This past December, Ohio became the 29th state in just 18 months to enact legislation concerning Transportation Network Companies (TNC). TNC laws regulate how ridesharing companies can provide access to transportation services using their for-hire driver networks. Similar legislation is being considered in a number of other states, including Pennsylvania, New Jersey, Michigan, Florida, and Massachusetts.

Formalizing TNC regulation has been the subject of a great deal of controversy since companies like Uber and Lyft became widely popular in 2013. Companies providing transportation services — taxis, limos, and charter buses — are generally heavily regulated by states and municipalities in regard to how, when, and to whom they offer services. Some states and cities have attempted to spread these burdensome regulations to TNCs, but many have instead given TNCs privileged treatment by lightening their load relative to the taxi industry.

The Origin of Taxi Regulations

The taxi industry in most localities has long worked under very specific, onerous, and sometimes even humorous laws. Initially, there was some sensible reasoning behind the regulations. A subset of taxi drivers nicknamed “nighthawks” would drive their passengers out into the middle of nowhere after dark and extort a higher fare from them to take them to their intended destination. If the passenger refused they’d be kicked out and face a long walk back through unfamiliar country in the middle of the night. Licensure laws and requirements to display official taxi driver identification documents helped curb this practice, since anonymity is the friend of those with criminal intent. However, these sorts of laws had more to do with public safety than with prescriptions of how service is to be provided, which now constitutes the majority of taxi laws.

The Rationale for Regulation

The initial rationale behind taxi regulation was broadly twofold. First, some of the requirements focused on public safety, which is especially relevant since most transportation services occur within public thoroughfares. The second, more malicious, rationale was to prevent “excessive competition” — city laws were implemented to limit the number of providers of transportation services and the way they could offer service in order to deliberately inhibit competition between firms and restrict the number of new entrants to the industry. This sort of flawed thinking was the result of Depression-era desperation (and corruption) to control the economy and prevent further economic collapse. Modern economists have found that such centralized-control and anti-competitive policies actually caused the Depression to be much more severe than would have otherwise been the case if policymakers had simply allowed the economy to naturally re-balance itself. In short, the current state of most local taxi industries is a prehistoric holdover from a time when policymakers considered industry cartels and institutional collusion to be sound economic policy.

The only justifiable basis for transportation service regulation is public safety. A problem called “asymmetric information” exists in most circumstances between a taxi driver and the prospective rider. The driver knows the condition of his vehicle, his driving ability, and whether or not he is an axe murderer — the passenger discovers this information only after getting in the vehicle. In cases such as these, taxi laws can bridge this information gap by requiring drivers to certify to a central authority their safety and display that certification to potential passengers. These laws are similar to “lemon laws” that protect consumers from purchasing defective products from unscrupulous sellers.

Platform Markets Can Reduce the Need for Governmental Regulation

Recent research by Adam Thierer, Chris Koopman, Anne Hobson, and Chris Kuiper at the Mercatus Center at George Mason University has shown how platform firms — companies like Uber and Lyft that serve as intermediaries between the buyer and seller — can also help close the information gap. In short, platform firms serve as matchmakers by reducing the “transaction costs” that buyers and sellers face, enabling exchanges to occur that otherwise would not. In the case of Uber or Lyft, this means linking up travelers with drivers willing to transport them to their destination, but taxi dispatch services fulfill a somewhat similar role, albeit less effectively.

In ordinary markets, firms have a clear incentive to keep customers happy to try to win repeat business. In platform markets this incentive is even stronger since the platform firm creates value primarily by providing matches between buyers and sellers, rather than offering the good or service to be purchased. Essentially, a platform market is a restricted-entrance exclusive market governed by the platform firm. If the platform firm fails to exclude bad actors from the exclusive market, it poisons the reputation of the platform market as being a better place to do business than the open market, meaning that the platform firm will lose customers and risk going out of business.

The reputational feedback mechanisms that are built into Uber and Lyft’s systems enable the platform firms to judge the quality of service provided and quickly respond — and potentially ban — platform users who display negative qualities similar to the unscrupulous sellers in the lemons problem. This provides a much more effective mechanism for ensuring service quality than mandating it via law and using the legal process to remove bad apples.

Are Platform Firms a Competitor to Governmental Regulators?

The advent of platform firms can be viewed as the emergence of a competitor to governmental regulation of transportation services. Uber and Lyft offer a very similar set of services as those provided by government regulators. For example:

1) Platform firms check drivers’ driving history and criminal record to guard against consumer safety concerns, which essentially replaces background checks done by municipal regulators as part of for-hire driver license applications.

2) Passengers identify their driver and the vehicle using on-the-spot information provided by the platform firm, versus relying on an eye-watering paint job and a name badge provided by the regulatory authority.

3) Problems are immediately identified via the reputational feedback mechanisms built into the systems that Uber and Lyft use. Problematic drivers and passengers can be warned, suspended, or permanently excluded from the system at any time. Taxi regulators must rely on much more cumbersome feedback systems that make it more difficult to prohibit problem drivers and impossible to prohibit problem passengers from using transportation services.

4) Safety is also improved relative to traditional taxis. Due to the connectivity of mobile phones, there is a continuous record of each passenger and driver’s location and identity, which disincentives criminal activity. In comparison, the relative anonymity of taxi passengers and drivers can make it difficult to identify the perpetrator of a crime. And the fact that many taxi transactions are done in cash — rather than credit card — makes it hard to safeguard against scammers. Cashless transactions are safer for transportation service providers, too — an important consideration given that taxi drivers experience a homicide rate over 20 times higher than the national average.

The tremendous success of platform firms in the transportation service industry is a clear indication of two things. First, existing regulations inhibited innovation by the taxi industry, leading to a situation where the transportation services market was eager for suppliers who could provide what consumers wanted. Second, platform firms thus far have seemed to do a better job self-regulating their own operations than municipal authorities did in regulating the taxi industry. If this were not the case, then consumers would be fearful of using Uber and Lyft — the additional risk would increase the “transaction cost” associated with these services. Their meteoric rise in popularity indicates that they have satisfied an unmet demand by consumers and done so in a more effective, more efficient, and safer way.

The Best Way Forward

Communication innovations like the internet and smartphones have enabled person-to-person and person-to-firm connection like never before. Accordingly, platform firms like Uber, Lyft, eBay, Facebook, etc., have emerged to host, coordinate, and regulate these interactions. With regard to the taxi industry, the opportunity for the development of platform firms actually occurred in the late 1940’s when radio dispatches and two-way radios in cabs were first used. However, it appears that the strict regulatory structure already in place kept the taxi industry from innovating.

We face a new opportunity today to get things right. The best way forward is to allow transportation service entrepreneurs the ability to seek out new ways to serve their customers and to ensure that all businesses have this same opportunity. The way to do this is to regulate down to the least burdensome denominator, creating a level playing field in the transportation service industry by repealing onerous taxi regulations. This will allow established companies to compete with the newcomers on an equivalent basis, which will produce better service and safety than possible even through legal mandates.