Why the Government Doesn't Need to Regulate the Sharing Economy

The state of Minnesota briefly banned free online education. That’s right: Last week, an entire state told its residents they couldn’t take free online courses. Well, to be more precise: It prohibited degree-granting universities from offering classes through online community learning sites such as Coursera without first obtaining permission from the state regulatory body (and paying a registration fee, naturally).

Minnesota’s regulators reversed their decision the next day, following widespread criticism online. But this isn’t an isolated government dispute in the new economy of shared services. Over the same week, on-demand car service provider Uber pulled out of the taxi business in New York after facing obstacles from NYC’s Taxi and Limousine Commission (TLC to us locals). And the apartment-sharing marketplace Airbnb hired a government relations expert to help it face regulatory issues as it expands.

Clearly, issues around regulating the “sharing economy” -- whether Coursera, Uber, and Airbnb, or TaskRabbit, Zipcar, and Couchsurfer -- affect our daily lives in more ways than we realize.

Because today’s internet is not just for sharing information and commerce and things: It’s now the internet for sharing and accessing real-world services. We may call it the “sharing” economy (its philosophical roots are in peer-to-peer), but the services in it aren’t free or reciprocal – these are real markets in which you pay for what you get.

However, this doesn’t mean we need to regulate it with the structures and rules of the real world. It’s a mistake to assume that just because technology provides “new leverage for old behaviors” that we need old ways of regulating new things.

But First, Why Regulate?

One obvious motivation for regulation is safety and protection – making sure consumers get what they were advertised, without undue risk to their well-being. Because the newly minted Airbnb rental service providers aren’t hoteliers, they aren’t monitored for fire safety or cleanliness. Similarly, Lyft ride-share drivers aren’t licensed taxicab operators. Nor have online courses passed the same accreditation standards as university degree programs.

But more compelling near-term motivations for the recent regulatory action could be protecting entrenched businesses and recouping lost tax dollars. Though Airbnb-ers might pay federal and state taxes on their extra income, they don’t pay local hotel taxes or other fees. As Airbnb continues to grow – apparently there is now one Airbnb listing for every six hotel rooms in New York City alone – these taxes could represent a lot of money for city governments.

So the regulatory microscope has started to focus in on this new internet economy – examining companies with dictums ranging from New York’s hotel, rental, and taxicab laws to California’s Money Transmission Act.

Yet it’s important to remember that the true, long-term objective of regulation in this context isn’t government revenue maximization. Rather, a central goal is to prevent “market failure” – ensuring that commercial exchange that is good for society isn’t stifled by information asymmetry or blocked by firms with too much market power.

Technology Giveth and Technology Taketh Away

Digital technologies created the sharing economy. Simply put, this economy facilitates new markets by matching providers who have specific assets or skills with the people who need them, dramatically expanding the possibilities for private commercial exchange of services between consenting entities.

This economy couldn’t exist at scale in the past because transaction costs were too high. But as Hal Varian reminded us at his Ely lecture to the American Economic Association, the internet and information technologies continually reduce trading frictions over time, largely by facilitating better measurement, accountability, and verification.

And now, these very technologies and the changes they engender provide the means for the sharing economy to regulate *itself. *

Technology enables digitally mediated self-policing: the reputation systems and monitoring tools that dramatically smooth the safety and friction of peer-to-peer transacting parties without requiring centralized intervention, and which are now creating distributed digital institutions that reduce the need for government oversight.

Think about eBay for a moment, even though it’s largely for owning goods and not accessing services. It seemed inconceivable in the mid-1990s that it could grow into more than a marketplace for trading Beanie Babies. How, we asked ourselves, would strangers in different countries trade products of unverifiable quality and authenticity – without some form of central intermediation or control? But now, it comprises billions of dollars’ worth of trade; people trustingly buy even their cars there.

Because salient details are made visible not only to transacting parties but to the entire community, sellers (and buyers) have to stay honest and reliable to stay in business. In the sharing economy, reputation serves as the digital institution that protects buyers and prevents the market failure that economists and policy makers worry about.

Reputation Replaces Regulation

I’m not suggesting this kind of community- and reputation-driven enforcement is new. The legendary Maghribi traders of 11^th century Northern Africa evolved their own reputation-based “institutions” from within their distributed trading community to deal with the uncertainties of international commerce. As documented in a wonderful bookby Avner Grief of Stanford, the traders used social norms, community transparency, and collective sanctions – instead of enforcement by centralized rulers, legislation, or armies – to steer participants away from the short-term gains of cheating.

The same essential process is at play today, scaled by the connectivity and transparency of the internet. Much like eBay, almost every site from SnapGoods to Zimride gets transaction-by-transaction feedback from buyers and sellers. These reputation systems take community enforcement up a few notches from the time of the Maghribis, combining numerical scores and textual feedback with reviews, pictures, and peer references that are instantly visible to any potential market participant. By making both product and trader quality instantly transparent, this approach reduces the risks that often lead to market failure. It also provides a first digital safeguard against much of what regulators aim to protect consumers from.

After all, profit is a much more powerful driver for quality than regulatory compliance. If your last customer – one who has been vetted by others and has built reputation credibility – complains about the hygiene levels of your shared lodging, your future business prospects on Airbnb are pretty bleak.

But group sanctions through online reputation mechanisms are just one part of regulating the sharing economy. The other (often overlooked) part is observability – which can be accomplished by using digital monitoring tools for regulatory oversight.

For example, couldn’t video monitoring inside Lyft cars – made ubiquitous and inexpensive by today’s technology capabilities – enhance our system of centrally licensing taxi operators, while also helping resolve driver-passenger disputes? Perhaps low-cost surveillance technologies in Airbnb shares (with a guest-controlled opt-out option) could substitute and supplement conventional lodging inspectors. The self-regulatory capabilities of the online sharing economy could permeate traditional commerce as well. Why bother with restaurant inspections, when we could put a camera in the kitchen to spot health violations and leave Zagat and Yelp reviews to “administer” the quality control? Do we even need hotel regulators any more, when we have TripAdvisor to give us instant feedback on cleanliness, service, noise levels, and several other dimensions?

With these mechanisms, centralized government intervention will continually become less critical. In a way, we’ve come full circle since the times of medieval trade: going back to our distributed roots. Overly enthusiastic regulators could stifle the very exchange their intervention aims to facilitate; and create the perception they are going after more than their fair slice of the new sharing pie. It’s useful to remember that one role of the Maghribi trader guilds was to prevent rulers of other governments from excessively infringing on their gains from trade.

Many of today’s regulations were right for their time, and contributed to the safe and efficient growth of services over the last century. But emerging digital institutions have already started to make them obsolete. We are simply witnessing the beginning of this disruption.

So governments should tread carefully: as the Minnesota-Coursera reversal "to meet modern circumstances" illustrates, overreaching just might refocus the conversation on whether their regulatory agencies are really even necessary any more.

Editor: Sonal Chokshi @smc90