(This essay was published in Hong Kong Economic Journal on 2 September 2015.)

 

Passengers’ outpouring of dissatisfaction with taxi services erupted after police made a high profile arrest of Uber staff at its offices for alleged violation of regulations governing the operation of commercial vehicles.

 

Many of the comments in the media have been spot on about the problem of an over-regulated industry that has completely stifled competition for too long. Current regulations work in the interest of taxi license holders (valued currently at $7 million a piece), but not the taxi drivers, not the passengers, and not even the interests of the general public.

 

If more taxis were dispatched either by radio or over the internet, then there would be fewer of them cruising the streets as they waited on call. Conceivably, congestion, accidents, and even pollutant emissions would be reduced. The general public and all drivers would become beneficiaries.

 

The government’s framework for regulating commercial transportation seeks to satisfy multiple goals, including meeting the different demands of passengers, avoiding excessive congestion on the roads, ensuring standards of safety are met and prices are reasonably affordable by passengers, and providing choice between transportation modes. This is not an easy task and one should not belittle its accomplishments despite some obvious flaws.

 

One of those flaws is that we have ended up with a taxi industry that provides a homogeneous low-quality service that fails to satisfy customer demand. There are two kinds of dissatisfaction. First, customer preference for higher value-added service, for which they are willing to pay a higher fare, has not been met. Second, the existing taxi services often fail to meet the basic standards set by regulators, resulting in overcharging, refusing rides, poor quality driving, and so on. Customer complaints against taxi drivers have been rising year on year.

 

Why have we come to this?

 

Three regulations have driven the industry to behave as if it were a uniform monopolized service. First, the number of taxi licenses has been fixed at 18,138 since 1998 and no new licenses have been issued. Second, the fare is also fixed and only periodically adjusted. Third, taxi vehicles have to be painted in the same uniform silver-red color by requirement and any permitted variation in terms of car models is severely limited.

 

The regulated fares mean price competition is absent and the only form of competition possible is service quality. The third regulation on vehicle color and model makes it practically impossible to compete on branding and product differentiation through legally permitted means. Lack of competition has stifled industry innovation altogether and transformed the industry into a minimal quality service industry.

 

Although the industry has 8,977 taxi license owners, of which 6,873 owners possess a single license, 1,058 owners possess two licenses, 901 owners possess 3-10 licenses, and 145 owners possess more than 10 licenses, there is no competition to improve services. It has been reported that the largest single owner possesses 600 licenses in July 2015.

 

In practice, over 90% of the taxis are primarily managed by four taxi companies creating essentially a quasi-monopolistic industry. In this respect, the Hong Kong taxi industry is very different from that in London, where taxi companies do not hold taxi licenses but individual owners operate their own vehicles and compete against each other for passengers.

 

Most taxi license owners are essentially rent collectors. The annual rent collected per license after costs is around $250,000 –– equivalent to the price of a vehicle –– producing a net return of 3.6% per annum on the $7 million license. The net rental yield in the industry is not maximized by actively managing the business to improve service quality or introducing service innovations because this would add to operating costs and cut into profits.

 

With fare competition made illegal, the best business model is to provide the lowest tolerable service quality the market can bear. Such a business strategy is an assured winner because there are a total of 218,617 licensed taxi drivers, which means the taxi drivers’ market is fully competitive. They outnumber taxis by more than six times per shift on average, leaving them little room to make a better living –– which also makes their wages fully competitive all the time.

 

The regulations require that a person have three years’ driving experience to take the taxi driver license test. The taxi industry (i.e., taxi license holders) has complained that this requirement is too stringent and a barrier against young drivers entering the industry. It stretches the imagination to believe that loosening the requirement would result in service quality improvements.

 

We can see that the interests of taxi license holders and taxi drivers are not aligned. With the total number of taxi licenses fixed, an increase in customer demand for taxi services is an opportunity to raise the daily rental charge on taxis. Taxi license holders are typically keener on lobbying government for fare increases as a measure to improve rental charges, while taxi drivers see this as deterring customer demand and reducing their daily earnings.

 

Landlords of residential units and shopping malls have to compete for tenants by making improvements that differentiate their products. Banks used to compete for customers through branching and today compete even harder through services, fees, and interest rate competition.

 

Taxi license holders do not have to compete because government regulations disallow product differentiation. The “20% fare discount” operator teams are attempts to differentiate product not only in terms of price, but also some elements of service quality improvement. But now this has been treated as illegal by the authorities, even while being welcomed by customers. Only the interests of taxi license holders are hurt if they reduce the total demand for taxi rentals.

 

The entry of Uber and other mobile apps like HKTaxi, GoGoTaxi, Easy Taxi and Kuaidi nonetheless are changing the industry landscape. Uber has introduced fare competition and also brought in new outside drivers. The other apps serve primarily as platforms for the taxi drivers and feed business to them.

 

The interests of customers and taxi drivers are best served when there are more platform-based apps. More platforms imply more competition through product differentiation online, even if the taxis may still be required to look physically alike offline. The real breakthrough here is that information technology has unraveled a government regulatory framework that homogenizes taxi services into a uniform low-quality service.

 

Taxi groups have recently indicated they plan to launch their own car-hailing mobile app and a credit system for drivers to help improve service quality in the face of the new competition. This is to be welcomed, but the critical issue is whether it is being put forward to stop all other platform-based apps and make theirs the exclusive one. If so, it would once again stifle competition in the industry in favor of a single monopolistic online platform. Product differentiation achieved through online competition would end. The old regulatory framework would be restored and extended to cyberspace.

 

It has also been reported that government is pondering whether to permit the introduction of a more luxurious type of taxi service. But this would only set back market innovation and the great advantages of allowing competition online to bring market-driven improvements to the industry.

 

Car-hailing mobile apps encourage less taxi cruising on the roads, producing cleaner air and less congestion. They also reduce service quality-adjusted fares. Lower fares and less congested roads in turn would allow the industry to expand and produce more jobs for drivers. And best of all passengers, drivers, and apps companies would be allowed to agree on fares for mutual benefit at low transaction costs.

 

Some customers would gain from paying higher fares for better quality services and others would continue to benefit from lower fares for the standard service determined by government tariffs. Taxi drivers would gain because they would now have an opportunity to make higher earnings provided they are willing to offer a better standard of services, a choice they do not have at present.

 

The prospect of online apps evolving into platforms that are not limited to transporting passengers is all the more reason why innovation should not be stifled. The Octopus card began as a transportation device but evolved into a payments method. Who knows what the taxi industry may become in the future.

 

Can all this be done without bringing excessive disruption to the industry and existing stakeholders?

 

A moderate approach would be to require all online car-hailing apps, including Uber, to use licensed taxis and licensed taxi drivers. Apps companies could add value by hiring, firing, and managing those taxi drivers in their service. Drivers could simultaneously work for themselves and for multiple app companies. Fares on rides booked through apps could be deregulated and free, but taxis hailed down on the streets and boarded at taxi stands could be regulated as they are now.

 

Taxi license holders could be allowed freedom to provide a greater variety of vehicle models to meet market demand. They could also lease out their taxi licenses to apps companies altogether, to be stocked with their own vehicles. Licensed taxi drivers could in principle hire-purchase their own vehicles, or sign up to work for apps companies with taxi licenses to rent. Government regulation on the physical look of taxis could also be relaxed to allow for car body branding to function.

 

Legislator Michael Tien announced a proposal quite similar to what has been outlined above. The critical point is that the taxi industry would still be based on taxi licenses and use licensed taxi drivers. Taxi license holders’ interests would be preserved but shared. As the taxi industry grows in size and quality, they need not be losers. Government would then also be in a position to issue more taxi licenses.

 

Under this proposal the basic underlying regulatory framework would be unchanged except to allow for product differentiation through the branding secured through apps. Since this is a value-added service, tariff deregulation would be appropriate and would not constitute a violation of tariff regulation.

 

A better and more progressive approach is to obviate the need to require apps companies to use only licensed taxis. This would bring even greater benefits to society by tapping into the full potential of resources in the economy and offering more job opportunities. Innovation for the benefit of services other than passenger transportation could occur even faster.

 

We should be asking which approach will better fit in with an appropriately proactive government: moderate, progressive, or maintaining the status quo?

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