Inefficiency of subgame optimal entry regulation

The literature on excess entry shows that the free-entry equilibrium number of firms may be greater than is socially optimal, and proposes government entry regulation as a remedy, This article tries to show that such a policy recommendation is misleading. A two-period, three-person entry game model, which explicitly includes second-best government, shows that entry regulation aimed at preventing excess entry actually induces the incumbent to behave strategically against the government and makes the final outcome socially suboptimal compared to cases in which there is no government intervention. Entry regulation is subgame optimal; however, it is globally suboptimal.