Online markets reduce frictions, but there is a key difference between labor markets and the market for goods that implies that an improvement in available information will impact price differently in these two types of markets—in the market for goods prices go down; in the market for labor prices (wages) may go down or up.
In a market for goods, consumers have preferences over price and quality and will choose to purchase the good that maximizes the difference between the utility they get from the quality of that good and the price they must pay for that good. A seller can only hope to get customers if his price-quality pair is at least as good as the other options those consumers have.
So, if there are many other options (the seller is not monopolistic), and the consumers have perfect information about each seller’s price-quality pairs, then sellers will be driven to push their prices down. Therefore, prices will be higher than the competitive rate when 1) there aren’t many sellers and 2) information about a) price and b) quality are not readily available.
When it comes to the market for goods, the internet has done an amazing job solving these 3 issues. The internet has reduced barriers to entry (a seller no longer has to physically set up shop, for example), thus more sellers are entering the market. It has become much easier for consumers to locate the lowest price for a specific good they want to buy (old version: `Should I buy this blender at the department store I am at, or should I drive across town to see whether the other store’s price is lower?’; new version: ‘Amazon says there are 3 sellers of this blender, and I see seller A has the lowest price. Click.’). And finally, reviews! Consumers no longer have to take risks when choosing between products–there is plenty of information available about the quality of goods, which means consumers won’t overpay for low quality merchandise.
The market for goods is a one-sided search (consumers are looking for goods). Because better information availability benefits searchers, the demand-side of the goods market, the consumer, benefits from the online market. The labor market, on the other hand, is a two-sided search (companies look for workers AND workers look for jobs), so increased information could benefit either side. This means that, like in the goods market, the demand side (employers) benefits, but increased information also helps the supply side (workers).
When it comes to information about price, the labor market differs from the goods market in two additional and important ways. First, in the labor market, prices are set by the demand side (an employer offers the worker a wage) rather than the supply side (a store posts the prices for its goods).* So the demand side in the labor market isn’t really ‘shopping for the best price’. Second, while recruitment is costly for employers, the relative cost for workers (perhaps going unemployed) is much greater. So a worker is under more pressure to take the offer in front of him instead of continuing the search for a better wage. These two facts together imply that workers, rather than firms, would benefit more from better labor market information.
Hunter Walk recently wrote a post about situations where online markets’ improved information about quality led to increases in wages. His two examples illustrate the importance of information about quality to both sides of the market.
Demand-side quality: Online markets allow workers to more easily find jobs that fit their skills the best. A better fit means that a worker will be more productive, which allows him to command a higher wage. In addition, increased information about demand-side quality can provide workers with benefits beyond pay increases: they can more easily find jobs they enjoy as well as jobs that can increase their skills, making them more marketable in the future.
Supply-side quality: In the traditional labor market, employers can’t observe how productive an employee will be before hiring him. Wage offers, then, will be based on the average productivity of the labor market. Furthermore, once an employer finds out who his high productivity employees are, he has an incentive to be secretive about that information because these employees are under-priced. Therefore, the reduced information in the offline labor market helps employers keep wages down, particularly for high performers. Reviews and ratings in online labor markets can help high-performing workers capitalize on their skills.
Online markets decrease frictions by making information more readily available. A reduction in frictions usually means more competition, which in the goods market drives prices down. But in the labor market, there is competition and a need for information on both sides of the market. Economics shows us that there are several ways that this increase in information can increase wages for workers participating in online labor markets.
Information technology is transforming labor markets in ways that will help individuals better market and profit from their skills. This, in turn, will change the way we invest in ourselves, pursue careers, and take control of our futures. Specialized online labor markets are just the tip of an iceberg we should be ready to jump on and conquer.
*Food for thought: wages are most closely associated with the characteristics of the job being offered, rather than the characteristics of the worker’s skills that the wage is supposed to be paying for.