Category Archives: Innovation

Modernity is the most beautiful process in the world. As Deirdre McCloskey explains in great detail, since 1800 or so life expectancy has doubled, infant mortality is down more than 90 percent, incomes are up at least 16-fold, transportation is anywhere from ten-fold to a hundred-fold faster, we can instantly communicate with loved ones even if they’re thousands of miles away, and virtually the entirety of human knowledge and culture are available to nearly everyone for free or close to it, thanks to the Internet.

We truly do live in amazing times. And according to Michael Munger, who directs Duke University’s multidisciplinary PPE program (it stands for Philosophy, Politics, and Economics), we are on the cusp of a revolution that could accelerate the ongoing betterment of humankind. He makes his case in the new book Tomorrow 3.0: Transaction Costs and the Sharing Economy.

If the first major revolution in human history was the Agricultural Revolution and the second was the Industrial Revolution, Munger’s new book argues that a third, technology-based revolution is just getting underway. Imagine an economy that has an Uber for nearly everything, and renting and sharing are more common than ownership.

Munger uses the example of a power drill. Most people have a bunch of tools sitting in their garage or basement, sitting idle almost all the time and doing little more than taking up space. The average drill, for example, might have a cumulative lifetime use of a half hour, even if it’s owned for decades. This drill, along with unused cars, housing, and more, is idle capital that people could be making use of. So what’s stopping them?

Transaction costs are. A student of the late Nobel economist Douglass North, Munger observes about his old teacher that “for Doug North, it did not really matter what the question was. The answer always starts with ‘transaction costs.’” Transaction costs are the costs of doing business. In addition to the price of a good, the consumer pays, with time if not money, the cost of finding a good in the first place, waiting in line for it, verifying its quality, shopping around for a good price, and so on. According to Munger (and Doug North and Ronald Coase, no doubt, if they were still with us) transaction costs are key to understanding the third economic revolution now underway.

Going back to the drill example, Munger says, “I don’t need a drill. What I need is a hole in this wall, right here.” If you own the drill, problem solved. Just fetch it from the closet when you need it. But what about the other 99 percent of the time when the drill does nothing but collect dust? Drill-less people who need holes in their walls could be using it, and you could profit from it. Everyone would benefit.

So why don’t these win-win arrangements happen more often? Because the transaction costs are too high. The new economy being born doesn’t depend so much on making stuff as it does on lowering transaction costs so win-win deals can happen more often and more easily.

The drill owner needs to solve three problems—triangulation, transaction, and trust. Triangulation is finding a renter in the first place, and figuring out how to get her the drill. Transaction is making sure money changes hands. And trust is being confident that the other person will make good on their end of the deal. Both owner and renter have to solve all three of these transaction cost problems, or else they will never get together in the place.

Companies like Uber and Airbnb work by lowering transaction costs. If I need a ride, Uber’s app can connect me with a driver in seconds. That solves the triangulation problem, especially compared to waiting for a cab in the rain during rush hour. Uber also solves the problem of the transaction itself. It has both the rider and drivers’ credit card info, making payment so easy neither rider nor driver even need to carry a wallet. And the trust problem is solved by a ratings system that incentivizes both rider and driver to treat each other honestly and well.

In the years to come this type of business model will expand, lowering transaction costs across the economy, opening new opportunities people haven’t even thought of yet, and making life cheaper and more convenient for nearly everyone. It will also greatly reduce waste and idle capital. People won’t need as much stuff, and the stuff there is will be used much more intensively and efficiently.

It is too early to see all the positive and negative consequences this third revolution will have, but change is inevitable. Modernity is a never-ending process; people are always looking for ways to make things better. The transaction cost revolution is the next step, and it is already changing lives. With Munger’s help and a little Econ 101 knowledge, that change will be much easier to navigate.