How incentives matter in Regualtory Policy?

There is an important economics lesson to be learnt from the regulated taxi and auto hiring system in place in many Railway Stations and Airports. The taxis and autos are all pooled into a que and then allotted customers at the hire counter depending on arrival of passengers. After dropping their fares, the autos and taxis rejoin the line to await their next turn. The customers pay upfront the standard fares for their respective destinations at the hiring counter. The accounts of each driver are maintained and their shares distributed at the end of each day.

What struck me about this arrangement, is its incentive structure. The customers are not cheated nor made to wait, as the fare is notified and there is a continuous and regular supply line of vehicles. The auto and taxi drivers benefit from the disciplined arrangement of an assured market, instead of jostling with each other for customers. The taxi drivers most benefitting from this arrangement are those drivers, who in an environment of open competition would not stand much of a chance against the more enterprising drivers.

Critics would say that this arrangement would benefit the lazy and inefficient drivers at the expense of the more hardworking and enterprising drivers. But this argument is untenable since the total number of customer trips possible remains the same under any arrangement. Therefore the more hard working and active drivers will continue to get more share of the trips than their less enterprising counterparts. But the less efficient and lazier drivers are assured atleast a basic minimum of trips. This arrangement meets the dual test of efficiency and fairness, while at the same time not distorting the incentive structure. This incentive structure passes the basic fairness test of equality of opportunity. It is a good example of a regulated free market.

In contrast, a free market in taxi and auto hiring would have driven out the weaker and lazier drivers and placed the customers at the mercy of rapacious taxi and auto drivers. Even among the more enterprising drivers, the intensity of competition would have led in undesirable results. There would be no winners, and every one would be a loser.

There is a lesson to be learnt from this in policy making and regulation. We need to structure incentives in a manner that enables the poor and the less advantaged to atleast access and participate in the market. But at the same time it should not penalize or disincentivize the more enterprising participants. Reconciling these two objectives will be the critical determinant of any regulatory policy.