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 face a trade-off in 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. Larger firms pay more than smaller firms in the resulting pay equilibrium, leading to a free-riding effect. Specifically, firms smaller than a critical size pay the minimal rate possible (the workers' reservation wage), and all firms larger than the critical size earn the same total profit regardless of size. Together, these results show that gig firms experience strong diseconomies of scale in labor cost. We also show formation of a gig economy requires the existence of a firm large enough to support a worker pool on its own. We then examine the implications of this wage equilibrium on the demand side of the market. When firms share workers but sell in independent product markets, it is a dominant strategy for firms to price to maximize the surplus they generate. This maximum surplus provides an endogenous measure of firm size. When firms are perfectly competitive in the same product market, market collapse (zero output) is the only equilibrium, which may lead to tacit collusion among the firms to avoid this outcome. Our findings are consistent with stylized facts about the evolution of gig markets such as ride sharing.

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

JEL Classification: L11, J49, D24