The economic case for towing kickbacks

The city's 'medallion' system fosters inefficiency

officers, while corrupt, were providing competition

March 01, 2011|By Andrew Samuel and Jeremy Schwartz

When 17 Baltimore City police officers were arrested last week for steering towing business to a non-authorized company, it was hardly surprising to economists. In fact, most economists would predict that such "corruption" would be inevitable in Baltimore's highly regulated towing market. What may be surprising to some is that such kickbacks may contribute, in a way, to economic efficiency.

Baltimore city runs a "medallion system," which gives authorized towing companies exclusive rights over police-dispatched tows and illegally parked vehicles. The city restricts these companies, when called to an accident, to charge no more than $140 per tow. The rationale is that it prevents so-called predatory pricing. At accident scenes, towing companies have all the bargaining power to charge a very high price. These high prices could hold up the towing process and delay clearing vehicles from the accident scene, as many people may not be willing or able to pay this price. Thus, the city clearly has reason to prevent such predation.

However, despite the good intentions behind keeping the price artificially low, it is not clear that the current medallion system corrects the problem. Indeed, the medallion system creates precisely the incentives for the alleged extortion racket that was exposed in Baltimore recently. Much as New York City's rent control system forces rents lower than market rates, the medallion companies are forced to charge a price lower than what many drivers are willing to pay. Thus, there are clear incentives for non-medallion companies to try to enter this market illegally and charge a higher price.

For example, if motorists are willing to pay, say, $600 for a tow, then a non-medallion company could charge up to that amount and capture some of the market — as long as customers do not know that medallion companies are required to only charge $140. This is where the extortion racket arises. Since non-medallion companies can charge higher rates, either directly through towing charges or subsequently in auto repair costs, they can easily afford to pay a dishonest officer the several hundred dollars the Sun has reported they received to "steer" accident victims to them. Thus, the medallion system creates a black market for towing, and the incentives for this extortion racket arise from the very system that was designed to prevent (legal) extortion.

While the city certainly views extortion as a problem, economists do not always agree. The police officers have taken it upon themselves to allow firms to enter this market (albeit illegally), effectively increasing competition among towing companies. Further, like landlords who under rent control allow real estate to depreciate and provide poor maintenance service to their tenants, we may reasonably suspect the medallion towing companies of providing inefficient service to the city and its drivers. Indeed, introducing greater competition could provide accident victims with better service and increased efficiency, even if the improvements result from bribery. Thus, setting aside moral and legal questions, from an economic standpoint, the biggest problem with what the officers did was perhaps to concentrate on just one towing company rather than many.

If the city provides incentives for crime, and if these actions may have improved economic efficiency, of what "economic crime" are these officers actually guilty? By guiding business to one company, they limited consumers' information, when information is critical to making a proper economic decision. Today's Internet-savvy consumer has access to unbiased product reviews of thousands of her peers, which only enhances her ability to choose which product to buy. Often these companies provide reference bonuses to consumers that recommend a product or service. But when recommendations become big business, they are no longer unbiased, and consumers can be influenced into making a dishonest recommendation solely for the money. Similarly, when police officers use their positions of authority to influence and (mis)guide consumers' decisions for their own benefit, the consumer loses.

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