Daniel Sutter: Unintended consequences of Uber

Uber driver app

The disruption of established taxi markets by ridesharing services like Uber and Lyft is bringing financial ruin to some in the industry. The consequences raise complicated economic, political and ethical questions.

Uber and Lyft are ridesharing services. People sign up to drive 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 customers trust the stranger giving them a ride.

Governments have regulated taxis for decades, requiring taxis to possess a medallion to operate legally. Limits on the number of taxis increase fares compared to unregulated competition, making customers pay extra for rides. But cab drivers do not typically benefit from the system.

Why not? Regulation makes each fare somewhat higher than otherwise; let’s say that this totals an extra $20 over a typical shift. But the cabbie will not get to keep the $20 – the taxi company monitors rides and fares. The extra revenue collected day after day goes to the medallion owner, not the cab driver.

Obtaining a medallion would seemingly allow the driver, not his employer, to keep the extra revenue. Taxi medallions can be bought and sold, and generally purchase is the only option, since cites rarely issue new medallions. 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 higher fares, and will accordingly charge more for the medallion. This 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 companies. Most medallion owners today entered the business by purchasing medallions, and so profits from operating cabs merely pay back 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 benefit much from regulation, but they certainly bear the losses from its disruption. Not surprisingly, taxi companies have battling tooth-and-nail, seeking regulations to hamstring ridesharing and suing the companies. 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 face financial ruin. They made business and life decisions based on expectations created by government policy over decades. Should cities make good 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 is not supposed to simply enrich one group of citizens (sellers) at the expense of another (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 ineffective government programs shape our expectations and decisions. Consequently, ending wasteful government programs costs more than imagined. Gordon Tullock concluded that avoiding such messes altogether 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 governments propose this year.

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Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.


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