Invisible Hand Revealed: Beijing taxis

GETTING BEIJING’S TAXIS TO MOVE, NOT SIT

Starting this week, Brian Viard, Associate Professor of Strategy and Economics at Cheung Kong Graduate School of Business, will explore the workings of economics in everyday life and business in China through this fortnightly column

A few weeks ago, I was standing outside a Beijing subway station desperately hoping to hail a cab for my friends visiting from out of town. Thirty minutes later, I was still there – my arm was tired but no cab, even some that were empty, had stopped. So we opted for the much longer subway ride instead.

A recent Economist article (‘All Hail: Dissent in the Capital’s Taxi Ranks’, March 31, 2012) reported on the difficulty that Beijing residents have had finding cabs and the Beijing government’s possible interim solution. Regulated taxi fares have budged little over the last decade while a key cost for cabs – gasoline – has increased significantly.

As a result, cab drivers often choose not to drive during heavily congested periods when the meter moves slowly. Increasing rates would fix the problem but the government is reportedly reluctant to do this for fear of increasing officially-reported inflation and because it wants to ensure taxis are readily available to the expanding Beijing middle class.

The government’s proposed solution is to supplement cab drivers’ incomes by RMB 300 per month. While these transfers would help partially restore the incomes of hard-working cab drivers who have seen their profits decline over the years, this won’t help you the next time you are standing on the street waving frantically for a cab.

Here’s why: there is a simple principle of economics at work here that is deterring cab drivers from behaving the way the government wants them to. Cab drivers, like the rest of us, usually make decisions by comparing marginal benefits and marginal costs.

A cab driver facing a traffic jam may take some comfort in his monthly salary having increased by RMB 300 but it will make him no more likely to pick up a ride. That’s because in deciding whether to sit out the jam or pick up a fare, the driver’s incentives remain the same. He will compare the marginal cost of the ride – primarily his time and the gasoline burned – to the marginal benefit, the fare he will receive. Since his time and gas prices remain unchanged and fares have not been adjusted, the calculation remains the same as before he received that month’s extra RMB 300.

Let’s return to one of the government’s suspected goals – making taxis readily available to the middle-class. Rather than hindering the pursuit of this goal, raising fares will help. Higher fares increase effective supply because drivers are less likely to shut down during times of congestion. Unless potential riders are priced out of the market at the new rates (unlikely since as the Economist notes taxi rides are a “rare bargain” in Beijing) this will increase availability to middle-class commuters. At the same time, the city can better utilize the cabs on the road and reward the cab drivers for what they do best – driving not sitting.