June 14, 2014

Transportation Apps Offer Alternative to Taxis

Matthew D. Mitchell

Senior Research Fellow
Summary

The recent cease-and-desist letters from the Virginia Department of Motor Vehicles to taxi alternatives Uber Technologies and Lyft remind me of my first trip to D.C. in 1997. An awkward high school junior traveling alone, I landed at National Airport, followed the signs and hopped into a filthy Virginia-sanctioned taxicab. The heavy stench of stale cigarettes clung to the papers, cups and clothes littering the floor.

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The recent cease-and-desist letters from the Virginia Department of Motor Vehicles to taxi alternatives Uber Technologies and Lyft remind me of my first trip to D.C. in 1997. An awkward high school junior traveling alone, I landed at National Airport, followed the signs and hopped into a filthy Virginia-sanctioned taxicab. The heavy stench of stale cigarettes clung to the papers, cups and clothes littering the floor.

En route to my hotel, the driver suddenly stopped and, without explanation, got out of the car. After making a 10-minute payphone call, he nonchalantly resumed our drive. I reached the hotel unscathed, but the unpleasant trip — costing about $15 — seemed second-rate to a first-time cab rider.

A few years later, a freshman econ course revealed that economics can explain the sub-par service I received. The problem is that there is an “information asymmetry” between the driver and the person hailing the taxi.

A would-be passenger on a curb can’t see (or smell) the cab’s interior, can’t assess the driver’s record or confirm that the driver knows his way around. Typically, no other cabs are immediately available, so customers can’t feasibly walk away if they think it’ll be a bad deal.

A traditional “solution” to the problem is regulation. States and localities administer tests to aspiring drivers and those failing are denied an operating license. My experience suggests, however, that the regulatory solution is imperfect. Once drivers pass the test, there’s little incentive for them to maintain quality service. (The low Yelp reviews of taxi companies in most major cities attest to the problem.)

Moreover, the regulatory solution has negative side effects. Many major cities tightly limit the quantity of licenses. With supply constrained, prices tend to rise. To forestall this, regulators often impose additional rules fixing the price per mile that cabs may charge. But this, in turn, incentivizes cab owners to cut corners on quality (for example, by making fewer stops at the car wash).

As the late Nobel Prize-winning economist George Stigler showed, regulators often end up serving the interests of the firms they oversee rather than the customers they are supposed to help. This explains why regulators typically limit supply.

Consumer advocates Mark Green and Ralph Nader put it well in 1973 when they wrote, “the verdict is nearly unanimous that economic regulation over rates, entry, mergers, and technology has been anticompetitive and wasteful.” The system, they argued, “undermines competition and entrenches monopoly at the public’s expense.”

But there is another way. My teenaged nephew — a less-awkward version of me —recently retraced my trip to D.C. Armed with a cell phone and an “Uber” application, this 13-year-old safely traversed the city. Each time he pressed the button, a clean, safe car zipped to his location. His chauffeurs were all insured and passed Uber’s background checks.

While waiting for each driver, he could see how past customers rated them. If he didn’t like what he saw, he could cancel the trip. That never happened, though, because Uber itself monitors these scores and stops working with drivers who get too many 4s out of 5.

The company can afford to be picky because there is no shortage of people wanting to drive for them. I quizzed dozens of drivers, and they all seem to love the ease and convenience of their relationship with Uber: They own their cars and work when they want to. They also deal with well-behaved patrons since customers, too, are rated. (If a college kid vomits in an Uber car and refuses to pay, he won’t be riding Uber again.)

Uber and its competitor, Lyft, solved the asymmetric information problem plaguing the traditional taxi model and obviated the need for state regulators. Nobody likes to be made obsolete, so local taxis and their lobbied regulators are fighting Uber and Lyft tooth and nail globally.

The latest volley — Virginia DMV’s cease-and-desist letters to both companies — came from the same agency that certified my ride some 17 years ago. The letters complain that the companies lack “proper operating authority,” suggesting that the new business models are presumed illegal until found otherwise.

But don’t worry, the state has its own plan for overcoming the asymmetric-information problem with the creation of a DMV-approved list of transportation services: Once you hail a cab and politely ask for the driver’s name, you can use your cell phone browser to peruse the 462-page list at a DMV website. (There’s no app for this, so you have to bookmark the URL). If, as the DMV states in its press release, the name “isn’t on the list, it’s not recommended.” In that case, politely refuse and wait for another cab to drive by. Then repeat the process.

Sounds like a plan from 1997.