Uber, but for Regulation

In competitive market economies, prices and profit opportunities signal scarcity and valuable production, and together, they coordinate efficiently the plans of millions of individuals in a decentralized fashion. But ironically, free markets have given rise to the modern corporation, microcosms  of command and control. Famed economist Ronald Coase solved the apparent paradox of the modern corporation by highlighting the importance of transaction costs. If a product has many inputs, negotiating each individual transaction and coordinating them across multiple parties can be extremely costly. Firms emerge to economize on these and other transaction costs, with competitive pressure leading to an optimal mix of outsourcing and insourcing.

The nature of the firm is a useful starting point for thinking about the distinction between government and governance. Both the state and the firm partake in governance by setting and enforcing rules, monitoring compliance, and engaging in rational planning to solve coordination problems in light of transaction costs. Likewise, when a state or a firm fails to practice good governance in the long run it either reforms or it ceases to exist. Reform and ruin occurs most often when the broader institutional setting somehow changes and, in turn, the nature of transaction costs also change. When transaction costs are falling, for example, governance can unbundle, which is what happened in the 1990s when firms began widely outsourcing customer support services to foreign call centers following lower trade barriers and innovations in communication technology. In addition, it is no coincidence that many countries undertook, in tandem, so-called “neoliberal reforms” during the same period. From deregulation to a greater reliance on subcontracting, public governance may be slower and clumsier, but it too is shaped by transaction costs.

Consider the battle raging between Uber and the global taxi industry. Although the current taxi licensing schemes in North America cities are conducive to rent seeking, I believe they reflect genuine efforts at good governance. Licenses are simply a blunt and easily-abused tool that gives customers some expectation of a minimum standard for quality and safety, and regulated prices eliminate the need to haggle with drivers. Uber’s innovation was in developing a multisided platform (MSP) technology that reduces transaction costs for both sides of the market. This platform features a driver and customer rating system and a responsive pricing algorithm that combines with preauthorized payments to remove any need for haggling. And by controlling a bottleneck to market access, Uber acts as a de facto private licensing authority.

To see why MSPs make for agents of good governance consider the market itself. Contract law, property titling, and a system of arbitration represent platform technologies for reducing transaction costs to the benefit of both buyers and sellers. And much like Uber, markets are subject to network externalities. The more sellers in a market, for instance, the more likely that buyers will agree to participate and vice-versa. But as long as there is the possibility of exit, market “regulators” will be driven to maintain a balance between the interests of buyers and sellers that is roughly consistent with minimizing social cost, even if their network effects tend them toward natural monopoly. Therefore, it should be no surprise that some of the earliest modern MSP technologies include marketplaces like eBay and Amazon, neither of which is primarily a retailer. Instead, they represent platforms that help connect independent buyers and sellers from around the world. Technologies like PayPal and services for dispute resolution are all ways to reduce transaction costs and to engage in genuine governance.

Similar to how Uber is disrupting traditional taxi governance, ecommerce is displacing conventional commercial governance. One could even imagine all rental units to eventually list on something akin to AirBnB, effectively rendering local Residential Tenancy Acts as obsolete and archaic as taxi industry regulations. Existing rental markets, for example, often dramatically favour tenant rights over landlord rights or vice-versa, depending on who had the greatest historical influence on the local council. But as Coase famously argued, the dual-sided nature of externalities makes the assignment of rights ambiguous in the abstract. While noise pollution has a social cost, for instance, forcing tenants to quiet themselves imposes a cost as well. If the loud tenant is having an amazing party, he may be more than willing to fully compensate the landlord or the sleepless neighbors. But more often than not, anger and ego are the ultimate barriers to a transaction and such a bargain rarely unfolds. Thus, good and effective laws are ones that approximate the assignment of rights that will minimize social cost on average; however, this attempt often fails because of special interest groups who capture the legislative process.

MSPs are adept at assigning these rights efficiently. Credit card networks, for example, make sellers bear the full cost of processing payments, while customers are often cross-subsidized through rewards and promotions. The only way to supplant an incumbent platform is to adjust the governance structure in such a way that social costs are better compensated by maximizing the bargaining surplus. In other words, MSP technologies are not just a bit better at governance. They potentially meet the economic definition of an ideal “public interest” regulator. Whether this technological revolution translates from local to national governments is not a question of if but when.

Much like the liberalizations of the 1990s, changes to the very nature of transactions have brought all forms of public administration and regulation to the precipice of a new way of reform. Critics will dub it an era of massive deregulation, yet that will be wrong. Less government does not imply less governance. Indeed, there will be exactly as much governance as you can bargain for.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Pasteurizing the Canadian Dairy Industry

The CBC reported recently that residents of Newfoundland and Labrador pay double for dairy products compared with Ontarians. In Windsor, Ontario, for example, one may expect to pay $3.65 per gallon, whereas in some rural Newfoundland communities, one can expect a similar price per litre. On average, in fact, the price of dairy in Canada is almost 43 per cent higher than in the United States.

For Canadians–including even the lactose intolerant among us–this deal is raw.

Since the 1970s, Canada has run a system of “supply management,” through which provincial marketing boards, sanctioned by the federal government, set the price of dairy products, protect the Canadian industry from foreign competition, and control supply in the domestic market. Each board determines a quota governing both entry into the market and production within it, and requires farmers to purchase producer rights. Producers must sell that milk back to the marketing board, which then distributes the product to stores. Furthermore, the government enforces import quotas and imposes high tariffs on foreign products to insulate domestic production from outside competition.

In essence, this process “protects” both consumers and producers from market fluctuations that come with globalized trade and the associated risk of shocks in the agricultural industry. It also promotes local agriculture and ensures product quality.

Despite these objectives, the reality is different. Firstly, Canadian consumers pay more for dairy products than do consumers in other countries. The Conference Board of Canada estimates that Canadian families can expect to spend $276 more per family on dairy than our counterparts in the developed world. Dairy Farmers of Canada (DFC) claims that Canada, unlike our trading partners, does not devote subsidies to agriculture, implying that consumers do not give domestic producers “special treatment.” Consumers do subsidize Canadian dairy, however, through paying artificially inflated prices: setting the price of dairy products, insulating our industry from foreign competition, and controlling its supply is an indirect subsidy to the industry. Moreover, limiting the supply drives prices upward and higher prices means additional income for those with producer rights. Lastly, limiting entry into the market, while simultaneously enforcing prohibitively high tariffs on foreign products, reduces competition, which affords Canadian farmers an advantage. Indeed, the World Trade Organization (WTO) restricts Canadian dairy exports specifically because they view supply management as a subsidy.

This variety of quota and regulatory system is, essentially, geared to make market entry incredibly difficult and concentrate power in the largest firms. First and foremost, one must purchase quota rights to begin producing. In Newfoundland and Labrador, a scarcity of inputs raises the cost of production even further, while the provincial government pushes aggressively for “pro local” policies, such as an initiative to allot land for homegrown feed, which is the chief expense of Newfoundland and Labrador dairy farms. Unfortunately, these developments have consequences for the market structure: Newfoundland has the most concentrated dairy industry in Canada, with just 34 farms and 174 cows per farm. Even Prince Edward Island, with 200 smaller farms, produces more than twice the milk of Newfoundland.

It is difficult to identify how supply management benefits Canadians. The system is not necessary to ensure quality, and although it may protect producers from unanticipated price fluctuations, several industries fare well without government protection. The foregone benefits of a deregulated dairy industry far outweigh the complications of price volatility. It seems the only remaining claim is that “locally grown, locally produced” is better–a dubious and subjective claim at the very least. After all, many consumers may believe milk imported from the Maritimes, or internationally, is “better.” In any case, it ought not to be the producer that decides what each consumer prefers. Supply management is a net loss for Canadians and a particularly grave loss for residents of Newfoundland and Labrador.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Uber, Economic Regulation, and the Open Market

In municipalities throughout Nova Scotia, as is the case across much of the Western world, local councilors are responsible for regulating the taxicab industry. This process primarily entails controlling prices and restricting licenses, as well as implementing safety regulations. Technological innovation, however, is changing the taxicab industry and governments have failed to heed the improvements brought by it.

Upon moving to Halifax in 2010, I noticed that taxicabs didn’t offer debiting services; in 2014, nearly every taxicab in the city provides this service. Halifax may be unlike other “big cities” in Canada, yet, technology available in Toronto, Montreal, and Vancouver is available here. To attract and retain consumers, i.e. riders, taxicab drivers must offer good services in return for the price they charge. In The Road to Serfdom, for instance, Friedrich Hayek argued, “Our freedom of choice in a competitive society rests on the fact that if one person refuses to satisfy our wishes, we can turn to another. But if we face a monopolist, we are at his absolute mercy.”

The law of supply and demand suggests that the price for any given product will be variable until quantity demanded by consumers matches quantity supplied by producers, at which point there is equilibrium and all markets “clear.” This law does not apply strictly to the taxicab industry, where government controls the price of taxicab services and regulates the entry, and, therefore, “supply,” of drivers: restricting the supply of drivers creates excess demand for them, and this excess demand places upward pressure on the price of their services. Consumers, many of whom rely on taxicabs as their primary mode of transportation, absorb the rising costs of ineffective taxicab regulation.

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Taxicab drivers in Nova Scotia operate in a “non-market economy,” wherein government intervenes in the process of allocating goods and resources and determining their prices. This intervention creates a deadweight loss: “A buyer would be willing to buy the good at a price that the seller would be willing to accept, but such a transaction does not occur because it is forbidden by the quota.” Economic regulation of this type results in a net loss for consumers: “In every case in which the supply of a good is legally restricted, there is a wedge between the demand price of the quantity transacted and the supply price of the quantity transacted. This wedge has a special name: quota rent. It is the earnings that accrue to the [taxicab licensee] from ownership of a valuable commodity.”

In an open market, competition between drivers would place downward pressure on the price of their services and consumers would reap the benefits. Moreover, competition compels taxicab licensees to vie for consumers by offering better services, which results in a more robust and efficient market, whereas in the absence of market dynamism, the incentive to innovate is very low (or nonexistent).

Restrictive regulations in the taxicab industry, combined with the advent of technology, have resulted in emerging markets that fall outside the purview of economic regulation. Uber is a prime example.

Arriving in Halifax this past summer, the Chronicle Herald welcomed Uber with the headline, “Controversial Uber car service starts up in Halifax.” Uber provides a car-for-hire service similar to taxicab companies, however, its operations are unregulated due to “laws [that] weren’t written to account for technology that exists today.” One of the primary reasons that governments pursue economic regulation is to compensate for “information asymmetry,” but Uber provides a solution to this problem: it uses a rating system that gives consumers pertinent information about their driver. In other words, Uber is a product of competition and the company’s innovative model benefits drivers and riders. Perhaps it is time for governments across Nova Scotia to consider whether deregulating the taxicab industry and using a model similar to Uber’s would benefit consumers.

Rinzin Ngodup is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Dalhousie University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies