Tag Archives: Russ Roberts

The Sharing Economy

Over at the Tech Liberation Front, my colleague Adam Thierer has sketched out a few themes in the debate over the sharing economy. His discussion of leveling the regulatory playing field is particularly important. Here is my favorite part:

Alternative remedies exist: Accidents will always happen, of course. But insurance, contracts, product liability, and other legal remedies exist when things go wrong. The difference is that ex postremedies don’t discourage innovation and competition like ex ante regulation does. By trying to head off every hypothetical worst-case scenario, preemptive regulations actually discourage many best-case scenarios from ever coming about.

Adam asks for comments and additional reading suggestions. In that spirit, here are my own additional talking points on the issue:

  • Reviving dead capital: Something that Dan Rothschild has emphasized in a lot of his writings and that I’ve tried to stress when I can is that the “peer production economy” breathes life into otherwise dead capital. Cars, tools, apartments, planes, kitchens, and even dogs are now creating value for people when they otherwise would just be collecting dust (or fleas). This may help to explain the extraordinary value investors see in firms like Uber.
  • Exposing regulatory failure: Another—though not mutually-exclusive—view is that these new firms are making lots of money not because they are doing anything particularly revolutionary. Instead, they are doing well because they have found a way around traditional regulations which have rendered incumbent services truly abysmal and consumers are rewarding them for this. In this sense, Uber is profitable because it isn’t a cartelized taxi company. This is generally the view that Mike Munger expresses in his EconTalk with Russ Roberts. This is probably more applicable to Uber and Lyft than to AirBnB or 1000Tools.com since the ride-sharing firms compete with an industry that has obviously captured its regulator.
  • Transitional gains trap: The whole experience offers us an opportunity to illustrate one of Gordon Tullock’s most-valuable and least-appreciated points. When regulators contrive some artificial exclusivity, they allow incumbent firms to earn above-normal profits (rents). But often these firms are only able to earn above-normal profits for a time (a transitional period). That’s because eventually, the value of the rent is “capitalized” into whatever assets must be purchased in order to enter the industry. These assets may include taxi medallions, specially-outfitted cabs, well-connected lobbyists, or any other asset that is necessary to gain access to the exclusive club. This is important because it means that many of the current incumbents had to pay large sums of money for their exclusive position and, net of these payments, they really aren’t cleaning up. Just as Adam is right to say that “regulatory asymmetry is real” we should also acknowledge that, in many cases, taxi regulations that started out as privileges are now more like burdens.
  • Value is subjective: No two customers have the same values and interests. I may want the windows down on a hot day and you may want them up. It’s simply absurd to think that regulators could devise an objective quality-control checklist for firms to follow or that they could properly vet cab drivers better than consumers. Yet that is exactly the approach they’ve taken (see here for just how clumsy it’s been in VA). The customer rating systems are really revolutionary because they collapse these subjective, multidimensional quality scales down to one simple 5-point rating that captures a driver’s ability to tailor his or her services to the subjective needs of each customer. Your Uber ride begins with a conversation between you and your driver about what is important to you (music, temperature, windows, speed, route, etc.) and ends with a 1 to 5 rating. It’s as simple as that.
  • True competition is a discovery process: Regulations “lock in” the status quo technology (again, because they attempt to objectively state every possible quality that customers might care about). But this misses the whole point of competition. As Hayek taught us, true competition is about discovering things you never knew (and never knew you didn’t know), such as that customers like being able to order cars from their smartphones.
  • Empowering Diffuse Interests: Traditional public choice models predict that small, concentrated interests such as an incumbent taxi industry willtypically prevail in a political battle with a large, diffuse interest such as taxi customers. This time may be different though. Wherever it goes, the peer-production economy has quickly developed a large and happy base of tech-savvy customers. Since the firms themselves have tended to innovate without asking for permission, this has often meant that a city will have tens of thousands of loyal peer-production customers long before its regulators can say “cease and desist.” So in a number of places, we’ve seen regulators move to shut down the peer production economy, then we’ve seen customers protest en masse and regulators withdraw their proposals.
  • Safety: Uber and Lyft drivers carry no cash. Customers have an electronic record of the ride and their driver. Drivers have an electronic record of the customer. These simple solutions accomplish what reams of taxi regulations never could: they ensure that both the customer and the driver are as safe as possible.
  • Flexibility: Because they don’t work for the companies, Uber and Lyft drivers work when they want to. Most of them seem to report that this is one of the best features of the job.
  • Beware of Uber too!: As Milton Friedman put it, one must be careful to distinguish being “pro-free enterprise” from being “pro-business.” The goal here is not to allow Uber to be profitable but to allow competition which will enhance the customer experience. We have already seen that when given the chance, Uber—like most firms—will take an exclusive privilege when one is offered. We must be very careful that Uber isn’t let inside the regulatory velvet rope only to put it back up behind them.

Why Matching Formulas Don’t Make Sense

Politico reports:

As part of the economic stimulus, the DOT allocated $3.3 billion to California’s planned high-speed rail line, which has become bogged down in a high-stakes fight over its price tag and location. California risks losing those federal funds if the state Legislature doesn’t approve $2.7 billion in bonds by mid-June.

To understand the incentives of a state legislator, consider a hypothetical example. Imagine there is a new restaurant in town. It is called “matching formula.” The restaurant has fifty tables and offers a special deal: no matter what you order, you get to split half of your bill with the rest of the restaurant’s patrons.

Now think about the value you would derive from a nice steak meal. Let’s say it is worth $26.00 to you. Unfortunately, at this restaurant, the meal costs $50.00.  Normally you wouldn’t pay that kind of money. But given the matching formula, it is only going to cost you $25.50 (that’s half the price, $25.00, plus one-fiftieth of the other half, $0.50). Since you derive $26.00 in value from the meal and since it only costs $25.50, you go ahead and order it.

But there’s more. The other patrons at the other 49 tables face the exact same incentive. If they too value the meal at $26.00, they too will order it. That’s another 49 meals, half the cost of which will be split 50 ways. Your share of their meals works out to $24.50 (that’s $25, times 49, divided by 50). So your final bill is $50.00 (that’s $25.50 for your meal, plus another $24.50 for everyone else’s).

Remember, you only valued it at $26. So on net, you are down $24 ($26 value, minus $50 cost). You might be thinking that it would be better to just order nothing. But if you do that, you still end up paying $24.50 for everyone else’s meal, but in this case you get nothing at all. It is better to be down $24 than $24.50.

Given the incentives of the restaurant, it is completely rational for you to order your meal and it is completely rational for everyone else to order theirs. The system as a whole, however, is nuts.

You could try convincing everyone else in the restaurant to order nothing. In that case, you would all be out $0. This is a winning strategy, but it can be very difficult to convince everyone. If 49 tables agree not to order anything, the 50th can get a GREAT deal: one steak valued at $26.00 that will cost them only $25.50. Once others see that the hold-out is profiting, they will refuse to abstain and the agreement will fall apart.

Strange as this story seems, this is exactly the way the federal government structures a number of federal-state programs. According to the story cited above, for example, California legislators can foist 55 percent of the cost of their high-speed rail on to federal taxpayers. And presumably other states’ legislators can do the same.

Under normal circumstances, the average state can export 58 percent of the cost of its Medicaid program on to federal taxpayers and some states can export up to 74 percent of the cost. But the stimulus bill temporarily enhanced these matching formulas so that now the average state can export 71 percent and some states can export up to 81 percent.

Notice that you don’t have to dislike steaks, trains, or Medicaid to find fault in these formulas. You just have to understand that there are costs and benefits to everything and recognize that these formulas bias cost/benefit calculations in favor of spending more than these things are worth.

The great 19th Century French economist Frédérick Bastiat once defined the state as, “that great fiction by which everyone tries to live at the expense of everyone else.”

Matching formulas institutionalize this fiction.

My apologies to Russ Roberts who once told a very similar story far better than I.

Edward Pinto on the Community Reinvestment Act

The debate about the role of the Community Reinvestment Act in the current mortgage morass — and its effects on neighborhoods — continues with this article from Edward Pinto in City Journal. Pinto writes:

Whatever the precise magnitude of the CRA’s role, there is no question that as the government pursued affordable-housing goals—with the CRA providing approximately half of Fannie’s and Freddie’s affordable-housing purchases—trillions of dollars in high-risk lending flooded the real-estate market, with disastrous consequences. Over the last 20 years, the percentage of conventional home-purchase mortgages made with the borrower putting 5 percent or less down more than tripled, from 8 percent in 1990 to 29 percent in 2007. Adding to the default risk: of these loans with 5 percent or less down, the average down payment declined from 5 percent to 3 percent of the loan’s value.

As for Fannie and Freddie, most of the loans with 5 percent or less down that they had acquired by 2005 had down payments of 3 percent or even no down payment at all. From 1992 to 2007, the two entities acquired over $3.1 trillion in low-down-payment or credit-impaired loans and private securities backed by credit-impaired loans—and these are performing horribly: the delinquency rate on Fannie’s and Freddie’s remaining $1.1 trillion in such high-risk loans is 15.5 percent as of this past June 30, about 6.5 times the rate on the entities’ traditionally underwritten loans. All this risky lending, of course, drove the nation’s homeownership rate up and inflated a housing-price bubble.

Last year, Tyler Cowen disagreed. Here is Randy Kroszner’s take. Russ Roberts wrote about it in the Wall Street Journal last year.