Labor Cost Free-Riding in the Gig Economy

Abstract

We propose a theory of gig economies in which workers participate in a shared labor pool utilized by multiple firms. Firms must make a trade-off when setting pay rates. High pay rates are necessary to maintain a large worker pool and thus reduce the likelihood of lost demand, but they also lower profit margins. We show that workers will accept any job paying more than their reservation wage rate, yet larger firms pay more than smaller firms in the resulting pay equilibrium. This leads to a strong free-riding effect; specifically, firms smaller than a critical size pay the minimal rate possible (the workers' reservation wage), while all firms larger than the critical size earn the same total profit regardless of size, implying strong diseconomies of scale in labor costs.  Nevertheless, we show that the formation of a gig economy requires the existence of a firm large enough to support a worker pool on its own. We then analyze the role of demand competition. Under perfect price competition, market collapse is the only equilibrium. However, when at least one firm has a sufficiently large base of loyal customers, market collapse is avoided, and free-riding occurs in the pay equilibrium. Comprehensive simulations confirm the robustness of these results to various model assumptions. Our results offer insights into critical strategic decisions for gig-economy firms, such as the rationality of entry by small firms, the advantages and defensibility of scale, and the payoff firms can expect from gaining market share.

    

Keywords: Gig economy, economies of scale, wage equilibrium, free-riding, queueing

JEL Classification: L11, J49, D24