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Michael C. Munger: Tomorrow 3.0, Transaction Costs and the Sharing Economy

Lower transaction costs facilitate a hybrid form of “collaborative consumption”. But this more intensive use of existing resources can only happen if transaction costs – the sum triangulation, transfer and trust – convert unused stuff into usable excess capacity.

The notion of a “market” as a means of reducing transaction costs long meant a physical place where people knew to gather to buy and sell. Transaction costs were always present, but mainly as part of product price (together with innovation costs) and lowering them meant being more competitive.

The sharing economy is:

  • Entrepreneurship applied to reducing transaction costs rather than reducing production costs.
  • Working through new software platforms.
  • Operating on smart, portable hardware.
  • Connected over web.

Variables that sharing economy is addressing are excess capacity and transaction costs. The middleman economy arises from the ability to sell reductions in transaction costs to enable mutually beneficial exchange in commodities, services and activities that may not even have been conceived as commercial until now. Value proposition in the new economy is selling access to excess capacity.

People own stuff, but in reality, they want stream of services that stuff provided. But they own stuff because owning provide services more reliable and with less cost than renting it. But if entrepreneurs will figure out a way to sell reductions in transaction costs, this will change quickly. So far in order to earn money, people have had to make and sell stuff. From now on making value in economy could come from creating and selling reduction in transaction costs, making better use of stuff that already exists.

Cost of use is called marginal cost. And if you can share something that you are paying some cost (average cost) to own it for marginal cost + some additional cost covering this would bring you benefits. Reason why we are not doing it more is because three elements of transaction costs is so hard to negotiate:

  • Triangulation – information about identity and location and agreeing on terms, including price
  • Transfer – a way of transferring payment and goods that is immediate and as invisible as possible
  • Trust – a way of outsourcing assurance of honesty and performance of terms of contract

When you go to a hotel in some foreign town, you choose brand since it covers all three elements mentioned above, but it is expensive, since you need to cover all their average costs (marginal + ownership cost).

People in their nature want to cooperate. But transaction costs are sometimes too high. They act as send in a gear box sometime. It is software that could bring change in our society and elevate it into exchange society. Software is the “robot” of exchange, where automation replaces human in manufacturing, software automates transactions. It was emergence of internet and development of hardware into portable devices like smartphones and other that enable connection of everybody to everything.

Until today the drive to reduce transaction costs has been in service of selling new production. In only few cases somebody tried to sell reduction in transactions cost it self (auction house). But in order to move in that area we would first need to solve dilemma of how to make information libre (free), but not gratis (free of charge). How can societies share what they already have, but also induce individuals to make more? We would need entrepreneurs for that, to act like middleman in a way that they will find new ways to connect buyers and sellers and to deliver products.

Development in selling reductions in the costs of renting can be separated in three parts:

  • Third great economic revolution will be based on innovations that focus on digital tools that reduce transaction costs.
  • Society will be able to make much more intensive use of durables of all kinds. Excess capacity will become commodity to be sold. Quality of products will go up, quantity will go down.
  • People will collect experience not belongings. Very few people under thirty will have jobs or driver licence.

Sharing is human natural action, that comes from cooperation that is based in human specialization and dependency on others to provide what each individual is not able to do it himself as a consequence of specialization. Gerald Gaus in his The Order of Public Reason is saying that humans are “rule-following conditional co-operators”. But how this reflects in real world and if cooperation is really best approach for individuals. E.O. WIllson in his The Meaning of Human Existence is saying that. “Within groups selfish individuals beat altruistic individuals, but group of altruists beat group of selfish individuals. Because of that the idea of voluntary sharing is important for economy development.

If sharing economy is third big economic revolutions, first two were Neolithic and Industrial revolution. Neolithic revolution brought move to fixed agriculture, that brought specialization. Specialization brought need for large groups cooperation and open possibilities for creating cities. With people staying in one place and being bind to peace of land, owning rights emerged. Specialization is limited by cooperation horizont. Specialization (or division of labour) created enormous increase in output, but also knowledge and as such needed to be preserved and passed on. Cooperation horizon of cities allowed this specialization to flourish so that inside organised communities of specialized individuals could collectively address all needs. Trade expanded this horizon also to trade routes that needed military protection.

When limits of cooperation horizont of cities were reached new cooperation horizont started to appear, it was markets and with them quest for profit and industrial revolution. Revolution of production and ownership. With division of labour that went down to phases of process not only for process itself, markets had grown into arena of cooperation. Cooperation being limited only by transaction costs.

In today’s revolution we need to separate Middlemen Economy and Sharing Economy. And when we talk about transaction costs, we talk about expenses – including time, inconvenience and actual payments required to obtain and use the item. Rental markets sellers usually own assets and rent it out. New economy is bringing new sort of rental called peer-to-peer, when sellers own assets for private use and also rent it out. Rental approach is accepting higher monthly payment for the gain of flexibility and risk mitigation.

This new opportunity in sharing economy is not fully used since entrepreneurs are still looking for the best way to lower transaction cost and create durables in excess capacity to use for commercial use. Schumpeter defines entrepreneurs as creative destructor, Kirzner sees them as constant searchers for profit using awareness as their main tool. Many of the entrepreneurs of Tommorow 3.0 will be middlemen. There are two sorts of middlemen. Ones that only re-sale products and use difference between buying and selling price for their profit. And ones that create new business model by using ability to connect buyers and sellers. First ones are also important since they make transactions possible that otherwise would not happen. Transportation, information, assurance of quality through brand name and financial services are all means of making possible transaction that otherwise would be blocked by transaction costs. Example of second ones are Airbnb, Lyft, Uber, BlaBlaCar (ride sharing application). One of great examples of company that reduces transaction costs and as such disturbed existing industry is Amazon. As with other revolutions this also can lead to job lost (since less products will be sold for ownership) and worse life for some individuals but that will not stop the change that is coming. There will always be somebody who will oppose changes. When cars were replacing horses, we had buggy whip makers, people that take care of horses and were at that time out of business. Buggy whip makers are, in the argot of scorned business failures, manufactures or service providers who fail to recognize that times are changing or who find that their once-valuable skills are now obsolete.

All over the world stuff is in the wrong place. And that is why exchange happens. And they are in the wrong place because of transaction costs. Ronald Coase was the father of “transactional costs economics”. He believed that firms will shrink or grow until cost of making will not equal cost of buying.

Communication technologies did enable new business model of sharing economy with enabling constant on-line presence. Software also brought new trust protocols, based on reviews and surveys. New generation is not looking for some authority or regulation to provide trust, they are actually using crowdsourcing trust protocols and check for feedbacks. But all those are tools that entrepreneurs can use in order to find proper set up for new business practice.

Economy of Tommorow 3.0 will bring disruption that is sure. It can bring disruption in two ways: saltation and separation. It was already Keynes that realise that development is bringing “technological unemployment”. This means unemployment due to discovery of means of economising the use of labour outrunning the pace at which we can find new use for labour. Since it is consumer that drives economic evolution, changes will happen. Market systems are mechanisms for facilitating cooperation, cooperation among people who own things, who make things and people who want things. Ludwig von Mises got that right. When we are looking at a value of companies and industries and we only use GDP formula, we actually miss value that services, or product is bringing to consumer outside price range. And since the consumer is the dynamic force of economy, we are missing a lot. Actually, economist have a term for that added value that consumer is getting without paying for it. It is called consumer surplus. It is a value consumer would pay in order to have this free service. If we are measuring economic activity only through GDP formula, we could say we are facing slowing down or even stagnation. The reduction of price and increase level of services and activities that are offered to consumer for free can lower official output, but in reality, this can actually create platform for new business model, that will cause disruption in existing institutions and business organisations.

World saltation means abrupt movement or transition. In standard economic theory there are certain assumptions about what kind of institutions and preconditions economy needs in order to develop and through which stage development goes. Things like law, currency, banks, transportation system, infrastructure. But in new economy a person with a phone and internet access can jump through all this preconditions and stages and get into business, new kind of business.

Three most important effects of the Middleman’s Sharing Revolution will be:

  • A reduction in the amount of physical stuff, in the form of consumer durables, being produced in factories by workers.
  • A decline in the cost of having access to a variety of stuff, and reduced needs for storage.
  • An ambiguous, but unsettling, effect on real wages, with both the direction and variance of real wages very much in flux.

Those changes will happen and that can lead to separation, since wages will drop due to dropping of prices and drop in required labour force. With loss of manufacturing jobs and increasing value in other areas, poorer will be poorer and richer will be richer. But changes can also lead to lowering cost for services needed and improved consumer surplus. Virtuality will not only change business model, it can lead also to new identity setting, by offering new generations a place where they can build their communities in virtual world, based on shared preferences. And with this development we could see Keynesian idea of two-day work being realistic. We could see “gig” employment taking over instead of classical life-long employment. If we look from global perspective this is just question of transaction costs and “rent” versus “own” question.

Capitalism does not produce jobs, it produces consumer surplus. Paradox is that capital (and that includes software) destroys jobs but makes jobs that adapt and survive much more productive. Saltation can benefit displaced workers since there are new industries that need workers and people that can quickly acquire new skills and adapt will take premium. Separation is not good.

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