DRI-280 for week of 7-7-13: Unintended Consequences and Distortions of Government Action

An Access Advertising EconBrief:

Unintended Consequences and Distortions of Government Action

The most important cultural evolution of 20th-century America was the emergence of government as the problem-solver of first resort. One of the most oft-uttered phrases of broadcast news reports was “this market is not subject to government regulation” – as if this automatically bred misfortune. The identification of a problem called for a government program tailored to its solution. Our sensitivity, compassion and nobility were measured by the dollar expenditure allocated to these problems, rather than by their actual solution.

This trend has increasingly frustrated economists, who associate government action with unintended consequences and distortions of markets. Since voluntary exchange in markets is mutually beneficial, distortions of the market and consequences other than mutual benefit are bad things. Economists have had a hard time getting their arguments across to the public.

One reason for this failure is the public unwillingness to associate a cause with an effect other than that intended. We live our lives striving to achieve our ends. When we fail, we don’t just shrug and forget it – we demand to know why. Government seems like a tool made to order for our purposes; it wields the power and command over resources that we lack as individuals. Our education has taught us that democracy gives us the right and even the duty to order government around. So why can’t we get it to work the way we want it to?

The short answer to that is that we know what we want but we don’t know how government or markets work, so we don’t know how to get what we want. In order to appreciate this, we need to understand the nature of government’s failures and of the market’s successes. To that end, here are various examples of unintended consequences and distortions.

Excise Taxation

One of the simplest cases of unintended, distortive consequences is excise taxation. An excise tax is a tax on a good, either on its production or its consumption. Although few people realize it, the meaningful economic effects of the tax are the same regardless of whether the tax is collected from the buyer of the good or from the seller. In practice, excise taxes are usually collected from sellers.

Consider a real-world example with purely hypothetical numbers used for expository purposes. Automotive gasoline is subject to excise taxation levied at the pump; e.g., collected from sellers but explicitly incorporated into the price consumers pay. Assume that the price of gas net of tax is $2.00 per gallon and the combination of local, state and federal excuse taxes adds up to $1.00 per gallon. That means that the consumer pays $3.00 per gallon but the retail gasoline seller pockets only $2.00 per gallon.

Consider, for computational ease, a price decrease of $.30 per gallon. How likely is the gasoline seller to take this action? Well, he would be more likely to take it if his total revenue were larger after the price decrease than before. But with the excise tax in force, a big roadblock exists to price reductions by the seller. The $.30 price decrease subtracts 15% from the price (the net revenue per unit) the seller receives, but only 10% from the price per unit that the buyer pays. And it is the reduction in price per unit paid by the buyer that will induce purchase of more units, which is the only reason the seller would have to want to reduce price in the first place. The fact that net revenue per unit falls by a larger percentage than price per unit paid by consumers is a big disincentive to lowering price.

Consider the kind of case that is most favorable to price reductions, in which demand is price-elastic. That is, the percentage increase in consumer purchases exceeds the percentage decrease in price (net revenue). Assume that purchases were originally 10,000 gallons per week and increased to 11,200 (an increase of 12%, which exceeds the percentage decrease in price). The original total revenue was 10,000 x $2.00 = $20,000. Now total revenue is 11,200 x $1.70 = $19,040, nearly $1,000 less. Since the total costs of producing 1,200 more units of output are greater than before, the gasoline seller will not want to lower price if he correctly anticipates this result. Despite the fact that consumer demand responds favorably (in a price-elastic manner) to the price decrease, the seller won’t initiate it.

Without the excise taxation, consumers and seller would face the same price. If demand were price-elastic, the seller would expect to increase total revenue by lowering price and selling more units than before. If the increase in total revenue were more than enough to cover the additional costs of producing the added output, the seller would lower price.

Excise taxation can reduce the incentive for sellers to lower price when it is imposed in specific form – a fixed amount per unit of output. When the excise tax is levied ad valorem, as a percentage of value rather than a fixed amount per unit, that disincentive is no longer present. In fact, the specific tax is the more popular form of excise taxation.

The irony of this unintended consequence is felt most keenly in times of rising gasoline prices. Demagogues hold sway with talk about price conspiracies and monopoly power exerted by “big corporations” and oil companies. Talk-show callers expound at length on the disparity between price increases and price decreases and the relative reluctance of sellers to lower price. Yet the straightforward logic of excise taxation is never broached. The callers are right, but for entirely the wrong reason. The culprit is not monopoly or conspiracy. It is excise taxation.

This unintended consequence was apparently first noticed by Richard Caves of Harvard University in his 1964 text American Industry: Structure, Conduct, Performance.

ObamaCare: The 29’ers and 49’ers

The recent decision to delay implementation of the Affordable Care Act – more familiarly known as ObamaCare – has interrupted two of the most profound and remarkable unintended consequences in American legislative history. The centerpiece of ObamaCare is its health mandates: the requirement that individuals who lack health insurance acquire it or pay a sizable fine and the requirement that businesses of significant size provide health plans for their employees or, once again, pay fines.

It is the business mandate, scheduled for implementation in 2014, which was delayed in a recent online announcement by the Obama administration. The provisions of the law had already produced dramatic effects on employment in American business. It seems likely that these effects, along with the logistical difficulties in implementing the plan, were behind the decision to delay the law’s application to businesses.

The law requires businesses with 50 or more “full-time equivalent” employees to make a health-care plan available to employees. A “full-time-equivalent” employee is defined as any combination of employees whose employment adds up to the full-employment quotient of hours. Full-time employment is defined as 30 hours per week, in contradiction to the longtime definition of 40 hours. Presumably this change was made in order to broaden the scope of the law, but it is clearly having the opposite effect – a locus classicus of unintended consequences at work.

Because the “measurement period” during which each firm’s number of full-time equivalent number of employees is calculated began in January 2013, firms reacted to the provisions of ObamaCare at the start of this year, even though the business mandate itself was not scheduled to begin until 2014. No sooner did the New Year unfold than observers noticed changes in fast-food industry employment. The changes took two basic forms.

First, firms – that is, individual fast-food franchises – cut off their number of full-time employees at no more than 49. Thus, they became known as “49’ers.” This practice was obviously intended to stop the firm short of the 50-employee minimum threshold for application of the health-insurance requirement under ObamaCare. At first thought, this may seem trivial if highly arbitrary. Further thought alters that snap judgment. Even more than foods, fast-food firms sell service. This service is highly labor-intensive. An arbitrary limitation on full-time employment is a serious matter, since it means that any slack must be taken up by part-timers.

And that is part two of the one-two punch delivered to employment by ObamaCare. Those same fast-food firms – McDonald’s, Burger King, Wendy’s, et al – began limiting their part-time work force to 20 hours per week, thereby holding them below the 30-hour threshold as well. But, since many of those employees were previously working 30 hours or more, the firms began sharing employees – encouraging their employees to work 20-hour shifts for rival firms and logging shift workers from those firms on their own books. Of course, two 20-hour shifts still comprises (more than) a full-time-equivalent worker, but as long as the total worker hours does not exceed the 1500-hour weekly total of 50 workers at 30 hours, the firm will still escape the health-insurance requirement. Thus were born the “29’ers” – those firms who held part-time workers below the 30-hour threshold for full-time-equivalent employment.

Are the requirements of ObamaCare really that onerous? Politicians and left-wing commentators commonly act as if health-insurance were the least that any self-respecting employer could provide any employee, on a par with providing a roof to keep out the rain and heat to ward off freezing cold in winter. Fast-food entrepreneurs are striving to avoid penalties associated with hiring that 50th full-time-equivalent employee. The penalty for failing to provide health insurance is $2,000 per employee beginning with 30. That is, the hiring of the 50th employee means incurring a penalty on the previous 20 employees, a total penalty of $40,000. Hiring (say) 60 employees would raise the penalty to $60,000.

A 2011 study by the Hudson Institute found that the average fast-food franchise makes a profit of $50,000-100,000 per year. Thus, ObamaCare penalties could eat up most or all of a year’s profit. The study’s authors foresaw an annual cost to the industry of $6.4 billion from implementation of ObamaCare. 3.2 million jobs were estimated to be “at risk.” All this comes at a time when employment is painfully slow to recover from the Great Recession of 2007-2009 and the exodus of workers from the labor force continues apace. Indeed, it is just this exodus that keeps the official unemployment rate from reaching double-digit heights reminiscent of the Great Depression of the 1930s.

Our first distortion was an excise tax. The ObamaCare mandates can also be viewed as a tax. The business mandates are equivalent to a tax on employment, since their implementation and penalties are geared to the level of employment. The Hudson study calculated that, assuming a hypothetical wage of $12 per hour, employing the 50th person would cost the firm $52 per hour, of which only $12 was paid out in wages to the employee. The difference between what the firm must pay out and what the employee receives is called “the wedge” by economists, since it reduces the incentive to hire and to work. The wider the wedge, the greater the disincentive. Presumably, this is yet another unintended consequence at work.

ObamaCare is a law that was advertised as the solution to a burgeoning, decades-old problem that threatened to engulf the federal budget. Instead, the law itself now threatens to bring first the government, then the private economy to a standstill. In time, ObamaCare may come to lead the league in unintended consequences – a competition in government ineptitude that can truly be called a battle of the all-stars.

The Food Stamp Program: An Excise Subsidy

In contrast to the first two examples of distortion, the food-stamp program is not a tax but rather its opposite number – a subsidy. Because food stamps are a subsidy given in-kind instead of in cash – a subsidy on a good in contrast to a tax on a good – they are an excise subsidy.

Food stamps began in the 1940s as a supplement to agricultural price supports. Their primary purpose was to dispose of agricultural surpluses, which were already becoming a costly nuisance to the federal government. Their value to the poor was seen as a coincidental, though convenient, byproduct. Although farmers and the poor have long since exchanged places in the hierarchy of beneficiaries, vestiges of the program’s lineage remain in its residence in the Agriculture Department and the source of its annual appropriations in the farm bill. (Roughly 80% of this year’s farm bill was given over to monies for the food-stamp program, which now reaches some 47.3 million Americans, or 15% of the population.)

The fact that agricultural programs help people other than their supposed beneficiaries is not really an example of unintended consequences, since we have known from the outset that price supports, acreage quotas, target prices and other government measures harm the general public and help large-scale farmers much more than small family farmers. The unintended consequences of the food-stamp program are vast, but they are unrelated to its tenuous link to agriculture.

Taxes take real income away from taxpayers, but – at least in principle – they fund projects that ostensibly provide compensating benefits. The unambiguous harm caused by taxes results from the distortions they create, which cause deadweight losses, or pure waste of time, effort and resources. Subsidies, the opposite number of taxes, create similar distortions. The food stamp program illustrates these distortions vividly.

For many years, program recipients received stamp-like vouchers entitling them to acquire specified categories of foodstuffs from participating sellers (mostly groceries). The recipient exchanged the stamps for food at a rate of exchange governed by the stamps’ face value. Certain foods and beverages, notably beverage alcohol, could not be purchased using food stamps.

Any economist could have predicted the outcome of this arrangement. A thriving black market arose in which food stamps could be sold at a discount to face value in exchange for cash. The amount of the discount represented the market price paid by the recipient and received by the broker; it fluctuated with market conditions but often hovered in the vicinity of 50% (!). This transaction allowed recipients to directly purchase proscribed goods and/or non-food items using cash. The black-market broker exchanged the food stamps (quasi-) legally at face value in a grocery in exchange for food or illegally at a small discount with a grocery in exchange for cash. (In recent years, bureaucrats have sought to kill off the black market by substituting a debit card for the stamp/vouchers.)

The size of the discount represents the magnitude of the economic distortion created by giving poor people a subsidy in excise form rather than in cash. Remarkably, large numbers of poor people preferred cash subsidies to markedly that $.50 in cash was preferred to $1.00 worth of (government-approved) foodstuffs. This suggests that a program of cash subsidies could have made recipients better off while spending around half as much more money on subsidies and dispensing with most of the large administrative costs of the actual food-stamp program.

Inefficiency has been the focus of various studies of the overall welfare system. Their common conclusion has been that the U.S. could lift every man, woman and child above the arbitrary poverty line for a fraction of our actual expenditures on welfare programs simply by giving cash to recipients and forgoing all other forms of administrative endeavor.

Of course, the presumption behind all this analysis is that the purpose of welfare programs like food stamps is to improve the well-being of recipients. In reality, the history of the food-stamp program and everyday experience suggests otherwise – that the true purpose of welfare programs is to improve the well-being of donors (i.e., taxpayers) by alleviating guilt they would otherwise feel.

The legitimate objections to cash subsidy welfare programs focus on the harm done to work incentives and the danger of dependency. The welfare reform crafted by the Republican Congress in 1994 and reluctantly signed by President Clinton was guided by this attitude, hence its emphasis on work requirements. But the opposition to cash subsidies from the general public, all too familiar to working economists from the classroom and the speaking platform, arises from other sources. The most vocal opposition to cash subsidies is expressed by those who claim that recipients will use cash to buy drugs, alcohol and other “undesirable” consumption goods – undesirable as gauged by the speaker, not by the welfare recipient. The clear implication is that the food-stamp format is a necessary prophylactic against this undesirable consumption behavior by welfare recipients, the corollary implication being that taxpayers have the moral right to control the behavior of welfare recipients.

Taxpayers may or may not be morally justified in asserting the right to control the behavior of welfare recipients whose consumption is taxpayer-subsidized. But this insistence on control is surely quixotic if the purpose of the program is to improve the welfare of recipients. And, after all, isn’t that what a “welfare” program is – by definition? The word “welfare” cannot very well refer to the welfare of taxpayers, for then the program would be a totalitarian program of forced consumption run for the primary benefit of taxpayers and the secondary benefit of welfare recipients.

The clinching point against the excise subsidy format of the food-stamp program is that it does not prevent recipients from increasing their purchases of drugs, alcohol or other forbidden substances. A recipient of (say) $500 in monthly food stamps who spends $1,000 per month on (approved) foodstuffs can simply use the food stamps to displace $500 in cash spending on food, leaving them with $500 more in cash to spend on drugs or booze. In practice, a recipient of a subsidy will normally prefer to increase consumption of all normal goods (that is, goods whose consumption he or she increases when real income rises). Any excise subsidy, including food stamps, will therefore be inferior to a cash subsidy for this reason. In terms of economic logic, an excise subsidy starts out with three strikes against it as a means of improving a recipient’s welfare.

So why do multitudes of people insist on wasting vast sums of money in order to make people worse off, when they could save that money by making them better off? The paradox is magnified by the fact that most of these money-wasters are politically conservative people who abhor government waste. The only explanation that suggests itself readily is that by wasting money conspicuously, these people relieve themselves of guilt. They are no longer troubled by images of poor, hungry downtrodden souls. They need feel no responsibility for enabling misbehavior through their tax payments. They have lifted a heavy burden from their minds.

The Rule, Not the Exception

These common themes developed by these examples are distortion of otherwise-efficient markets by government action and unintended consequences resulting from the government-caused distortions. By its very nature, government acts through compulsion and coercion rather than mutually beneficial voluntary exchange. Consequently, distortions are the normal case rather than the exception. Examples such as those above are not exceptions. They are the normal case.

DRI-305 for week of 3-17-13: What is Behind the New ‘Sharing Economy?’

An Access Advertising EconBrief:

What is Behind the New ‘Sharing Economy?’

The once-distinguished British weekly The Economist highlights a new Web-based economic phenomenon in a recent (03/9-15/2013) issue. The name assigned by the magazine to this activity is the “sharing economy” – a dreadful misnomer that conjures up images of 60s counterculture and communes. But however misnamed, the transactions it denotes are a sign that cannot be ignored.

In his Wealth of Nations, Adam Smith explained the growth of markets by citing man’s innate “propensity to truck, barter and exchange.” Ever since, these words have received both veneration and ridicule. Smith’s admirers saw in them a beautifully realized portrait of human nature. Opponents of free markets have scoffed. They long since rejected whatever validity Smith’s “higgling and haggling of the marketplace” might have had in favor of Thorstein Veblen’s picture of “shadowy figures moving in the background;” they see corporate power, not voluntary exchange, as the dominant motif in the market. Since 2008, the Left has pooh-poohed the notion of rational choice by citing the financial collapse as proof of the irrationality of crowds and the infeasibility of deregulated markets.

But now comes The Economist to point out that even as world financial markets were imploding, unregulated private markets were springing up to enrich the daily lives of billions of the world’s citizens. Alas, the magazine itself misses the significance of its own reporting.

The “Peer-to-Peer” Rental Market

Every night some 40,000 people around the world rent rooms from a service that operates throughout the world – 192 countries, 250,000 rooms in 30,000 cities. The customers choose their rooms and pay online. But the provider is not a commercial business chain like Hilton, Marriott or even Motel 6. Instead, a San Francisco-based firm called Airbnb matches up customers with rooms in homes owned by private individuals. The company has operated since 2008, attracting roughly 4 million customers. Room renters choose and pay for their rooms online.

This is perhaps the largest business in the “peer to peer” rental market. Individual consumers rent assets like beds, boats, and cars directly from other individuals rather than from businesses. The rationale for these practices is quite straightforward. You may wish to cut your automotive transportation costs by earning income from giving rides to people whose destinations coincide with yours. Or, viewing the same situation from the other side of the market, you may wish to cut your costs by paying a peer to chauffeur you to a common destination rather than calling a taxi or riding the bus.

Boat ownership is commonly likened to owning a hole in the water into which you pour money. One way to offset this outflow is to rent the use of the boat to peers. The intermediary and clearinghouse for all this activity is the World Wide Web.

Observing and noting this market is easier than pinning a descriptive label on it. The Economist calls it “the sharing economy.” This is surely wrongheaded, if only because we do not associate “sharing” with commercial transactions. Carpooling arrangements, for example, involve a spatial arrangement for the pooling of transportation services. Participants “share” a common space inside a single vehicle for the purpose of reducing joint transportation expenses. But each vehicle’s owner is commonly responsible for fuel purchases. Pooling equalizes travel responsibilities and costs among participants; the net exposure should be zero. The benefits are symmetrical, both in quantity and kind. This is sharing in a true, meaningful sense; the benefits are objectively equal and depend on the shared use.

Charity is another conventional form of benefit sharing. The owner of income or assets shares it (them) with others with no reciprocation except, perhaps, a “thank you.” The mutuality derives from the satisfaction gained through helping.

But the peer-to-peer market is simple commerce, unlike the genuine sharing examples just cited. There is an exchange of money for goods-or-services. The buyer gains the usual consumer surplus – the excess of the maximum price he or she would have been willing to pay over the price actually paid. The seller gains better utilization of existing capacity, whether the capital good is a personal automobile, spare bedroom or pleasure boat. Sellers are no more “sharing” than are taxi drivers, motel owners or charter-boat skippers. Indeed, a better descriptor would be the “utilization” or “capital-utilization” economy. Of course, this clinical language lacks the warm and fuzzy feel of “sharing” but it compensates in accuracy.

The Economist also tosses out the term “collaborative consumption,” which is just as inapropo as “sharing.” Fairness and full disclosure require noting that the terms “sharing economy” and “collaborative consumption” date back several years. They are particularly associated with left-wing authors like Rachel Botsman, whose communitarian views are hostile to capitalism and private property. But The Economist, of all publications, should know that private ownership is essential to the preservation and maintenance of capital goods, without which the peer-to-peer market would vanish into thin air.

Come to think of it, why not follow current buzzword practice and adopt digital vernacular, using The Economist‘s own phrasing? Call it the P2P market.

The Key Role of the Internet

Where has this new economy been all our lives? Did it take over a century for people to wake up to the possibility of using their cars as taxis or rental cars? Was there an epiphany, a la Bell and Watson, when a restaurant habitué decided he could pay his bill by ferrying his fellow diners back and forth for a fee?

Actually, P2P has been operating in the background all along. It ran on word-of-mouth or classified advertising, using referrals as its primary security. This guaranteed that its importance would remain marginal. It took the Internet to turn it into a $26 billion annual, growing enterprise.

First, the Internet gave P2P the reach it lacked heretofore, allowing sellers to reach an unlimited audience at extremely low cost. Second, the Internet provided the security necessary to both sides of the market. For example, taxi drivers lead a notoriously precarious existence at the mercy of their passengers. But insecurity runs in both directions when the driver is not a business owner or employee, operating a highly visible vehicle. On the Web, though, the platform fulfills the role otherwise played by the business in vouching for its representatives. Follow-up reviews and ratings ensure that bad trips are not repeated.

The surest sign that P2P really works is that commercial businesses want a piece of the action. The Economist reports that Avis, GM and Daimler have all acquired their own piece of P2P; e.g., acquired P2P assets or entered the market de novo. The magazine speculates that the acquisition may enable the parent to list its excess capacity-assets on the P2P firm’s website. This looks like a clear case of evolutionary adaptation rather than creative destruction; P2P does not rate to destroy its competing industries but rather to modify their operations for the better.

Last April, The Wall Street Journal reported on the hottest extension of P2P in the financial realm – P2P lending. For roughly a decade, at least two P2P firms – Prosper Loans and Lenders Club – have offered individuals a chance to lend directly to their peers. The loans are extended versions of the payday/high risk loan that has long been a staple of the low-income and pawn-loan credit market. These P2P loans have terms of up to five years and principal amounts ranging up to $25-35,000. They are unsecured and assigned a risk rating based on the borrower’s creditworthiness.

The success of these P2P firms has now attracted the attention of Wall Street. Fund managers have started funds organized along similar lines, offering investors the chance to pool investment capital into funds offering the same types of high-risk, unsecured loans. Risk spreading and high returns make these funds an attractive alternative to current low-yield, fixed-income investments. The high risk means that their fraction of the total portfolio should be low. Naturally, the increase in lending activity will improve terms and outcomes for borrowers.

Lessons Learned

Even if we accept that P2P is an adaptive rather than a disruptive force, this should not obscure the powerful message it conveys. The rise of P2P overturns the conventional thinking that had prevailed since the financial crisis of 2008 and the ensuing global recession. That dominant view has been that market participants do not act rationally. They act emotionally, even hysterically. They are stampeded by mob psychology and incapable of gauging their own interests. Without the wise guiding hand of government regulation, free markets will inevitably devolve into chaos.

To be sure, this view is itself hysterical. It offers no clue as to why or how regulators themselves escape the emotional distractions that sway market participants. It doesn’t explain how regulators regulate markets without actually substituting their own decisions for those of markets. It also doesn’t tell us how regulators are able to perceive the interests of market participants who (supposedly) cannot discern their own interests. Nonetheless, this regulatory view won out (essentially by default) in 2008-2009.

Every major regulatory agency in Washington – OSHA, EPA, FDA, SEC, FTC, DOT, DOE, FMCSA, et al – has presided over a reign of terror for the last four years. If federal-government regulation were the key to safety, America would now be the safest nation on Earth by far. There is no logical or empirical case for this regulatory full-court press, other than the fact that the Democrats won the last two Presidential elections and the Republicans did not. Still, asking Democrats not to regulate is like asking a horse not to eat hay.

P2P offers the perfect test case for the new conventional thinking. Here we have both supply and demand sides essentially pioneering a new market all by themselves. According to today’s party line, this is a sure-fire recipe for disaster. After all, taxi regulators in New York
City have spent decades warning consumers to beware of “gypsy [unregulated] taxicabs.” Riders might be placing themselves in the hands of robbers, rapists or even worse. Unfortunately, New York City hasn’t approved the issue of a single new taxi license (they are issued in the form of medallions) since World War II, so its citizens have conditioned themselves to ignore these admonitions. They actually want to get somewhere without waiting for a bus or walking. Well, if an unregulated commercial vehicle is this unsafe, just imagine how risky P2P must be!

No, according to The Economist, “the remarkable thing is how well the system usually works.” Then again, P2P “is a little like online shopping,” where “15 years ago…people were worried about security. But having made a successful purchase from, say, Amazon, they felt safe buying elsewhere.” And there was eBay, which began essentially as P2P and morphed into a vehicle for professional sellers.

Well, gol-l-l-l-l-e-e, Sgt. Carter, could it be that old Adam Smith was right – not just about mankind’s inherent affinity for trade but also about the self-adjusting character of mutually beneficial voluntary exchange? So it would seem.

Yet The Economist‘s liberal knee cannot help jerking towards regulation. “The main worry,” they declare gravely, “is regulatory uncertainty.” Yes, politicians in America have cast lascivious glances at Internet trade for years, longing to tax it under a guise of benevolent regulation. Since The Economist sails under the banner of …er, economics – where a tax discourages the taxed activity, creates a welfare burden and reduces the well-being of the taxed – it should come out forthrightly against Internet taxation, right?

Wrong. “People who rent out rooms should pay tax, of course [of course!], but they should not be regulated like a Ritz-Carlton hotel. The lighter rules that typically govern bed-and-breakfasts are more than adequate.” Mere readers – being only consumers, humble recipients of The Economist‘s sunbursts of illumination – needn’t expect any illuminating insight on why tighter regulation of Ritz-Carltons is either necessary or beneficial, because none is forthcoming. The editorial’s anonymous author has the wit to notice that incumbent taxi firms are even now mobilizing the forces of regulation to protect their monopoly position. But the magazine’s leftist editorial stance is so ossified that it cannot permit that admission without an accompanying qualification that “some rules need to be updated to protect consumers from harm.” Taxicab regulation is probably the most notorious textbook example of regulatory harm to consumers in the history of economics, but The Economist is bowing its knee to it. (Elsewhere, the magazine laments the absence of even more Keynesian stimulus spending policies to create jobs.)

This is an old story. A precursor to P2P sprang up in black communities throughout the U.S. during the early and mid-20th century. Taxicab service was often sparse in these areas, not merely because of racial discrimination but also because high crime posed serious risks to drivers. Taxi regulation typically prevented black taxicab companies from entering the market or expanding to meet demand. It became common practice for private individuals to frequent grocery stores, barber shops and other high-traffic areas in order to provide “car service.” This service consisted of informal, unmetered charges (sometimes on a flat-rate basis) in return for carriage to and from shoppers’ homes. Carrying of bags and escort duties were usually included in the service.

Researchers have applied the term “jitneys” to the unregistered, unlicensed vehicles used to provide this service. Research is conclusive on two points: Consumers benefitted unambiguously from the service, and jitneys were legally hounded by taxi and bus companies in their jurisdictions. They were made illegal because taxi and bus owners feared and resented the competition and loss of income that this low-cost alternative form of transportation inflicted on them. Amazingly, jitneys still survive today in inner-city America; they are the “missing link” connecting modern P2P with its ancestral forebears.

When the worst that The Economist can cite is that “an Airbnb user had her apartment trashed in 2011,” you can rest assured that today’s P2P system is working extraordinarily well. It is a measure of our times that even a single complaint instantly triggers the demand for more regulation. When abuses occur despite the presence of tight, heavy regulation – as in financial markets – it should be clear that regulation is the problem rather than the solution. When complaints are rare, it hardly suggests a need for regulation.

The word “regulation” itself has become a rhetorical refuge of first resort precisely because its meaning is so vague. There is no clear-cut theory of regulation to explain why it is necessary, exactly what it does or how it does it. To a bureaucrat, this may constitute a highly desirable sort of flexibility. But it is not conducive to favorable outcomes.

All the News That’s Fit to Decode

Readers of The Economist should probably be grateful that the magazine deigned to notice P2P at all. The fact that we have to hack our way through the magazine’s ideological bias and occupational ineptitude to glean any value from the article is a journalistic scandal. Still, these days students of economics have to take our good news where we find it and our sources as we find them.