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VoxEU Column Competition Policy Industrial organisation

Monopoly and restricted entry: Lessons from the notary professions

Entry restrictions can help correct market failures, but also serve to maximise industry profits. This column studies how geographic entry regulation of the Latin notary system balances consumer and producer interests. Using a spatial demand model, it shows that the state places significantly more weight on industry profits than consumer surplus when granting entry licenses. Furthermore, it estimates high markups for notaries, particularly in real estate transactions. Reforms such as reducing fees and liberalising entry can have substantial welfare-improving effects.

Entry restrictions, or occupational licensing requirements, are common across many service sectors. They typically consist of general training requirements, but they are often also combined with geographic entry restrictions and price regulation. According to the public interest view, entry restrictions serve to correct market failures such as insufficient quality provision or excessive entry in the presence of market power (see, for example, Mankiw and Whinston 1986 for a theoretical analysis, and Berry and Waldfogel 1999 for an early empirical analysis). According to the private interest view, entry restrictions are the result of regulatory capture, and primarily serve to maximise industry profits (Stigler 1971).

Although the impact of general occupational requirements has already received considerable attention in economics research,1 there is only limited research on the role of geographic entry restrictions combined with price regulation. A notable exception is the work by Seim and Waldfogel (2013), who analyse the effects of entry regulation in the context of a public monopoly: the Pennsylvania Liquor Control Board. They find that the number of entry licenses is in line with the maximisation of industry profits and is too low from a welfare point of view.

However, the question of how entry regulation balances consumer and producer interests in the context of a privately regulated industry remains underexplored. In our new paper (Verboven and Yontcheva 2022), we analyse geographic entry restrictions in a private monopoly enforced by the state.

The Latin notary system

We study the Latin notary system, under which the state appoints high-skilled lawyer notaries. It grants them exclusive rights to produce authentic deeds at legally fixed prices to certify various important economic transactions, such as real estate purchases, business registrations, marriage contracts, and inheritance matters. The system is very widespread: it exists in 22 out of the 27 EU countries and in 87 countries worldwide. Its size is also economically important: there are 40,000 notaries across the 22 EU countries with a notary system, with a total number of 160,000 employees. In Belgium, the country which we study in more depth, total sales of the sector amounted to approximately €1.6 billion in 2016, which is roughly comparable to the total public budget allotted to law enforcement.

In almost all countries the notary profession has two distinct features: high fixed prices (notably on real estate transactions) and regulated entry based on territorial criteria. As such, the system is explicitly designed to eliminate competition between notaries and other professions (such as real estate agents, banks, and lawyers), as well as among the notaries themselves. A common justification of these restrictions has been that they ensure the impartiality of notaries, who are tasked with representing the interests of all parties in a transaction, while also fostering sufficient geographic availability. Because the high fixed prices have been responsible for high profits, the notary profession provides an ideal setting to study the role of geographic entry restrictions.

Do the entry restrictions maximise welfare or industry profits?

Our main question is whether the entry restrictions maximise total welfare, or whether they primarily serve industry profits as under regulatory capture. To address this question, we proceed in several steps. In a first step, we estimate a spatial demand model for the demand of notary services. We find that consumers value the proximity to nearby notaries. As a result, new entry would result in considerable business stealing from other notaries. But it would also lead to some limited market expansion: consumers would more quickly engage in real estate and other transactions if there would be a denser geographic coverage.

In a second step, we quantify the notaries’ markups for real estate and other transactions, at the current fixed prices. As shown in Table 1, in 2016 a Belgian notary received on average €2,053 for certifying a transaction that is related to real estate (a property purchase or a mortgage), whereas its marginal cost for producing such a transaction was only €1,305. This amounts to a markup of €748, or 36.7%, of the price. Other transactions come with lower prices and markups, yet they are still profitable contrary to what is sometimes claimed by the sector.

Table 1 Prices, marginal costs, and markups of notaries

 

                                                

Note: This table shows prices (p), marginal costs (mc), and absolute and percentage markups, for notaries in Belgium in 2016.

In a third step, we use an entry model to uncover the state's objective function. We find that the state attaches a much higher weight to industry profits than to consumer surplus when granting new entry licenses. Intuitively, allowing additional entry would substantially raise total welfare because the consumers' value from additional notaries outweighs the duplication of fixed costs. 

Policy reform 1: Reforming fees

To obtain further insights in the current distortions, we perform various policy counterfactuals. We first consider the impact of reforming fees to make them more cost-oriented, while keeping the current geographic entry distribution fixed. At the prevailing fees, the sector realised net profits of approximately €440 million, distributed over the 1,152 notary offices in 2016. We find that there is considerable scope for reducing the fees. Reducing fees uniformly for all transactions by 16% would still guarantee net industry profits of €200 million, while reducing fees by 23% would guarantee industry profits of €100 million. Figure 1 presents the distribution of profits across Belgian municipalities at the prevailing fees and the reduced fees. This shows that geographic coverage is not jeopardised by reduced fees.

Figure 1 Average office-level profits under alternative fee structures

 

Note: The left panel present average office-level profits across Belgian municipalities in €1000. The middle and right panels plot the same variable after fee reductions of 16% and 23%, which guarantee industry profits of respectively €200 million and €100 million. 

Note that these fee reductions would raise total welfare to only a limited extent, because demand is relatively inelastic. However, they would entail a substantial transfer from notaries to consumers.

Policy reform 2: Liberalising entry and reforming fees

We next consider deeper reforms that also loosen the entry restrictions. We consider both welfare-maximising entry and a full liberalisation to free entry. Keeping the current fees constant, the welfare maximising number of firms would be more than twice the current number. This implies substantial potential welfare gains of up to €463 million, as the consumer surplus gains (€552 million) significantly outweigh the losses in industry profits (€89 million). A full liberalisation to free entry without adjusting fees would result in an excessive number of firms, but would still imply a welfare improvement compared with the current outcome of insufficient entry. More interestingly, if free entry is accompanied with an 19% fee reduction, this would result in an outcome close to the first best (welfare gains of €485 million). In other words, reducing fees serves as an additional regulatory instrument to prevent excessive free entry. Finally, free entry combined with a fee reduction would also entail a substantial redistribution from firms towards consumers, without threatening geographic coverage.

References

Berry, S T and J Waldfogel (1999), “Free entry and social inefficiency in radio broadcasting”, The RAND Journal of Economics 30(3): 397-420.

Kleiner, M M and E J Soltas (2019), “A welfare analysis of occupational licensing in US states”, NBER Working Paper No. w26383.

Mankiw, N G and M D Whinston (1986), “Free entry and social inefficiency”, The RAND Journal of Economics 17(1): 48-58.

Pagliero, M (2011), “What is the objective of professional licensing? Evidence from the US market for lawyers”, International journal of industrial organization 29(4): 473-483.

Seim, K and J Waldfogel (2013), “Public monopoly and economic efficiency: evidence from the Pennsylvania liquor control board's entry decisions”, American Economic Review 103(2): 831-62.

Stigler, G J (1971), “The theory of economic regulation”, The Bell Journal of Economics and Management Science 2(1): 3-21.

Verboven, F and B Yontcheva (2022), “Private monopoly and restricted entry: evidence from the notary profession”, CEPR Discussion Paper 17367.

Endnotes

1 For example, Pagliero (2011) shows how general entry restrictions result in excessive salaries to US lawyers. Kleiner and Soltas (2019) provide a broader analysis of the costs from occupational licensing in terms of reduced labour market competition.