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Capturing Uber Efficiency with Smart Regulation

After erupting onto the scene six year ago, Uber now operates in sixty countries and is valued at over $50 billion. However, its meteoric rise has not come without controversy. The company is criticized for allegedly skirting regulations with its innovative software platform. State and local regulators are attempting to oversee Uber and other companies, including Lyft and Airbnb, that also use applications to provide services to consumers. Recently, two scholars proposed a regulatory regime that they claim would equip regulators with the tools necessary to monitor this new, evolving industry.

ThinkstockPhotos-467062542In a working paper, Harvard Business School professor Benjamin Edelman and George Mason University law professor Damien Geradin identify potential market failures that they argue regulators should seek to avoid in drafting regulations that affect businesses that rely on burgeoning software platforms. Some of the market failures identified in the paper are specific to certain industries, while others apply broadly. Edelman and Geradin argue that regulators should seek to prevent or minimize negative externalities while capturing the market efficiencies that these software platforms provide.

According to Edelman and Geradin, the challenge facing regulators is discovering how to prevent genuine market failures while creating a marketplace where new companies can compete fairly with existing providers. Edelman and Geradin point out that even the sharing economy’s most outspoken critics often acknowledge that firms such as Uber and Airbnb provide substantial efficiencies to existing industries. These efficiencies include reducing transaction costs by getting rid of costly intermediaries like dispatchers, improving resource allocation by allowing people to rent their apartments or use their cars temporarily, and increasing pricing efficiencies by basing rates on real-time supply and demand.

One foreseeable problem that Edleman and Geradin point out is ensuring the safety of passengers and pedestrians when there are more drivers on the road employed by transportation software platforms like Uber and Lyft. They argue that without regulation, ridesharing companies may fail to provide adequate precautions to ensure safe drivers. Currently, drivers for transportation platforms must have a valid driver’s license, but are not required to obtain a commercial endorsement or undergo any special training. Edelman and Geradin argue that increased training would likely improve the safety of drivers who are on the road longer than they ordinarily would be without the market opportunities created by Uber and Lyft.

Edelman and Geradin also point to underinsured drivers as another pitfall that regulation should address. Transportation platforms typically provide insurance coverage for the driver and passengers for the duration of the trip. However, insurance gaps occur when a driver for Uber or Lyft is waiting for a request or en route to a new customer. During this time, the driver is usually not covered by a transportation platform. Personal insurance plans typically fail to provide coverage if an accident should occur during those times, as insurers argue that the overall trip was for a commercial purpose and therefore outside the scope of personal insurance coverage.

Over the last few years, some state legislatures have responded to the insurance gap problem by passing legislation prohibiting noncommercial insurance plans from paying on claims resulting from “transportation platform activity.” As a result, both Uber and Lyft changed their insurance policies to provide coverage to drivers during this period. Edelman and Geradin hail this response by state legislatures as successful, claiming that it solves an apparent problem while creating few side effects.

Edelman and Geradin add that an unregulated short-term housing rental market will create problems since renters on platforms like Airbnb often feel unaccountable for their actions in communities where they do not live. Their presence may inconvenience neighbors who are permanent residents. Additionally, Edelman and Geradin recognize that expanding the short-term housing rental market will likely shrink the supply of long-term rental housing, thereby driving prices up in already expensive markets. They propose a private self-ordering system according to which communities decide whether they will allow owners to rent their property on such platforms; the members would then choose where they would prefer to live and what property to buy.

Edelman and Geradin foresee another issue with software platform services: equal access to services for members of “disfavored groups,” such as persons with disabilities. Currently, the American’s with Disabilities Act compels taxi fleet operators to provide a certain proportion of wheelchair-accessible vehicles and require hotels to maintain a certain percentage of handicap-accessible rooms. Edelman and Geradin note that sharing economy firms “tend to circumvent these requirements, either through decentralized decision-making that favors individual preferences over government mandates, or through software implementations that otherwise do not require compliance.” The authors propose leveling the regulatory playing field by implementing similar requirements for companies operating through software platforms. They argue that this would also promote competition as the software platforms would have to take on compliance costs which are currently only borne by traditional providers such as taxis and hotels.

Overall, Edelman and Geradin caution against what they deem as protectionist regulation, which favors traditional providers and in turn diminishes the efficiencies that emerging software platforms offer to society. However, the authors promote and encourage regulation that is needed to prevent true market failures and appropriately compensate the injured and inconvenienced for harm inflicted. Although more problems will surely present themselves as sharing economy firms become even more popular, Edelman and Geradin argue that their regulatory framework is a good starting point for smart regulation of this innovative form of economic activity.

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