Economics & Finance,Social Responsibility
• 9 minute read
The Unknown Benefits of Black Markets
Research on the license plate market in China’s capital finds that black markets can potentially serve as an auction mechanism to redistribute limited resources to those in need
By Jaymee Ng, Principal Writer, China Business Knowledge@CUHK
It’s human nature – where there is regulation governing the transaction of goods and services, a black market which allows people to skirt the rules and make a quick profit would also typically arise and, in many cases, thrive. No one really knows how big they are, and what makes them illegal can either be the goods and the services traded or the illegal nature of the transaction or both. Although black markets operate on the on the sly side of the law, findings from a recent study conducted on the Chinese license plate market has added to the argument that they help to smooth the functioning of economies by lubricating market distortions brought about by government regulation, and relocating resources to those who are in need. It does so, however, at very high transaction costs.
The study The Black Market for Beijing License Plates was co-conducted by Mandy Hu, Associate Professor in the Department of Marketing at The Chinese University of Hong Kong (CUHK) Business School, Prof. Øystein Daljord and Prof. Guillaume Pouliot at the University of Chicago and Prof. Xiao Junji at Lingnan University.
“Black markets are inherently not very efficient as transaction costs can be very high.” — Prof. Mandy Hu
There are different types of black markets, but they usually involve a combination of government quotas and price controls driving up demand that could not be met by the “white” or the legal and authorised market for goods and services. Some are driven primarily by licensing restrictions, meaning that the government imposes a certain quota on the number of licenses being issued and the demand for these licenses is usually greater than the supply. The black market for license plates in Beijing studied by Prof. Hu and her co-authors is one example of licensing-driven black markets.
Other types of black markets can primarily be driven by trade, such as illegal immigrants who do under-the-table jobs to make ends meet; or regulations, which will happen when the government decides to impose price ceilings and consequently create shortages for the items with capped prices. For example, the government may cap the price for bottled water following a natural disaster because there is a shortage of water but as the water quickly runs out, people may be willing to pay extra money to get water on the black market.
The Chinese Black Market in License Plates
In urban China, traffic is a major problem and to address congestion in its megacities, local governments have adopted schemes to ration the issue of new car license plates to control the number of cars permitted to drive within city limits. The schemes vary from city to city. For example, Shanghai has adopted an auction mode which has driven the price for a new car license plate be as high as a new car in some cases. Guangzhou, Shenzhen and Hangzhou have implemented hybrid auction and lottery systems whereby a portion of license plates is auctioned to the highest bidder while the rest is randomly assigned to people by lottery. Beijing, on the other hand, is using solely the lottery mode and the chances of getting a new car license plate in the capital were one in 2,898, according to a report in China Daily.
Beijing formally implemented the lottery mechanism in 2011 and a black market for license plates emerged soon after. In theory, the license plates are not transferrable, but what can be transferred are the cars attached with these license plates. This has led to the growth in popularity of loophole-exploiting schemes as a way for those not lucky enough to secure access to a new license plate such as phoney marriages, where a person marries someone who owns a car with a Beijing license plate and they usually divorce soon after the transfer is done. Car rentals, meaning that the license plate holder and the person in need of a license plate sign a fake car rental contract to cover up the fact that the license plate is being sold, is another popular way of getting license plates on the black market.
Given the complexity of the license plate trade, it is not surprising that the price of a Beijing license plate can be exorbitant. In 2019, the newspaper Beijing News did an investigative report on the Beijing license plate black market and found that the price for a vehicle tag was going for as much as 160,000 Chinese yuan, which is almost the price for a foreign branded sedan.
In approaching their research, Prof. Hu and her co-authors wanted to explore how black markets correct distortions in the market created by regulation. The biggest challenge they faced was that black market transactions are (by definition) not officially recorded. To get around this, they sought to infer the size of the black market in Beijing by comparing the data on nearby markets such as Tianjin and Shijiazhuang, which are less than 150 km and 270 km away, respectively.
They compared the transactions of new car sales in Beijing before and after the lottery and cross-referenced transactions with those in neighbouring cities to control for any change in demand over time that was not related to the introduction of the license plate lottery. The researchers obtained the vehicle registration data in 35 Chinese cities from a Chinese marketing research company for the period between January 2010 and December 2015. They found that the average price of new cars in Beijing surged by 24 percent following the introduction of the car license plate lottery, while the average price of new cars in Tianjin and Shijiazhuang only went up by about 3 percent in the same period, meaning that the new car license plates were somehow being channelled to more expensive cars through a black market.
“If the license plates were indeed assigned to random users by the lottery and there was no black market trade, then we would have seen fewer new car sales. But our results tell a different story,” Prof. Hu says. “The surge in Beijing’s new car prices strongly suggests a healthy black market trade for license plates exists and that these license plates were sold to wealthier car buyers, who buy more expensive cars.”
Tacit Government Approval
Although the license plate black market operates outside of the law, the researchers believe that the proliferation of local and international media reports that detail the ease with which buyers can procure license plates in the city through less-than-completely-legitimate means suggests that at the very least it exists with the tacit approval of the Beijing government. Prof. Hu points out that one possible reason may be that the scale of the trade is too large, and consequently the cost of strict enforcement might be too high to bear. Another possibility is that some illegal trade occurs between family members, which makes it difficult to regulate.
Looking at their data, the researchers found that roughly 11 percent to 27 percent of the license plates that were assigned by the lottery were traded on the black market, representing an estimated net gain of 1.3 billion Chinese yuan to 5.3 billion Chinese yuan. “In a way, the black market is serving as a de facto auction mechanism that allows the license plates goes to the highest bidder,” says Prof. Hu.
“What we are seeing is in fact a lottery and a black market acting in tandem in the same way that a hybrid allocation mechanism would to correct some of the misallocations of the license plates, similar to the auction/lottery hybrids in cities like Tianjin and Guangzhou,” adds Prof. Hu. “But a black market can only be as efficient as an auction without any transaction costs and we find that these transaction costs can be very high.”
High Transaction Costs
The researchers noted that the inherent illicit nature of black markets creates extra transaction costs, which in the Beijing context could include items such as potential legal liability that come with signing a fake car rental agreement. In this case, if a person who “rents” a car from the legitimate license plate holder gets into a traffic accident, it is the license plate owner but not the driver who would be liable.
There could also be non-monetary transaction costs, as would be the case for people who may feel uncomfortable with breaking the law simply to secure the use of a motor vehicle. Other costs may include the effort and time invested in finding a reliable seller online and the difficulties of enforcing illegal contracts. Even though the profits of the black market license plate trade seem high, Prof. Hu and her co-authors point out that a large portion of it could be lost to transaction costs.
In the study, the researchers used information from news reports to infer the transaction costs and prices for the car licence plates sold on the black market. In addition, they developed a theoretical model of the black market that uses people’s willingness to pay for Beijing license plates to derive the demand and supply for license plates on the black market. The results show that the black market itself could only realise between 7 percent to 28 percent of the potential gains from the license plate trade while about 61 percent to 82 percent were being lost to transaction costs.
Prior studies conclude that the lottery/auction hybrid mechanism in Guangzhou has an efficiency of about 83 percent. Based on their calculations, Prof. Hu says the Beijing black market can have 30 percent efficiency at most, and the number can be as low as 10 percent.
“As for why would government tolerate the operation of an illicit market so openly? Perhaps they see it as a second-best solution to solve the problems brought by the lottery. The problem with that scenario is that black markets are inherently not very efficient as transaction costs can be very high,” Prof. Hu says. “It would be interesting to see if Beijing would rectify or stick with this mechanism for the foreseeable future.”
