Markets without Friction

A commenter on my blog, without having read the book, offered what amounts to a pithy summary:3

• Ownership is a form of market failure
• – Your car being parked 23 hours a day just to ensure that it’s there when you need it.
• – Transaction costs of selling/buying your house tying you down and decreasing efficiency of your human capital.

“Market failure” is a loaded term. It might be better to say that we own consumer durable goods in part because of market frictions, or transaction costs. Munger describes transaction costs as:

• … the sum of what I will call triangulation, transfer, and trust (page xi)

“Triangulation” is how potential buyers and sellers finding one another. “Transfer” implies getting the good from the seller to the buyer. And “trust” means that the buyer and seller both are assured that they will receive what they expect.

In the case of triangulation and Airbnb, somebody who wants a short-term rental in a particular location needs to find someone who is willing to rent space there. The transfer can be effected by getting the renter the keys to the room, along with instructions about how to use the appliances, connect to Wi-Fi, and so on. A major source of friction is trust; the renter wants to be confident that the room is satisfactory and the owner wants to be confident that the renter will leave the space in good condition.

If all of these sources of friction were to disappear, then you might be willing to let someone else use your apartment any time you don’t need it. We have come to describe this as the “sharing economy,” although “sharing” is another loaded term. In fact, a rental transaction takes place.

Imagine how you might live if there were no frictions:

Instead of storing pots, pans, and other kitchen equipment in your home, you could rent these goods as needed. A business would deliver them before you prepare a meal and take them away after you have finished eating. Or you could do away with a kitchen altogether and simply have meals delivered to your dining area.

Instead of storing clothes in your home, you would rent them on an as-needed basis. A business would deliver in the morning the clothing you want to wear today, and at the end of the day it would take them away and clean them.

In fact, your family might not have a single residence at all. You might have one place where you sleep during the week and a variety of different places where you sleep on weekends.

Munger acknowledges that we may be unlikely to go to such an extreme renting scenario, but,

• … each of us will have far fewer actual possessions while we make better use of the stuff we still have. We’ll be less selfish, less crowded, richer, and more cooperative, all because entrepreneurs can sell reductions in transaction costs. (page 8)

Munger believes that this transition toward fewer goods used more intensively is a revolution, comparable to the adoption of agricultural or the Industrial Revolution.

• The third great revolution will be based on innovations that focus on digital tools that reduce transaction costs, not on the creation of new physical products themselves.
• The result will be that society will be able to make much more intensive use of durables of all kinds… the quality and durability of the items being rented will increase sharply, but also the quantity of items actually in circulation will plummet.
• People will collect experiences, not belongings, and the idea of ownership will seem quaint and archaic by the end of this century. Very few people under the age of thirty will have driver’s licenses. Or jobs. (page 23)

Because Munger is concerned about jobs disappearing, near the end of the book he makes a case for a universal basic income. At a more philosophical level, he writes

• People do not really need jobs as much as they need an identity, something that they can define themselves as and form communities around.
• … People will be obliged to find new meaning in their lives and new identities to organize that meaning. (page 152)

Lessons in Economics

Tomorrow 3.0 would be an excellent book to assign as a supplemental reading for an introductory or intermediate economics course. First, it would help students anticipate and navigate the economic changes that are likely to occur over the course of their lives. Second, Munger articulates very well the economic role of the market and of the entrepreneur. For example, he writes

• Clearly, specialization can be achieved in a “command,” or government-organized, hierarchy. But the full benefits of sharing can only be realized in an exchange setting… price signals are crucial for allocating resources, and profit signals are crucial for determining which new products should survive and which should be discarded. In command hierarchies, there is no effective way of determining when the commands are wrong, because people just do what they are told. (page 31)

In standard economics courses, students get so caught up in exercises of shifting curves and calculating elasticities that they lose sight of the larger picture. Munger, by dwelling on the processes of human cooperation, long-term growth, and entrepreneurial competition, redresses that balance.

A Road to Serfdom?

Ownership of property has long played a role in libertarian thought. When America was founded, for example, it was considered wise to restrict the right to vote to men who owned property.

Suppose that home rental becomes so much more cost-effective than traditional home ownership that we become a nation of renters, with the housing stock held mostly by corporations. Suppose that the same thing happens with automobiles. As households, we might own shares of stock in the corporations that provide housing and transportation services, but this gives us only indirect ownership in the buildings and cars themselves.

Does such a scenario represent a new road to serfdom? As citizens become renters, will they be less vigilant about defending individual liberty? Will we be too beholden to others who have the power to deny us access to shelter, transportation, or other vital needs?

As I see it, the long-term historical trend is for increased human interdependence. Munger points out that the agricultural revolution, which brought humans out of hunter-gatherer bands, enabled us to specialize on a larger scale. At the same time, we became dependent on strangers. Indeed, some people became city dwellers, which means living among strangers.

The Industrial Revolution greatly increased this interdependence. Cities became larger and more important. Recently, we reached the point where over half of the world’s population lives in cities, and the trend toward urbanization is accelerating.

The more interdependent we become, the more we need institutions and well-established norms. You can trade with someone face-to-face in a village without an intermediary or a legal system to ensure good behavior. Trading in a modern economy does require those institutions.

Up until now, it seems to me that we have managed to become increasingly interdependent without a loss of liberty. That is, we have developed norms and institutions that facilitate interdependence while maintaining our ability to make individual choices freely. Many of the important institutions that provide this governance are in the private sector, and the norms that they develop evolve over time (think of the evolution of payment from cash to checks to credit cards to smart phone apps). Going forward, I would be optimistic that although a society of renters may require more governance and more rules, these will evolve primarily from competition and cooperation among private entities, and we need not see an increase in centralized coercion.

Footnotes

[1] Michael Munger, Tomorrow 3.0: Transaction Costs and the Sharing Economy. Cambridge University Press, 2018.

[2] For example, see Tyler Cowen, “Americans Own Less Stuff, and That’s Reason to Be Nervous”. Bloomberg, August 12, 2018.

[3] Comment 480073. ASKblog.com, August 17, 2018 at 9:36 am.