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Uber vs. Laws

Will the “sharing economy” help kill off government regulation?

The “sharing economy” has suddenly become a focal point of the presidential campaign, with candidates on all sides embracing companies like Uber for their disruptive, customer-focused innovation. On Wednesday, Sen. Marco Rubio (R-Fla.) thanked Uber in a tweet for giving him a ride in New York City; Jeb Bush took a stage-managed ride in an Uber in San Francisco last week. Hillary Clinton’s big economic speech raised some labor concerns, but also highlighted sharing-economy firms for “creating exciting opportunities.”

One of those opportunities could well come in the realm of government regulations: The sharing economy, many observers hope, could start wiping them out. As sharing companies build powerful, influential customer-rating systems — think of Uber driver ratings, or Yelp stars —the thinking is that the market itself will increasingly police bad actors and frauds, weeding them out without the need for onerous rules.

Economists on both left and right believe digital platforms have the potential to protect consumers without the need for government intervention. It’s a particular favorite of anti-regulation politicians such as Sen. Rand Paul (R-Ky.), who told a conference in San Francisco last year: “The crowd wants good service — you rate your Uber driver, your stay at a hotel. As information becomes more widespread, maybe you need less and less government.”

If this does unfold as promised, it will be a huge boon for anyone worried about the growing thicket of government regulations. Onerous licensing laws, different in every state and a barrier to many kinds of small businesses, would give way to a far more flexible and fast-moving system that polices itself.

Just one problem: When it comes to weeding out the bad actors, experts are starting to find, customer ratings don’t actually work that way. What customers actually do is say things are great.

Researchers have begun to take a deep look at customer rating system, and what they’re discovering is that reviews are biased upwards. Users tend to give higher ratings than sellers really deserve, like college professors who give pretty much everyone in class an A or A-minus. One recent study found that 94 percent of visible listings on Airbnb have an average rating of 4.5 or 5 stars.  

“I would say that an empirical fact is that rating systems generate star ratings that look extremely high,” said Chris Nosko, a marketing professor at the University of Chicago’s Booth School of Economics who has studied reputation systems.

Reputation systems have been mounting in importance since early in the Internet era. eBay, for instance, has used them since near its founding in 1995, so that shoppers would have the confidence to spend money on products without worrying that the seller would just take the money and run. Without that trust, eBay’s entire business strategy would fall apart.

“Take a platform like eBay and ask yourself the question of how the hell does it even exist in the first place,” Nosko said. “You have anonymous traders where one part of the market, namely sellers, knows more information than another part of the market, the buyers. The point to the reputation system is being the thing that allows these markets with asymmetric information to exist.”

Digital platforms like Uber and Airbnb are still young, but they also have customer-rating systems at their core. Uber customers see a driver’s ratings and can cancel the ride if they aren’t comfortable with his score. Airbnb users similarly see reviews of each other before agreeing to a transaction.

As they grow, economists have high hopes for their potential to create a market that rapidly and effectively polices itself. By giving customers the information they need about potential vendors, such a system “will potentially supplement if not supplant a good deal of what regulation was put in place to accomplish,” said Adam Thierer, a senior research fellow with the Mercatus Center.

For example, regulations for cab drivers, who are most at threat by Uber’s emergence, vary by state. But they typically require cabbies to keep their cars clean and paint them a certain color, among other things. Taxi commissions also standardize fares. These regulations made sense in the past when consumers couldn’t shop around for a taxi. They just got one on the street and had to accept its condition.

These and countless other regulations are all designed to protect consumers. It would be a huge economic change if reputation mechanisms started to supplant those regulations – a triumph for the wisdom of the crowd and the free market. This is where economists get excited, but researchers who’ve spent time with customer data start to get worried.

One thing they find is that happy customers leave reviews, but unhappy ones often don’t. Nosko and a colleague have conducted research on eBay to see if the reviews accurately represent consumer sentiment about sellers. Like Airbnb, the vast majority of eBay sellers have high scores. If buyers really thought so highly of the sellers, Nosko reasoned, then both consumers who did and didn’t leave a review would be equally satisfied with their transaction — i.e. the ratings wouldn’t be biased. The researchers used a controlled experiment to test this hypothesis and found the exact opposite: consumers who didn’t leave feedback were more likely to be dissatisfied with their transaction, an indication that eBay’s high ratings were masking consumers’ actual feelings.

Chrysanthos Dellarocas, a professor of information systems at Boston University and an expert in online reputation systems, has researched eBay’s rating systems as well and found similar results. “Most systems have a skewed distribution of ratings, which is actually skewed positively for the most part,” he said at a workshop on the sharing economy hosted by the Federal Trade Commission in June.

As reputation systems move from simply buying objects to making much more personal decisions, there’s a lot more at stake. With eBay, said Arun Sundararajan, a business professor at NYU. “You’re essentially getting a package from someone else. …There’s something very different about having a stranger sleep in your spare bedroom or getting into someone’s car.”

Not everyone is quite as hopeful about reputation systems. “I think it’s being hugely oversold and I think it’s being hugely oversold by companies that have an interest in it,” said technologist Tom Slee, who has written extensively about reputation systems. He warned that customers were unable to tell—and thus unable to review—the cleanliness of restaurant kitchens or the maintenance state of an Uber driver’s car.

Despite the concerns research is raising, Sundararajan, Nosko and almost all the researchers I talked to had high hopes for reputation mechanisms to eventually replace consumer protection regulations. They actually do believe that reputation systems are good at getting rid of the worst of the worst actors. “If something really bad happens, the reputation system starts to collect information that helps rectify that,” Nosko said. What they’re not so good at is what he called “the medium case,” an unsatisfied customer who probably isn’t the top concern for regulators now.

And people aren’t necessarily fooled by an easy grading curve. “Do buyers seem to understand that these things are skewed upwards and adjust for that?” Nosko said. If so, the bias may not be an issue. Additionally, Sundararajan noted, reputation systems are just one component of these companies’ larger consumer protection frameworks, which also includes features like dispute resolution mechanisms.

Given all that, the question may not be if reputation mechanisms will replace consumer protection regulations but which ones they’ll replace. Multiple people drew a distinction between regulations around what people see—think cleanliness of a cab—versus what they can’t see, such as the date of the cab’s most recent oil change. Reputational mechanisms are better positioned to replace the former than the latter. After all, consumers can see the state of a cab. They can’t find out when the driver last changed its oil.

Nobody’s about to throw out restaurant inspections because Yelp exists; even Rand Paul would probably find that premature. But figuring out just what consumer reviews can do is going to be increasingly important. Many experts think that the real impact is going to be in even bigger realms than car rides and crash pads.

“These little internet sharing markets are a drop in the bucket to something like health care,” Nosko said. “To the extent that we think that reputation systems can come in and start dealing with problems in the health care industry, it becomes really interesting and really big.”