A Certificate of Need for Pizza Shops, a Thought Experiment in Planning

This is a thought experiment, and a satire. Everything in the town of Marlowe Falls, its Board of Pizza Planning and its pizzerias is invented, and no sentence below describes a real place or a real person. The only real things in this post are the real state laws discussed at the very end, and I will tell you when we get there. Now, pull up a chair and a slice, because I have a planning application to read you.

The premise

Picture a town of about forty thousand people. Call it Marlowe Falls. It has a river, a high school football team of modest talent and, as of this morning, four pizzerias. A resident named Dana, whom I have made up for this exercise, has a recipe, a lease on a vacant storefront and a dream of opening a fifth.

In the Marlowe Falls of our story, the town council has passed a Pizza Certificate of Need Act. It was supported by the best of motives. Pizza, the council noted in its findings, is an essential service for a community. Duplication of pizza resources leads to waste. Excess pizza capacity increases the cost of pizza to the public. The solution, obviously, is planning.

So before Dana may buy a single bag of flour, Dana must obtain a Certificate of Need from the Marlowe Falls Board of Pizza Planning. The application must show that the community needs a fifth pizzeria. The board consists of five members appointed by the council. By long-standing tradition, and in the interest of expertise, the board's advisory panel includes one representative from each existing pizzeria.

I want you to notice how reasonable every step of this sounds, because that is the whole trick. Nobody in our story is a villain. Nobody wakes up wanting to prevent a pizza. Each person is following a rule that makes sense once you accept the previous rule, and that, my friends, is how a government gets from a good intention to a pizza shortage.

Step one: the application

The application for a certificate of need is forty-one pages. Page one asks for Dana's name. Page two asks for Dana's projected oven count and a statement of the demonstrated community need for each oven.

The instructions explain that need may be shown by a population-to-pizzeria ratio, a market study or a letter of support from a local organization. The board's planning staff maintain a formula, which they update every few years, that determines how many pizzerias a town of Marlowe Falls's size can support. The formula says four.

Dana now has to prove that the formula is wrong. That means hiring a consultant, which costs more than the oven. The consultant produces a study, which costs more than the consultant, and which shows that a town of forty thousand people eats a great deal of pizza and that Friday evenings in particular are, in the technical language of the field, "a madhouse." The application fee is paid. The study is filed. The clock starts.

A good satirist would stop here and note that the town's pizza lovers had already stated their need by a method known as ordering pizza. But the board does not accept that as evidence. Revealed preference is, in the official view, "anecdotal."

Step two: the hearing

The hearing is scheduled for the second Tuesday of the following quarter, because the board meets quarterly and the March meeting was consumed by a dispute over parking.

Dana arrives with the consultant, the study and a plastic container of sample slices, which the board's counsel advises against presenting as evidence. Across the room sit the representatives of the four existing pizzerias, each with a lawyer. They have come, they say, out of a deep concern for the community.

Here is a transcript of the hearing, and I stress again that it is invented.

The chair: The board will hear from Pizzeria One.

Pizzeria One's lawyer: Thank you. We are not opposed to competition. We are opposed to unnecessary competition. The applicant has not demonstrated that the community's pizza needs are not already being met by the existing providers, namely us.

The chair: Does the applicant have a response?

Dana: People are waiting forty minutes on Friday.

Pizzeria Two's lawyer: Forty minutes is within the range of acceptable wait times. It builds anticipation.

That is the heart of the process. Dana's evidence, the forty-minute wait, is the very thing that proves demand, and the incumbents describe it as proof of adequacy. A shortage becomes a feature. A line out the door becomes a sign that the system is working as designed.

Then comes the objection that every certificate-of-need hearing in the real world has some version of: duplication of services. Pizzeria Three's lawyer notes that a fifth pizzeria would duplicate the services that already exist. The board nods gravely. Duplication is a very serious word in planning. It has the sound of a crime. It also happens to be the definition of competition. Two businesses doing the same thing is not a defect in a market. It is the market.

Step three: the decision

The board takes the application under advisement, which is a way of saying it goes into a drawer. Six months later it issues its ruling, which finds that "the applicant has not demonstrated sufficient unmet need within the service area," and denies the certificate without prejudice, meaning Dana may apply again.

Dana does. The second application is sixty-three pages, because the board's staff has issued new guidance on the format of consultants' appendices. The new study has a graph. The graph has a trend line. The trend line goes up and to the right. It makes no difference.

At some point in the second year, Dana's lease on the storefront runs out, and a landlord rents it to a business that does not require a certificate: a vape shop, a mattress store, or, in the best tradition of the genre, a nail salon that has also applied for a Certificate of Need and been told, with great regret, that the town is saturated with nail salons.

I will tell you who loses in this story. It is not just Dana. It is every person in Marlowe Falls who waits forty minutes on Fridays, and the people who would have worked in the fifth pizzeria, and the supplier who would have sold it flour. The loss is real, it is large, and it will never appear in a statistic, because it is made of a thing that did not happen. That is why this kind of regulation survives. Nobody ever holds a protest about a pizzeria that does not exist.

Step four: prices

Now follow the logic one more step, the way the planners should have, and ask what happens to the price of a pizza.

The four existing pizzerias, shielded from a fifth, discover something delightful. They no longer have to compete for the customer who is deciding between them and a newcomer. They can raise prices a little. Then a little more. The pepperoni pie that cost fourteen dollars in the year before the Act now costs sixteen, and the crust, I am told by an invented source, has become noticeably more austere.

The council, alarmed by the rising price of an essential service, commissions a study. The study finds that the price of pizza is increasing. The council responds in the traditional way, by identifying the cause as "greed" and proposing a Pizza Price Review Board to oversee the pricing of the pizza that the Pizza Planning Board has shielded from competition. This is the oldest trick in the planner's book: a rule creates a problem, and the problem justifies a second rule, and the second rule creates the next problem.

I would like to say that I am exaggerating. I am following the logic one step further than its defenders do, which is not the same thing. If you want to see this pattern in earnest, read Rent control's record from Stockholm to San Francisco is the same story, where the story is real, and a thought experiment where the grocery store gets rent control too, where it is satire again.

Step five: the planner's surprise

By the third year, Marlowe Falls has a pizza shortage. The wait on Fridays is now an hour. A rumor goes around that people are driving to the next town for pizza. A second rumor holds that the next town has a certificate-of-need law too, and the drivers have simply discovered a longer line.

The Board of Pizza Planning convenes an emergency session. The chair opens it by noting, with real puzzlement, that the board has done everything right. The applications were thorough. The hearings were fair. The formula was followed. And yet the town is short of pizza, and the price has gone up.

This is the moment I love, because the planner is honestly surprised. He has made a model of the town in which pizzerias are fixed quantities that the board can count and allocate, and the model did not include the fifth pizzeria that is not there. It did not include Dana, or Dana's recipe, or the idea that a person who has never been asked might know something the formula does not. The planner is not stupid. He is just working with the information that a planner can get, which is the information that exists in the existing system.

The Austrian economist Friedrich Hayek made this point in an essay in 1945, "The Use of Knowledge in Society." The knowledge a society needs does not sit in one place. It is scattered among millions of people, each of whom knows a small piece, and the market is how those pieces get combined. A planner who sets the number of pizzerias is trying to do by formula what the price system does by itself, and he is working with less than half the data.

The board proposes a solution, naturally. A pizza task force. It will study the issue and report in eighteen months. The task force will have representatives from each of the existing pizzerias.

The Founding, for the record

Let me step out of the story for a minute, and the satire with it, and say something serious.

The Declaration of Independence lists among the grievances against the King that he "erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance." Now, I am not comparing a town board to George III, and I would be embarrassed to be heard making the comparison with a straight face. But the underlying idea, that an office created to permit or forbid ordinary activity tends to become a toll booth, and that a toll booth tends to be operated for the benefit of whoever is already on the road, is as old as the Revolution. The founders feared concentrated power because they had seen what it did with a permission slip.

And the legal tradition they inherited was friendly to the right to pursue a trade. Justice Stephen Field, dissenting in the Slaughter-House Cases in 1873, argued that the right to pursue a lawful calling is one of the privileges of citizenship. That dissent did not carry the day then, and economic liberty has been a battleground in the courts ever since. But the idea behind it is not a fringe idea. It is the idea that a person with a lawful skill and a willing customer should not have to ask a committee of competitors for permission.

Now the real thing

The satire ends here. What follows is not invented.

In a number of real states, certificate-of-need laws apply to health care. A hospital that wants to add beds, a provider that wants to buy a scanner, and an entrepreneur who wants to open a surgery center may have to apply to a state board and prove that the community needs the service. In many states, existing providers are allowed to participate in the process and to object. The details vary by state, and they change, so read your own state's statute on your legislature's website instead of trusting any summary, including this one.

The history, in short: New York adopted the first such law in 1964. In 1974 Congress passed a law that pushed every state toward one. In 1986 Congress repealed that mandate. Several states have repealed or narrowed their laws since, and the Federal Trade Commission and the Justice Department have criticized the whole approach. I walk through that record, with sources and with the best defense of the laws answered, in Certificate-of-Need Laws Make a New Clinic Ask Its Rivals for Permission.

Here is the comparison that the joke exists to make. In Marlowe Falls, everyone can see the absurdity, because everyone knows what a pizzeria is, what it costs and who eats the pizza. In a hospital context, the same structure hides behind words that sound like safety, such as "need," "duplication" and "service area." The pizza version is funny because the stakes are small and the logic is exposed. The scanner version is not funny, because the person waiting is waiting for an image of something that might be serious, and the line is longer than it should be.

Notice also that the objection to my satire is available, and I should state it. A critic would say that health care is not pizza. A hospital must provide emergency care to anyone who walks in, whether or not they can pay, and pizzerias do not carry that burden. That difference is real and it deserves a real answer, which is in the longer post: if a community wants to support emergency care, it can fund emergency care directly and openly, instead of funding it through a barrier that raises everyone's prices and keeps new providers out. The joke is about the structure. The remedy is about the details.

For a related point about how large incumbents benefit from rules that small rivals cannot meet, see big companies love the regulations their small rivals cannot afford.

The case in brief

1. A certificate-of-need rule makes a newcomer prove "need" to a board, and where incumbents may object, the people with the most to lose from competition get a hand in deciding whether it exists.
2. The thought experiment shows the chain: a shortage appears, prices rise, a second rule is proposed to control the prices, and the planner is surprised, because his model could not include the business that never opened.
3. The knowledge the planner lacks is the thing Hayek described in 1945, scattered among millions of people and combined only by a free market.
4. The real laws are about hospitals, beds, scanners and surgery centers, where the cost of a missing provider is a longer wait for care, not a longer wait for dinner.
5. The serious answer is to repeal or narrow the real laws, and to fund any real community need, such as emergency care, directly and in the open.

What you can do: read your own state's certificate-of-need statute on your legislature's website, find the list of services it covers, and ask your state representative why those services need permission.