File illustration picture showing the logo of car-sharing service app Uber on a smartphone next to the picture of an official German taxi sign in Frankfurt, September 15, 2014. A Frankfurt court earlier this month instituted a temporary injunction against Uber from offering car-sharing services across Germany. San Francisco-based Uber, which allows users to summon taxi-like services on their smartphones, offers two main services, Uber, its classic low-cost, limousine pick-up service, and Uberpop, a newer ride-sharing service, which connects private drivers to passengers - an established practice in Germany that nonetheless operates in a legal grey area of rules governing commercial transportation.    REUTERS/Kai Pfaffenbach/Files  (GERMANY - Tags: BUSINESS EMPLOYMENT CRIME LAW TRANSPORT)

We currently are in the Wild West of “sharing.” Many people hate that term but I actually think it is useful. I would define the “Sharing Economy” as follows:

1. Individuals own key assets — cars, dwellings, their time etc.

2. There exists a market platform to match those individuals with consumers that satisfies the key market design criteria (a la Al Roth) of liquidity, temporal agglomeration and safety.

1 hasn’t changed but 2 has largely as a result of mobile technologies. Not because these technologies were required for customers necessarily but because they were great in overcoming the temporal agglomeration issues for suppliers; i.e., a supplier could signal their availability and location in real time.

As it turns out, the first criteria — ownership — is becoming a big issue in regulatory circles. Last week, in California, an Uber driver was found not to be an independent contractor but something closer to an employee. Employees have rights that contractors do not and, importantly, if such rulings spread, the first criteria is at peril but it may also undermine the flexibility by which suppliers could operate in these markets.

This flexibility was emphasised by Tyler Cowen today in the New York Times.

In short, these developments benefit those workers who are willing and able to turn their spare time to productive uses. These workers tend to be self-starters and people who are good at shifting roles quickly. Think of them as disciplined and ambitious task switchers. That describes a lot of people, but of course, it isn’t everybody.

What he was saying is that traditionally cab drivers were in an environment that created strong incentives for maximisation of asset value — in this case, the value of a medallion — and this required cab drivers to be full time and on the job everyday. By contrast, Uber and others, by allowing sharing of assets across uses, change the job incentives away from such maximisation and towards something more flexible. Cowen suggests that this favours ‘self-starters’ although I have to think that maximising the value of a medallion requires some self-starting pressures as well. What he means to say, I think, is that people who like to operate in an environment free from competition are harmed when competition is created. From a Pareto perspective, they are losers and so we can’t say definitively, that the creation of competition is a welfare improvement.

This is true of many situations and, normally, economists do not apply a strict Pareto criterion to evaluate them. When it comes to work in general, because people are paid to work with money, we make the converse assumption that for any losses from a change there exists a monetary compensation mechanism that can make the potential losers at least no worse off from the change.

There is plenty of reason to believe that there is potential for compensation to eliminate opposition in the sharing economy. The reason is simple: competition creates more value than monopoly and, absent compensation, that additional value resides with new competitors and, most critically, consumers.

The problem is that economists have been notoriously unable to deploy compensation mechanisms as a means of facilitating change. There are exceptions. For instance, in the early 1980s, the Australian government negotiated a wage-tax trade-off with trade unions to rid that economy of a decades-long wage-price spiral. But usually we are stuck lamenting an inability to move forward.

This issue lies at the heart of the sharing economy. The notion that we should allow these new services is obvious: they are good things as competition and innovation are good things. When we dress them up in regulatory arguments over safety etc, while these need to be worked out, they aren’t that hard to work out. Apply standards consistently but allow entry and competition.

Instead, the real barrier to change is compensation. Owners of taxi licenses paid sizeable sums for them at the behest of local governments. Also, those governments’ benefit from the sale of such licenses. And when those governments get to decide the rules, it doesn’t take a genius to wonder why change is hard.

Emilio Calvano suggested in Italy that we move from a situation of issuing licenses to a tax on those conducting ride sharing services. The tax revenue could then be used to finance the buy-back of existing licenses.

This is a start but I think that we will need to think even more out of the box to find compensation mechanisms. Here are some suggestions of others to consider:

1. Non-license taxes: suppose that we have a two tier system. You can purchase a taxi license and operate free of other constraint (or just with a cap on prices) or you can agree to pay a per mile charge (when you are actually sharing rides) but otherwise be free of non-safety regulations. This would allow existing taxis to earn money as a full time job while taxing the peak demand times to provide additional revenue to local governments from the loss in value of future licenses.

2. Radical future: the future with ride sharing is that we get rid of car ownership as the norm. In this situation, I wonder whether all cars should be licensed (a la Singapore) to encourage their use either as full time taxis or for ride sharing.

This is going to take some time but I think we economists need to get more serious of coming up with compensation mechanisms that can move things forward.

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6 Responses to Uber, sharing and the compensation mechanism

  1. […] 2. Joshua Gans on the sharing economy and compensation mechanisms. […]

  2. Josuha;

    “What he was saying is that traditionally cab drivers were in an environment that created strong incentives for maximisation of asset value — in this case, the value of a medallion — and this required cab drivers to be full time and on the job everyday.”

    During the period from 1998 through to 2009, I represented the class of taxi cab drivers most affected by the City of Toronto’s decision to treat every cab driver as not working towards acquiring property, a transferable license, or medallion.

    The lawsuit was ultimately ineffective.

    The rise of Uber may bring about more serious thought to the problem.

    The taxi cab industry has alway historically attracted part-timers – quick entry, cash payments, and work on the weekends only.

    For city wide transportation system to work effectively, you need serious participants. People attracted to driving in the long term. These drivers typically have to have lower collision rates because otherwise they cannot afford the insurance.

    Since 1960 in the City of Toronto, this was the reason for having a driver’s waiting list: those drivers who had put in enough service could eventually get a plate or medallion. And this was valuable property.

    We have regressed in Toronto, and so have many other North American cities.

    You have to have a serious mechanism for rewarding long term service, unless you want to have a city full of “Nigerian” Cab Drivers. (See: https://www.youtube.com/watch?v=Lsna3DfonI4)

    • sort_of_knowledgeable says:

      The valuable property was to be able to charge high fares by restricting competition. As result in the far west of San Francisco people sometimes had to wait over an hour for a cab because they cab drivers wanted the more lucrative downtown fares. This was not an effective city wide transportation system.

      Do we have to have a wait list of cooks and waiters and those who put in enough service can get a restaurant license to get good restaurant service since that also attracts many part time workers?

      • Yes, it is true that medallion system doesn’t produce by itself efficient allocations of routes.

        What you are describing is the need for a “jitney” route in areas less travelled.

      • You ask: “Do we have to have a wait list of cooks and waiters and those who put in enough service can get a restaurant license to get good restaurant service since that also attracts many part time workers?”

        There is no comparable public interest in overseeing the number of restaurant licenses.

        So, no we don’t have to create property for this class of license holder. The market for restaurant success/failure works tolerably well.

  3. […] 2. Joshua Gans on the sharing economy and compensation mechanisms. […]

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