World per capita income didn’t change much from the time of Christ to the founding of the United States ($444 to $650 in 1990 dollars), a period of 1,790 years. But in the following 320 years it jumped to $8,080. And about half of that jump came over the last 50 years. What explains this fairly recent explosion of well being? Many things, of course, but central to this explosion of wealth was trade. Only when people could specialize, which requires relying on others to produce part of what they need or want, i.e. to trade, was it possible to dramatically increase the productivity of individuals. The prospect of selling to others also carried the incentive to innovate and develop new technologies, etc.

Trading requires some level of trust in the person you are trading with and mutual acceptance of the rules of the game (contracts). This is relatively easy when you trade with your neighbors and fellow villagers face to face. But as trade extended over longer distances—as it expanded from personal to impersonal dealings— the development of trust became more challenging but no less essential. Product standardization, for example, allowed even greater efficiency and productivity but also facilitated the development of trust in the quality of what we are buying. Companies invested in building and preserving their reputations, which became associated with brand names. As trade expanded, the need for trust was satisfied in more innovative ways.

In today’s rapidly expanding Internet world, where virtually anything under the sun (virtual or real) can be traded via the impersonal Internet, the old brand name reputation approach to establishing trust continues to be useful. Thus we trust the level of quality of products marketed by Sears, or Nieman Marcus on their website to match what we find in their physical locations. However, “the customer review” is rapidly becoming an important source of trust, whether looking for a plumber, a restaurant, a hotel room, or buying a new car.

Government’s have long facilitated trade via providing security (Feudal Lords providing Sheriffs to hunt down highway robbers) and enforcement of contracts. At some point governments began to think that they could establish (or replace) trust more effectively than did competitive markets by imposing regulations to inform or protect consumers. Standard product information, for example, the contents and their nutritional values on the labels of food products, help consumers decide which product best meets their needs. Licensing practitioners of various professions—from cab drivers to physicians—became a widespread form of vetting minimum professional competence or standards. In many if not most professions the regulators tended to be captured by the industry they regulated resulting in protection of the practitioners from competition rather than protection of the customers from poorly trained service providers. Medical doctors fought, often successfully for a long time, competition from providers of alternative medical services (chiropractors, acupuncturists, Internet medical service providers, etc.). Licensed taxi companies obtained exclusive rights to serve specific areas and limit their number in order to boost fares in the name of consumer protection.

The medallions required to operate a taxi in New York City are a famous example of a government created monopoly. The following is from the website of the New York City Taxi and Limousine Commission announcing the auction of 89 medallions on May 2, 2008:

New York City Taxi and Limousine Commission (TLC) Commissioner/Chairman Matthew W. Daus has determined that the Minimum Upset (Bid) Price for each of the 43 available lots of two Minifleet (Corporate) Accessible Medallions that will be auctioned on May 2, 2008 will be $700,000. One Individual Accessible Medallion will likewise be available for bid on that date at a Minimum Upset Price, also set by the Chairman, of $189.000, as will two Individual Alternative-Fuel Medallions at a Minimum Upset Price of $300,000.

The Minimum Upset Price is the minimum amount that will be considered valid. The highest valid bids will be named apparent winners.

Such systems of licensing are meant to insure minimum quality of service (both of the car and of the driver). They are meant to establish trust on the part of customers that when a yellow car pulls up, he will not over charge or rape or rob you. These issues are explored in an interesting paper by Christopher Koopman, Matthew Mitchell, and Adam Thierer: “The Sharing Economy and Consumer Protection Regulation: The Case for Policy Change” Mercatus Center, George Mason University

“Under the traditional ‘public interest theory’ of regulation, regulation is sought to protect consumers from externalities, inadequate competition, price gouging, asymmetric information, unequal bargaining power, and a host of other perceived ‘market failures’.”

Unfortunately, as economists Mark Steckbeck and Peter J. Boettke observe, regulators often ignore ‘the dynamism of markets and the incentive mechanism driving entrepreneurs to discover ways to ameliorate problems associated with market exchange.’” page 6

“Writing in 1920, Arthur C. Pigou cautioned against contrasting ‘the imperfect adjustments of unfettered private enterprise with the best adjustment that economists in their studies can imagine.’ Instead, he noted that in the real world, policymakers may not implement policy as scholars think they ought to: For we cannot expect that any public authority will attain, or will even whole-heartedly seek, that ideal. Such authorities are liable alike to ignorance, to sectional pressure and to personal corrup¬tion by private interest. A loud-voiced part of their constituents, if organised for votes, may easily outweigh the whole.” Page 7

“Because rent-seeking is used to contrive exclusive privileges rather than to create value for customers, these efforts cost society forgone productive opportunities. To compound the problem, rent-seeking changes the way people allocate their talents. Rather than keeping a focus on devising new and innovative ways to create value, entrepreneurs turn their efforts toward devising new ways to acquire these regulatory privileges.” Page 10

So how has NYC’s medallion system worked? Ask a New Yorker. In 2006 there were only 12,799 licensed taxicabs in New York City, compared with 21,000 in 1931, when the city had about 1 million fewer inhabitants.

Koopman, et al, explore the implication of the choice (or mix) between market and government regulation for the area of what they call the “sharing economy.” The trading facilitated by Craigslist, Uber, and Airbnb has existed for centuries, but the use of the Internet by some clever entrepreneurs has transformed the business model.

Most of us in years past have taken advantage of a limousine driver between official jobs passing by slowly and offering a relatively cheap fare. Unauthorized drivers hang around airports and Theaters to pick up extra fares illegally. My favorite experiences were in the former Soviet Union in the first few years after its collapse. Most everyone wanted free markets but didn’t have a very clear idea how they were organized. We came to realize that virtually any car on the road was potentially an informal taxi. We could flag down almost any car and if we could communicate where we wanted to go and agree on a price, we had a ride. Uber has provided a high tech means of connecting such drivers with customers. “The company says it is not a transport or taxi service; it is a technology company whose product is not car rides but the phone application used to arrange them. Its UberX service relies on partnerships with thousands of independent contractors who use their own vehicles. Drivers find passengers using Uber’s phone app and then remit a percentage of the fare to the company.” uber-pressures-regulators-by-mobilizing-riders-and-hiring-vast-lobbying-network/2014/12/13/Washington Post

But what about trust? Those of you who have used Uber have probably experienced, as I have, an easier, faster, more polite, and cheaper ride. But how can we trust that the car will be safe and the driver competent and honest? The success of Uber and other web based services rests on their being able to satisfy these concerns. Will the dictates of market success do a better job than government regulation in satisfying these customer concerns?

“Reputation systems are arguably the unsung heroes of the social web. In some form or another, they are an integral part of most of today’s social web applications.” Chrysanthos Dellarocas, “Designing Reputation Systems for the Social Web,” in The Reputation Society: How Online Opinions Are Reshaping the Offline World, ed. Hassan Masum and Mark Tovey (Cambridge, MA: MIT Press, 2011), 3. To gain and keep the public’s trust, Uber has established internal standards for the private drivers and their cars that it signs up to connect with customers through Uber. The failure of any driver or car to live up to those standards (and they have several car types) hurts Uber’s reputation and thus its bottom line. It has a strong incentive to get it right. Uber also uses easy to provide customer reviews of each ride experience as do a growing number of web based trading serves.

But what about dishonest reviewers, perhaps working for a competitor (the world is a harsh and cynical place)? The presence of dishonest people lowers the standard of living in any society whatever its system of government or economy. Societies heavily dominated by honest people, are more prosperous. But some people will be dishonest and we need ways to deal with them and minimize their damage. Waze, the very popular GPS based car destination app, provides up to the minute information on traffic conditions on your route provided by users on the spot. It harnesses the desire of most people to be helpful. The information provided by users (their reviews, if you will) is rated for accuracy by other users (in the form of an easily delivered “thank you”). I have no doubt that services traded via the Internet will continue to explore better ways of establishing trust in the products and services traded there.

The recent alleged rape of a young woman in New Delhi, India by an Uber driver raises this issue in a dramatic way that the rape of a young woman in Fort Lauderdale two months earlier by a Yellow cab driver didn’t seem to. A foolish, careless comment by an Uber official about how he might use travel information on Uber’s customers, also raises questions about the safety and uses of such information. Are these problems better handled by regulation or by market competition?

The answer in my view is that the government should provide the foundation for trade provided by contract law and its enforcement, and minimal requirements that are generally applicable (a driver’s license and appropriate insurance). But the Uber’s of the world should be required by free competition to prove themselves and their service to the satisfaction of their potential customers rather than to regulators. If you want to know the standards of safety Uber has set for its self as it seeks customers, check its website, for example:


About wcoats

Dr. Warren L. Coats specializes in advising central banks on monetary policy, and in the development of their capacity to formulate and implement monetary policy. He is retired from the International Monetary Fund, where, as Assistant Director of the Monetary and Financial Systems Department, he led missions to over twenty countries. Before then, he served as Visiting Economist to the Board of Governors of the Federal Reserve System, and to the World Bank, and was Assistant Prof of Economics at the Univ. of Virginia from 1970-75. Most recently he was Senior Monetary Policy Advisor to the Central Bank of Iraq; an IMF consultant to the central banks of Afghanistan, Kenya and Zimbabwe; and a Deloitte/USAID advisor to the Government of South Sudan. He is currently a member of the Editorial Board of the Cayman Financial Review and until the end of 2013 was a member of the IMF program team for Afghanistan. His most recent book is entitled "One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina."
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