THE current economic growth is being challenged by institutional concerns, particularly those regarding the delicate balance between the state and the market. Major issues, like inadequate infrastructure, abuse of market power and new market institutions, bring to the fore the need to understand the increasing complexities brought about by technology, organization and capacities to regulate.
But why do we need regulation? When there is market failure, basic economics tells us that the state needs to intervene, because some industries—like infrastructure, utilities and transportation—have large capital requirements that can limit ownership to a few and lead to a lack of competition. With few producers, there is a strong tendency to abuse market power, or the power to dictate prices and minimize the supply or availability of services. Abuse of market power—a classic sign of market failure—is a great challenge to the state regulator, where it needs to walk on a tightrope, given the varying interests of stakeholders.
Economists have been working on regulations for some time now. In fact, out of the 46 times the Nobel Prize in Economic Sciences has been awarded, 12 were related to research on the efficient functioning of markets. And out of the 12, two were focused primarily on regulations. George Stigler won in 1982 for his research on industrial structures, the functioning of the market, and the cause and effects of public regulations. This year French economist Jean Tirole earned the prize for his work that extensively analyzed the behavior of firms and regulatory agencies. His trailblazing researches have altered the simplistic view of applying general regulatory policies to all industries, with price caps as a typical example. He proposed that the best regulatory framework is one that is carefully adapted to the specifities of an industry.
With the onset of new technologies, new types of industries are rising, many of which are part of what economists call the “sharing economy.” This is composed of enterprises developed based on the principle of sharing resources—allowing customers to access on time goods and services that are, more often than not, of good quality and reasonably priced. While sharing goods has always been typical behavior among friends, family and neighbors, the idea of collective consumption has been transformed from a family and communal system into a lucrative business model. Recent examples of these are Airbnb, a web site that permits people to rent out lodging, and Uber, which offers transport services.
Applying regulation to these emerging industries will surely baffle even the most competent regulators. Are these new private solutions to market and regulatory failures that the state should back off from? Or are these sunrise
industries vulnerable to abuse of market power? As an example, let us look at the recent issue about Uber and the reaction of the Land Transportation Franchising and Regulatory Board (LTFRB).
In its March 29 issue, The Economist argued that Uber is revolutionalizing the taxi industry all over the world. On one hand, it is making taxi riders happy, but, on the other, it threatens the industry. The taxi industry is heavily regulated, and entry is sometimes expensive. In New York City the equivalent of a franchise, called a medallion per vehicle, has fetched over $1 million each. In principle, and from a purely competitive situation, what you really need is a car and a driver’s license to start a taxi business. More cars can enter the business if demand increases, and exit it if demand falls. However, as taxis are public transportation, they have to align their objectives with public welfare. This is why, in the Philippines, the LTFRB regulates the industry and has the sole authority to grant permits to operates, called certificates of public convenience.
The recent apprehension of an Uber car by the LTFRB and its being charged with providing a service without a franchise is a case in point. The existing system of franchising is not able to catch up with the efficiency of information that technology is providing for an emerging enterprise, like Uber. It also shows how ineffective the current franchise mechanism is responding to demand. We note the rise of FX and other utility-vehicle services, most of which do not have legal franchises. These developments, including that of Uber, are responses to market and regulatory failures. The action of the LTFRB is meant to protect the current status quo, but riders are looking for better options. Hence, it makes sense when people are willing to pay more just to reach their destination on time. Riders are not really concerned if the vehicle is insured or not. How many of us will be willing to pay more just to reach the airport before the check-in counter closes?
The LTFRB may be legally right to require Uber to get franchises, but, at the same time, technology is telling the government that regulation is demanding more from it. Similar to the conclusion of Tirole, regulation cannot be a pattern for all types of industries. Rather, it requires the regulator to carefully study the industry concerned well beyond its current and past performance, and look way ahead into the future. Otherwise, technological innovation and great enterprises that respond effectively to market demand may be hampered. The regulatory role of the LTFRB should not inhibit the better functioning of markets, but to expand them for the benefit of the riding public.
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Alvin P. Ang, PhD, is a professor of economics at the Ateneo de Manila University and a senior fellow of Eagle Watch, the university’s macroeconomic research and forecasting unit.