An Argument for the Sharing Economy

I haven’t taken a taxi in about three years. In the rare occasion that I find myself needing one, my smartphone comes to the rescue. A few taps later, I’m being picked up by someone under the corporate umbrella of UberX. Such is the nature of today’s sharing economy. Since the advent of the internet, the sharing economy has been made increasingly convenient as well as cheap. Users of online platforms such as Uber who are on either side of the buy-sell agreement are matched together to facilitate transactions that would not have been possible otherwise.

Kind of like online dating, but less disastrous.

Among the most well-known of these companies are Uber and Airbnb, platforms that have used the sharing model to disrupt their respective markets, taxis and hotels. The operating idea is that people do not always use their resources at maximum capacity. Cars, for example, are left unused 95% of the time. The combined value of the unused capacity is called idling capacity. These platforms were built to capitalize on that, allowing providers to “cash in” their idling capacity by renting out their resources to people who are willing to pay. What they all do in common is give regular people a way to do business, provided they meet certain criteria. As long as you have a couple hours and a car, you can be a taxi driver. As long as you have a spare room in your house, you can be a hotel.

                      

In economic terms, the providers believe that the economic benefit from using the online platform to share their resources outweighs the opportunity cost of using those resources for themselves. In some cases, providers may see zero opportunity cost in sharing. For example, if an owner of a property knows they will have to be overseas for a couple months, then they experience no opportunity cost by using Airbnb to rent it out for a while – their house or apartment would have been sitting there, gathering dust anyways.

Another way of looking at opportunity cost is the provider’s ability to opt out of providing the service at any time. While a taxi business remains a taxi business no matter the demand for taxis, an Uber driver can choose not to work on days where they will not see business. The scales of cost have tipped to the other side – now, it is better for them to use their car and time for other activities that have more value.

Sounds fantastic. Now, the question is, what are the advantages and disadvantages of such a system?

The Bad News

All for One

The nature of these platforms ensures that each region will eventually be dominated by one platform. It’s easy to see why. It is in the best interest of the buyer to have the most sellers, and vice versa, because the number of users directly impacts how easy it is for both parties to do business. As a result, people will be more and more likely to join the largest platform, ignoring the smaller ones. In the case of Airbnb, a provider wants the market with the most customers to have the best chance of getting his property seen, while the customer wants the market with the most variety of accommodations. Intrinsically, the value of a sharing economy comes from other users.

This is known as a natural monopoly. The barrier to entry of new platforms is exceedingly high. It is very difficult for new platforms to attract enough users to even start competing. Even Lyft, a popular competitor and alternative to Uber, commands only a distant second place, with a mere 13.9 million trips against Uber’s 62 million as of July 2016.

Users of these sharing services are bound by the terms and conditions set forth when they opened the app, which is really a disguised contract. This grants the company power over its users. They can control the price as they wish. They determine what they take as a cut from each transaction. The only recourse open to users is to leave the service – but to what? If there exist no comparable services in the same area, you’re out of luck.

Law and Order

The advent of the sharing economy is a legal and regulatory nightmare, for both the government and the sharing economy. Businesses like Airbnb have expanded exponentially, moving into cities much faster than they can legislate. In some cities, incumbent organizations lobbied the government to slam the newcomer and bar it from operating, while in others, it is allowed to roam freely.

One tough question to answer regards the employment status of those who choose to use their resources to earn money on these platforms. A whole slew of issues come up. Are they considered employees or contractors? Self-employed? What if, like 19% of Uber drivers, they work full-time, counting on the sharing economy for all of their income? The verdict is all over the place on this one. In the U.K., they are employees, but only if the driver brings it up.

The Incumbent

Finally, existing traditional businesses in fields that are being introduced to the sharing economy will experience a decline. As the sharing economy expands, it will invariably draw people away from existing businesses as they provide a substitute good or service. The introduction of Uber and its subsequent expansion is correlated strongly with a decline in yellow-cab taxis in New York. Airbnb has expanded its operations by incredible amounts year over year, undoubtedly chewing a bit off of hotels’ market share. Why is this happening?

321
Market share of Taxis vs. Ridesharing services in New York City.

Sharing economy businesses have very low marginal costs, and the lower cost translates into a lower price for the end consumer. After all, their major concern is developing and running a website or app. The actual operation of the business is left to their users, including all the maintenance and upkeep. Airbnb does not pay for housekeeping, and Uber does not reimburse drivers for oil changes. These are all expenses that their traditional counterparts have to account for, unlike the sharing economy.

This is the one that won’t be fixed, only softened. While some of these advantages may be eroded by legislation (especially those to do with tax), it is inevitable that the sharing economy will take customers away from existing businesses. To put it bluntly, people will lose their jobs and will have to find other means of employment.

Solutions

First, let’s take a look at what the government can do to help. The function of government in the sharing economy is to protect the interests of both types of users in the economy. They need to make sure that both providers and consumers are getting a fair deal from the sharing platform. This could come, for example, in the form of regulations that require companies in the business to disclose their pricing models in a full, true, and plain manner. That would allow both providers and consumers to make a more informed decision when choosing between platforms.

They need to also look at the benefits that some platforms enjoy over their traditional counterparts and determine if they are, by nature, unfair. Should these platforms be able to keep their tax advantages? Should they be required to treat their providers as employees? A high school economics student cannot provide the answer to all these questions. What I do want to see, though, is more consistency in the regulation. What it takes to drive for Uber in Canada is markedly different from what you need in the U.K., for example. Ideally, some kind of international agreement should provide guidelines for how these cases should generally be handled.

In order for the sharing economy to be a platform that works for the good of its users, it cannot be owned by a corporate entity beholden to profits. Enter the cooperative. The idea behind them is that the people who use the service should also own the service. Juno is an alternative to Uber that has allocated 50% of its common stock to its drivers as part of a business model that “puts drivers first.” The effect is that Juno’s drivers have a say in the company’s executive matters as a shareholder, enabling them to vote on decisions that benefit the users of the service. Makes sense, right? The ones who are concerned with the company’s matters the most should be the ones who rely on it the most.

In time, I am confident that these issues will be resolved. All that we need is a quick and intelligent government and some cooperation between humans. Simple, really.

The Good News

The Pareto argument

On the whole, the sharing economy is a way to improve efficiency. We cannot say objectively that it is perfectly efficient, that making someone better off will always make someone else worse off. However, we can easily demonstrate that it is more efficient than an economy where resources are being left idle. Consider the following:

You need a drill. You go to Home Depot and buy this drill. You use the drill for a total of one day. You put down the drill, where it sits for a few years serving dutifully as a $139 (plus tax) paperweight.

Now consider that you are one of the 100 proud owners of drill-shaped, dust-gathering paperweights in your neighborhood. This little community could clearly have been serviced using a fewer number of drills. If you had decided to split the cost of the tool with your neighbor and used it for one day each, then you would have been better off! You used less money to get the same thing – the right to use a drill for a day.

In essence, the excess of drills is inefficient. The neighborhood would become more efficient by sharing a fewer number of drills across a higher number of people.

In fact, the introduction of a sharing economy in an existing industry would induce a Pareto improvement in that industry. By connecting people who have unused resources with people who can use them, the resources have been allocated in a more efficient manner. As demonstrated using power tools, the sharing economy is capable of making someone better off without making someone else worse off.

It is a way of dealing with scarcity that is, frankly, not as novel as it sounds. One of the options we have available to us is to change the distribution of resources. In subsistence economies of the past, an egalitarian approach was always taken, where scarce resources were shared with others, out of necessity. The price was generally a debt held by the other party, a promise to do something in return later, creating what is known as a gift economy. Now, we can use the power of the internet to make these connections across countries instead of with neighbors.

Flexibility

The sharing economy is flexible, as there are low barriers to entry and exit. This means that it appeals to a wide variety of providers. Jonathan Kay, a journalist who investigated firsthand the difference between driving a taxi and an Uber, explains:

Drivers with UberX aren’t required to present themselves for formal interviews or even meet anyone from company headquarters. The registration process is online, earnings are automatically deposited…

Just about anybody can start driving for Uber and reap the rewards, which cannot be said for a taxi driver. The taxi medallion system found in many cities puts a huge barrier to entry on the business. Medallions are licenses to operate taxis, and were issued by municipal governments to place a hard limit on the number of taxis in operation. In the present day, the majority of medallions are owned by taxicab companies, and cost a pretty penny – at their peak, New York taxi medallions sold for over $1 million.

1.png
S&D graph of taxi rides with medallions. “m” indicates price and quantity with medallions. Dashed line represents supply without medallion system.

The use of medallions to artificially eliminate competition and limit the supply of taxi services generates deadweight loss. Above some certain price where the number of willing taxi drivers equals the number of medallions, the supply becomes perfectly inelastic. In other words, people demand taxi rides that physically cannot be provided by the number of taxis on the road.

On the other hand, a sharing economy like Uber has a very elastic supply, which is driven by a dynamic pricing system. As soon as an increase in demand is detected, their system raises the price appropriately to try and find equilibrium. Uber calls this a “surge,” and drivers are notified via the app if a surging area is nearby. The overall supply of Uber drivers in that surging area is increased to meet the demand.

An Uber driver can also choose to call it a day at any point in time. If the demand drops to the point where they are waiting a long time between rides, they may elect to do something else with their time instead. A taxi driver is in that car for up to 72 hours a week whether they like it or not.

The Verdict

I like the sharing economy.

The benefits of the sharing economy are obvious and present. We enjoy the lower fares and wait times of Uber and the personalized and flexible accommodations of Airbnb. All this is possible because of the ability of the internet to connect together buyers and sellers quickly and on a large scale. By allowing people to rent out their resources while they are in disuse, the economy becomes more efficient – the same limited number of resources can now be distributed across a wider range of people. Furthermore, the providers in the sharing economy enjoy a flexibility that was not seen before. Some Uber drivers drive over 40 hours a week, some 15, some a mere 3, but they are all taking part in the sharing economy because it provides value to them.

Not to say the obstacles are negligible; we have a long way to go before we can call it anywhere close to perfect. The sharing economy has a tendency to spawn monopolies. The rules and regulations governing them are a mess because the governments are not used to dealing with a novel economy such as this. While the new economy flourishes, the old inevitably will experience hardships if they don’t keep up with the incredible growth of the likes of Uber and Airbnb.

But we can get over that. In the next decade, I am confident that these issues will be mostly resolved, while the benefits will only expand as users flock to the sharing economy. The benefits outweigh the costs.

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