Silicon Valley Reinvents The Invisible Hand

Jobs are the lifeblood of the economy. Whether self-employed or company-employed, workers rely on steady incomes to consume goods and pay for all of the necessities of life. When jobs are plentiful, friction decreases between job applicants and employers, ensuring that income is earned earlier and more frequently.

Adam Smith’s invisible hand is the guiding force of the market in a capitalist system. By allowing everyone to make independent decisions in whatever way they define their self-interest, the market is presumed to automatically clear, moving goods and services from those who can offer them to those who most desire them. It’s ultimately a statement about market efficiency.

That same invisible hand also rules the labor markets. Salaries are commensurate with skills, and employers compete for the workers they desire. If one company is able to create more profit from a talented individual than another company, then they theoretically will offer greater rewards (since they can) and poach that worker away.

That’s the theory anyway. In reality, labor markets are filled with a viscous friction that continues to bedevil hiring managers and workers alike. Even in the best of times, it can take weeks from the moment someone starts seeking a job until they have secured a new income (and of course, it can take another several weeks for the first paycheck to actually arrive). In worse times, those weeks can quickly drag out to months and even years, creating a permanent class of unemployed workers with little hope of securing a job.

Labor markets are filled with friction, which means that losing a job can easily destroy the financial security of an entire family.

To get a sense of this friction, just note how easy it is to buy a product versus hiring an employee, and more importantly, how much easier the former has become over the years compared to the latter. Buying a product from Amazon today can be as simple as a single click, and it arrives on time with great customer service in case something goes wrong.

Labor markets seem like they are stuck in Adam Smith’s era. We still apply for jobs the way we did decades ago, with resumes and cover sheets. We still conduct interviews, even though there is increasing proof not to mention plentiful anecdata that such practices are not a good judge of a worker’s abilities. Frankly, the biggest improvement to the process has been the use of machine learning to read resumes, but that has only led to keyword gaming and other useless activities which fail to actually make hiring more effective.

Put simply, the invisible hand has been broken in the labor markets for years, even if we haven’t fully realized it. The reason is that labor markets are thin, with few available workers and even fewer employers. That’s why algorithmic marketplaces are so important. Startups are completely transforming the nature of labor markets, changing our notions of what employment can be and how income security functions. In the process, they are not just making our economy more efficient, but improving the lives of workers.

Job Security and Thick Labor Markets

To understand the context for these changes to our labor markets, we have to peer back into history to understand their development. For centuries, work revolved around the land. Nearly everyone in Europe following the fall of the Roman Empire was related to the land, whether working it directly, or in the case of feudal lords, sitting and waiting for the land to be tilled.

What if looking at the past is precisely the wrong way to solve the problem though? What would happen if we actually had thick labor marketplaces without the friction that exists today?

Our modern notion of income security is completely alien in this context. Income was the harvest, and variations in weather patterns could ensure a bountiful crop or a disastrous winter. There were some means of absorbing these shocks, but ultimately the market could force even the most careful families to succumb to its will.

The growth in cities started to change this dynamic. For the first time, a worker was able to move between jobs, freed from a direct connection to the soil. These markets were rudimentary, and they remained so for centuries until the rapid growth of the industrial age in the early 1800s transformed them. From then on, we observe steady progress toward our modern notion of labor.

What are some of those qualities? A safe work environment is one key component of the modern workplace, as well as various mechanisms for rest like weekends and vacation. But probably the most important element of the modern development of labor markets is the protections afforded workers from being fired. Whether tenure laws, anti-discrimination laws, human resources rules, lawsuits, or other institutions, safety from job termination is arguably one of the most fought after rights of workers over the past two centuries of development.

I’ve already alluded to the reason for this focus. Labor markets are filled with friction, which means that losing a job can easily destroy the financial security of an entire family. Since it can take weeks or even months to find new employment, workers desire to stay in their current jobs as long as possible. As employment protections have decreased in the United States over the past few decades, families have compensated by relying on dual-incomes to ensure steady finances. In short, job security in our current labor markets is about avoiding job switches.

Fundamentally, the challenge is one of the “thickness” of the market. Market thickness can be defined as the simultaneous number of buyers and sellers in a market. When there are only a handful of consumers and producers, it is hard for prices to be set and thus, for transactions to be completed. As both sides increase in volume, markets have more information, and thus are able to operate more efficiently and more rapidly. This is one of the reasons why it is easier to buy clothes than a house – the high price of houses and thus limited number of transactions makes it difficult for buyers and sellers to understand the market and make a deal.

This is even more acute in the labor market. Outside of a handful of tech hubs where employee turnover is rapid, hiring is not at all robust. That makes labor markets quite thin, with limited numbers of employees moving from company to company to provide information on current market conditions to other participants. In these locales across the United States and really the whole world, the entire goal is to hold on to employment as tightly as possible and avoid the labor market as much as possible. For all of our progress, so little has changed.

What Happens If We Have Thick Labor Markets?


Actually, there has been some progress, most of it terrible. If you want to see what a somewhat thick labor market looks like, take a look at the service jobs in areas like food preparation and building maintenance. Due to innovations like franchising and increased usage of independent contractor terms for employment, these workers have none of the job protections of their predecessors and all the downside of friction-filled labor marketplaces.

Employers have the upper hand in these transactions, and that has led to a disintegration of living wages and stable work arrangements. The schedules for service workers are anything but stable from week-to-week, creating vast problems for scheduling multiple jobs and child care for families. That has led to even more focus on holding onto a job no matter what the costs are, since switching jobs when you are living on the razor’s edge is impossible without financial disaster.

We can see these trends reflected in all of the statistics about inequality that have been discussed in the media and academia the past few years. Middle-class jobs that used to provide job security and decent pay are increasingly being replaced by low-wage contract labor without any job protections at all. Wealth is being accumulated by a small percentage of the population, while the sons and daughters of middle-class families discover that the hollowing out of the American economy is going to force them to slide down the economic ladder.

That has led to movements like Occupy Wall Street to demand changes to the ways that companies handle workers. Looking back at the 1960s and 70s, there is an increasing desire to return to the way things were, with secure employment in companies with greater job protections (of course, with women actually in the workplace this time). The cry from all of these movements is the same and it is clear: they want greater protection from the vagaries of the market, and they want everyone to be placed on an equal footing in the economy.

That is one approach, but what if looking at the past is precisely the wrong way to solve the problem though? What would happen if we actually had thick labor marketplaces without the friction that exists today?

Take, for instance, the service worker who can’t risk changing their job because they need their wages to arrive absolutely on time otherwise everything will fall apart. Since their shift schedule is changing so often, this individual also can’t switch jobs because they can’t find the time to interview.

With a thick labor market, suddenly this person is able to seek out employment and instantly know who is hiring. Wages would be clearly available since information in the market is plentiful, and shift schedules would have to be equally spelled out. If the market was thick enough, it would even be possible to switch jobs within a single day. The ability of a software engineer in Silicon Valley to be working at Google in the morning and then switch to Facebook by the afternoon would be available to everyone in the market.

It is our current system that is dehumanizing, whether it is applying for hundreds of jobs and never receiving a response or doing stupid exercises during interviews that are completely unrelated to the job that we applied for in the first place.

For the first time, those service workers who have been powerless to resist their employers’ caprices would suddenly find that they have new leverage to use: they can actually leave since the market can provide them immediate employment. Their employer would be forced to comprehend their loss of power, or otherwise they may soon find that they have no workers at all.

Suddenly, job security isn’t about avoiding the market, but rather fully embracing it. Knowing that you always have another job available can provide a psychological relief that no rule or law will ever fully offer. That also ensures that those who leave the market, say for maternity leave, can easily find their way back into the market again.

It isn’t just job security that benefits with this development, but also job flexibility. Thick labor markets can also facilitate greater flexibility with shift schedules and work hours. A worker who wants to take a Wednesday off can now just choose to do so, knowing that the market will work its invisible hand to find another worker to take the shift. Similarly, workers with an extra hour or two may be able to find something to do productively in that time, providing them an extra bit of income.

All of this sounds great, but there is an obvious concern. Markets only work when the price mechanism is allowed to be fully determined by market dynamics, and that means that wages will fluctuate until an equilibrium is established. Doesn’t that mean wages will plunge as a great mass of workers seek out these newly accessible service jobs that were previously difficult to get due to market friction?

It is an obvious criticism, and an important one, but it makes one fatal flaw: it takes its data from thin labor markets, and not thick ones. With thick labor markets, employers could no longer miss wage payments because they want to make an extra buck – they would be forced out of the market due to their terrible reputation. Employers for the first time would actually have to compete for workers, since workers would have the leverage to leave at will at the prevailing wage. Perhaps most powerfully, consumers would know the general pay of individual establishments, because again, the market is able to provide that information to all participants. All of these forces would be strong, and all would push wages higher.

We shouldn’t assume that the dynamics of our current labor market would carry over to a thick labor market. It’s entirely different, and in terms of job security, is vastly superior to our current model. The question of wages is vitally important, but we shouldn’t immediately dismiss thick labor markets as wage destroyers. There are other forces at work they may actually make them higher.

Rebuilding The Invisible Hand

The idea of thick labor markets is not unknown to Silicon Valley – Uber is the obvious example that comes up here. According to their own research, the company has created 160,000 flexible jobs for workers, and many thousands more are on the way. But Uber is just one small piece of the overall labor market, and thus its effect is still not enough to thicken the overall market.

The idea of thick labor markets may be a bit of a thought experiment. Certainly their effects are a bit of a mystery – markets work in complex ways, and emergent properties of these markets may be difficult if not impossible to predict without building them in the first place.

However, it is not hard to believe that technology and startups are going to increasingly take the friction out of the marketplace. Better algorithms can align the right workers with the right employers almost instantaneously, and reputation systems ensures that workers are more consistent in their work (and employers act responsibly as well).

There are concerns that workers are dehumanized in such algorithmic assignment of work, a criticism that I strongly disagree with. It is our current system that is dehumanizing, whether it is applying for hundreds of jobs and never receiving a response or doing stupid exercises during interviews that are completely unrelated to the job that we applied for in the first place.

Thicker labor markets would be an incredible improvement over our existing arrangement. I want to make finding work as easy as buying a pair of socks on Amazon. I want to hit a button, and be at my job in 20 minutes ready to go. When technology has allowed that to happen, we will have finally have given the power to workers to shape their lives how they want to. What a revolution indeed.