The 2 Genuine Economic Gains of Uber

A common accusation against Uber and other web-facilitated car-hire services is what looks like a competitive advantage only arises because they operate under a different and more lax set of rules than regular taxicabs. In other words, the newfangled service looks great until you are in a situation with an unsafe and undermaintained vehicle, along with an untrained or underinsured driver. In “The Social Costs of Uber,”  Brishen Rogers points out two sources of genuine economic gains from Uber and similar firms (The University of Chicago Law Review Dialogue, 2015, 82: pp. 85-102). He also describes the evolving negotiations over rules that Uber and other companies seem sure to face.

A company like Uber offers two sources of genuine economic gains: reduced search costs for both passengers and drivers, and gains from horizontal and vertical integration. Here’s Rogers on the mess that search costs on the part of both drivers and passengers create for conventional taxicab markets, and how Uber addresses them (with footnotes omitted).

“[B]oth regulated and deregulated taxi sectors suffer from high search costs. Riders have difficulty finding empty cabs when needed. Taxis therefore tend to congregate in spaces of high demand, such as airports and hotels. Deregulation arguably made this worse. Since supply went up, cab drivers had even greater incentives to stay in high-demand areas, and yet they had to raise fares to stay afloat.

High search costs and low effective supply may also reduce demand for cabs in two ways. First, if consumers have difficulty finding cabs because cabs are scarce, they may tend not to search in the first place. Second, high search costs may create a vicious cycle for phone-dispatched cabs. Riders who get tired of waiting for a dispatched cab may simply hail another on the street; drivers en route to a rider may also decide to take another fare from the street, rationally estimating that the rider who called may have already found another car. In some cities, the result is that dispatched cabs may never arrive—full stop.

Uber has basically eradicated search costs. Rather than calling a dispatcher and waiting, or standing on the street, users can hail a car from indoors and watch its progress toward their location. Drivers also cannot poach one another’s pre-committed fares. This is a real boon for consumers who don’t like long waits or uncertainty—which is to say everyone. Uber can also advise drivers on when to enter and exit the market—for example, by encouraging part-time drivers to work a few hours on weekend nights.

The article cite some evidence from a few years back in San Francisco that fewer than half of the attempts to dispatch a cab to a certain address ended up with a cab actually arriving.

For economists, “vertical integration” refers to whether a few or many economic actors are involved in number of steps along the chain of production from start to finish. In contrast, “horizontal integration” refers to whether a few or many are involved in a particular stage of the production process. Rogers argues that the taxicab industry has evolved in ways that don’t involve much vertical or horizontal integration, and Uber and other ride-sharing services are creating efficiency gains bringing greater integration in these ways. Rogers writes:

Uber is also extremely important for another reason that has received little attention: it is encouraging vertical and horizontal integration in the car-hire sector. … In Chicago, for example, medallion owners often lease their operating rights to management companies; management companies in turn purchase or lease cars and outfit them as required per local regulations; drivers then lease those cars from management companies on a weekly, daily, or even hourly basis. Other cities have different licensing systems, but any licensing system that does not mandate owner operation or direct employment of drivers will encourage similar vertical fragmentation. Taxi companies will rationally (and lawfully) lease cars to drivers rather than employ drivers in order to avoid the costs associated with employment, which include minimum wage laws, unemployment and workers’ compensation taxes, and possible unionization. Uber is now reducing such vertical fragmentation, since it has a direct contractual relationship with its drivers. It is also integrating the sector horizontally as it gains market share within cities. Meanwhile, the company is compiling a massive database of driver and rider behavior. Those data are essential to Uber’s price-setting and market-making functions but would be all-but-impossible to compile in a fragmented industry.

In short, the economics behind Uber and other ride-sharing services suggests the possibility of substantial and real economic gains. Rogers quickly mentions some other gains, as well: “For example, Uber reduces consumers’ incentives to purchase automobiles, almost certainly saving them money and reducing environmental harms. As consumers buy fewer cars, Uber also opens up the remarkable possibility of converting parking spaces to new and environmentally sound uses. Uber may also reduce drunk driving and other accidents.”

But even if Uber isn’t just a case of those who can sidestep existing regulations having a cost advantage, it is nonetheless true that Uber like any company providing service to the public is going to find itself facing some rules and regulations. For example, basic checks on driver competence, as well as rules about vehicle safety and appropriate insurance, seem to be on their way.