By Fredrik Thomassen, Co-founder & CEO | Konsus
Across emerging markets, hundreds of millions of people are connecting to the Internet and starting to learn skills that are marketable to western firms online.
On the three largest Internet work platforms alone, 25 million CVs can be searched and instantly contracted, with little technical or legislative friction. For the first time in modern history, free trade of labor across trade blocks is a possibility.
This will impact labor markets in five very important ways:
1) Reduced global inequality
2) Less racial and gender discrimination
3) Lower wages for medium-skilled workers in the western world
4) Reduction in firm size
5) Reduced tax evasion
1) Reduced global inequality
According to neo-classical economic theory countries with a lot of cheap labor (say, India) should trade a lot with countries with very little cheap labor, but perhaps abundant capital (say, Norway), and wages should "equalize" over time.
However, the lion's share of global trade is intra-regional trade, such as French Peugeots sold to German customers, and German Audis sold back to the French, and very little "equalization" is going on. With the impact of the Internet, two of the most important factors, transaction costs and trade barriers, are, for all practical purposes, removed.
With the impact of the Internet, two of the most important factors, transaction costs and trade barriers, are for all practical purposes removed.
Cross-country trade in labor has never been freer, and huge gains should be expected to arise in the poorest countries in the world. Internet payment services, such as Payoneer and Paypal, and platforms such as Upwork and Freelancer, have largely removed barriers to trade completely.
At these platforms, firms can find and hire freelancers in a few minutes. As shown in Figure 1, the poorer the country (the more abundant labor as a resource endowment), the higher the potential gain from doing Internet work.
Figure 1: Internet freelancer wage rates (USD) compared with average wage rates in the country. Indian and Pakistani internet rates are a 10-15x markup from normal rates. Source: Payoneer data, Konsus Analysis
2) Less racial and gender discrimination
Gary Becker’s seminal book, “The Economics of Discrimination,” famously predicted that labor-market discrimination would go down if market competition would intensify. Since not hiring someone talented based on prejudices is costly, it should be expected that when an industry’s competitiveness increases, there will be less discrimination.
Since not hiring someone talented based on prejudices is costly, it should be expected that when an industry’s competitiveness increases, there will be less discrimination.
The prediction that increased competition reduces discrimination has been studied quite extensively empirically: Economists from Harvard and Brown universities (Levine, Levkov, Rubinstein, 2009), found that one-fourth of the racial wage gap was eliminated when competition-enhancing banking deregulation happened across the U.S. in the 80s and 90s.
Similarly, a widely cited report from the Bureau of the Labor Statistics (Black 1999) found that increased international trade in manufacturing industries led to a sharp decline in discrimination against women in these industries.
Within Internet work, according to the theory, there should be almost no discrimination, as 1) the purchasers of Internet labor are fragmented and do not hold market power, 2) Internet work is almost completely deregulated and 3) it is harder for employers to identify characteristics they dislike and they are likely to care less about racial/gender stereotypes when interactions are only virtual.
Data from payment provider Payoneer, the largest payment platform for freelancers, shows this remarkable development clearly. On average females make only three percent less than men online, compared to approximately 20-25 percent less in most western economies.
3. Lower wages for medium-skilled workers in the western world
One has to dig pretty deep down into the protectionist toolbox to argue that increased Internet work is bad for workers in emerging markets. For workers in the western world though, it is still unclear.
Will our services be substituted by cheap labor or will we find more productive work to do, while Internet workers are doing all the "boring stuff"?
It might be that workers in the western world can outsource their lowest-productivity tasks on the Internet and focus their time on what they do best.
There are at least four points to consider:
a) The first-order effect is pretty clear: All else being equal, workers should expect reduced demand if they: 1) perform tasks that can be solved by others online, 2) happen to have been born in a high-income country and 3) are not specialists.
b) Specialists can use the Internet to get more leverage on their skill and to measure their performance better. As such, they should expect increased demand and higher wages (the superstar effect).
c) Cheap Internet labor can be viewed as a decline in input prices much in the same way as a decrease in oil prices. This will increase firm profits, allowing it to pay higher wages or cut prices. This is a second-order effect though, and cannot offset the large first-order effect.
d) The tractor magically turned farmers into accountants, painters, mechanics, politicians or engineers, and probably everyone is better off having tractors around. Fundamentally, the Internet might not be so different from the tractor, simply speeding up specialization and creating new patterns of trade and specialization.
It might be that workers in the western world can outsource their lowest-productivity tasks on the Internet and focus their time on what they do best. The size of this effect depends largely on how effectively firms in the western world adopt new technologies.
4) Lower between-firm transaction costs
In one of the most influential papers in the history of economics, Ronald Coase’s 1937 paper, "The Nature of the Firm," explains succinctly why a firm exists:
“The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of ‘organizing’ production through the price mechanism is that of discovering what the relevant prices are. [...] The costs of negotiating and concluding a separate contract for each exchange transaction which takes place on a market must also be taken into account.”
"The costs of negotiating and concluding a separate contract for each exchange transaction which takes place on a market must be taken into account.”
Essentially Coase is saying that firms exist to reduce 1) search cost and 2) transaction cost. Clearly, Internet work dramatically reduces search costs for labor. On Upwork alone, more than 10 million freelancers with full skill profiles and salaries are listed and can be instantly contractable.
Transaction costs are also much lower than in traditional labor markets, as hiring and firing costs are virtually zero, payment gateway fees have plummeted to 1-2 percent and the hassle of sign up is fairly low.
A huge problem that remains on these platforms though is quality uncertainty. If only 1 in 5 or so of the freelancers that a firm hires off of UpWork are actually able to do the job to a sufficient standard, despite astounding reviews, then this imposes very high costs on the firm since they have to spend a lot of time coordinating. Over time though, more rigorous screening and testing procedures are certain to emerge.
It should also be expected that within a country firms will trade much more with each other via the Internet, and business models such as Hourly Nerd, a marketplace for top-tier consultants, will emerge.
In sum, reduced search and transaction cost creates less incentive to organize the means of production within a firm. This should lead to lower firm size. In addition, governments will have reduced incentives to artificially increase firm size (see next point).
5) Reduced tax evasion and less government control of business structure
Those digital nomads hanging out in Thailand making websites for western companies surely don’t pay any taxes do they? Isn’t the Internet going to stay just free and anonymous forever? What about those bitcoins and the dark web?
The amount of tax evasion depends largely on the quality of the financial information trails a government can collect (in addition to social norms, state capacity, tax structure, etc.).
All else being equal, the cheaper it is for the government to collect information trails, the harder it will be to evade taxes. And what is easier than simply requiring PayPal, Payoneer, Upwork, Freelancer and everyone else to verify their workers' identities and to report their income to their authorities? There is just no way governments will allow a significant fraction of their economy to operate tax-free online.
Full-time employees who are working for big companies that very accurately report all employment data to the government are very unlikely to evade taxes. Conversely, a government looking to increase its tax base will seek to convert people from self- employment to full-time employment.
By means of interventions masquerading as social welfare initiatives, such as pension systems that heavily penalize workers who are self-employed or work for small companies, or government-granted special interest subsidies to large rent-seeking firms, governments have sought to change business structures to increase their tax base.
With the Internet allowing close-to-perfect information trails, governments can track all earnings of their inhabitants everywhere, and the incentive to create regulation to support big corporations will be reduced.
For questions and feedback about remote work and productivity, visit www.konsus.com or email firstname.lastname@example.org
(Black, 1999): http://www.bls.gov/mlr/1999/12/art5full.pdf
(Levine, Levkov, Rubinstein, 2009): http://faculty.haas.berkeley.edu/ross_levine/Papers/RDandC.pdf
(Gary Becker, 1957): http://press.uchicago.edu/ucp/books/book/chicago/E/bo22415931.html
Elance Talent Report: https://www.elance.com/trends/talent-available/geo#GeoRanking