July 11, 2014 | by Dmitry Vasishev Print

Transportation authorities in Virginia recently issued a cease-and-desist order to Uber, a mobile app that allows users to order and pay for private drivers. It was not the first attempt to ban the increasingly popular service. Created in 2009, Uber today is represented in 37 countries and was recently valued at over $18 billion. To see why, despite its popularity, Uber faces constant legal trouble, one must understand the dynamics of market competition in the context of government regulation and rent-seeking, the quest for profits in the political realm rather than in the marketplace.

Uber’s success is easy to explain. With the benefits of geolocation and the elimination of cash payments, it is much more convenient than taxis. Uber is also safer, since both drivers and riders need to confirm their identities and all transactions are registered, in contrast to the more anonymous and, therefore, potentially dangerous taxicabs. In addition, Uber’s prices are often significantly lower than those of taxis.

Services like Uber clearly represent a technological breakthrough in urban transport. Why, then, the threats to ban it?

The answer lies in another feature of Uber’s business model. It relies on low barriers to entry into the industry. A potential driver only needs to pass a background check and have a relatively new car to join – no exams, quotas, or taxi licences. Meanwhile, drivers’ incomes depend only on the amount and quality of their work. Uber and its main competitor, Lyft, suggest that drivers and customers rate each other, and Lyft bans drivers with an average rating below 4.5 out of 5.

Taxis typically operate on the opposite model. The incomes of incumbent drivers are essentially guaranteed due to stringent requirements that limit the supply of taxi services. To get a licence in London, for example, a driver needs to pass five exams and memorize 320 routes, 25,000 streets, and 20,000 landmarks, which takes on average three years of study with all the associated costs. These costs are naturally reflected in London’s record high cab prices.

Taxi profits therefore largely result from artificial restrictions on competition, which force consumers to buy the services of selected drivers. This business model, first described (PDF) by Gordon Tullock, is called rent-seeking. Instead of improving their services or reducing prices, rent-seeking companies spend resources to convince regulators to limit competition or otherwise redistribute resources in their favor. Tullock demonstrated that rent-seeking benefits privileged companies at society’s expense.

In contrast, free-market competition forces businesses to focus on consumers. Better and cheaper products yield billions in profits, while bad products disappear from the market. This process, which economist Joseph Schumpeter called creative destruction, underlies technological progress and enriches society.

Not surprisingly, in the age of satellite navigation, the simple and affordable Uber wins the competition with taxis, whose only advantage is personal knowledge of city geography. But while Uber appeals to consumer preferences, taxis respond by appealing to regulators. Last week in Washington, D.C., and earlier in several European cities, thousands of taxi drivers gridlocked traffic, demanding regulatory action against ride-sharing services.

How is it possible that, for example, London’s 20,000 taxi drivers, less than 0.2 percent of the population, can maintain their monopoly to the detriment of the rest of the city? As in many other cases of rent-seeking, democracy fails in this situation because an industry’s returns from regulation (which economists call rents) are concentrated on the 0.2 percent, while the costs are diffused among the remaining 99.8 percent. The taxi drivers’ jobs and lifestyles are at stake in any change to the regulatory regime, so they are willing to block streets and spend money lobbying to protect their privileges. Consumers overpay only a few dollars per ride and often do not understand how legal monopolies raise prices.

It is precisely the concentrated benefits and diffused costs that explain the appeal of rent-seeking, and the taxicab industry is not its most glaring example. Failing automobile industries in many countries have for decades won harmful tariffs rather than improving their cars (PDF). Energy subsidies across the world redistribute resources to selected companies, from American alternative energy producers to any energy-intensive industry in Ukraine. Subsidies to American farmers making up 1 percent of the population will cost taxpayers around a trillion dollars over the next 10 years, comparable to all federal education spending.

As noted, eliminating protectionism is extremely difficult politically. Rent-seeking companies are usually willing to do anything -- from organizing protests to bribing politicians -- to preserve their privileges. It took a revolution, a foreign invasion, and an economic collapse to break the deadlock over energy subsidies in Ukraine.

Society appears to be winning the battle with the taxi lobby so far. Uber still operates in Washington. The British government has even directly encouraged it, and the number of UK downloads jumped by 850 percent after the protests. However, rent-seeking is usually much harder to combat.

Business is inherently based on the maximization of profits, and no democracy can prevent rent-seeking as long as businesses can legislatively secure profits. The only way to direct all entrepreneurial efforts toward competing for consumers rather than winning the favor regulators is to strip the latter of the authority to pick winners. Only where there are no pointless licences, permits, and monopolies will businesses not seek regulation to get rid of competitors at the expense of society. A good way to start would be to eliminate taxicab regulation, especially after it has been proven useless by the better and cheaper ride-sharing services like Uber.


Headline photo credit: Chris Goldberg (the picture has been re-sized in order to meet our website's specifications)