How do price and entry regulations affect market structure, industry evolution, management quality, and through these, dynamic efficiency? Relatively little is known about this question. The literature on the effects of price and entry regulation on efficiency has shown that such interventions can reduce static efficiency by preventing firms from allocating their assets optimally. For example, trucking regulations prevented carriers from hauling regulated commodities on return trips, making empty backhauls a serious problem.
Airline regulations increased costs by reducing load factors and by preventing airlines from routing optimally (Morrison and Winston 1986). Lifting these regulation-induced production distortions led to one-time improvements in efficiency. Data limitations, however, have limited work on the effects of entry and price regulation on the evolution of industry costs over time (Winston 1993).
In this paper, we find that the severe restrictions imposed on the geographic scope of banks retarded the natural process of selection whereby better managed, lower cost firms expand at the expense of inefficient firms. Consequently, these restrictions raised the costs associated with the average bank asset. The banking industry is a unique source of evidence on the dynamic effects of entry regulation. First, banks were subjected to extremely severe entry barriers in the form of branching restrictions at a relatively early stage of the industry's development.
Banks have traditionally been prevented from crossing state lines and, until the 1980s, they were unable to cross county lines in many states. These restrictions have probably been binding since the 1890s, when banks began forming chain banks (banks commonly owned by a group of individuals) as a means of getting around branching restrictions (Calomiris 1993)2. These long standing restrictions have contributed to the extremely fragmented structure of the U. S. banking industry, with thousands of banks and bank holding companies, a structure which contrasts sharply with other countries where a few very large institutions dominate.
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Entry Restrictions, Industry Evolution and Dynamic Efficiency: Evidence from Commercial Banking
