Working Paper Series, Center for Labor Studies,
Uppsala University, Department of Economics

Abstract: Economists often point out that regulations meant to correct market failure sometimes do more harm than good, in particular in developing countries. In this paper, I set up a field experiment to test this proposition in the Cape Town market for metered taxis. I find that if strictly enforced, the local meter regulations provide taxi drivers with an incentives to take detours in order to inflate mileage. Strict compliance to the regulations decreases the trade surplus by 10 percent and increases carbon dioxide emissions by 8 percent. Both private and environmental costs are reduced if the regulations are sidestepped and replaced by informal bargaining. I show theoretically that these results are consistent with a model where the regulations frame the informal bargaining process through the outside option. The combined results show that regulations can have unintended consequences that go well beyond local markets, but that deregulation does not necessarily achieve the first-best.

Keywords: Informal sector; Market regulations; Taxi Experiment; Incomplete Contracts; Transac- tion Costs; Institutions; Natural Field Experiment; Environmental Economics

JEL-codes: H10; Q50

26 pages, First version: December 5, 2011. Revised: August 12, 2013.

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