I just got back from a trip to Pittsburgh for a successful thesis defense (congratulations to Dr. Justin Dunmyre) and had an education in taxi cab metering. On my outbound trip to the airport, by sheer coincidence I left seconds behind another cab going to the exact same destination. The meter on that cab, which I could see through the window, read about 15% higher than my meter. On my return trip, the fare on the meter was also much higher than a return fare from just three weeks ago. This led me to think about how meters are calibrated and what disincentive there is for drivers to tamper with them.
When I fly into an unfamiliar city, I get into the first cab available. In most cases, I have no idea how far the hotel is, what is the optimal route, and what the fare should be. I must trust the driver completely. There are so many ways that the driver can overcharge me and I really have little defense. This is why almost all cities regulate taxi cabs.
I think this is also a perfect example of how competition cannot always ensure the best price. In any situation where transactions are not repeated, the classic results of the prisoner’s dilemma should apply. That is to say, it is only rational for the cab driver to defraud the passenger. It is an asymmetric situation where the driver has all the information and the passenger has none. Now I’m sure that libertarian leaning economists would argue that repeat customers and intracity users will be sufficient to ensure that cabs are fair. However, it is not too difficult for the driver to identify who is naive and who is experienced and they can behave accordingly especially for drivers that pick up passengers from hotels and airports, which in many cities is a large fraction of the taxi business.
Now, it is not in the interest of the city to have corrupt taxi cab drivers. It gives a city a bad reputation and that could discourage tourism, conferences and business. That is why it is in the interest of the population of the city to regulate taxi cabs. I do believe that there are cases where regulation only serves as a barrier to entry and discourage competition but in the case of taxi cabs, I’m all for it.