A few years ago researchers studying the use of tools by animals reported a fascinating discovery: New Caledonian crows could not only use tools to get at food, they could fashion a tool to get at food. Specifically, Betty, the crow in the scientists’ lab, showed that she could shape a twig or wire into a hook to pull otherwise inaccessible food out of a transparent tube. This was the first reported instance of a non-human animal that purpose-shaped tools. Check out the remarkable video of Betty:
As a business academic, I was of course struck by the use of technology. But there is another parallel with humans that struck me just as much. I’ll tell you what it is, but first, let’s take a short detour into the taxi industry.
The typical taxi driver works a 10 to 12 hour day, often laboring through meal times to maximize vehicle usage, and starting very early or working until late at night to minimize competition.
The driver pays a lease of about $100-150 per day and buys his own gas. He or she keeps the rest of the take, which can amount to about $100 to $200 per day – or about $10-$20/hour, but this can be lower or higher depending on many conditions, including the weather, traffic, accidents, etc. Idle times during the shift are expensive. The drivers’ lease payment meter never stops running.
In other words, the taxi driver is the entrepreneur, risk taker, and labor for this business.
The lease is high (you could rent the car alone for about $30/day, but the taxi driver pays three to five times as much) because it includes fees for a decal – a license to operate a taxi -- issued by the city. There can only be as many taxis on the streets as there are decals in circulation, and the city limits the number of decals issued.
Over time, a secondary market for decals develops. Because of their scarcity, decals are bought and sold on this secondary market at prices that are generally higher than the initial issue price. On the secondary market, folks with available cash (e.g. dentists; other investors) buy the decals in the expectation that they can get a decent return on them. And often, they do.
The decals often climb in price as cities grow, the demand for taxis outstrips supply, while the number of decals remains constant. Cities tend to be cautious about how many they issue. Decals also generate a return because they are rented out (to the taxi drivers or to owners of taxi fleets). The rent is included in the lease the driver pays. The amount of the rent varies, but generally goes up as decals become more scarce relative to demand.
The decals often climb in price as cities grow, the demand for taxis outstrips supply, while the number of decals remains constant. Cities tend to be cautious about how many they issue. Decals also generate a return because they are rented out (to the taxi drivers or to owners of taxi fleets). The rent is included in the lease the driver pays. The amount of the rent varies, but generally goes up as decals become more scarce relative to demand.
Revenue too is regulated for taxis – the meter runs at per-mile rates ordained by municipalities.
So spare a thought for the taxi driver who gets squeezed between capped revenues on the one hand, and rising costs of fuel and lease on the vehicle and the decal on the other.
Once in a while, if fuel costs have gone up too quickly, or decal leases have climbed too far or too fast, you will find taxi drivers get really, really mad. Sometimes, they even go on strike. That’s when they’ve had it with creating value that others capture.
Now if you go back and watch the last couple of seconds of the Betty video, you will notice that her companion, Abel, makes an appearance. He captures the food that she extracted by fashioning the tool.
Happens in every industry. Perhaps in every species?
5 comments:
Very nice observation and very nicely written. Enjoy your posts, keep them coming
And this is how it is done: http://dailybail.com/home/eliot-spitzer-the-federal-reserve-is-a-ponzi-scheme-inside-t.html
I have to disagree with several points on your post.
First, you say the taxi driver is the "entrepeneur" and "risk-taker". With this language you've drawn a comparison to startup companies who develop new products and take high amounts of career risk on success or failure of their product. Taxi driving isn't nearly so risky. One has a pretty good idea of the income to expect, the hours to be worked, and the outcome of their career being a taxi driver. You state risks like "weather, traffic, accidents, etc" as if they are a danger to their earning potential, when really they are a single day's hiccup. (Accidents they are involved in could be worse, but that's what insurance is for, and one could argue that everyone, taxi driver or not, bears a significant level of car accident risk.) I hope you can agree that your characterization of taxi drivers is a bit more heroic than the actual occupation.
Second, you give a very one-sided portrait of decal pricing. The leasing serves a social function. Here's a thought experiment: imagine there were no decals required for taxis. What happens? The streets will fill up with taxis until it gets to a point where the supply of taxi drivers is limited by how much money they can earn. I would venture that a great many people would be willing to be taxi drivers, even working more than 12 hrs/day, if the pay is enough to reach lower middle class, since ability to drive is not an uncommon skill (in fact many people enjoy driving) and demand for work is high.
Decal pricing and meter regulation are a way for the government to control the number of taxis on the road and simultaneously supply a decent income to the drivers. The alternative of a free market in taxis couldn't result in a higher income for taxi drivers (since no one is forcing people to become taxi drivers, the supply of taxi driver jobs wouldn't decrease in deregulation, and thus taxi driver incomes couldn't come down from where they are now, under an assumption of a minimal amount of efficiency in the market). Therefore, your suggestion that secondary investors in decals are taking money from taxi drivers is false. Rather, investors in decals are taking money from the government, since the government has underpriced decals.
...[split comment due to length]
[continued]
Finally, your suggestion that Wall Street's business model is primarily rent extraction (hopefully that is a fair characterization of what you suggested with the final analogy) shows a lack of knowledge or understanding of Wall Street. Nearly all financial markets are extremely competitive. Perhaps it was not always this way, but in this age of computers, information travels so easily--and almost all of finance is just information, as opposed to physical products--that there is basically no line of financial business that could not be easily undercut if services were overpriced. There is nothing resembling a monopoly in any line of business. Some lines of business, like market making in equities, have such tiny margins they aren't profitable unless they can be done in very large quantities and without any human labor.
[To head off a possible objection, it's not inconsistent that Wall Street employees earn large salaries even though their work is not overpriced. One distinguishing feature of finance as a career is that it gives extraordinary leverage to the employees--a handful of people can do a deal worth millions, even billions, of dollars--and so taking tiny fees out of that is still very profitable per person. Second, many of the revenue-generating jobs require unusally high levels of talent (technical or social, depending on the position) and willingness to make personal life sacrifices, so the technicals of the job market favor employees in many ways.]
Furthermore, a great deal of Wall Street's business model is based on services, and not on the sort of trading suggested by your decal analogy (which I might describe as arbitrage of inefficient markets). Investment banks provide security services and execution facilities (in fact this is a great deal of what their trading desks actually do) to investors, such as offering derivatives, financing products, and other bespoke financial products. They function as intermediary between counterparties that otherwise wouldn't be able to find each other, or wouldn't have exactly compatible trades. They lend money. They market debt and equity offerings to the investor community. They provide financial advice to companies, and financial services such as merger/acquisition execution. They operate exchanges where a variety of investors can find a place to trade various products in an efficient way.
As for arbitraging market inefficiencies, this is NOT the main business model of investment banks (though it plays a role), and is mainly done by hedge funds and some mutual funds. Although I think it's a difficult argument to make that arbitraging inefficiencies is not a social good, I will defer this point as I do think it's debatable, and that it requires consideration of an enormous number of factors which is getting outside the scope of a comment. One should at least be pleased that most of the money made in these industries is distributed to the investors who supplied the capital--thus circulating the earnings outside of the financial industry (e.g. to dentists). The fund managers might take more than their fair share (however one might define that), but frankly, that's a really small number of people and not at all unique to the financial industry.
Luke, thank you for your thoughtful comments. In characterizing the taxi driver as the entrepreneur and risk taker, I intended to say just that: the taxi driver bears the bulk of the risk in this business. I agree that other businesses (e.g. some start ups) may carry more risk, but that does not change the subsequent analysis in this post.
Our description of decal pricing is very similar. We agree, for example, that "Decal pricing and meter regulation are a way for the government to control the number of taxis on the road..." Where we differ is in your conclusion that decal pricing is intended to "... simultaneously supply a decent income to the drivers." The rents due to the minimization of competition from limited decals are part of the lease prices for the decals -- they go to the dentists, not the taxi drivers.
Otherwise, I agree with your analysis that unrestricted entry into the business would drive down wages (through lower taxi utilization).
Yes, the government is under-pricing the decals (as the difference between the primary and secondary market prices shows). But the essential element here, and the analogy to wall street, is that the decal becomes a derivative whose price is determined by its own supply and demand, which is disconnected from the value creation and risk taking of the business it represents. The price of this derivative then gets priced into the lease the taxi driver pays, skimming part of the value created by the risk-taking entrepreneur.
As for whether the efficiency of Wall Street guarantees that it gets rewarded only for the value it creates, I can't put my response any better than Taleb does here: http://www.project-syndicate.org/commentary/taleb1/English
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