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The Autshumao and Krotoa International Airport of Cape Town: My letter to ACSA

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AutshumaoKrotoa

Renaming of Cape Town International Airport: A proposal

I would hereby like to submit a nomination for Cape Town International Airport’s new name.

Cape Town is an international, cosmopolitan city, a ‘melting pot of cultures’. Many individuals from Cape Town’s rich history deserve to be celebrated in the renaming of Cape Town International Airport. Yet I often find that little attention is given, in place names, traditions, and heritage symbols, to the indigenous inhabitants of the region before the arrival of European settlers in the mid-seventeenth century.

I therefore feel it is appropriate that Cape Town’s international airport should celebrate the people who had lived in the region for several centuries before European arrival, who had contributed to the economic and social development of the Cape, often in subordinate positions of indentured labour, and whose descendants still reside here, now mixed with more recent immigrants from Europe, Asia and Africa, a city that is, indeed, a ‘melting pot of cultures’.

My proposal is therefore to rename Cape Town International Airport to the Autshumao and Krotoa International Airport of Cape Town.

Autshumao was the first inhabitant of South Africa to travel abroad. In 1630, Autshumao was picked up by a British ship – called ‘King Harry’ on board – and travelled to the East. There he learned Dutch and English, and when he returned to the Cape, he would become postmaster on Robben Island. He would also act as the first translator and trader when the Dutch East India Company settlers established a refreshment station in 1652. Autshumao later fell into disfavour as trading partner, and was banned to Robben Island. Nelson Mandela would later call him the ‘first freedom fighter’.

His niece, Krotoa, was a translator in the household of Jan van Riebeeck, the first VOC commander of the Cape. She would marry a Danish surgeon and her progeny would include several South Africans of note, including Paul Kruger, Jan Smuts and FW de Klerk.

Naming Cape Town International Airport the Autshumao and Krotoa International Airport of Cape Town would signal recognition of the first inhabitants of Cape Town, and the ‘melting pot of cultures’ that Cape Town has become.

Kind regards,

Johan Fourie

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Land expropriation: learning from the Chinese

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GreatLeapForward.jpg

The complexity of the debate about land expropriation without compensation can ultimately be summarized into two questions: Should land be expropriated without compensation? And, if so, who should own the expropriated land? While much media attention has focused on the first, with the focus often on how such a policy will scare off foreign investment, it is the answer to the second, ultimately, that will determine the success of any attempt at redress and wealth creation.

The two proponents of a policy of land expropriation without compensation in South Africa – the ANC and the EFF – stand on very different sides with regards to answering the second question: the ANC has made it clear that ownership should be in private hands, while the EFF has forcefully and repeatedly made the case that the state should be the custodian of all land. Their policy would see the state expropriate all private farm land and lease the land ‘equally’ to the people of South Africa. Dali Mpofu, National Chairperson of the EFF and a respected advocate, has defended this stance by referring to China in a 2017 tweet: ‘Chinese land is owned … by the state and it has registered the highest consistent economic growth in the world!’

Mpofu’s example is an interesting one, and worth exploring. Indeed, Chinese economic growth over the last four decades has been a historically unprecedented 8% per year. But Mpofu would do well to note that this growth was not a consequence of agriculture. Between 1990 and 2016, the share of agriculture in GDP has fallen dramatically from 26.5% to 8.5%. This was associated with massive urbanization; in 2016, 57.4% of the total population lived in urban areas, a dramatic increase from 26% in 1990. Far fewer people now live off the land, and those that have moved to the (often new) cities, are remarkably better off.

This is because land is not the valuable commodity it once was in the nineteenth and twentieth centuries. As a way to empower people, land is probably the least useful asset nowadays, because it requires significant investment in physical and human capital to make it productive. Even then, the most valuable assets today are intangible – skills, intellectual property rights, data. In the twentieth century, agriculture could only thrive with significant state intervention in the form of marketing councils, favourable tariffs and other measures, measures that came at the cost of the South African consumer. In the 21st century economy, living off the land – without significant capital investment – will limit the ability of those that most need access to good education and health services and opportunities for social mobility that are found in cities.

This is even more true if the expropriated land is owned by the state. Let us return to Mpofu’s country of choice: China. Between 1955 and 1957, 96% of China’s 550 million peasants were dispossessed of their private property rights. This was the largest movement from private to communal property rights in history. As Shuo Chen and Xiaohuan Lan show in a 2017 paper published in the American Economic Journal: Applied Economics, the results of this process of land dispossession was devastating for the peasants, and the Chinese economy. The authors use data of 1600 counties that launched the movement in different years, and find that in the year of the dispossession, the number of cattle declined by 12 to 15%. In total, this was a loss of almost 10 million head of cattle. Why? Because people started killing their own animals to keep the meat and hides as soon as they released that they will lose the property rights to the use of those animals, and they did not trust the state to be able to safeguard what used to be theirs. This loss also affected grain output, which fell by 7%. We now know that Mao was not discouraged by this initial production shock. No, he doubled down. This initial process of land dispossession set the stage for the Great Leap Forward movement of 1958, which led to the worst famine in human history that killed an estimated 30 million people.

China’s process of collectivization should be the example that Mpofu and the EFF leadership study. If they want more evidence of how collectivization collapses an economy, they need look no further than Tanzania’s Ujamaa and Operation Vijiji, a much understudied but enlightening experience. Or ask our Zimbabwean neighbours about their land reform programme. As Tawanda Chingozha, a PhD student in the Department of Economics at Stellenbosch University, shows using sophisticated satellite imaging technology, Zimbabwe’s land reform programme caused a significant reduction in both the quantity and quality of crops harvested, and not only on formerly white commercial farms. The empirical evidence against state-owned land ownership is unequivocal.

Land is an emotive issue because the memories of dispossession, forced removals, and apartheid segregation remain vivid for many. Others are simply unhappy with the slow process of economic progress in the last decade, and see in land a source of safety and security.

But if land is expropriated and private property removed, the hope of economic progress will be nothing more than a mirage. We have smart people in South Africa. Surely we can find a way of redress that actually empowers people – and won’t replicate our disastrous past policies that subjugated the poorest to a life of poverty on the periphery of progress?

*An edited version of this article originally appeared in the 26 April edition of finweek.

Should South Africa host the 2023 Rugby World Cup?

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South Africa 2023

Tomorrow (Wednesday) we will know whether South Africa will host the 2023 Rugby World Cup. Here are my thoughts on hosting mega-events:

One of my aspirations when I was in high school was to bring the Olympic Games to Cape Town. Imagine a brand new athletics stadium and athlete village at Ysterplaat. Athlone Stadium could play host to sevens rugby, while the breathtaking Cape Town Stadium would host all football games. Newlands Rugby Stadium could be converted into a 20 000-seater indoor gymnastics stadium, Bellville velodrome would play host to cycling, Hartleyvale could host hockey, Camps Bay beach volleyball, Muizenberg surfing, the Waterfront sailing, and Langa could get a brand new boxing venue and swimming pool that could serve the community long after the Olympics is gone. And what better venue to launch the new Olympic code of T20 cricket than Newlands cricket stadium?

The sports stadia would, of course, be just one element of a much bigger infrastructure drive. The largest innovation will be in transportation: a new, world-class international airport, built on the N7 to Malmesbury, would allow Cape Town to lift international arrivals from 2 to 10 million. A new CapeRocket mass rapid rail network would connect the new airport with the city and neighbouring towns of Paarl, Stellenbosch, Somerset West and Simon’s Town, perhaps even Worcester through the Huguenot Tunnel. If a train could take you from Worcester to Cape Town City Center in less than an hour, imagine what that would do to the daily commute – and property prices in rural areas! (That is radical economic transformation, I can hear Cape politicians say.) And an Uber-like app for all city transport, including taxis, now electric, would allow spectators to seemingly move between the different transport modes.

In moments of weakness, these dreams return. But then reality kicks in, informed by several years of research on the impact of mega-events. The picture is not a positive one. In short, the Olympic Games is an expensive undertaking which rarely delivers on the promises of spectacular economic growth. Robert Baade and Victor Matheson, two experts in the field, summarises it best: ‘In most cases the Olympics are a money-losing proposition for host cities; they result in positive net benefits only under very specific and unusual circumstances.’ There are exceptions, of course. Los Angeles in 1984 was a financial success for two reasons: it built very few new stadia, and the costs that were incurred were mostly funded by the private sector. Barcelona in 1992, too, is considered a success, uplifting a city to global tourism status to the extent that Catalonians are now trying to curb tourism.

But these are the exceptions that prove the rule. Most cities that host the Summer Olympic Games continue paying for the event long after the closing ceremony. Montreal hosted the 1976 Olympic Games; Canadians finally repaid all of the debt in 2006, 30 years later. Many even argue that Greece’s economic woes of the last decade was a direct consequence of its 2004 Olympic Games expenditure. Most Olympic venues, built specifically for the event, are, at best, used for occasional events, much like the Cape Town stadium that was built for the 2010 World Cup. At worst, these venues fall into disrepair, and become a huge fiscal burden on the local government. Consider, as example, Rio’s Olympic venues only one year after the event!

Ex post studies of mega-events confirm the visual evidence. In a paper I co-wrote with Maria Santana-Gallego in 2011, we found that mega-events like the Olympic Games and Soccer World Cup boost a host country’s tourism by about 7%. This varies depending on whether the event was held during the off-season (like the 2010 World Cup in South Africa, and unlike the Olympics in Athens), the type of event (the Olympics is held within one city, the Soccer World Cup in several cities) and even who participates in the event.

Even if tourism increases substantially, as it did for South Africa before, during and after the 2010 World Cup, these advantages can easily be undone. In a back-of-the-envelope calculation, I have shown that all the tourism benefits South Africa derived from hosting the FIFA World Cup were undone by our ridiculous visa rules in 2015, a classic case of the negative unintended consequences of good intentions without sound analysis.

Despite the evidence against mega-events, cities and countries still line up to bid for them. It seems like an irrational thing to do, but there are very rational reasons cities and countries do so. These reasons are mostly political. The politician who hosts the event, will often not be the one who pays for it. There is an immense feel-good factor associated with hosting mega-events; having watched 8 games of the 2010 World Cup around South Africa, I know these emotions very well. And voters often vote for politicians not based on calculated policy statements, but on how they make them feel. A second reason is that cities can use a mega-event to get a larger share of the national budget.

South Africa 2023 stadiums.png

South Africa wants to host the 2023 Rugby World Cup. There are reasons for and against doing this. On the positive side, no new large infrastructure will be required. The event will also be held during the tourism ‘off-season’, meaning that rugby supporters would likely not displace other tourists. Its bid document projects an economic impact of R27 billion, with R5.7 billion to low-income households. A total of 39 000 temporary and permanent jobs is expected to be created. Sounds like a no-brainer.

But it’s not that simple; there are few things in life that are certain, but that these numbers are inflated is one of them. Cabinet has already approved a guarantee of R2.7 billion which was required World Rugby. The event will require public resources in an era when budgets are already under considerable stress. On the tourist side, South Africa have strong existing links with rugby-playing countries; tourism is therefore unlikely to see much of an increase before and after the event. And the feel-good factor of a tournament the size of the Rugby World Cup is limited if your team don’t win the finals; as a thought experiment, would 1995 have had such treasured memories were it not for Joel Stransky’s final drop goal?

Despite my childhood dreams, we were fortunate to escape the 2004 Cape Town Olympic bid, and even more fortunate to escape Durban’s Commonwealth Games disaster of 2022. Hosting mega-events are expensive parties, with inflated benefits and underestimated costs. (I should add: this is not only true for South Africa, but for Ireland and France, our competitors for the 2023 bid, as well.)

My heart wants us to win the bid; my head says it’s probably not the worst thing if we don’t. Let’s see what happens tomorrow!

*An edited version of this first appeared in Finweek magazine of 19 October 2017.

Written by Johan Fourie

November 14, 2017 at 07:05

The politics of infrastructure

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Cape Town railway historic

What type of infrastructure would be best for South Africa’s future? The answer, of course, depends on your point of view. If you live and work in Gauteng, your answer might well be to expand the Gautrain network. Or if you reside in Cape Town, you might prefer investments in desalinization plants. Your occupation may also be relevant. If you’re a miner, you are unlikely to support the expansion of renewable energies. A trained software engineer? Well, you’re likely to support large investments in telecommunications infrastructure.

An important – but often underappreciated – role of government is to choose the type of infrastructure that is destined to shape the country’s future development path. This choice is never neutral though: for every decision, there are winners and losers. Choose to build a new coal-fired power plant? That will benefit coal mine owners and workers, while the users of electricity, were the costs of alternative sources to fall rapidly, will pay. Choose to build a high-speed train network across the country (a hyperloop, perhaps!), then users of this network, likely to be high- or middle-income South Africans, will benefit, while long-distance bus services, taxi operators and rental cars will pay. The government’s job, in theory at least, is to choose the projects that will maximize the benefits and minimize the costs.

But things are never that simple. A research paper that will soon appear in the European Review of Economic History, written by Alfonso Herranz-Loncan and myself, investigate the infrastructure in the Cape Colony built during the second half of the nineteenth century. Before the discovery of diamonds in 1867, the few railways that existed (in and around Cape Town) were privately-owned and largely unprofitable. But the discovery of diamonds and the rush to the mines meant the demand for fast, affordable inland transport increased exponentially. The Cape government had to react.

They did. They bought the few existing lines, and then began to the process of connecting Cape Town to Kimberley, finally achieved in 1885. The connection to the booming diamond region brought huge economic benefits: we estimate that the railway may account for 22-25 percent of the increase in income per capita in the Cape during the diamond-mining period (1873-1905). This is a massive share for a single investment and a clear indicator of the transformative power of railways during the first era of globalisation.

But these benefits were not equally shared by everyone. Surprisingly, the government itself earned a meager 3.7% average return on its capital. Had a private firm built the railways, far fewer branch lines would probably have been built. As Stellenbosch PhD student Abel Gwaindepi now shows, the government incurred huge debt to build this infrastructure, and although the government did benefit through customs duties and other tariffs, the main beneficiaries were the owners of the diamond fields. The railway link between Cape Town and Kimberley could now transport the machinery and foodstuffs required to feed the growing Kimberley population. Western Cape wheat farmers, who supplied the mines with food, was another group of beneficiaries. It is not entirely coincidental that it was also these two groups – mine owners and Western Cape farmers – who had formed a political alliance in Cape parliament.

Of course, it was not only mine owners and Cape farmers that benefited. As detailed reports of passengers show, Cape Colony residents from all walks of life used the railways. But, ultimately, it was tax payers who had to foot the debt that were incurred, and often these tax payers were spread across the entire colony (far from the direct benefits of the railways) – and after unification in 1910, the rest of the country. And the location of the railways meant that those with less political influence – like Basotho farmers, who were of course producing wheat much closer to the diamond fields – lost out. Here is one missionary report from 1886, the year after the railway line was completed: ‘Basutoland, we must admit, is a poor country… Last year’s abundant harvest has found no outlet for, since the building of the railway, colonial, and foreign wheat have competed disastrously with the local produce.’

The nineteenth-century Cape railways contributed significantly to economic growth, but it inadvertently also had distributional consequences: some benefited more than others, and some even suffered as a result of its construction.

The lessons for today? Politics shapes the type of infrastructure that’s built. And infrastructure shapes the direction of economic development. So the key question is this: Are we building the type of infrastructure that will put South Africa on a path of broad-based economic development, or is the choice of infrastructure determined by the self-interest of those with decision-making power, much like Cecil John Rhodes and his cronies during the late nineteenth-century?

Put differently, when we choose a new power-generating facility or national air carrier or telecommunications license, do we consider the benefits for society as a whole or the benefits for a specific interest group?

*An edited version of this first appeared in Finweek magazine of 5 October 2017.

How do we build a prosperous, decolonized South Africa?

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boys-plowing

I recently attended an academic conference at the University of the Free State on the topic ‘Decolonizing Africa’. Much of the debate was, understandably, about the past: about the lingering effects of the (Atlantic) slave trade, European colonization that included the imposition of largely artificial borders, and the post-colonial failures of independent Africa. But at the final keynote, delivered by Prof Alois Mlambo of the University of Pretoria, the discussion turned to the future. How do we build a prosperous, decolonized South Africa?

One unescapably emotive topic is land reform. The expropriation and dispossession of land in South Africa is the root, many agreed, of the severe levels of inequality that plague the region. But how to correct this past injustice was not so easy; in the audience, too, were several Zimbabwean scholars quite critical of that country’s land reform programme. Over lunch, one Zimbabwean student told me the tragic story of his grandfather, a former farm worker on a white farm turned successful tobacco farmer after land reform, only to lose his land because he was considered ‘too successful’ by the ruling ZANU-PF party. The farm is now dormant.

Getting land reform right is fraught with difficulty. Not everyone that suffered land expropriation wants to return to farming – by far the largest number of recipients of successful land claims in South Africa choose the cash instead of the land. (This is often ignored by politicians and commentators when simply taking the hectares transferred as measure of land reform success.)  And even when recipients choose to return to the land, they often struggle to support themselves because of the small size of land allocated, or a lack of capital investment, or a lack of technical or management skills. There are also political consequences: because land recipients, like those in Zimbabwe, often do not receive title deed to the land they are given, they become ensnared by the political party that gave them the land. Why do people still vote for ZANU-PF despite the state of the economy? Because they worry a vote for the opposition means that they might lose their land. Most worryingly, it is often the original farm workers who lose the most, like the Zimbabwean student’s grandfather.

This is not to say that some form of wealth redistribution is not imperative. But whereas land (and the minerals it contained) was clearly the most productive resource when it was expropriated in the nineteenth century (which is the reason it was expropriated), a valid question is whether it still is the most productive. Of course, people value land not only for its economic uses: there are a myriad of historic, cultural and religious reasons why the land of your ancestors are treasured. But as a redistributive policy aimed at creating a more equitable society, is land reform the best way to create prosperity for those who suffered historical injustice?

Think of the fastest growing companies globally: which of them still rely predominantly on land ownership? AirBnB is a great example: it is the world’s largest accommodation service, without owning any property! For AirBnB and the myriad other unicorns that have created incredible wealth for their founders and shareholders, it is not land or physical property that creates wealth, but science and technology. (Even farmers know this: that is why they are investing in science to improve their crops and in technology to mechanize production.)

In the twenty-first century, land is what you buy with your wealth, and not the reason for your wealth. A quip about Stellenbosch wine farmers summarize this well: How do you make R1 million farming in Stellenbosch? You spend R2 million.

Prof Mlambo remarked that India and China, both with a history of colonisation, is not growing at above 5% because they have redistributed land. They have prospered because they embraced science and technology. Consider this: in the 2015/2016 academic year, 328,547 Chinese students studied in the United States; only 1,813 South African students did. (If you account for population size, 7 times more Chinese than South Africans students study in the US.) Take South Korea, a country with roughly the same population size as South Africa: 61,007 South Koreans traveled to study in the US in 2015/2016, 33 times more than South Africa.

So how would a redistribution policy look that takes science and technology seriously? I don’t have the answers, but here are some suggestions. Most of us would agree that education is key, but the South African education system has not made much progress in the last decade and it is unlikely to do so in the next. Redistribution must start at the first year of life. Publicly funded but privately run nurseries will remove the gap between the rich and poor that has already emerged when kids arrive at school. For primary and secondary education, a voucher system that incentivize private schools for the poor is an option. At tertiary level, we need more and better-funded universities, notably in science and technology. (It would help to send more of our smartest students abroad to study at the frontiers of science – they will return with new ideas and networks to propel our industries forward.) Visas for and recruitment of skilled immigrants can boost research and entrepreneurship. Improve free wifi access and invest in renewable energies. The private sector, because that is where most innovation occur, can be incentivized through appropriate legislation to offer shares to workers – or to those living in communities where they operate. There are a myriad of innovative possibilities.

If Zimbabwe has taught us anything, it is that politics may triumph over economic logic. Land reform in Zimbabwe was not an economic strategy in as much as it was a strategy to keep the ruling party in power. It has had severe economic consequences, as anyone visiting Zimbabwe today can attest. The real radical economic transformations of our age – just in my lifetime, the Chinese has managed to reduce the share of people living in absolute poverty from 88% to less than 2% – have not come from redistributing an unproductive twenty-first century resource. It has instead been the result of investments in science and technology. Any attempt to redistribute with the purpose of building a more prosperous society should take this as the point of departure.

*An edited version of this first appeared in Finweek magazine of 29 June 2017.

How to get good politicians

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South African President Jacob Zuma visit Berlin

Politicians can shape the fortunes of countries. Presidents, in particular, set the tone: balancing many stakeholder interests, their job is to create a unifying vision that should guide policy-making. Members of parliament act upon this vision, designing and implementing policies that affect the lives of millions of people. One would imagine, then, that those with the best aptitude for leadership get elected.

That is the theory. But in practice politics is a messy business. For many reasons, it is often not the smartest candidate who gets elected, or the most effective member who gets selected for higher honours. Some economic models even explain why it is not the most capable that move up: Someone without a proper education (but a charismatic personality) has a much higher chance to see greater returns in politics than in the private sector. (In technical terms, lower opportunity costs give the less able a comparative advantage at entering public life.) These selection effects are compounded by the free-rider problem in politics, where work effort is not directly correlated to political outcomes. In other words, according to this model, it is society’s ‘chancers’ that are more likely to end up in politics – and the hard-working, smart ones will tend to end up in the private sector.

Competency in public office is, of course, is not the only goal of a parliamentary system. Representation – having politicians that reflect the demographic and geographic make-up of society-at-large – is also a key concern. But competency and representation, at least theoretically, do not always correlate. Take the following example: a proportional representation system, like we have in South Africa, would require members of all districts to be represented. But what if one region – let’s call it Farmville – has few university-trained citizens, whereas another region – Science City – has many citizens with university degrees? A proportional representation system will necessitate some Farmville politicians also be elected to parliament, even though the Science City politicians will probably be best qualified for the job. In contrast, in a plurality rule system – where the candidate with the most votes gets the job – competency often trumps representation.

A new NBER Working paper – Who Becomes a Politician? – by five Swedish social scientists, casts doubt on this trade-off. Using an extraordinarily rich dataset on the social background and competence levels of Swedish politicians and the general public, they show that an ‘inclusive meritocracy’ is an achievable goal, i.e. a society where competency and representation correlate in public office. They find that Swedish politicians are, on average, significantly smarter and better leaders than the population they represent. This, they find, is not because Swedish politicians are only drawn from the elite of society; in fact, the representation of politicians in Swedish municipalities, as measured by parental income or occupational class, is remarkably even. They conclude that there is at best a weak trade-off between competency and representation, mostly because there is ‘strong positive selection of politicians of low (parental) socioeconomic status.

These results are valid for Sweden, of course, which is a country unlike South Africa. Yet there are lessons that we can learn. First, what seems to matter is a combination of ‘well-paid full-time positions and a strong intrinsic motivation to serve in uncompensated ones’. In other words, a political party in South Africa that rewards hard work for those who serve in uncompensated positions, are likely to see the best leaders rise to the top, where they should be rewarded with market-related salaries. Second, an electoral system which allows parties to ‘represent various segments of society’. Political competition is good. Third, the ‘availability of talent across social classes’. This, they argue, is perhaps unique to Sweden, known for its universal high-quality education.

This reminded me of our State of the Nation red carpet event, where the cameras fixated on the gowns and glamour of South Africa’s political elite. How do the levels of competency in our parliament, I wondered, compare to Sweden and other countries?

Let’s just look at the top of the pyramid. The president of Brazil, Michel Temer, completed a doctorate in public law in 1974. He has published four major books in constitutional law. The Chinese president, Xi Jinping, also has a PhD in Law, although his initial field of study was chemical engineering. Narendra Modi, prime minister of India, has a Master’s degree in Political Science. Former US president Barack Obama graduated with a Doctor of Jurisprudence-degree magna cum laude from Harvard University. Angela Merkel, chancellor of Germany, has a PhD in quantum chemistry. Most of these widely respected leaders gave up a top job in the private sector or academe to pursue a political career.

Politics is messy, but given the right conditions, it can still attract high-quality leaders. For that to happen, though, aspiring politicians must put in the hard yards, even if initially uncompensated, supported by a competitive political party system and broad access to quality education. South Africa, unfortunately, is still a long way from meeting these criteria.

*An edited version of this first appeared in Finweek magazine of 9 March.

Written by Johan Fourie

March 24, 2017 at 07:35

How Uber makes the world a better place

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uber-logo

The first thing students are taught in any introductory microeconomics course is that the price of something, let’s say chauffeur services, and the quantity of it that consumers want is depicted by a negative-sloping demand curve. The difference between what consumers are willing to pay for a chauffeur ride (the demand curve) and what the chauffeur asks (the market price), is what is known as the consumer surplus. The bigger the consumer surplus, the better for society.

But even though the idea of consumer surplus is used in many applications, measuring it has always been problematic. That is because, in the real world, demand and supply move together, and it is therefore difficult to establish the exact shape of a demand curve.

That was, until Uber. A team of economists (including Steven Levitt of Freakonomics fame) recently published an NBER Working Paper that uses almost 50 million UberX ‘consumer sessions’ to identify a demand curve for taxi services, and then calculate the consumer surplus that these services generate. A ‘consumer session’ is basically when someone logs onto the UberX app and requests the price for a proposed trip. The consumer either accepts the price and wait for an Uber driver to pick them up, or they don’t, and find alternative transport.

What makes Uber unique is that its prices vary according to demand (for its services) and supply (the availability of drivers). This unfortunately also means that it is not possible to simply calculate a demand curve when the price increases by 10%, because the increase might be the result not of greater demand by consumers for Uber trips, but of lower supply (having fewer drivers on the route). The research team use a clever trick to get around this. Say the algorithm predicts that the price must increase by 1.249. This is then rounded down to 1.2 for the consumer. Other times the algorithm suggests the price must increase by 1.251, but the app then rounds this up to 1.3. It is this discrete difference when the price is essentially the same which the authors exploit using regression discontinuity analysis.

uber_advertIf this sounds very geeky, the results are worth the wait. First, the authors find that demand is quite inelastic (around 0.5). This means that if prices increase by 10%, demand will only fall by 5%. Second, they compute the dollar value of consumer surplus in Chicago, Los Angeles, New York and San Francisco to be roughly $2.8 billion annually. This is more than six times Uber’s revenue in those cities. Put another way, for each $1 spent on an UberX ride at the lowest price, the authors estimate that the consumer ‘receives’ $1.57 in extra surplus. In short, Uber generates massive benefits for society-at-large.

Why does Uber generate so much consumer surplus compared to normal taxi operators? Another NBER Working Paper, written by Judd Cramer and Alan Krueger, suggests that it is because of the higher capacity utilisation rate of Uber drivers: “UberX drivers spend a significantly higher fraction of their time, and drive a substantially higher share of miles, with a passenger in their car than do taxi drivers.” There are four reasons for this. First, Uber’s better matching technology (an app that anyone can download on their phones). Second, the larger scale of Uber’s usage in comparison to taxi companies. Third, highly inefficient taxi regulations which limit the number of routes or time periods taxi drivers can operate. Fourth, Uber’s flexible labour supply model and pricing model which match supply with demand.

South African regulators have had varied responses to Uber’s entrance in the local market. There has been opposition from the taxi industry, sometimes violent. Proponents of Uber, on the other hand, often highlight the entrepreneurial and job-creating opportunities the service creates.

What this research shows, though, is that Uber’s main benefit is the massive surplus it generates for consumers. According to the Levitt research team, one day’s worth of consumer surplus in the four US cities they analyse is worth about $18 million. “If Uber were to unexpectedly disappear for a day, that is how much consumers would lose in surplus.”

Aside from this consumer surplus, Uber services create many positive externalities, from lower congestion and pollution levels to semi-skilled employment to, perhaps more tenuously, greater social interaction and cohesion – I’ve had some fascinating conversations with Uber drivers, and know of one driver that was offered a scholarship by a client. But, most importantly, when regulators and policy-makers debate the pros and cons of Uber and other such services that will almost certainly appear in the next few years, it is worth remembering one of the basic principles of introductory economics: the immense benefits society derives from the additional consumer surplus.

*An edited version of this first appeared in Finweek magazine of 20 October.

Written by Johan Fourie

November 23, 2016 at 08:56