...Archive for December 2014


So-called “surge pricing” is not the main thing to worry about with Uber. Investors who value the ethically challenged firm at an astonishing $40B have made a cynical (also ethically challenged) bet that “network effects” will permit the firm to basically own the 21st century successor to the taxi industry. Our main concern should be to ensure investors do not win that bet. In particular, public policy should focus on encouraging “multihoming”, where drivers advertise availability over several competing platforms (Uber, Lyft, Sidecar, etc.) simultaneously. Municipalities might also consider requiring that ride-sharing platforms support standard APIs that would enable Kayak-like metaplatforms to emerge. Or municipalities might offer such applications to the public directly. As usual, the question here is not “regulation” vs “deregulation”, but smart regulation to ensure a high-quality competitive marketplace. Fortunately, the right of municipalities to regulate transportation services is well established, so it should be straightforward for cities to impose conditions like nonexclusivity and publication of fares in standardized formats.

I don’t care all that much about Uber’s “surge pricing” — its practice of increasing its usual fare schedule by multiples during periods of high demand. I do, however, care about the damage done by a kind of idiot dogmatism that hijacks the name “economics”. Uber’s surge pricing may or may not serve Uber’s objectives of profit maximization and world domination. It may or may not increase “consumer welfare”. But it is not unambiguously a good practice, either from the perspective of the firm or as a matter of economic analysis. Its pricing practices impose tradeoffs that must be addressed with reference to actual, on-the-ground circumstances. Among prominent academic economists there may well be a (research-free) consensus that surge pricing promotes consumer welfare (ht Adam Ozimek), but that reflects the crude selection bias of the profession much more than actual analysis of the issue. The dogmatism which has arisen in support of Uber’s surge pricing is quite analogous to the case of urban rent regulation, a domain in which there is incredible heterogeneity across localities and nations, both of circumstance and policy, and a wide range of legitimate values that conflict and must be reconciled. (Here’s an interesting case in the news today, in Spain, ht Matt Yglesias.) Almost as a rite of passage, economists drone in every intro course that rent controls are bad. By preventing price signals from working their magicks, they prevent the explosion of real-estate supply that a truly free market would deliver. This is stated as uncontroversial fact even while economists who research and opine prominently on housing policy have endlessly documented that housing supply is not in fact price-elastic in the prosperous cities where rent controls are typically imposed. None of this is to say that rent controls are good or bad, or that non-price barriers to construction are good or bad. These are complex questions involving competing values textured by local circumstance. They deserve bespoke analysis, not pat dogma imposed by distant central planners economics professors.

Anyway, surge. The excellent Tim Lee grapples with the miserable dogmatism that surrounds the subject here:

The thing Lyft customers seem to hate the most about Uber is surge pricing. That’s when Uber automatically raises prices during periods of high demand…

The economic argument for surge pricing is impeccable: varying prices helps to balance supply and demand, ensuring that people who really need a ride can always get one. But businesses have to take customer preferences into account whether or not they’re rational. So it might make sense for Uber to adopt Lyft’s softer approach to demand-based pricing.

As in the case of rent control, the stereotyped economist’s case for surge pricing is based on a conjectured elasticity of supply. With higher prices, the reasoning goes, more drivers will hit the road, more customers will be served, and the world will be better off. And that’s a good case, as far as it goes. But it doesn’t go very far, without some empirical analysis. It doesn’t justify Uber’s actual practice of surge pricing, which is far from the transparent auction our stereotyped economist seems to imagine. It doesn’t account for the trade-offs imposed by price-rationing (as opposed to time- or lottery- rationing), both between customers and for the public at large.

First, how price elastic is driver supply? If we presume that Uber is a Walrasian auctioneer, a disinterested matchmaker of supply and demand, apparently supply is not very elastic. Uber surges prices by multiples, two, three, even four times “typical” pricing in periods of high demand. That’s extraordinary! If supply were in fact elastic, small increases in price would lead to large increases in supply. The supply-centered case for dynamic pricing is persuasive in direct proportion to actual elasticity of supply. Uber’s behavior suggests that the supply-based case is not so strong. Of course, we cannot make very strong inferences about driver supply from Uber’s behavior, because they are not in fact a disinterested Walrasian auctioneer. When Uber surges, it dramatically raises its own prices and earns a lot more money per ride, whether ride supply increases not at all, or whether it spikes so much that drivers end up competing heavily for riders and suffer long vacancies. As a profit maximizer, Uber’s incentives are to impose surges primarily as a function of demand, and say nice things about supply to con economists and journalists.

Suppose, then, that supply is not elastic. Is there any problem with Uber “charging what the market will bear”? Even for inelastically supplied goods, the stereotyped Econ 101 professor recommends price-rationing, as that should ensure that the scarce supply goes to those who most value it. Unfortunately, the argument for price-rationing (as opposed to lottery-rationing, or queue-rationing) of goods as being welfare-maximizing depends (at the very least) upon a rough equality of wealth so that interpersonal dollar values can stand in for interpersonal welfare comparisons. In an unequal society, price rationing ensures disproportionate access by the rich, even when they value a good or service relatively little. There is no solid case that price-rationing is optimal or even remotely a good idea when dispersion of purchasing power is very large. I’ve written about this, as has Matt Yglesias very recently. Matt Bruenig has two excellent posts relating this point to Uber specifically (as well as another post on ethical claims about Uber’s pricing). For a deep dive into how distributional concerns affect welfare-economic intuitions under perfectly orthodox economic analysis, I’ll recommend my own welfare economics series. It’s easy to write-off Uber controversializing as a masturbatory first-world problem among hipsters, rather than a pressing question of wealth and poverty. That’s a mistake. There’s little question that “app-mediated” car provision will soon replace conventional taxis, because it is a much higher quality product. Poor people are in fact one of the main clienteles of traditional taxis in the US, since nonpoor households typically own cars and use taxis primarily when traveling. As the industry transitions, poor people will be hit very immediately by whatever practices become standard. In an unequal society, distributional effects are a first-order concern.

Suppose you just don’t care about distribution and you favor price-rationing of scarce goods over alternative schemes full stop. Then you should still be troubled by Uber’s surges, because Uber itself is a cartel. The actual service providers are individual drivers. When Uber “surges”, it raises prices across its whole fleet of drivers. Yes, Uber faces competition, from traditional cabs, and (depending on the city) from other startups. But between perfect competition and monopoly, there are a lot of degrees of pricing power. In many cities, Uber already has a lot of pricing power, and that may increase over time, depending on how today’s competitive battles shake out. Like any potential monopolist, Uber’s incentives will be to “surge” to a price that is higher than the output-maximizing price that would obtain in a competitive market. There is no technical reason why Uber needs to be organized like a cartel. In fact, one of its competitors, Sidecar, allows each driver to set her own price, encouraging competition within the service. Like Sidecar, Uber claims to be a “platform”, and disavows any employment relationship with or liability for the actions of its drivers. Fine. It makes a market for independent contractors. Then why on earth do “free market economists” applaud when it forces those contractors to coordinate price increases? Why would antitrust laws even tolerate that?

Finally, we need to consider questions of economic calculation. In macroeconomics, we sometimes face tradeoffs between an increasing and unpredictably variable price-level and full employment. Wisely or not, our current policy is to stabilize the price level, even at short-term cost to output and employment, because stable prices enable longer-term economic calculation. That vague good, not visible on a supply/demand diagram, is deemed worth very large sacrifices. The same concern exists in a microeconomic context. If the “ride-sharing revolution” really takes hold, a lot of us will have decisions to make about whether to own a car or rely upon the Sidecars, Lyfts, and Ubers of the world to take us to work every day. To make those calculations, we will need something like predictable pricing. Commuting to our minimum wage jobs (average is over!) by Uber may be OK at standard pricing, but not so OK on a surge. In the desperate utopia of the “free-market economist”, there is always a solution to this problem. We can define futures markets on Uber trips, and so hedge our exposure to price volatility! In practice that is not so likely. For many people, time-uncertainty may be more tolerable than price-uncertainty in making future plans. If this weren’t the case, congestion pricing of roads would be much more popular than it is. Just as we leave home early now to account for the time we’ll spend parked on the expressway, we can summon a ride early to ensure we arrive on time even when there is no car immediately available.

It’s clear that in a lot of contexts, people have a strong preference for price-predictability over immediate access. The vast majority of services that we purchase and consume are not price-rationed in any fine-grained way. If your hairdresser or auto mechanic is busy, you get penciled in for next week. She doesn’t tell you she’ll fit you in tomorrow at double her usual rate. There are, as far as I know, no regulatory or technological impediments to more dynamic pricing schemes for everyday services. Even in the antediluvian, pre-app world, less routine sorts of service provision like hotels did price dynamically. People seem to tolerate dynamic prices of services they consume sporadically or as a discretionary luxury, but prefer price predictability and time uncertainty for services they consume routinely. You’d think economists of all people would “mark their beliefs to market”, but the stereotyped practitioners who define what Tim Lee calls “impeccable” economics are in fact wide-eyed utopians. They look past actual preferences that consumers express in purchasing behavior, and that providers reflect in pricing behavior, to a hypermarketized alternative reality where interactions are governed in a very fine-grained way by price-signals and market incentives. It’s not clear that very many humans actually want to live in their world. Lee expresses the incoherence of the “impeccable” economist very well when he writes, “businesses have to take customer preferences into account whether or not they’re rational.” In theory, of course, customer preferences can be inconsistent, but they can never be irrational. Economics as a discipline takes human preferences as given, and defines rationality as action that maximizes the degree to which those preferences are satisfied. But the “impeccable” economist so privileges stereotyped market mechanisms as analyzed in a deracinated fictional theoryworld that any preferences not consistent with means chosen a priori get deemed irrational. That way of thinking may be “impeccable”, but it is the opposite of good economics.

I don’t want to be too negative. As I said at the start, surge pricing per se is really not the major concern with Uber. Our efforts should be devoted to ensuring that no single price-coordinating “platform” dominates the nascent on-demand transportation industry. There is a solid case for using price to incentivize ride supply, or even to ration relatively fixed supply. Price-rationing may be welfare maximizing, among the options available to a firm like Uber. But there is also a solid case against, for preferring predictable pricing and lottery- or time-rationing. Even if we stipulate that price rationing is best, it’s hard to think of any consumer-welfare rationale for Uber-style fleet-wide surge pricing rather than a Sidecar-style competitive auction among drivers. Sidecar’s competitive provision is less prone to consumer-welfare-destructive monopoly rent extraction than Uber’s coordinated pricing. Sidecar’s system also permits heterogeneous strategies among drivers, allowing the market to decide and perhaps segment, as some users pay up for immediacy, while other users reward drivers who hew to stable prices by preferring them even when demand is slack.

Update History:

  • 30-Dec-2014, 11:15 p.m. EST: “to ensure that investors”; “over several competing platforms”; ” while the economists who research and opine most prominently on housing policy have endlessly documented the fact that”; “encouraging competition within the platform service“; “defines rationality as action that maximizes the degree to which those preferences are met satisfied“; “it’s hard to think of a any consumer-welfare rationale”
  • 31-Dec-2014, 10:15 a.m. EST: Added link to Dempsey paper, both as related academic work and as cite for claim that taxis significantly used by the poor.
  • 31-Dec-2014, 10:30 a.m. EST: Added link to third Matt Bruenig post on Uber.
  • 18-Jan-2015, 7:05 a.m. PST: “right rite of passage”, thanks Bob Jansen and commenter Bruce