The unintended consequences of Uber

Published 11:35 pm Wednesday, January 20, 2016

The disruption of established taxi markets around the nation and world by ridesharing services like Uber and Lyft is ruining some in the industry.  The financial impacts raise complicated economic, political and ethical questions.

Uber and Lyft are ridesharing services.  People sign up to driver using their own cars and drive on their own schedules.  Riders use an app to request a pickup.  The companies facilitate sharing by generating a minimum threshold of initial trust.  We teach children not to accept rides from strangers; Uber helps assure customers that the stranger giving them a ride can be trusted.

Governments have licensed taxis for decades.  Each legal taxi must possess a medallion under regulation.  Limits on the number of taxis result in higher fares than with unregulated competition, making customers pay extra for rides.  But cab drivers do not typically benefit from the system.

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Why not?  Each fare is a little higher than otherwise due to the limited number of cabs.  Let’s say that this amounts to an extra $20 over a typical shift.  But the cabbie will not get to keep the $20 – the cab company monitors rides and fares.  The extra revenue collected day after day goes to whomever owns the medallion, not the cab driver.

Taxi medallions can be bought and sold.  Obtaining a medallion would allow the driver, not his employer, to keep the extra revenue.  In New York City, purchase is the only option, since the City hasn’t issued new ones since the 1930s.  But as Lee Corso says on ESPN’s College Game Day, “Not so fast!”  Owners looking to sell a medallion know that the buyer will get to charge extra fares, and so will charge more for the medallion.  This whole process, known as rent capitalization, constitutes one of the more confusing results of economics.

The price of medallions illustrates the extent to which cities restrict the number of taxis.  The medallion, after all, is just a bureaucratic permission slip and doesn’t help transport riders.  In New York, the price of medallions reached $1.2 million.

Taxi regulation costs consumers enormously, and yet in a very real sense does not benefit the vast majority of cab drivers and cab companies.  Most medallion owners today entered the business by purchasing medallions, and so profits from operating cabs are just paying off the cost of getting into the business.  Economist Gordon Tullock called such a situation the Transitional Gains Trap.

Ridesharing has driven fares down to the level that would have prevailed without regulation.  The price of taxi medallions has fallen dramatically, by more than 25% in many cities.  The city of Philadelphia recently sold some new permits for $80,000; they had hoped to sell them for nearly $500,000.

Current medallion owners may not really benefit from regulation, but they bear the losses from its disruption.  Not surprisingly, taxi companies have been battling ridesharing tooth-and-nail.  This political opposition may, at least in some markets, limit realization of the potential gains from ridesharing.

The situation also raises an ethical question.  Is it fair for the current owners of taxi medallions to bear this loss?  Many were hard-working cab drivers who saved and borrowed to buy a medallion, and now might lose their homes.  They made business and life decisions based on expectations created by government policy over decades.  Does the government have a responsibility to honor the promise of regulation reflected in medallion purchase prices?

On the other hand, taxi regulation represents an improper use of government’s regulatory power.  Regulation was (and still is) defended as protecting consumers from unscrupulous or even criminal behavior on the part of taxi drivers.  Government’s powers are not supposed to be misused to simply enrich sellers at the expense of customers.  Haven’t taxi riders suffered enough?

We make decisions based on the economic world around us today, and the world we expect to prevail tomorrow.  Even costly and inefficient government programs shape our expectations and decisions.  Consequently, the costs of ending wasteful government programs can be higher than expected.  Gordon Tullock concluded that avoiding the mess in the first place was the only good solution to the Transitional Gains Trap.  Hopefully the difficult straits of many in the taxi industry today will encourage us say no to new ill-advised regulations proposed this year.

About Dan Sutter

I am the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

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