Wednesday, July 17, 2013

Regulation and Innovation

To say the topic of government regulation is controversial would be an understatement.  Opinions on the matter vary from "Let the free market rule!" to "The only fair economy is a managed economy." Like most of the public my personal opinion falls somewhere between the extremes.

The majority of the rational populace would agree that some regulation is at least helpful if not necessary. Few people wish to purchase medical drugs that haven't been proven to be safe or effective.  Likewise most people agree that it's likely a good idea to ensure pilots can actually fly a plane before being allowed to ferry passengers from New York to LA. Yet, venture into the domains of healthcare insurance, banking or pollution control and you'll find debates aplenty as to what, if anything the government should be doing to guide these industries.

In order to highlight how even well intended and beneficial regulation can go astray I'm going to discuss the fascinating world of the taxi cab driver. I want to make clear that I do not believe taxi regulation is a bad thing. Over the past decades it has done a great deal to make transport in major cities reasonably efficient and safe.  However, currently in many cities taxi regulations are being abused for the profit of a few rather than the benefit of many. 

Let's briefly touch upon a few points that a consumer desires when looking for a cab.

1. The consumer wants a cab to be available OR have assurance that a cab is en route AND know approximately that cabs time of arrival.
2. The consumer wants to know the approximate cost of the trip before arrival at the destination.
3. The consumer wants a safe, efficient, pleasant ride.

The local government of course wants the consumer's desires satisfied but has one additional concern. Namely:

4. The government wants traffic congestion kept to a minimum.

This desire is inextricably linked with the consumer's third desire as sitting in traffic is neither efficient nor pleasant. 

So given these desirable traits how does taxi regulation improve the situation? Generally taxi regulation goes something like this:

Local Government: "Alright guys, we're going to require a special limited license to drive a taxi. We're also going to require you all charge the same rates per mile or minute of wait time. If you work with us you'll get your license and will have limited competition since all the licenses will already be issued to existing drivers. Don't work with us and we'll just give your license to someone else and you'll be out of business."

Taxi Companies: "Sounds great."

The end result is that the consumers second desire is fully met, since prices are uniform everyone knows charges before the service is complete. The consumer's third desire is reasonably met, drivers generally aren't serial killers, are easily identified for complaint and are prohibited from running up the meter. The government's desire to minimize congestion is met, taxis are artificially limited. Finally, the consumer's first desire for an available cab is initially met but generally deteriorates as demand increases with population growth but the taxi population remains constant. Notably the taxi population could be grown with new permit issues but such action always meets with strong opposition from the taxi companies whom of course have the closest relationship with taxi regulators.

Additionally, the value of taxi licenses generally begins a rapid climb. In several major cities a taxi license approaches a million dollars if not more despite a cost of only a few hundred dollars annually. Rents from licenses are in fact so lucrative that most are held as investment vehicles in New York City. 

So under the current system of regulation we end up with a reasonably safe and profitable taxi system without roads swarming with cabs to the point that other traffic is impossible. On the downside there's nearly zero incentive for a driver to do anything beyond the bare minimum of transport the consumer from point A to point B as quickly as possible. As long as the owner holds the license the cab will keep operating regardless of how clean it is, how pleasant the driver, or loud the radio.  

A brief summary of what we've learned so far:

Current Regulation Pros:

  1. Safe
  2. Predictable Cost
  3. Limited Traffic Congestion

Current Regulation Cons:

  1. Limited Incentives for Owners
  2. During Peak Times Supply and Demand Disparity
  3. Regulation Often Abused to Stop Competition

So how can we develop a better system? As is often the case technology as developed an answer.  Most people in major cities at this point already carry a communication device that knows their location. Why not simply have a phone app that lists available cab companies (along with prices for your trip), contacts the company to provide your location and then tracks the cab en route to pick you up so you know it's arrival time.

When combined with the removal of current regulations, with the exception of driver licensure and identification rules, this improves on the current system in a variety of ways. Road congestion is further reduced during non-peak times (there's no reason for an empty cab to drive around looking for fares). Supply and demand are balanced as competitors can freely enter and exit the market. Competition incentivizes superlative performance at the firm level. Consumers will be more easily able to obtain a cab in areas taxis are less common. Direct price competition will allow for a more accurate representation of costs (which may lead to higher or lower prices). 

This innovation ends up leaving everyone except current taxi license owner's better off. However, it's exactly this group that has been opposing development of such systems in major cities. A company called Uber has attempted to implement such a service in major metropolitan areas throughout the US. Unsurprisingly they've been met with opposition with each attempted launch. 

Uber utilizes mostly limousine services to do their pickups. The primary difference between a limousine and a taxi from a regulatory perspective is a limousine is not allowed to simply drive around and pick you up on a street corner. You must make a reservation to be picked up by your driver.  Therefore the most common avenue of attack against a service like Uber has been to place a minimum time that must pass after a reservation is made before a limousine may transport you. For example, in Miami you must make a reservation at least one hour before your desired pick up.  As a result an on demand service like Uber loses a great deal of appeal compared to a standard cab which is immediately available.

Similar regulations are being passed or contested in major cities throughout the country. On one side of the battle stands new innovators like Uber who seek to improve the existing system (and of course make a profit doing so). On the other are the old guard taxi companies attempting to protect not only their current business, but in many cases the value of the licenses which amount to millions of dollars. The consumer will likely be better off if Uber and it's like prevail, but overcoming the inertia of the existing regulatory system is a daunting task.

That's all for this week. Until next time stay safe and rational.

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