The Effect of the Internet on Labor Markets

By: Brian Egge

In the mid 1990′s the advent of the Internet promised to make our lives easier and markets more efficient. The availability of information and low transaction costs made sites like eBay and Amazon possible, and in turn changed many primary and secondary markets. The Internet has also had a large effect on labor markets; it has allowed people to work from home, and also allowed work to be performed where and when it’s most economical. Some of the most interesting changes have occurred only in the last few years.

When Jeff Bezos started Amazon.com, he decided to start by selling books because there were so many existing databases of book information. Taking the existing databases of standardized products, and offering a more efficient market for them, allowed Amazon to make an economic profit. The revenue for a website which improves the efficiency of labor markets stands to be larger than any of the existing marketplaces on the Internet.

In a perfectly competitive market, each participant is a price taker and has no influence over the price of the product it buys or sells. One of the requirements for a competitive market is homogeneous products. A product, like a new book or a bond, is homogeneous because every unit is alike. As no two people are alike, it makes it difficult for buyers and sellers or employers and employees to agree on a rate and transact business. The easier the output is measured, or the more quantifiable the skill, the easier it is for markets to become competitive. Some jobs, such as sales, have quantifiable outputs, and pay is often tied directly to the revenue produced. While the output of many knowledge based jobs is difficult to quantify, the knowledge and skills required can often be quantified and measured. Various industry certifications exist to help validate a candidate’s skill, though it varies to the extent in which employers rely on these measures.

For a while now, sites like eLance.com have attempted to connect buyers and providers, or employers and employees.  The majority of the projects on these sites ask for bids for a specific project. One of the difficulties with the project based approach is again the homogeneity.  Each project is unique as is each provider (or worker). This results in an increase in higher transaction costs and requires parties to bid on less than perfect information. Each bidder has to attempt to estimate the time the project will take and convert that into their rate. If bidders were to spend 25% of their time bidding on projects, that time would be added to the cost of the average project. Additionally, one often has the problem of the winner’s paradox. That is, the bidder who submits the lowest bid and ‘wins’ the project is also probably the same bidder who either underestimated the project time or has the least skill to complete the project. The buyer doesn’t have to accept the lowest bid, but instead evaluates each bid and may look at the provider’s history and background will contribute to their choice. While this can help prevent ‘a race to the bottom,’ it increases the transaction cost even further. The time the buyer spends evaluating each bid adds to the transaction cost as well.

One way of reducing the transaction cost is to agree on a time based rate. Traditionally, most employers pay either an hourly wage or an annual salary. If each time a boss wanted to worker to do something they had to negotiate a fixed price, huge amounts of time would be wasted estimating and negotiating. This model is very easy to implement in a brick and mortar setting, where employees may time in using a time card, or for call centers where when you’re on the phone, you considered to be working. The site oDesk.com is working on changing this, and allowing people to work remotely and charge an hourly rate. The solution oDesk has come up with is for workers to run a program on their computer which takes a screenshot about every 10 minutes, while the worker is signed in to a project. At the end of the day, the worker can remove screenshots during periods that they weren’t working, and their employer doesn’t get billed for them. On oDesk, a provider can offer their service, say Ruby on Rails programming, at a fixed hourly rate. Buyers can then post projects and accept bids, or directly contact a worker at their posted rate. This creates a double sided auction, a more homogeneous offering, and results in lower transaction costs.

In a market, if one party has more information than the other this can create an advantage to the person with more information. If the information asymmetry is too large, it will discourage trading. Jewelers allow customers to get an independent appraisal of a potential purchase, not because they want to be nice, but they want to reduce the information asymmetry just enough to encourage trading to occur. Consumers in this situation recognize they have virtually no ability to price a product, and the dealer has near perfect information. Allowing for a third party appraisal gives the consumer enough information so they will trade, but still gives the dealer plenty of room to make a profit. Outside of government jobs, salary information is usually kept fairly secret, and generally the employer has more information than the employee. Many websites and salary surveys have attempted to gather this information, but the results they gather are incomplete at best. The website oDesk.com makes all transaction information publicly available. A provider can see what a buyer has paid other people for similar work, and has visibility into the market as a whole. This also benefits the buyers, by seeing their earnings history. While, it can be a bit uncomfortable at times, the market as a whole becomes more efficient. Not only can skills and projects be priced better, but it allows the market to adapt to changes in supply and demand. When the iPhone SDK was first released, there was a shortage of workers with the skill to create apps. As the information became known – through higher wages paid to those with the skill – many people around the world taught themselves the required skill.

The Internet has greatly reduced many of the barriers to entry/exit the labor market. Generally, it’s easier for the suppliers (employers) to enter and exit the market. An employer simply needs a credit card and some work to be done to enter the market. For most firms, labor is a variable cost, but property and equipment are fixed. When sourcing work online, generally the provider has their own office space and equipment. This allows firms to rapidly enter and exit the market, and means they can shutdown quickly in the event their average total cost exceeds the price of their product. At the same time, it allows employees to rapidly enter and exit the market. While there is some barrier, as buyers prefer providers with longer histories, it generally takes only a short while to setup an employee profile. Unemployment figures might make people assume that the supply of workers fixed, but it reality it is quite elastic. Consider a stay at home mom who as a four year degree. Her indifference curve might make her willing to work part time if she can do so at home and earn more than $30 an hour. If the demand of a skill like medical insurance processing causes wages to move into this range, then she will enter the market. If, absent any regulation or unions, there are 10 workers for nine jobs, the wage for the workers will drop to the point in which one of them decides they would rather not work than accept the offered wage. The more elastic the supply of workers, the better off those who are working will be.

The same low barriers to entry/exit in the online labor market also discourage larger employers and higher paying jobs. First, it is not easy to filter the supply of workers and determine who is serious and capable about working, and who is not. Despite the large number of online job sites, recruiters or head-hunters are still used by employers, and provide an important benefit. Qualifying and filtering applicants is time consuming and certainly a skill. Finding someone who can commit to working for 2000+ hours in a year can be difficult to do, and is even more difficult online. This causes employers who want long term work to avoid looking at sites like oDesk and eLance, and also means it’s difficult to find workers there. The company which runs oDesk.com hires most of its employees as full time non-telecommute positions.

In an efficient market transactions are costless. Even if costs related to non-homogeneity are minimized, there are many other exogenous costs. These costs create a gap between the supply and demand curve, and causes less trading or employment to occur than would otherwise. Both employers and employees pay taxes, and the amount of taxes largely depends on where there are physically located. This gives an advantage to firms who choose to locate themselves in a lower tax area, and also to employees whose location offers lower taxes. For example, News Corp relocated itself from Australia to the USA largely due to the lower corporate taxes. In general, this is good, as it can encourage governments to find other methods of raising revenue other than income and corporate taxes. oDesk charges a 10% transaction fee on all payments going through the site. Other sites charge listing fees and one may be exposed to exchange rate fees or other costs. When transaction costs are low, it makes it possible to profit from arbitrage opportunities. Subcontracting work out is an arbitrage. One can simultaneously change a higher rate for the services for which one pays for at a lower rate. The less friction involved in the transaction, the easier this is to do. The existence of these parties who are neither have work nor have employees, but rather make money by either connecting buyer and sellers as recruiters do, or by being an intermediary as consultancies and agencies do, can have the positive effect of increasing liquidity.

I’ve used the site oDesk.com to find workers to help me with design and programming projects. The hourly model, salary transparency, low barrier to entry, and low transaction costs make it one of the better online marketplaces for employers and employees to meet. The site is most suited for employers with small projects and defined work, and for employees who value working where and when they want. The efficiency gains being made by sites like oDesk and it’s competitors will benefit employers and employees alike and both traditional jobs as well as jobs performed online.