Beware bogus taxi surcharges when travelling on an expense account

In my ECON100 and ECON110 classes, we discuss moral hazard. In ECON110, we also discuss supplier-induced demand. So, I was interested to read this new paper (ungated earlier version here) by Loukas Balafoutas (University of Innsbruck), Rudolf Kerschbamer (University of Innsbruck), and Matthias Sutter (European University Institute), published in the journal The Economic Record.

In the paper, Balafoutas et al. look at moral hazard among taxi drivers. Recall that moral hazard is the tendency for a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behaviour. That is, moral hazard is a problem of post-contractual opportunism, where people have the incentive to change their behaviour to take advantage of the terms of the agreement (or contract) to extract additional benefits for themselves, at the expense of the other party.

However, what the authors are looking at in this paper isn't your run-of-the-mill moral hazard. They distinguish it as what they call second-degree moral hazard:

As an illustration consider the market for health care services and assume that the consumer of the service – in this case, a patient – is fully insured and interacts with a seller of the service – in this case, a physician. Moral hazard implies that the patient may have incentives to demand more of the service than required (by asking for more numerous or more extensive tests or treatments), since he will not bear its costs. However, the behaviour of the physician may also be affected by the extent of the coverage: if the physician expects that the patient is not concerned about minimising costs, he may be more inclined to suggest or prescribe more expensive treatments. Notice that the two stories – which we will call first-degree moral hazard and second-degree moral hazard – are observationally equivalent in terms of final outcomes, in the sense that more extensive insurance coverage leads to higher expenditure, but the mechanisms are different. While first-degree moral hazard operates through the demand side, second-degree moral hazard increases expenditure through supplier-induced demand – the artificial increase in demand induced by the actions of the seller.

Supplier-induced demand occurs when there is asymmetric information about the necessity for services. In a city that is unfamiliar to the taxi passenger, they may not know the shortest route to get to their destination, whereas the taxi driver does. So, the taxi driver has an incentive to take the passenger on a longer (and more expensive route). Balafoutas et al. note:

In the case of taxi rides in an unknown city, the service traded on the market is a credence good... meaning that an expert seller possesses superior information about the needs of the consumer. In particular, the driver knows the correct route to a destination while the consumer does not. This property of credence goods opens the door to different types of fraud: overtreatment occurs when the consumer receives more extensive treatment than what is necessary to meet his needs (with taxi rides, this amounts to a time-consuming detour); in the opposite case of undertreatment, the service provided is not enough to satisfy the consumer (i.e. he does not reach his destination); finally, in credence goods markets where the consumer is unable to observe the quality she has received, there might also be an overcharging incentive, meaning that the price charged by the seller is too high, given the service that has been provided.

The paper uses an interesting field experiment to tease out how (and by how much) taxi drivers engage in second-degree moral hazard behaviour. They used four research assistants (two male, two female), who each took 100 trips across Athens. All four of them went on each trip within a few minutes of each other (to ensure they faced similar traffic situations, etc.), and two of them (one male, one female) made it clear to the driver that their (the passenger's) employer was paying for the ride (which I guess was true - the researchers no doubt paid for these rides). The research assistants then recorded the price paid for the journey, plus measured the distance travelled using a portable GPS. This allowed the authors to compare rides between male and female passengers, as well as between the 'moral hazard treatment' and control. They found that:

our moral hazard manipulation has an economically pronounced and statistically significant positive effect on the likelihood and the amount of overcharging, with passengers in that treatment being about 17% more likely to pay higher-than-justified prices for a given ride. This also leads to significantly higher consumer expenditures in this treatment on average. At the same time, the rate of overtreatment (by taking time-consuming detours) does not differ across treatments. Hence, second-degree moral hazard does not increase the extent of overtreatment compared to the control, while it does increase the likelihood and the extent of overcharging.

The actual mechanism of the overcharging was interesting:

In the large majority of these cases (86 out of 112, or 76.8%) bogus surcharges were applied, namely higher-than-justified extras from and to the airport, the port, the railway station and the bus station. The second most frequent source of overcharging (14 cases) were manipulated taximeters or the use of the night tariff during daytime, while rounding-up (not tipping!) of the price (by more than 5%) accounted for the remaining twelve cases of overcharging.

I also found it interesting that in the control, female passengers were more likely to pay a higher fare than male passengers. However, in the moral hazard treatment (i.e. when passengers told the drivers their employer was paying) there was no gender difference in overcharging.

Overall, this is a really interesting use of a field experiment to tease out results that would not be easily possible in other ways. The only part of the paper that made me a little concerned was buried in a footnote:

We note that the sample initially consisted of 256 observations collected in 2013. The remaining 144 observations were collected in 2014 at the advice of the editor and referees and resulted in stronger statistical significance. Based on the initial sample alone, some of the results outlined in subsection 2.2 were only marginally significant.

This trick of boosting the sample size in order to generate effects that are statistically significant is a trick that experimental psychologists use, and shouldn't really be condoned. It's been implicated in the replication crisis that psychology is facing. At least they were up-front about it, and the results were published. But imagine, if the results became less statistically significant, then what do they do? Not publish? Or continue to collect additional data, until eventually they attain some statistical significance?

Anyway, that little gripe aside, I found this paper a good read, with important implications. One of which is that I will certainly be looking out for bogus taxi surcharges the next time I take a taxi from the airport in a strange city.

[HT: The Economist]