Freedom from Market Frictions

Digital platforms are but the latest innovation to empower workers and unburden consumers.

Independent work—labor performed for the end consumer without an intermediating employer—has been with us as long as there has been trade. It is as American as Mark Twain and the small farm, and it is a significant part of the American economy today. In 2019, an estimated 57 million Americans did some freelance work, bringing in nearly $1 trillion of income—almost 5% of gross domestic product and larger than the entire construction industry.

But in recent years, a new wave of independent work, often referred to as “gig work” and “sharing economy” work, has swept certain industries and created several new ones. Traditional freelancers tended to be professionals whose specialized skills could attract buyers with some modicum of marketing. Today, however, digital platforms make it easy for suppliers and buyers of services and products to find each other—so easy that almost anyone can supply or buy less specialized skills such as driving or assembling IKEA furniture.

Companies like Uber and Lyft have grown explosively by matching riders and drivers for short trips. Instacart has become a grocery lifeline for people quarantining during the COVID-19 pandemic. Airbnb matches people who wish to temporarily rent out rooms or houses that they own to potential guests. TaskRabbit connects people with small tasks to do with people who have the time and ability. Other platforms like Etsy, Shopify, and Substack make it easier for individuals to produce products or content, market it, and get paid for it—no employer needed. Even traditional high-skilled freelancers are using digital platforms like Upwork to facilitate their work.

Not all these types of independent work substitute for a traditional employer-employee relationship. Some 46% of freelancers report that they wouldn’t be able to work at all if they couldn’t freelance. But to the extent that these independent jobs do replace traditional jobs, we might call it a form of “disintermediation”—the removal of a mediating institution, the employer. Or, perhaps more accurately, a change in the type of mediators, where digital platforms connect buyers and sellers of labor—but not as the employer of the sellers.

The new wave of digital-platform-supported independent work has eliminated many costs and market frictions and, in turn, reshaped business models to pass low costs on to buyers and flexibility on to worker themselves. Rather than a novel challenge to be regulated anew, the digital disintermediation of work should be viewed as yet another welfare-generating innovation in a long tradition of such innovations.

Getting More for Less

Some wonder whether this disintermediation has downsides. But to understand the potential downsides of digital gig platforms, we need first to understand how and why they have changed business practices in several industries.

Gig platforms succeed because they reduce what economists call “transaction costs.” Transaction costs are like the drag on an airplane: they are the inevitable friction that results from trading with another party. Transaction costs abound in our everyday marketplaces. When you buy a box of pencils at a retail store, for example, the cost of producing the pencils isn’t the only price you pay. There’s the time you spend traveling to the store, searching the store, waiting in line to check out, paying with cash, or figuring out how to swipe your card. The store also incurs costs when selling you those pencils, such as rent, maintenance, and labor. Likewise, the transaction between the retail store and the pencil manufacturer entails costs, such as transportation and negotiation. All these transaction costs are tangential to the actual production cost of manufacturing pencils, but they are necessary to facilitate the transaction of selling pencils to you. Indeed, from the point of view of the end consumer, all costs are transaction costs.

What makes the sharing economy 'sort of new' is that it is a result of entrepreneurs offering new means to reduce transaction costs without controlling who will offer what products or services as a result.

Companies compete vigorously to reduce costs, including transaction costs, and thereby improve efficiency. In fact, the Nobel-prize-winning economist Ronald Coase claimed that companies exist primarily as a mechanism to reduce transaction costs. Companies are islands of planning and organization in a sea of marketplace exchanges, specializing in certain types of labor, bundling transactions, and streamlining processes to minimize the time and money required to meet customers’ needs. Companies compete in markets, constantly searching out new and more efficient ways to trade. No market is ever perfected or finished because there are always transaction costs to be lowered.

Historically, then, companies have long competed to reduce transaction costs but usually as bundled with a particular product or service. What makes the sharing economy “sort of new,” according to economist Michael Munger in his book Tomorrow 3.0, is that it is a result of entrepreneurs offering new means to reduce transaction costs without controlling who will offer what products or services as a result.

Technologies that reduce transaction costs necessarily affect the shape and behavior of economic actors in the marketplace. If the costs of a particular type of transaction are sufficiently reduced, the company may outsource that type of transaction to an external provider. Reduced transaction costs can also mean that entirely new trades are possible, such as renting a stranger’s spare room. Indeed, such platforms can expand the market for the services that they provide: in NYC, for example, the Uber fleet is three times larger than the number of yellow cabs.

In short, lower transaction costs mean an increased number of arms-length market transactions. You don’t hire a driver anymore; you hail Uber rides. This also holds from the driver’s perspective: rather than compete for an expensive taxi medallion or rent one from a NYC cab company, the driver simply turns on the Lyft app. Munger describes three components of transaction costs that digital platforms, especially sharing economy platforms, address: triangulation (locating products or services and agreeing on terms); transfer (exchanging payment for the good or service); and trust (the assurance that the product or service will be as described). For example, the Uber app helps you locate a driver and identifies the price, makes it easy to pay, and offers a rating system that helps ensure quality service.

Digital disintermediation is, in this context, just another term for technology-driven reductions in transaction costs and the corresponding shift in economic arrangements. It's a dynamic as old as human exchange itself.

Or consider a newer example: the rising Substack platform, which describes itself as a “subscription publishing platform” where readers can subscribe directly to the writers they want to read. Substack helps readers find writers they want to read and helps writers find readers who are interested in their work (triangulation). Substack makes it very easy to charge readers and easy for readers to pay (transfer). And the Substack model provides a trustworthy model for writers owning and controlling the relationship with their fans and supporters (trust). In short, Substack’s lowering of transaction costs disintermediates writers from magazines or newspapers, enabling writers to produce work and get paid without having to satisfy anyone but the readers.

Digital disintermediation is, in this context, just another term for technology-driven reductions in transaction costs and the corresponding shift in economic arrangements. It’s a dynamic as old as human exchange itself. Currency, for example, was a technological innovation that replaced bartering and thus drastically reduced transaction costs across virtually all exchanges. Digital platforms are only the most recent technology to revolutionize what transactions are possible and thus how business is done—right down to the relationship between employer and employee.

Balancing the Tech Trade-Offs

Like all good things, the flexibility that results from reduced transaction costs comes with trade-offs. The most obvious downsides fall on the incumbents with higher transaction costs and who therefore lose out to more efficient competitors. For example, cab companies aggregate the supply of cars and drivers that made it possible to ride in a stranger’s car, but they have been at least partially displaced by ride-sharing apps that further reduce transaction costs. Unsurprisingly, displaced competitors often lead lobbying efforts against transaction-cost-reducing platforms for independent workers.

But the popular narrative of disintermediation centers on the independent workers who use digital platforms. Gig workers, in this story, are cut off from the social structures and legal protections available to traditional employees. Some of these concerns are paternalistic judgments of the choices made by the real people who work in the gig economy. The very benefits that some would argue that gig workers should have—predictability of income, regular hours, certain benefits—are in direct conflict with the main feature of gig work: its flexibility.

There are real concerns, of course, such as the high cost of health insurance for independent workers. But, like health insurance, many of the most tangible “lost” benefits of gig work are artifacts of decades of public policy to promote traditional employment. For example, the U.S. tax code has for decades subsidized employee-offered health insurance—that’s why employers offer health insurance but don’t offer, for example, auto insurance. Leveling the tax treatment of market-purchased and employee-provided health insurance would help address the lack of health insurance for gig workers.

The critics who seek to foist legal strictures on the gig economy for the sake of security or fairness of solidarity ignore a basic truth: there is no 'correct' boundary between what takes place in an arms-length transaction and what is bundled into more traditional employment.

Full-time employment has other, less tangible, benefits, including friendships, opportunities for mentorship, leadership, and personal development, as well as a sense of loyalty that may be difficult to replicate in arms-length, one-off transactions. But these benefits are not guaranteed features of employment; bad coworkers and malicious bosses also exist. Nor are these intangibles completely unavailable to gig workers. I’ve ridden many an Uber with a driver who was chatting away with other drivers. And on platforms like Substack, writers can directly and profitably build trust with their readers, even if their voices might not be welcome in more traditional media outlets.

The critics who seek to foist legal strictures on the gig economy for the sake of security or fairness or solidarity ignore a basic truth: there is no “correct” boundary between what takes place in an arms-length transaction and what is bundled into more traditional employment. As sellers of all kinds compete to meet buyers’ needs, traditional firms, gig workers, and consumers experiment with different business arrangements to see what can best facilitate the deals to be made. Gig work’s flexibility may come with trade-offs—but what it offers, many gig workers prefer.

Empowering Platforms

Digital platforms have circumvented certain employer-employee relationships and thus disintermediated conventional labor-market participants. But in doing so, these platforms have also reduced common frictions between traditional employment and other social institutions, like family, entrepreneurship, and community. These benefits can be substantial—after all, life isn’t just about work.

Gig work offers flexibility that benefits workers with families and appeals especially to primary caregivers—often women. Indeed, women have cited the flexibility of gig work as its main attraction. According to one study, “96 percent of women indicate that the primary benefit of engaging in platform economy work is the flexible working hours.” In fact, “70 percent of those platform working women are the primary caregivers in their homes.” Women also leave traditional work for gig work because they need the flexibility to care for family members. Some 60% of women who recently left full-time work for independent work did so “because they needed flexibility; needed more time to care for a child, parent, or other relative; or both.” Because gig work allows flexible hours, it enables women to better schedule work activities around home activities and has thereby increased female labor-force participation.

Gig work also supports entrepreneurship and business formation. The arrival of gig work in a city increases new business registrations by 4%–6% across several other empirical measures. The gig economy facilitates this growth in entrepreneurship by providing supplemental income and offering the “insurance” of easy-to-start work in the case of failure. The entrepreneur himself need not already be a gig worker. The ready availability of income-generating gigs makes it less risky to start a company. In short, “the gig economy provides the safety net that makes experimentation ‘safe’ to explore.”

Gig work's flexibility may come with trade-offs—but what it offers, many gig workers prefer.

Gig work can also strengthen communities. Sharing economy companies provide unique benefits to individuals and companies in low-income and marginalized communities. Residents of majority-minority communities report that ride-hailing companies, like Uber and Lyft, better serve their neighborhoods than traditional taxi companies that historically neglected them. Researchers have demonstrated that “peer-to-peer rental marketplaces have a disproportionately positive effect on lower-income consumers across almost every measure,” raising living standards most for those who are the worst off. The gig economy’s positive effect on entrepreneurship is particularly strong in cities with poor socioeconomic conditions.

It is likely that disintermediation in employment has not yet reached its apogee. Today’s gig platforms themselves have significant transaction costs that future technologies and business models may further reduce. Some imagine a day when transaction costs to borrow and loan property are low enough that, instead of buying many material goods, people will “rent” such goods, sharing the costs, raising living standards, and reducing unnecessary consumption. Even if that day is far off, the choices that current and future gig platforms provide empower people today to strengthen their families and communities and to exercise their own entrepreneurial spirit.

Changes to employment do highlight the inadequacies of ossified regulatory and tax structures developed in a previous pre-digital era. We should reform these structures but avoid imposing them on the gig economy. Instead, we should explore policy reforms that respect the variety of ways that people choose to earn a living and foster marketplace competition between all different models of work, from independent to employed.

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Neil Chilson is a senior research fellow for technology and innovation at the Charles Koch Institute.