DRI-305 for week of 3-17-13: What is Behind the New ‘Sharing Economy?’

An Access Advertising EconBrief:

What is Behind the New ‘Sharing Economy?’

The once-distinguished British weekly The Economist highlights a new Web-based economic phenomenon in a recent (03/9-15/2013) issue. The name assigned by the magazine to this activity is the “sharing economy” – a dreadful misnomer that conjures up images of 60s counterculture and communes. But however misnamed, the transactions it denotes are a sign that cannot be ignored.

In his Wealth of Nations, Adam Smith explained the growth of markets by citing man’s innate “propensity to truck, barter and exchange.” Ever since, these words have received both veneration and ridicule. Smith’s admirers saw in them a beautifully realized portrait of human nature. Opponents of free markets have scoffed. They long since rejected whatever validity Smith’s “higgling and haggling of the marketplace” might have had in favor of Thorstein Veblen’s picture of “shadowy figures moving in the background;” they see corporate power, not voluntary exchange, as the dominant motif in the market. Since 2008, the Left has pooh-poohed the notion of rational choice by citing the financial collapse as proof of the irrationality of crowds and the infeasibility of deregulated markets.

But now comes The Economist to point out that even as world financial markets were imploding, unregulated private markets were springing up to enrich the daily lives of billions of the world’s citizens. Alas, the magazine itself misses the significance of its own reporting.

The “Peer-to-Peer” Rental Market

Every night some 40,000 people around the world rent rooms from a service that operates throughout the world – 192 countries, 250,000 rooms in 30,000 cities. The customers choose their rooms and pay online. But the provider is not a commercial business chain like Hilton, Marriott or even Motel 6. Instead, a San Francisco-based firm called Airbnb matches up customers with rooms in homes owned by private individuals. The company has operated since 2008, attracting roughly 4 million customers. Room renters choose and pay for their rooms online.

This is perhaps the largest business in the “peer to peer” rental market. Individual consumers rent assets like beds, boats, and cars directly from other individuals rather than from businesses. The rationale for these practices is quite straightforward. You may wish to cut your automotive transportation costs by earning income from giving rides to people whose destinations coincide with yours. Or, viewing the same situation from the other side of the market, you may wish to cut your costs by paying a peer to chauffeur you to a common destination rather than calling a taxi or riding the bus.

Boat ownership is commonly likened to owning a hole in the water into which you pour money. One way to offset this outflow is to rent the use of the boat to peers. The intermediary and clearinghouse for all this activity is the World Wide Web.

Observing and noting this market is easier than pinning a descriptive label on it. The Economist calls it “the sharing economy.” This is surely wrongheaded, if only because we do not associate “sharing” with commercial transactions. Carpooling arrangements, for example, involve a spatial arrangement for the pooling of transportation services. Participants “share” a common space inside a single vehicle for the purpose of reducing joint transportation expenses. But each vehicle’s owner is commonly responsible for fuel purchases. Pooling equalizes travel responsibilities and costs among participants; the net exposure should be zero. The benefits are symmetrical, both in quantity and kind. This is sharing in a true, meaningful sense; the benefits are objectively equal and depend on the shared use.

Charity is another conventional form of benefit sharing. The owner of income or assets shares it (them) with others with no reciprocation except, perhaps, a “thank you.” The mutuality derives from the satisfaction gained through helping.

But the peer-to-peer market is simple commerce, unlike the genuine sharing examples just cited. There is an exchange of money for goods-or-services. The buyer gains the usual consumer surplus – the excess of the maximum price he or she would have been willing to pay over the price actually paid. The seller gains better utilization of existing capacity, whether the capital good is a personal automobile, spare bedroom or pleasure boat. Sellers are no more “sharing” than are taxi drivers, motel owners or charter-boat skippers. Indeed, a better descriptor would be the “utilization” or “capital-utilization” economy. Of course, this clinical language lacks the warm and fuzzy feel of “sharing” but it compensates in accuracy.

The Economist also tosses out the term “collaborative consumption,” which is just as inapropo as “sharing.” Fairness and full disclosure require noting that the terms “sharing economy” and “collaborative consumption” date back several years. They are particularly associated with left-wing authors like Rachel Botsman, whose communitarian views are hostile to capitalism and private property. But The Economist, of all publications, should know that private ownership is essential to the preservation and maintenance of capital goods, without which the peer-to-peer market would vanish into thin air.

Come to think of it, why not follow current buzzword practice and adopt digital vernacular, using The Economist‘s own phrasing? Call it the P2P market.

The Key Role of the Internet

Where has this new economy been all our lives? Did it take over a century for people to wake up to the possibility of using their cars as taxis or rental cars? Was there an epiphany, a la Bell and Watson, when a restaurant habitué decided he could pay his bill by ferrying his fellow diners back and forth for a fee?

Actually, P2P has been operating in the background all along. It ran on word-of-mouth or classified advertising, using referrals as its primary security. This guaranteed that its importance would remain marginal. It took the Internet to turn it into a $26 billion annual, growing enterprise.

First, the Internet gave P2P the reach it lacked heretofore, allowing sellers to reach an unlimited audience at extremely low cost. Second, the Internet provided the security necessary to both sides of the market. For example, taxi drivers lead a notoriously precarious existence at the mercy of their passengers. But insecurity runs in both directions when the driver is not a business owner or employee, operating a highly visible vehicle. On the Web, though, the platform fulfills the role otherwise played by the business in vouching for its representatives. Follow-up reviews and ratings ensure that bad trips are not repeated.

The surest sign that P2P really works is that commercial businesses want a piece of the action. The Economist reports that Avis, GM and Daimler have all acquired their own piece of P2P; e.g., acquired P2P assets or entered the market de novo. The magazine speculates that the acquisition may enable the parent to list its excess capacity-assets on the P2P firm’s website. This looks like a clear case of evolutionary adaptation rather than creative destruction; P2P does not rate to destroy its competing industries but rather to modify their operations for the better.

Last April, The Wall Street Journal reported on the hottest extension of P2P in the financial realm – P2P lending. For roughly a decade, at least two P2P firms – Prosper Loans and Lenders Club – have offered individuals a chance to lend directly to their peers. The loans are extended versions of the payday/high risk loan that has long been a staple of the low-income and pawn-loan credit market. These P2P loans have terms of up to five years and principal amounts ranging up to $25-35,000. They are unsecured and assigned a risk rating based on the borrower’s creditworthiness.

The success of these P2P firms has now attracted the attention of Wall Street. Fund managers have started funds organized along similar lines, offering investors the chance to pool investment capital into funds offering the same types of high-risk, unsecured loans. Risk spreading and high returns make these funds an attractive alternative to current low-yield, fixed-income investments. The high risk means that their fraction of the total portfolio should be low. Naturally, the increase in lending activity will improve terms and outcomes for borrowers.

Lessons Learned

Even if we accept that P2P is an adaptive rather than a disruptive force, this should not obscure the powerful message it conveys. The rise of P2P overturns the conventional thinking that had prevailed since the financial crisis of 2008 and the ensuing global recession. That dominant view has been that market participants do not act rationally. They act emotionally, even hysterically. They are stampeded by mob psychology and incapable of gauging their own interests. Without the wise guiding hand of government regulation, free markets will inevitably devolve into chaos.

To be sure, this view is itself hysterical. It offers no clue as to why or how regulators themselves escape the emotional distractions that sway market participants. It doesn’t explain how regulators regulate markets without actually substituting their own decisions for those of markets. It also doesn’t tell us how regulators are able to perceive the interests of market participants who (supposedly) cannot discern their own interests. Nonetheless, this regulatory view won out (essentially by default) in 2008-2009.

Every major regulatory agency in Washington – OSHA, EPA, FDA, SEC, FTC, DOT, DOE, FMCSA, et al – has presided over a reign of terror for the last four years. If federal-government regulation were the key to safety, America would now be the safest nation on Earth by far. There is no logical or empirical case for this regulatory full-court press, other than the fact that the Democrats won the last two Presidential elections and the Republicans did not. Still, asking Democrats not to regulate is like asking a horse not to eat hay.

P2P offers the perfect test case for the new conventional thinking. Here we have both supply and demand sides essentially pioneering a new market all by themselves. According to today’s party line, this is a sure-fire recipe for disaster. After all, taxi regulators in New York
City have spent decades warning consumers to beware of “gypsy [unregulated] taxicabs.” Riders might be placing themselves in the hands of robbers, rapists or even worse. Unfortunately, New York City hasn’t approved the issue of a single new taxi license (they are issued in the form of medallions) since World War II, so its citizens have conditioned themselves to ignore these admonitions. They actually want to get somewhere without waiting for a bus or walking. Well, if an unregulated commercial vehicle is this unsafe, just imagine how risky P2P must be!

No, according to The Economist, “the remarkable thing is how well the system usually works.” Then again, P2P “is a little like online shopping,” where “15 years ago…people were worried about security. But having made a successful purchase from, say, Amazon, they felt safe buying elsewhere.” And there was eBay, which began essentially as P2P and morphed into a vehicle for professional sellers.

Well, gol-l-l-l-l-e-e, Sgt. Carter, could it be that old Adam Smith was right – not just about mankind’s inherent affinity for trade but also about the self-adjusting character of mutually beneficial voluntary exchange? So it would seem.

Yet The Economist‘s liberal knee cannot help jerking towards regulation. “The main worry,” they declare gravely, “is regulatory uncertainty.” Yes, politicians in America have cast lascivious glances at Internet trade for years, longing to tax it under a guise of benevolent regulation. Since The Economist sails under the banner of …er, economics – where a tax discourages the taxed activity, creates a welfare burden and reduces the well-being of the taxed – it should come out forthrightly against Internet taxation, right?

Wrong. “People who rent out rooms should pay tax, of course [of course!], but they should not be regulated like a Ritz-Carlton hotel. The lighter rules that typically govern bed-and-breakfasts are more than adequate.” Mere readers – being only consumers, humble recipients of The Economist‘s sunbursts of illumination – needn’t expect any illuminating insight on why tighter regulation of Ritz-Carltons is either necessary or beneficial, because none is forthcoming. The editorial’s anonymous author has the wit to notice that incumbent taxi firms are even now mobilizing the forces of regulation to protect their monopoly position. But the magazine’s leftist editorial stance is so ossified that it cannot permit that admission without an accompanying qualification that “some rules need to be updated to protect consumers from harm.” Taxicab regulation is probably the most notorious textbook example of regulatory harm to consumers in the history of economics, but The Economist is bowing its knee to it. (Elsewhere, the magazine laments the absence of even more Keynesian stimulus spending policies to create jobs.)

This is an old story. A precursor to P2P sprang up in black communities throughout the U.S. during the early and mid-20th century. Taxicab service was often sparse in these areas, not merely because of racial discrimination but also because high crime posed serious risks to drivers. Taxi regulation typically prevented black taxicab companies from entering the market or expanding to meet demand. It became common practice for private individuals to frequent grocery stores, barber shops and other high-traffic areas in order to provide “car service.” This service consisted of informal, unmetered charges (sometimes on a flat-rate basis) in return for carriage to and from shoppers’ homes. Carrying of bags and escort duties were usually included in the service.

Researchers have applied the term “jitneys” to the unregistered, unlicensed vehicles used to provide this service. Research is conclusive on two points: Consumers benefitted unambiguously from the service, and jitneys were legally hounded by taxi and bus companies in their jurisdictions. They were made illegal because taxi and bus owners feared and resented the competition and loss of income that this low-cost alternative form of transportation inflicted on them. Amazingly, jitneys still survive today in inner-city America; they are the “missing link” connecting modern P2P with its ancestral forebears.

When the worst that The Economist can cite is that “an Airbnb user had her apartment trashed in 2011,” you can rest assured that today’s P2P system is working extraordinarily well. It is a measure of our times that even a single complaint instantly triggers the demand for more regulation. When abuses occur despite the presence of tight, heavy regulation – as in financial markets – it should be clear that regulation is the problem rather than the solution. When complaints are rare, it hardly suggests a need for regulation.

The word “regulation” itself has become a rhetorical refuge of first resort precisely because its meaning is so vague. There is no clear-cut theory of regulation to explain why it is necessary, exactly what it does or how it does it. To a bureaucrat, this may constitute a highly desirable sort of flexibility. But it is not conducive to favorable outcomes.

All the News That’s Fit to Decode

Readers of The Economist should probably be grateful that the magazine deigned to notice P2P at all. The fact that we have to hack our way through the magazine’s ideological bias and occupational ineptitude to glean any value from the article is a journalistic scandal. Still, these days students of economics have to take our good news where we find it and our sources as we find them.