Taxi Industry In India: A Story Of Bootleggers And Baptists

I’d like to begin with a small confession. Ever since I read Bruce Yandle’s ‘Bootleggers and Baptists - The Education of a Regulatory Economist’ (1983), it has become a cherished pastime of mine to view the many industries of the modern economy through the lens of the bootleggers and baptists analogy. Naturally, I was not surprised to find that that analogy was also useful in explaining the direction of taxi regulation in our country.

The bootleggers and baptists analogy

At the time of Yandle’s writing, many states in the United States (US) had laws which banned the sale of alcohol on Sundays (the days Christians go to church). These laws were not only supported by conservative baptists, who viewed alcohol as demonic, but also by bootleggers (illegal traffickers of alcohol) who made good money selling alcohol illegally on Sundays at higher prices.

While baptists would publicly lobby for the Sunday ban on the sale of alcohol, bootleggers would help out local politicians who were (and are) perennially in need of re-election funding. The law banning Sunday sales would contain no provision for banning the consumption of alcohol. This would ensure that both interest groups stayed happy.

And what about the consumer? The answer is simple; they get the short end of the stick. The higher prices due to the ban make their pockets lighter. In effect, it is the (un)holy alliance of baptists and bootleggers which would cause prices to increase.

Here is how Yandle explains it:

Another place where I’ve seen such behaviour is Bengaluru, where tree-hugging ‘environmentalists’ support high requirements for open spaces in new townships. Initially, I suspected that all private developers would oppose regulations which impose such requirements. Later on, I found out that many private developers (catering to the upper-middle classes and above) who have amassed sufficiently large land banks have no objections and, in fact, support such requirements. Who suffers as a result of this?

1. New developers and older, smaller developers who aren't able to amass large land banks and so have to face bigger roadblocks in competing with established developers
2. Buyers, who now have to pay higher for purchasing housing units; the poorer the buyer, the bigger the relative impact of such regulation

And this will go on because the media, under the influence of the baptists (tree-huggers), will continue to project the open space requirement as being in public interest.

Before we identify the bootleggers and the baptists in the taxi industry, let us take a look at taxi regulation in India and the business model of Uber.

Taxi regulation in India

The taxi industry in India is governed by the Central Motor Vehicles (MV) Act of 1988. The MV Act provides a broad framework which enables states to put in place rules for permits, regulate prices by setting maximum and minimum fares, limit the total working hours for drivers and so on. And the states have not resisted the temptation to act on these requirements.

The states do so by bringing out various ‘schemes’ that taxis can operate under. Each scheme governs a different part of the sector and, thus, brings in a certain element of choice for taxi operators with respect to the regulatory structure they want to come under. There is still an underlying assumption that planners have perfect knowledge of the market and so can fix prices themselves. There is also an assumption that there is a need to reduce ‘uneconomic competition’ in the sector by introducing constraints on the supply via driver and car requirements. These regulations are among the remnants of the pre-1991 thinking.

The problem for aggregator services like Uber and Ola arise from the fact that they do not want to be governed by the framework set out in the MV Act. They want to be recognised as a technology company and, therefore, be governed by the Information Technology (IT) Act of 2000. So far only one suburb of Kolkata (how incredibly shocking) seems to have accepted this line of thinking. The aggregators connect taxis with tourist taxi permits to commuters via their mobile phone apps. This is clearly a grey area. The two companies want to call themselves technology companies because the IT Act is not as stringent as the MV Act. If they ever come under the MV Act, their current business models would be termed illegal and shut down. The only way they can operate is by calling themselves tech companies and take advantage of the legal ambiguity.

The business model of aggregators

While the need for aggregators to call themselves tech companies is reasonable (in India and elsewhere), it isn’t really the case. To me, they are transportation platforms using cool technology. The platforms have not one but two different user groups, the commuters and the drivers, with each giving network benefits to each other (Consumers use it, as taxis are available quickly on the back of a large fleet; taxis use it, as consumers are readily available).

Christopher Tang describes the phenomenon as it happened in the US:

The business model is hedged on growth. Platforms will make profits only if they are big enough for both users groups to continue using it despite a rise in costs for each group. To enable quick growth, platforms usually subsidise the price-sensitive user group. Sometimes, they subsidise both user groups (some platforms may have more than two user groups). Indian taxi aggregators belong to the latter. When they tie up with financial institutions to subsidise the cost of finance for cars, they subsidise the driver. Other costs for drivers and car owners which may get subsidised are car insurance costs, driver insurance costs, maintenance charges and so on. When they come out with promotional offers and give massive discounts, they are subsidising commuters. Both the taxi aggregators currently offer discounts to commuters who get their friends to sign up on the app. This, again, is one of the many growth strategies that such platforms put to good use.

An added benefit of these aggregators is that both user groups get to rate each other. While the commuters rate drivers after the ride, drivers too rate commuters. This forces both user groups to be nice and deal fairly with each other. This also contributes to the network benefits of the aggregators and helps them differentiate themselves from other models of taxi services and even premium bus transport. By monitoring the behaviour of both the user groups through ratings, the aggregators can root out the bad apples. The ‘rooting out’ part helps build trust in the platform and the service among both the user groups. For instance, rarely do you see drivers with a rating below three on five on Uber. They most probably have been rooted out as bad apples among the drivers. This contributes, in no small way, to the fact that large portions of the middle class have reasonably high levels of trust in these aggregators. My cousin usually books a cab on an aggregator app for her mother who lives in a different part of Bengaluru from hers. She prefers aggregators to normal taxi cabs as she can track the location on her app and need not worry much about travel safety.

Surge pricing

Another important part of the business model is the use of surge pricing. Many readers get angry when they read about surge pricing. Several economists and intellectuals on the centre and on the left have for long defended regulation as a mechanism to improve ‘allocative efficiency’, reasoning that individual players in the market have no incentive to adopt ‘better’ or ‘necessary’ practices if other players refrain from doing the same. The reason most good economists (and students of economics like me) love surge pricing is that it increases market efficiency (by serving those commuters in areas where the supply of taxis at a particular point of time is low) without any specific government requirement for them to do so. Surge pricing is a very efficient way to get drivers to ply in those areas where demand outpaces supply. How would planners and other government officials attempt to solve the problem of demand outpacing supply in certain areas of the city for brief periods of time? Here are two counter-productive measures (there will be more):

1. Bring in regulation to make it a punishable offence for drivers to say no. This is already in place in most states.
2. Mandate that taxis in a particular scheme operate only in a particular area of the city. The police constables on traffic beat would love such a regulation.

While many commuters know that taxi availability was a problem earlier, before Uber and Ola solved the problem to a large extent, they don't seem to understand the role played by surge pricing in solving this problem. It is crucial to understand that surge pricing (or some variant of it) is necessary to ensure commuters experience continuous taxi availability. This experience gives many commuters the confidence to take decisions which would not be possible if they thought getting a taxi would be difficult at a certain time. For instance, surge pricing and the resulting continuous taxi availability would give people the confidence to, say, enjoy their drink at a club and expect to get an Uber or Ola cab back home even when it’s late at night.

Some people point to surge pricing as a problem.

1. They ask: Isn't it immoral to profit out of shortages?
2. They accuse: Surge pricing is not transparent and is rigged by the aggregators.
3. They pose rhetorical questions: What if you are stuck in a place late at night with no buses or autos in sight, and you can’t afford surge prices?

Responses to these pointers are quite simple. Here goes:

1. It is NOT immoral to profit out of shortages when you are alleviating those shortages in the process.
2. The lack of transparency in surge pricing is of no consequence given the fact that users have a choice and are affected by surge pricing only if they choose to. Also, how much more transparent do you expect them to be? Hand over proprietary software to be inspected by PIL activists and media inquisitors? (Also, would you go after Reliance Jio for not being transparent about its business model and how it plans to make profits, for instance?)
3. Again, users have a choice. If not for surge pricing, there is a possibility that they may not even have a choice. Blame your politicians (state and centre, NDA and UPA) for the unbearably bad bus transportation networks in our cities. Almost every state government effectively bans private bus operators from operating city bus networks. While the finance minister promised to remedy this situation in the Union Budget of 2016-17, nothing has come of it.

Bootleggers and baptists in the taxi industry

The ‘bootleggers’ are the established taxi players (cab companies and taxi associations) who are actively lobbying to prevent others from legally competing with them and raising the cost of operations for these new competitors who use better technology (more on this later). The ‘baptists’ are the ‘consumer protection’ activists who continue to spread hysteria over surge pricing and safety of using taxi aggregators, demanding that government equalise the playing field and more through the media.

While the ‘bootleggers’ don't even pretend to be acting in public interest, the anti-competitive rules and regulations that they support and lobby for is sanctified by the ‘baptists’, i.e., the consumer protection activists who pretend to act in public interest through the media.

Take a look at the draft of the Maharashtra City Taxi Rules, 2016. The rules are calculated to restrict more taxis from entering the market, decrease the competitiveness of new competitors by imposing onerous requirements and try the very best to make the business model unviable.

1. The draft rules make it mandatory for half the cabs operating on a platform to have an engine capacity of greater than 1400 cc, and no cab has an engine capacity lower than 980 cc. Both aggregators, Uber and Ola, aggregate cabs and don’t operate them. Taxi drivers decide what kind of car to buy. The aggregators, like they should, aggregate. Moreover, both the aggregators can offer lower prices with cabs equipped with lower engine capacity (higher mileage) and, therefore, expand the market.

2. Cabs operated by the aggregators would be barred from taking street hails. This rule, in my opinion, has been inserted for three reasons.

a) It will help the ‘bootleggers’ avoid competition for untaxed income via street hails.

b) It will help the traffic police earn extra money for their chai, coffee, breakfast expenses.

c) The rule would possibly be used as a tool for harassing the aggregator licence holder.

3. The licence fee for cabs with an engine capacity under 1400 cc would be Rs 25,000, while the same for cabs with an engine capacity of 1400 cc or more would be the exorbitant sum of Rs 2,61,000. Moreover, the aggregators need to pay Rs 50,00,000 per 1,000 cabs aggregated as a security deposit.

4. Quoting directly from the draft,

Induction schedule for vehicles as given below —
(i) 25% vehicles at the time of grant of licence.
(ii) 50% vehicles within three months from grant of licence.
(iii) 75% vehicles within six months from grant of licence.
(iv) 100% vehicles within nine months from grant of licence.

Failure to adhere with the timeline will entail a penalty fee of rupees 25,000 per month for a period of additional six months and thereafter, the licensing authority will be free to revoke the license and forfeit the bank guarantee. The licensee shall submit a compliance report of induction within 7 days of the prescribed time.

I feel compelled to ask, what is making the Maharashtra government extort from aggregators in this manner?

And as usual, there is price control.

The licensing authority shall prescribe the minimum and maximum limit for rates of fare, with respect to vehicles operating under permits granted under these Rules, which will be decided as per type of vehicle; provided that no such limits may be prescribed for vehicles with engine capacity of 2000 cc or more.

This will be defended by the baptists as ‘levelling the playing field’. That is a euphemism for amputating the limbs of the most innovative and competitive players to ensure that we end up, or at least appear to end up, with ‘equal outcomes’.

Here is the best part. In my assessment, the Maharashtra draft is better than the rules notified by the Karnataka government, the draft rules released by Rajasthan better than the Maharashtra draft. (For those interested, here is my take on the Karnataka rules.)

The impact of such regulation

The impact is easy to see - price increases, accompanied by a possible demand drop in the price-sensitive segments, increased costs to consumers and decreased income opportunities to drivers. We might even see Uber and Ola get out of a few cities after initially attempting to comply. I sure hope they get out of one major city and set an example. That might help deter other states from indulging in this extorting behaviour. Rajasthan has a good chance of getting out of this mess if they set a very high price cap and a very low price floor. Most of their other rules are not of much use but are at least not harmful. Telangana, Andhra, Tamil Nadu and a few other large states seem to be waiting for the model policy regime which will soon be announced by the centre. Given how much the NDA values the concept of ‘minimum government’, I’m fairly sure that they will be quite harmful.

With the entry of Uber and Ola, we got to see what some economists call spontaneous liberalisation or spontaneous deregulation. They pushed the boundaries of administrative law and transformed the taxi industry in India. Damien Geradin, GMU professor of Competition Law and Economics, in his paper ‘Uber and the Rule of Law: Should Spontaneous Liberalization be Applauded or Criticized?’ rightly described what Uber had done in the US as ‘a needed electroshock in an industry whose actors had often become complacent and failed to meet user expectations’. It is fair to say that both Uber and Ola have done the same in India.

The rules that our state governments are now bringing out will force the industry to regress to it previous ‘normal’ - bad customer service, higher prices and erratic taxi availability. It is an attempt at turning back the clock on a technological upgrade. In fact, through Uber Pool and Ola Share and even other regular offerings, they have brought in more innovation to the sector, and public transit at large, than the last 70 years of government domination.

The economic and the logical case against such regulation is for all to see. What many Uber and Ola supporters ignore is that regulations which govern established players also contribute to this mess by decreasing their ability to compete with Uber and Ola. Many of these rules need to be thrown into the dustbin too. I’ve pointed out the necessity of doing that previously too.

State governments looking to project a business-friendly image and increase the livability of its cities would do well to do the above. In his book, Citadels of Glass, Tathagata Chatterji points out:

That the quality of life in our cities influences its ability to retain and attract talent is a no-brainer. I can't imagine how harassing companies using a particular business model which has made urban commuting so much more easier, would help improve the quality of urban life. States looking to increase their business competitiveness should stare down these ‘bootleggers’ and ‘baptists’.

P S To those interested, here is a very good video explaining the Bootleggers and Baptists theory of understanding regulation.

Further Reading

India Is Better Off With Self-Employed Uber And Ola Drivers