Uber Solves the Fundamental Problem of the Marketplace

Steven Horwitz

As an economic innovation, Uber exemplifies the way creative entrepreneurs discover new methods of providing better, less expensive consumer products and services. It also demonstrates how such creativity helps people navigate around barriers to entry created by government regulations that, though designed to protect consumers, end up protecting incumbent firms.

The benefits of these innovations have prompted me to write glowingly about services like Uber — many times, in fact. As much as I had written about it, though, I’d never actually used the service.

Until this month, that is. After three Uber rides in the last two weeks, not only am I more convinced about the value that the so-called “sharing economy” is providing; I have been struck by the way technology helps to solve the fundamental problem of the marketplace.

The fundamental problem of markets is the need to establish trust among strangers. In a wonderful and unappreciated book called In the Company of Strangers, Paul Seabright explores this formulation in great depth. He argues that for markets to work more fully, we need various institutions that allow strangers to be less suspicious of one another. We need to turn them into “honorary friends,” or in my own preferred version, “honorary kin.”

For most of human history, we lived in small, kin-based bands, where the people we interacted with were all people we knew personally. Our minds have evolved to know how to deal with such situations after millennia of living that way. The modern world, however, requires that we interact with people we do not know personally — but treat them as if we do.

The fundamental problem of markets is the need to establish trust among strangers.

Think about having someone come to your house to repair an appliance. A person you do not know and who you have never seen before is asking for access to your house. You allow them in. What gives you the confidence to do that? Presumably that person arrived in a vehicle with a company name on it (say, Sears) and is wearing a uniform that also reflects that organization’s identity.

We know that the profit motive of the market provides an incentive for firms to hire reliable people, and we use the brand name, the uniform, and other markers to ascertain this stranger’s trustworthiness. If someone knocked on your door after getting out of a regular passenger car, with no uniform on, maybe not at the time you contracted for, you’d be very hesitant to let that person in.

When you think about what a taxi or Uber ride is, you can see the same process at work. After all, what makes us willing to get into the backseat of a stranger’s car? With taxis, there are the obvious markers that are designed to generate trust: yellow or green paint (in the United States, anyway), a corporate name, and the name and picture of the driver, among others. Many of those markers are possible because of the corporate structure that puts all of the drivers in similar-looking vehicles with the same company’s name.

That, of course, is not how Uber works. Not only are you getting into the backseat of a stranger’s car; you are getting into the backseat of their personal vehicle, which has no obvious marking that it is intended to provide rides to strangers. At first blush, it seems like a case similar to an apparently random person showing up at your home to do repairs.

But Uber overcomes this apparent problem in several ways that make clever use of technology. When you request your ride, you are immediately given identifying information about the driver and car, including a thumbnail picture of the driver, the color and make of the car, and its license plate. An additional way in which Uber establishes trust is by using GPS technology to show you exactly where your car is and how long (and what path) it will take to get to you. Watching the car drive up on the Uber app as you see it in front of you is a major signal of trust.

Uber also gives you a cell number for your driver, which is useful if the pickup location is ambiguous. It also makes retrieving anything you left in the car much easier. Have you ever tried to get a lost item back from a cab company?

On a recent airport pickup, my Uber driver even had an auto-response on her phone that told me exactly where to meet her and gave further details about her car.

Uber also establishes trust through its rating system, which works much like those of eBay and other online, anonymous exchange-based sites. Riders rate drivers, and the driver’s rating appears alongside the identifying information about the car. Drivers rate riders, too, so if you misbehave in a car, you are less likely to get picked up the next time you need a ride. After all, sellers also have to trust buyers!

If drivers are not trustworthy, people will not use the service, and Uber will suffer.

Finally, Uber has the profit incentive, just as our appliance repair company does. If drivers are not trustworthy, people will not use the service, and Uber will suffer. Notice that taxi companies with various forms of government protection from competition (for example, the taxi medallions in New York City) do not face the same strong incentive effects here. They don’t have to please their customers in quite the same way. And that might explain why my airport Uber had a bottle of water waiting for me in a very clean, very comfortable, and relatively new car. That does not describe most taxi rides in most cities.

Of course, Uber isn’t perfect, as several recent allegations against drivers demonstrate. But no system is perfect, and it is not as if cab drivers have never been accused of or arrested for abusing passengers. Any such comparison must take into account all of the costs and benefits of each alternative. The flexibility and lower cost of Uber, plus the various ways it provides superior customer service, matter too, as does the fact that all transactions are credit card based. Customers and drivers need not carry cash, making them less likely to be robbed while looking for and accepting a ride.

Living out beautiful anarchy by finding ways around the state and crony-capitalist providers like cab companies requires that the alternatives, such as Uber, solve the problem of turning strangers into honorary kin. Thankfully, modern technology, such as the combination of GPS, electronic payment, and smartphones that Uber and other services in the sharing economy are using, provides effective ways of doing so and makes us willing to get in the backseats of strangers’ cars as if they were the backseat of our parents’ minivan.