/McArdle’s Confusion About Costs of Inputs, by David Henderson

McArdle’s Confusion About Costs of Inputs, by David Henderson

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One of the best economic journalists in the United States is Megan McArdle of the Washington Post. That makes her error in a recent WaPo article all the more striking. Don Boudreaux at Cafe Hayek has pointed out the error. But I want to do my own analysis because it’s a more general error that I see people make and the first time I saw a friend make was when I was 20 and really starting to “get” economics. Coincidentally, the error my friend made was when we were talking about taxicab economics and he was a cab driver.

In her analysis of the market for Uber and Lyft, here’s the key paragraph in which McArdle veers into bad economics:

The companies’ [Uber’s and Lyft’s] problems essentially boil down to this: The barriers to entry into the driving-people-around business are functionally nil. Whenever the profits in the market rise above a subsistence wage, more drivers will enter, thus competing those profits away.

Notice the last sentence, which is absolutely true as long as we specify what’s being held constant. Whenever the wages rise about the wages drivers could make in other uses of their time, then, if the other components of the job (driving versus other uses) are the same, that will cause more drivers to enter.

But that’s not a problem for Uber and Lyft. That’s good for them. All else equal, Uber and Lyft do better when drivers enter because it keeps down labor costs and gives the two companies more of a chance to make money. Uber and Lyft are not in the driving business; they’re in the transportation business, and drivers’ services are inputs into the production of transportation.

McArdle’s next paragraph proceeds along this erroneous path:

That was the problem taxi medallions had been designed to solve. Drivers still didn’t make much money, because all you needed to get started in the business was a driver’s license. But the people who owned the right to drive were able to make a tidy living, with almost no downside risk. That’s why New York City taxi medallions got so valuable: Two decades of low-interest rates made them an attractive alternative to bonds offering yields in the low single digits.

Her thinking here is that restricting the number of cabs helped cab drivers. This is precisely wrong. Restricting the number of cabs hurt cab drivers but helped owners of medallions; the restrictions caused the medallions to be an artificially scarce resource.

To see the error more clearly, imagine–perish the thought–that the government handed out a certain number of “newspaper medallions” and that that restricted the number of newspapers. How would we know that it restricted them? By noticing that the price of a newspaper medallion was greater than zero. By McArdle’s reasoning, this should help newspaper columnists like her. But it wouldn’t. The restriction would reduce the demand for newspaper columnists and thus reduce the amount newspaper columnists are paid.

Back in 1970, when I was starting to get economics, a cab driver friend of mine in Winnipeg said that if the restriction on cabs were lifted, cab drivers would make less money. I made the same argument then that I’m making here. He didn’t have one of the scarce licenses (they didn’t call them medallions in Winnipeg) and so he would have lost no wealth once the restriction was lifted but would have gained as a driver. Of course, I’m assuming that the supply of labor was not and, in the current case, is not, perfectly elastic (horizontal.) So an increase in the demand for cab driver labor would drive up the price (wage) somewhat.

I pointed out this reasoning, by the way, in my biography of David Ricardo in The Concise Encyclopedia of Economics. See the last paragraph of the bio.

The application to farmers versus owners of farm land was a point that Thomas Hazlett made very clearly in the 1980s in an article or book review either in Reason or in the Wall Street Journal. I’ve forgotten which.