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We study the distortions of industrial organization caused by entry regulation. We take advantage of heterogeneity across industries in their natural barriers and growth opportunities to examine whether industries are differentially affected in countries according to entry regulation. First, we consider the effect of entry regulation on the (static) industry structure. We find that regulation has a greater impact in industries with lower natural barriers to entry, both on the number of firms and on the average size of firms. We find that the effect of entry regulation on industry share is not related to differences in natural barriers. Regarding industry dynamics, we 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, growth opportunities lead to the creation of new firms; finally, the total sectoral response is invariant to the level of regulation.

Economists have presented two contrasting views of government regulation of economic activity. Under the Regulatory Capture view (Stigler 1971), regulationis acquired by industries, and is designed and operated for their benefit, through the increased market power that regulation allows. By contrast, the Public Interest perspective, as initially suggested by Pigou (1938), holds that industry will be fraught with inefficiencies stemming from market failures of all kinds, if left to its own devices. Regulation is therefore required to achieve socially efficient outcomes. Both perspectives suggest that entry regulation in particular will have an impact on industrial structure by directly influencing the costs of starting a new enterprise in a given industry, but differ in their views on the relative trade-off between the correction of externalities and the creation of market power. In order to appropriately assess the extent of this trade-off requires some empirical sense of the actual distortions that may be caused by regulatory burdens. Even though this paper does not deal with the actual causes of regulation, it sheds some light on the matter, by means of analyzing some interesting consequences of entry regulation.

In this paper, we study the distortions to the organization of industry caused by entry regulation, taking 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