Gray Markets and Greased Pigs

John Hood is a reporter/researcher at The New Republic.

Hailing a taxi in Boston can be tricky It helps to be pushy, even rude. Tight city regulation of taxicabs has kept their number at 1,525 since 1934. Because government has prevented supply from rising to meet growing demand, there’s an artificial taxi shortage.

But the story doesn’t end there. Business travelers and tourists can still find transportation in Boston. Hotels, such as the Bostonian Hotel downtown, have begun operating their own limousines to take guests to airports, eateries, or other destinations around town. “I could not in good conscience sit there in the hotel watching guests stand on the street for 30 minutes to get to an airport that is five minutes away,” Tim Kitwan, manager of the Bostonian, told The Washington Post.

Markets are resilient. Try as they might, government and the special interests they protect (in this case, the cab companies) can’t completely suppress the forces of competition. By limiting one particular choice, they only direct enterprising people toward others. The result is either a black market, in which completely illegal transactions occur, or what might be called a “gray” market, in which firms substitute legal options for banned ones—either with the tacit acceptance of authorities or without their knowledge—thus defeating the intent of regulation.

Gray markets exist in many areas, such as zoning regulation (where business- or residential-only labels are routinely circumvented), but are perhaps most visible in the transportation field. In New York, for example, about 15,000 “gypsy cabs” operate in poor, minority communities, mainly in Queens, Brooklyn, and the Bronx. Strict regulation for half a century has limited the number of cabs in New York to 11,787. Consequently, over 600 “black car” livery companies have sprung up to bridge the gap between demand and legal supply.

Such companies are supposed to cater only to phoned-in customers, but many drivers take off their livery license plates (designed to help taxi commission inspectors spot them) and cruise the streets as “gypsies.” These cabs do business not only because of the general taxi scarcity throughout the city, but also because some yellow cabs won’t venture into unsafe areas to pick up minority customers.

Phone-in livery services are becoming a competitive force in many cities that regulate the number of taxicabs, such as Chicago and Atlanta. While not really illegal, they do circumvent the intent of regulations by giving taxis a run for their money.

Another form of competition—jitneys—has sprung up in Pittsburgh and Los Angeles. A jitney is a station wagon or small van that makes better use of miles traveled by carrying more than one passenger at a time. They were prevalent across the country in the early 1900s, but threatened transit and cab companies succeeded in outlawing them in most cities.

Their illegal status doesn’t hinder them much. In Pittsburgh, for instance, jitneys dominate the transport market: if the jitneys cut prices, the legal taxis do, too. And like New York’s gypsy cabs, jitneys provide service to neighborhoods shunned by the regular taxi fleets.

Of course, though governments may not be able to eliminate certain products or services from a market, they can make them more expensive. A “gypsy” ride in New York can sometimes cost two or three times what the same trip would cost in a yellow cab. Cab owners in Atlanta were even able to get a price floor codified in law: $50 a trip for limousines and $40 a trip for corporate cars, about three times what each would cost in a free market. (Jitneys, though, can sometimes offer lower prices than taxis, because they can carry more than one passenger at a time.)

Like alcohol and drug prices during times of prohibition, prices for illegal services rise because of increased risks to providers and lack of consumer information. Established interests count on the higher prices to reduce their competition, if they can’t get outright bans enacted and enforced. Even so, services that circumvent regulations—like New York’s gypsy cabs—flourish. Consumers are willing to pay more to get the services regulated monopolies won’t provide.

The artificially higher prices, though, do mean a loss of efficiency in the market. Consumers still buy more in goods and services from regulated industries, like the taxi companies, than they would if competition were freer.

Black and gray markets may seem a bit unseemly and corrupting, but they actually make up a large and crucial segment of our mixed economy. In some Third World countries they produce most of the goods and ser vices, including food and other essentials. In such countries, government power is employed not only excessively but arbitrarily to favor political cronies. Enemies are taxed into bankruptcy, while valuable assets and capital are seized for “the good of the state.” This creates so much uncertainty that businesses either leave (if possible) or go underground.

It may appear that the state, able to drive a business underground with its power to tax and regulate, exerts great control over the country’s economic life. But that misses the point—that there is always an underground, even in totalitarian societies like the Soviet Union, to which embattled businesses may flee.

A Losing Battle

Government is fighting a losing battle when it grapples with the discipline of the market. There’s no real mystery about why this is so. Free enterprise is not some fragile, delicate experiment in constant need of protection. It does not have to be imposed or fostered. It is, in short, the natural order of things.

Coercive government, on the other hand, needs constant attention and tinkering. Consider how difficult it is for government to maximize its revenues. As supply-siders have shown, hiking tax rates won’t always increase revenues because, among other factors, higher-income taxpayers lose their incentive to work and invest. Any increase in tax rates, in fact, sets off a market reaction that can actually reduce tax revenues. Witness, for example, the current controversy over capital gains taxes. The same principle applies to regulation. There is no shortage of ways to compete with a regulated monopoly, but there’s only a limited number of ways government can restrict competition. Insulate an industry from competition, and the resulting price increases and drops in service encourage consumers to substitute other products or services. And rest as-sured-firms will pop up to provide them. Frustrated regulators must feel like they’re chasing a greased pig.

Government action can’t eliminate market forces; it can only distort them. Sure, government’s attempt to tax or regulate producers out of existence has disastrous side effects. But they are, indeed, only side effects. The goal—o drive “illegal” competition out of the marketplace—is rarely achieved. Government just can’t catch the pig.

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