervention in professional services; when consumers areunable to assess the quality of services, competition may drive down the quality of servicesdelivered to consumers. Our empirical model of firm behavior then considers a two-stagesetup where firms initially make their quality decisions, taking into account the qualitychoices of their competitors. After making their initial quality choices, firms then chooseprices.We estimate our model using an extensive data set obtained from the Portuguese De-partment of Transportation, IMTT, covering all licensed driving schools and their studentsin 2010. The IMTT data contain information on school attributes (number of driving in-structions, size of the school’s vehicle fleet,age, etc.), the number of students registered witheach school over the course of the year, and the performance of the schools’ students in boththe theoretical and the practical driving exams. The data further supply information onthe regulatory environment facing each school in a local market, such as the presence anddistance to a testing center as well as the distance to the closest IMTT center, which repre-sent significant cost shifters for the firms. We complement the IMTT data with market-levelinformation from Statistics Portugal on income, the age distribution of the population, andvarious transportation related variables, such as the share of commuters, the extent of publictransportation, as proxies for variation in the value of a driver’s license across municipalities.Last, we hand-collected price information for a typical course of driving instruction via atelephone survey from each of the schools. We focus on small, self-contained local markets,defined as municipalities. We exclude the large urban centers of Lisbon and Porto from theanalysis resulting in a sample of 593 schools operating in 117 municipalities across mainlandPortugal.The data do not contain directly observable measures of firm quality. We exploit, how-ever, the availability of detailed information on student performance in driving exams toderive a measure of firm quality. Controlling for observable student attributes such as ageand gender, we estimate fixed effects models of a student’s propensity to pass a drivingexam. We include the estimated firm fixed effects as proxies for firm quality in a potentialstudent’s utility from choosing a particular driving school.We demonstrate in a series of counterfactual experiments how the 1998 deregulation ofthe industry has changed firm conduct and outcomes. First, we consider how prices andfirm quality would change were the number of firms to be restricted as in the pre-1998period. We consider both a case where the number of firms is restricted to the oldest firmscurrently operating in the market and a case where we randomly select who is allowedto operate. We similarly consider how quality offerings would change were IMTT to re-institute a binding price ceiling. We then turn to several prospective counterfactual analyses.2Portuguese regulations currently prohibit the existence of driving school chains, allowingonly stand-alone entrepreneurs to operate. Using several representative municipalities, weconsider the implications of possible mergers between competing schools and the resultingcreation of multi-school chains on social welfare, recognizing the potential for quality andprice adjustments, as well as the possible cost savings from economies of scope.3ReferencesBiggar, D. R. & Wise, M. O. (2000). Competition in Professional Services, OECDBest Practice Roundtables in Competition Policy 27, OECD, Paris. Available athttp://ssrn.com/abstract=318763.Commission of the European Communities (2004). Report on Competition in ProfessionalServices, European Commission Communication 83, Brussels. Available at http://eur-lex.europa.eu/LexUriServ/site/en/com/2004/com2004_0083en01.pdfPaterson, I., Fink, M. & Ogus, A. (2003). Economic impact of regulation in the fieldof liberal professions in different Member States, Research Report, Institute for Ad-vances Studies, Vienna. Available at http://ec.europa.eu/competition/sectors/professional_services/studies/prof_services_ihs_part_1.pdf4

Efficiency Gains from Removing Entry and Price Controls: Evidence from a Change in Regulation

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