The Sharing Economy: An Ocean of Unconscious Cooperation

The sharing economy is a topic of hot debate. It means different things to different people. For investors, firms like Uber and Airbnb offer tantalizing market capitalizations. For visionaries, the peer-to-peer transaction model represents a new, post-capitalist economic reality. Meanwhile, critics see the rise of these services as just another brick in the winner-takes-all wall.

Whatever your view, the collaborative economy chronicle is certainly becoming harder to ignore. Take Uber, the San Francisco Internet firm offering ride sharing. Perhaps unexpectedly, Uber is battling against vested interests. Taxi-drivers everywhere are uniting against it, taking them to court, securing bans and organizing protest marches. By the law of unintended consequences, the protests generated more publicity for Uber – bringing them to the attention of new clients!

With a market capitalization nearing that of Hertz and Avis combined, Uber is a darling of the peer economy. And Airbnb, which allows people to rent out spare rooms to strangers, enjoys a capitalization in the billions. The sharing economy is creating many new business opportunities. LeftoverSwap allows you to share the surplus noodles or curry you ordered. You can rent your household tools from neighbours with SnapGoods and Streetbank. DogVacay lets owners leave their dog with a host…there are myriad new businesses sprouting all over the globe.

Don’t Believe the Hype?

Critics of collaborative consumption claim that the hype is undeserved, that the business model is largely based on evading regulations and breaking the law. They argue that peer services are unfair competition to conventional companies, bound by higher regulatory standards; that the real test would be if sharing services were to last if they were forced to operate on a level playing field.

These criticisms fail to take into account that the sharing economy exists because it uses a new technology that reduces transaction costs . Uber and Airbnb simply provide information. They do not satisfy needs in a radical new way. They just make it easier for users to do something very familiar. But because they can do it with lower transaction costs, they can offer traditional goods and services more efficiently to a larger market.

This idea goes back some 80 years, to 1932, to a lecture given in Dundee, Scotland, by a 21-year-old professor called Ronald Coase. “The Nature of the Firm” became one of the most influential papers in the economic literature, and in it Coase answered some of the fundamental questions in economics.

If the market is an effective tool striking bargains and setting prices, why does it not dominate all economic activity? Why are some interactions internalized in large, complex enterprises? Or, why do firms exist? Why don’t entrepreneurs work as solo profit centers outsourcing each stage in the production chain?

The answer, Coase argued, lies in the presence of imperfect information and the importance of minimizing transaction costs. That is, the cost of searching for the right deal, negotiating the right contract, avoiding opportunistic post-contract behavior, and coordinating the production and marketing processes. In place of costly spot bargaining, a firm can reduce costs by setting up long-term contracts, such as an agreement with an employee to pay a monthly salary in return for set hours of work. “There’s a cost of using the price mechanism,” Coase said. And, citing D.H. Robertson, he suggested that this is why we find “island of conscious power (firms) in the ocean of unconscious cooperation (the market.)”

Coase effectively set up the framework for analyzing the impact of the Internet on the way we cooperate with each other in the marketplace. When “The Nature of the Firm” was published, giant multinationals such as General Motors were just coming into prominence. Coase observed first-hand the efficiencies to be gained by internalizing market transactions. And later in his life, Coates was able to observe how the Internet drastically altered the balance between the islands of conscious power and the ocean of unconscious cooperation. The Internet reduced transaction costs in the market more quickly than technology did in firms.

A Shift in How We Cooperate

The new technology brought at least two important changes to how people cooperate. First, it radically changed the optimum size of firms. More activities were left up to the market so in several industries outsourcing became widespread. Second, it made it profitable to use idle resources such as empty rooms and unused cars, and this created competition, extended markets, and jeopardized some industry structures.

The new technology also enabled crowd-based ratings at low marginal costs. Online ratings allow customers to do what we previously thought tight regulations were needed for. Before the rise of technologies that made it possible for Uber, Sidecar, and Lyft to exist, the taxi industry was able to argue that regulations prevented customers from being ripped off and safety requirements violated. Customer ratings overcome these issues. After all, would you be more confident having a cab driver with a long list of good reviews or one with a license issued by your local bureaucrat?

So the sharing economy has not, for the most part, birthed many truly novel services. Instead, what it has done is harness technology to connect buyers and sellers who otherwise would not have connected.

This is not the end of capitalism as we know it. The sharing economy is just a shift – albeit a fundamental shift – in the way individuals cooperate. We should not, however, underestimate the impact of this change. It poses several challenges. One is that the existing regulatory structure is not well-suited to the coming world. Another challenge is that like previous economic transformations, these changes do, in fact, result in winners and losers. How much would you be willing to pay for a New York City taxi medallion, which trade for a bit more than $1 million apiece?

Stay tuned because the sharing economy saga is just starting off. There are interesting times ahead.