Political Entrepreneurs

The Economic Engine of Political Change

Taxi Cab Medallions, Uber, and the Transitional Gains Trap: Part 2

June 27th, 2014 by Todd Nesbit

In my earlier post, I discussed the conditions that led to New York City enacting in 1937 the first policy to establish taxi cab medallions.  In short, the public’s discontent with high taxi fares, the cabbies’ dissatisfaction with their compensation, the relatively few but large fleet owners, and a general tendency to support government intervention in the wake of the stock market crash and depressed economy created an environment ripe for a new idea to change how the taxi market would function.

That idea–the taxicab medallion–limit the number of taxicabs that can legally operate within a city.  According to the Taxi and Limousine Commission, there are a total of 13,437 yellow medallions.  This is only about 14 percent more than were in existence in 1937 when medallions were made available to all existing taxicabs, at which time growth has been severely restricted.  The medallion is intended to signify that the taxicab has met or exceeded specific mechanical and safety standards set by the city.  While the medallion requirements may have improved safety, the more pronounced impact has been on the pocketbooks of fleet owners and medallion financing institutions.  The medallions themselves have proven a great source for capital gains in many markets (see chart below from Washington Post).  For instance, medallion values in 2013 in Philadelphia were seven times their sale price from year 2000 (where sale price is largely determined by computing the discounted present value of all future economic rents to be generated by the asset).   And with an average of only 18 percent of taxis being owner-operated, the overwhelming share of these gains in most cities are going to a relative few large fleet owners (here).  One exception is DC where nearly all taxis are owner-operated (here), which partially explains why in D.C. more than elsewhere the cabbies have vocalized more resistance to Uber.

medallions

Any new competitor, such as Uber and similar ride-share services, is a threat to not only the income but the wealth of the fleet owners and medallion financiers.  If Uber successfully gains a sizable market share in a region, taxi drivers receive fewer fares from which they can pay for the lease of the medallion and taxicab and pay for fuel, and they become less willing to pay as much to lease the taxicab and medallion.  As the flows being generated from holding the medallion decline, so, too, does the sale value of the medallions, reducing the wealth of the medallion holders and the willingness of others to finance their purchase as high rates of interest.

It is the holder of medallions and those financing their purchase–and not the cabbies–who stand to lose the most from new competition in the form of Uber and the like.  It should be no surprise that they will go to great lengths to protect the value of the medallions, which is artificially high purely due to the government’s restriction in the number of medallions issues.

The end result is that the medallions pose a transitional gain trap for policymakers.  First, it was an inefficient policy to begin with in that it ultimately benefited the initial recipients of the medallions at the expense of consumers who paid higher prices.  Second, all future producers who purchase a medallion at the market rate and consumers are worse of, as Gordon Tullock explains in his 1975 seminal article: “New entrants enter only by purchasing the medallion, with the result that they get only normal profits.  Further, the surviving original owners have opportunity costs equivalent to the value of the medallions upon which they receive normal returns.  The customers, of course, are worse off” (Tullock, 1975, p. 672).

Even though current participants may not be earning (after taking account of the opportunity costs of purchasing the medallion in the first place), on average, anything more than they could earn in other industries, they will still fight tooth and nail to preserve the medallion requirements so as to protect the value of the medallion from which they can monetize their wealth when resold.

It is these vested interests (medallion holders and medallion financiers) who have successfully opposed freer taxi markets.  Thus far they have been successful.  But, technology has brought about a new competitor in ride-share services such as Uber.  Uber’s value added is in information–who is available to drive others and where are the available drivers and the individuals wanting a ride. Ride-share services cannot be flagged down at the curb–they must schedule the pick-up in advance.  While scheduling using older technology was a hassle, mobile phone apps have improved the ease and quickness to the extent that it provides a serious challenge to taxis.  In most cases, people generally celebrate such advancements; that is, unless you are already heavily invested in the outdated product or business model.

Uber and other ride-share services have shaken the political inertia protecting taxicab medallion holders such that some sort of change should be anticipated.  Will it be enough to fully break through the barriers to major political change such that the market become characteristic of free competition and encouraging of innovation, or will space be carved out for the new entrants such that they, too, become protected from future competition from new and innovative entrepreneurs.  Time will tell how this scenario plays out, but one should never discount the power of political pull.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.189, ch.7)

The most successful entrepreneurs know what they do well, they know the market and the opportunities within it, and they choose those activities that create the most value. This is true in economic as well as political markets.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.178, ch.7)

[W]hen the right elements come together at the right time and place and overwhelm the status quo, it is because special people make it happen. We call them political entrepreneurs.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.176. ch.7)

While we started this book with Danny Biasone saving basketball, we end it with Norman Borlaug saving a billion lives. These stories are not that different. Both faced vested interests, which were reinforced by popular beliefs that things should be a certain way—that is, until a better idea came along.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.174, ch.6)

Because there was a general belief that homeownership was a good thing, politicians found the public with open arms.... Everybody was winning—except Alfred Marshall, whose supply and demand curves were difficult to see through the haze of excitement at the time, and except Friedrich Hayek, whose competition as a discovery procedure was befuddled... In short, once politicians started getting credit for homeownership rates, the housing market was doomed.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.166, ch.6)

Everyone responded rationally to the incentives before them. In short, the rules that guided homeownership changed over time, which in turn changed the incentives of these actors. And bad things happened.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.153, ch.6)

They understood the economics. The ideas had already won in ... the regulatory agency itself. All that remained to be overcome were some vested interests and a handful of madmen in authority.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.146, ch.6)

If the idea for auctions of spectrum use rights had been part of the public debate since at least 1959, why didn’t the relevant institutions change sooner? What interests stood in the way?

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.121, ch.5)

When an academic scribbler comes up with a new idea, it has to resonate well with widely shared beliefs, which in turn must overcome the vested interests at the table. Many forces come together to explain political change, even though it may seem like coincidence of time and place.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.120, ch.5)

It’s the rules of the political game that deserve our focus, not politicians’ personalities or party affiliations.

Madmen, Intellectuals, & Academic Scribblers

The Economic Engine of Political Change

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From the Pages of Madmen, Intellectuals, and Academic Scribblers (p.119, ch.5)

In short, ideas are a type of higher-order capital in society. Like a society that is poor in capital and therefore produces little consumer value, a society that is poor in ideas and institutions will have bad incentives and therefore few of the desirable outcomes that people want.

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