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Uber may ‘do a Napster’, but ride-sharing is here to stay

Uber is a great innovation. It allows individuals to find better, more convenient ways to travel around our cities. It will reduce congestion, save people money, and create new jobs. So why is it illegal?

In case you have just emerged from a few years wandering around the desert, Uber is a company that uses a smartphone app to bring drivers and riders together. Broadly, in Australia, there are two products. Uber Black allows customers to book licensed hire cars through the app on an ‘immediate ride’ basis. UberX allows customers to contact (otherwise) private drivers who are registered with Uber in order to ride-share (for a price).

The losers from Uber are traditional taxi licence holders. And the taxi cartel is fighting back.

Uber Black is broadly legal. The cars are licensed hire cars. The innovation is that, rather than having to book the car in advance, Uber allows ‘as need’ bookings. This is a great benefit, but makes hire cars more like taxis.

The taxi industry has fought back to limit this legal competition – usually by trying to get the law changed in ways that hurt customers. For example, in Germany, the taxi industry was able to convince the courts to require Uber drivers to return to a depot after each job, preventing them from being conveniently located around the city. In France, the government tried to make Uber cars wait for 15 minutes between receiving a request for a pick-up and making the pick-up. This bizarre restriction was overturned by the courts.

The UberX ride-share service is more problematic.

Under current state laws, UberX is clearly illegal. The drivers do not have the legal licences, vehicle checks and insurance cover. But UberX is continuing to operate in Australia and in a range of other countries where it is illegal. It is doing this to force inflexible, out-of-date laws to change.

It is doing a Napster. And Napster went bankrupt!

Starting in June 1999, Napster was the original peer-to-peer file sharing service. It enabled internet users to share music, both legally and illegally. Needless to say, it quickly ran into legal problems. In late 1999 it was sued by the Recording Industry Association of America. This was followed by Metallica and Dr Dre who sued Napster in 2000 for piracy of their music. Napster lost its legal cases, was closed down in July 2001 and was in bankruptcy by 2002.

Napster didn’t change the law. But technology won anyway. Don’t believe me? Ask anyone under 20 how much they pay for the movies they watch and the music they listen to.

The parallels between Uber and Napster are strong. Napster fought the entrenched interests of the recording industry. Uber is fighting the entrenched interests of the taxi industry.

Both businesses used leading edge technology to tackle the entrenched interests.

Consumers loved both technologies and both technologies benefited from the publicity caused by their opponents. Recent UK protests against Uber led to an eight-fold increase in the number of people registering with the app. The court cases against Napster led to it becoming a household name.

But there are also differences. Despite some dubious practices (such as the infamous ‘mickey mouse’ amendment) recording companies and music artists are legitimately trying to protect their creative work. They deserve to be paid for it.

In contrast, the taxi industry is simply an outdated government-created cartel. Taxi plates are transferred for hundreds of thousands of dollars in many Australian states. The value of these plates reflects the loss to customers. Taxi plate numbers are restricted and fares are kept high. And you are stuffed if you want a taxi during peak periods.

The taxi drivers do not get the benefit of the cartel profits. Plate owners are investors, not drivers. The drivers lose out and are paid ridiculously low wages by the plate owners. Services like Uber would free up the drivers because they would be able to run their own cars.

Governments have two options when facing Uber. First, they can side with the vested interests of the taxi plate owners against the public. They can try to restrict the Uber services by vigorously enforcing the existing laws.

Alternatively, government can be proactive and change the laws to become more flexible and accommodate new forms of competition. This may mean that UberX drivers have to go through a police check and that their vehicles must meet minimum standards. Uber would claim that they already check drivers and vehicles but that is not the point. The new laws would apply to all ride-sharing apps, not just Uber.

The flexible approach would embrace Uber, Lyft and the many alternatives that copy them. It will benefit the public.

The rigid policy of enforcing current laws will inevitably fail. It will force ride-sharing services into the black economy. Just as file sharing continues today, ride-sharing will also continue. Just as Napster was the first of many peer-to-peer services, Uber is just the first of many ride-sharing services in Australia. The government can either adapt the laws so we gain by sensible regulation of these services. Or the government can fail. But even if Uber, like Napster, goes bankrupt, ride-sharing is not going to go away.

A privatised monopoly is still a monopoly, and consumers pay the price

The economics of privatisation are pretty simple.

Moving a business from state-ownership to private-ownership improves the profit incentive. Private owners will focus on their return. That means lower costs, higher prices and increased profit. State-owned businesses can, at best, attempt to mimic private incentives through ‘corporatisation’. But even the best run state-owned business will have an eye on the government and can expect a ‘call’ if it crosses political objectives.

By themselves, both forms of ownership are imperfect.

State-owned businesses do not act in the general public interest. They respond to their own interests and the interests of the government that owns them. They usually pursue a variety of sometimes-contradictory objectives, some of which may be broadly beneficial to society. But some activities will be wasteful, or even harmful, to the country’s long-term interests.

In contrast, private businesses are more likely to focus on profit. This can be bad if the profit-maximising activities of the private business hurt society. It is good when those activities are aligned with society’s interests.

A simple example is pricing power. If a business is a private monopoly then it will use its market power to extract maximum profit from consumers. It will meet consumer preferences, but at a price. It will try to keep production costs down but will also want the sell the mix of products customers desire. Doing this means it can charge higher prices and maximise profits. A private monopoly is a servant who does what you want, so long as it can raid your bank account at the same time.

A public monopoly will focus less on profit. From the customers’ perspective, it will not do what you want – unless that aligns with the interests of its political masters. You may not pay as much, but paying less for something that doesn’t meet your needs doesn’t sound like a great deal.

So the trick with privatisation is to align private profit making incentives with the incentives of society. There are two ways to do this.

The first is through competition. In a competitive market, private profit maximising businesses try to steal each other’s customers. They do this both by better meeting customers’ needs and by undercutting their rivals’ prices. Each business acts to raise its own profits. But the overall effect is that profits are competed away. Customers gain, innovative businesses gain, and businesses that can’t meet customers’ needs go bankrupt. It is ruthless but it also aligns business interests with the interests of the public who are buying their goods and services.

So privatisation needs competition. As Kikeri and Nellis note, “[p]rivatization and pro-competition policies are in fact complements that are mutually reinforcing”.

But there is one problem with this solution. It means lower privatisation revenues for the government.

When a government business is sold to the private sector, the price the government receives reflects the future expected profits of the business with private owners. If the government privatises the business as a monopoly then the expected profits – and price received by the government – is high. In contrast, if the government sets up a competitive market for a newly privatised business then the future expected profits will be lower. And so is the price received by government.

So privatisation with competition can be a big win for Australia. Private ownership creates incentives to produce what we want, when we want it, at minimum cost. Competition keeps prices down.

But privatisation without competition is like a hidden tax. The government gets more today because we will all be paying more tomorrow.

Hence the comments this week by the ACCC chairman, Rod Sims, by Fred Hilmer and by former ACCC chairs, Graeme Samuel and Alan Fels (in the pay-walled AFR). If a state government privatises a monopoly port or airport, then it will get more money than if it establishes a competitive market. If it privatises those businesses with a first right of refusal to develop a competitor (such as Badgerys Creek airport or the Port of Hastings in Victoria) then the government will get even more money, because competition will never happen.

So the current debate on privatisation is only half the story. Privatisation without competition risks turning a public monopoly into a private monopoly. The owners may change but the public will get ripped off just the same.

What is the second option? If competition is not possible then the privatised business needs to be regulated so that it cannot exploit its market power.

In today’s Australian Financial Review, Graeme Samuel notes this alternative.

“He believed that most issues could be resolved through regulation and access regimes and that Australia had a reasonable record in that regard”.

Professor Samuel is correct. But regulation is always going to be a second best solution. Both government-owned and private monopolies can play games with regulators and the end result will always fall short of vigorous competition between private businesses. If competition is not possible, for example for monopoly electricity transmission lines, then privatisation and regulation is a compromise solution. But privatisation with competition is where society really wins.

The current round of privatisations is predictable and regular. Businesses move into and out of government ownership over time. Government ownership is only needed when there are strong conflicts between profit-incentives and public welfare. But if privatisation occurs without competition, then, as a nation, we only get a fraction of the benefit. The government will make more money but do not be fooled. It is just a future hidden tax as consumers pay for today’s increased government revenue through tomorrow’s higher prices.

Closing the company car tax loophole is an obvious budget winner

Expect a “tough love” budget from the federal government in two weeks. And expect lots of (pointless) debate about whether or not a levy is a tax.

If, however, we cast our thoughts back to July last year, we can find an easy and equitable $1.8 billion waiting to be picked up by the government. The money is from reforming the tax treatment of “company cars”. The problem? Well, it was Labor party policy going into the last election and was disavowed by the current government.

The treatment, under the Australian tax laws, of company cars for private use, is a transfer to (upper) middle class employees who get a company car for personal use through their employment. Closing this fringe benefits tax (FBT) loophole will raise $1.8 billion over four years. Not a huge sum, but every bit helps. The changes can protect legitimate business use of a car while getting rid of an inequitable tax perk.

The best evidence that the current rules are a rort came from the reaction to the policy announcement by the then Labor government last July. The price of shares in McMillan Shakespeare, a company that provides salary packaging to take advantage of the FBT loophole, fell by almost two-thirds.

During the 2013 election campaign, the coalition came out against FBT reform. It restated its position in November:

“During the 2013 election the Coalition pledged not to continue with Labor’s $1.8 billion Fringe Benefits Tax change that would make it harder for people to have a company or salary sacrificed vehicle. The Coalition Government today confirms it will not proceed with this measure.”

But the main reason not to proceed with the changes was the effect on local car manufacturers. And since November, all of the local manufacturers have announced that they will be closing domestic manufacturing by the end of 2017. So the main reason to keep the current FBT rort – protecting the local car industry – is no longer relevant.

Closing the fringe benefits tax loophole on cars is good economics. The whole idea of the fringe benefits tax is to remove the incentive for employers to pay their workers through “perks” rather than money. Before FBT was introduced in the 1980s), employee remuneration involved a range of non-monetary benefits used to top up wages. These benefits made sense for the individuals involved, but created a loss for the economy.

For example, say you are in the 30% tax bracket and there is no FBT. If you get tax-free benefits (for example, meals, travel, and/or a car) from your employer that costs your employer $10,000 and gives you a benefit of $8,000 then you are better off than if the employer paid you $10,000 in cash. The cash would attract $3000 in tax. Both the cash and the benefits cost the employer $10,000. But you prefer the $8,000 value from the benefits to the $7,000 after-tax cash.

But the nation is worse off when non-monetary benefits are used to avoid tax. If the employer pays you $10,000 in cash, you get $7,000 and $3,000 goes to the government, for use on schools, hospitals, roads, and so on. But if you get the benefits, your employer spends $10,000, you get $8,000 in value and $2,000 is destroyed. No one gets it. The scheme reduces value and creates what economists call a deadweight loss.

The Fringe Benefit Tax stops this value destruction. A comprehensive FBT would treat all payments – whether income or non-monetary benefits – the same. But our current FBT with the “company car loophole” is not comprehensive. Closing the loophole will improve the tax system.

With domestic car manufacturers packing up and leaving, the main losers from the FBT reform will be employees who currently use the tax loophole and the companies, like McMillan Shakespeare, who have a business helping people to minimise tax. But everyone else – and the economy as a whole – is a winner.

So, over to you Mr Hockey.