The Economics of Recorded Music:

From Free Market to Just Plain Free

By Peter DiCola
07.16.2000


Recorded music, though a unique phenomenon, will soon have the two main characteristics of a public good, non-depletability and non-excludability. The free-market mechanism does an extraordinarily poor job in handling public goods.


Dreaming of Economists
The other night, I read yet another story about Napster, Gnutella, and the continuing battles between artists, labels, and technology firms. As a longtime music fan, indie booker of shows, and student of economics these issues consume me. Again I found myself struggling through the details of the issues half-hoping I could I come up with a new way for musicians to be compensated for their work in the future. I wasn't getting anywhere. My economic theory felt rusty. Perhaps, I was over my head. I fell asleep anxious and frustrated. That's when Adam Smith came to me in a dream.

Odd as that may seem, in a way it sort of made sense. After all, Scotsman Adam Smith was one of the most famous economists of all time and was notorious for his ability to solve incredibly complicated economic issues with the force of simple logic. He was the Babe Ruth of his subject, the guy who changed the game. Actually, he wore knickers much like the Babe's, except without the Yankee pinstripes. But I digress. Smith tapped me on the shoulder and asked me what the trouble was. I explained how technological advances were threatening the sale value of music. I described digital downloads and file sharing technology that enable the free exchange of master-quality music files without providing for the compensation of the artists who created the music in the first place. "What's worse", I told him, "however frightening this may be for major label artists, it's my fear that independent artists and independent labels will be hurt the most. Indies receive a much higher percentage of their total revenue from direct sales than major labels and their artists."

Adam Smith scratched his funny wig and nodded sympathetically. After a long pause he spoke. "I can see why you are worried. But think about it ƒyou yourself have a degree in economics. You're about to start work on a graduate degree in economics. You were even a management consultant for a big-time New York firm. Can't you figure this one out? Begin with what you know. Music is a product just like any other. It's subject to the laws of supply and demand, the 'Invisible Hand' as I used to call itƒ"

"That's just it, Mr. Smith. Music doesn't seem to follow the laws of supply and demand. Not like other so-called 'consumer goods' like toothpaste or Swedish furniture."

"I see." He pondered for a moment, absent-mindedly tugging at his velvet balloon shorts, and then, with a glint in his eye he continued, "Well that must be your answer. Maybe you should consider the possibility that all goods are not alike," and with that he disappeared into the foggy moors.

Is Music a Consumer Good like Toothpaste?
For the past week I've thought about Adam's advice. What makes music a different type of product? How did I first experience recorded music? Would that give me a clue as to why it seems different to me than regular goods? Let's seeƒthe first band I listened to in earnest was the Beatles. My dad had purchased their entire catalog on CD and I made a set of copies on cassette. Within a year I was buying CDs myself - but only used CDs, thanks to the (now defunct) Chicago Digital used CD store. (My first CD purchase was R.E.M.'s Green for eight bucks.) Despite having a part-time job, I had the limited budget of a teen-ager. Fifteen-dollar CDs seemed awfully pricey compared to used ones or three-dollar Maxell blank tapes. In high school, I started buying new CDs and vinyl, mostly choosing music that was rare, and often stuff that was created by self-published indie label artists.

At first, I bought "new" products because they were all I was likely to find - no use waiting for a used Beat Happening CD to show up in the used binƒit wasn't likely to happen. It's important to note here that I was acting out of practicality, not morality. Only later did I realize that copied or resold music did not directly compensate the creator-artists (My sincere apologies to Michael, Mike, Peter, and Bill: I just wasn't thinking. And, hey, I was only 13 years old). Once my friends and I understood how we were affecting artists we all developed the stance that it was important to buy one's own copy, even though we could have easily traded copies. As I reflect back on this period, I realize the truth: my friends did this to be nice to the artists. It was altruism that prevented me from copying this music, without paying the artists or their label.

Altruism and the Music Economy
In a free-market, democratic, capitalist society, however, I understand that counting on people's altruism is a recipe for trouble. The US economy is based on the concepts of harnessing people's self interest, using supply and demand and letting things go where they go (the "free" in free market). Our system is not based on sacrificing one's own needs and wants for those of others. Following basic logic it's easy to believe that an altruism-driven economy would be void of homelessness, etc. Clearly, this is far from the world we experience. Sure seems like a nice, kind, and friendly thing to give every American a place to live - but who wants to personally sacrifice for it? No one. So it doesn't happen.

The music industry has depended on altruism for many years. Labels have hoped that the implied cost of illegal copies would be offset by gains in future purchases; people would get to know more bands, and buy more CDs and the profit would trickle down through the industry. That argument floats around even today, as some artists, agents, and labels take the stance that Napster is helping sales. This may be true, but if it is, I can't help believing it will only be so for a limited, intermediate period of time, before the market for recorded music changes. A product that is available free of charge right now isn't going to stop being free all of a sudden. If the market for recorded music is left to its own devices, the only money artists will be getting for their recordings will be rooted in altruism. The word for this is charity. Without some kind of change in the market - be it technological or economic - artists will become dependent on charity.

All Goods Are Not AlikeƒTake Spam, for Example
OK, enough with the doom and gloom. The good news is that there is an economic explanation for all of this. Adam Smith gave me an excellent clue at finding the answer when he revealed that "all goods are not alike". The first example of how some goods that seem similar can behave very differently involves Spam and ham. Both products are sold at the grocery store. Both of them are food. One of them is "meat," the other is meat. They seem, for the most part, very much alike. But consider this. When a shopper begins to make more money, he uses less of that increased income to buy Spam. Now that he's got money, he can afford to get some ham. Ham tastes better, which is part of the reason why it costs more. Once a person can afford it, he buys ham instead of Spam. Thus, Spam and ham behave very differently as consumer goods. When people's incomes increase, they buy less Spam, but more ham. Spam is therefore known as an inferior good. Ham is called a normal good. Most things are normal goods - the more money you have, the more products you'll buy. Since recorded music isn't an inferior good, i.e. the more money you have, the more music you'll buy, logic should follow that it is a normal good. But my point is that not all things that are bought and sold behave in the same way.

Music as Non-Depletable
Recorded music behaves uniquely because it is a strange hybrid of the intellectual and the physical. When music is purchased, a consumer obtains two things: exposure to a set of ideas conceived by the artist and the physical product. The "conceptual" half of recorded music is difficult to put a price tag on. When one person hears a musical idea, that idea is still 100% intact for the next person who experiences it. None of the idea goes away when someone consumes it. In economics, this is known as non-depletability. The cost of producing a musical idea is the same whether only the artist herself experiences those ideas, or whether 50 million people experience them. There is no way to prevent one more person from hearing music for free. As was my case, someone's dad could let them make a copy, someone else could sell the music to a re-seller of used CDs, or someone could use Napster to facilitate the downloading of the music from a stranger's computer. This is called non-excludability. This is what makes it impossible to put a price on an artist's creative concepts. These concepts aren't perishable commodities once they've been created, and there's no realistic way to control the number of people who hear them so it's difficult to objectively measure their value. Goods for which these two concepts, non-depletability and non-excludability apply, do not obey the typical laws of supply and demand. Supply is unlimited, demand is unconstrained, and the price does not exist - it is, in effect, zero.

Recorded Music: A Hybrid Good
Looking at how oddly music behaves as a product I can't help but wonder how the music industry even existed. How has there even been a market for recorded music? The answer lies in the fact that recorded music is a hybrid. The physical half of recorded music can be an object with height, depth, and width, like a CD, or can be a set of ones and zeros, like an MP3. In either form, there is some cost to producing a copy of the original representation. Once a CD is pressed, and one is sold, there is one less CD available for purchase. So the physical half of recorded music does have depletability. And because recorded music has always come with a license for use - "you can make copies for yourself, but not others" being a significant part of that license - the physical half of recorded music also has excludability. Thus, the hybrid nature of recorded music - concept and object, existing as one - has allowed labels and artists to charge money for it. The physical half of the hybrid can behave like a regular consumer good, because it is depletable and excludable. There is a cost to manufacturing and distributing CDs, tapes, and records. The labels would simply assign some sort of "wage" for the artists, add that to the cost, and charge a price with a hefty markup for profits. There you have it - a market for recorded music. Until the future happened.

Welcome to Your Future
Two critically important things are changing. First, recorded music in a digital format is not depletable. So theoretically, an unlimited number of copies can be made for virtually no cost. Second, the distribution is no longer controlled. Once music took a digital physical form, it became infinitely more difficult to prevent people from trading music for free. The implicit license that came with CDs in the old days is now almost totally unenforceable. Therefore, even the physical half of recorded music has become non-depletable and non-excludable. Thanks to digital download technology and file sharing, both halves of the recorded music hybrid fail to act like regular consumer good. It is nearly impossible to assign a cost to the musical idea, and there simply isn't much cost to the creation, replication, and distribution of a particular representation of that musical idea. The market is disappearing, and the price of music is becoming zero.

Some people - particularly music industry executives - lament this transition where technology has gone and "ruined everything" (most clearly their oligopolistic control of market and distribution). I would argue that the hybrid nature of recorded music, economically speaking, has always meant that the market mechanism didn't work right. The idea half of the hybrid can be corrupted by the very existence of the commodity half. If artists create their music with an eye towards selling it, they might create music of a lesser caliber than they would otherwise have created. (I use the term "might" here because we can all name a dozen respected musicians who worked within a patronage system. I won't be discussing them further in this essay because we are not living in a period of standardized and widespread patronage.) The market system we experience today encourages innovation. Everyone knows that much. But another ironic aspect of this, which plays a key part in the economy, is the fact that the market system encourages the process - gradual or otherwise- of copying what works. In fact, the market will copy a given product until enough people are providing it so that price competition occurs and profits disappear. Let's call this the "knock-off" mechanism.

The Knock-Off Mechanism
When you apply this to music, you understand why both 'N Sync and the Backstreet Boys exist. The industry will produce copycat acts of something that sells until it doesn't sell anymore. Those artists who copy instead of create, in order to sell records, are damaging the "idea" half of their own recorded music hybrid to serve the "commodity" half. Few, if any, other products in the economy are like recorded music in this respect. Its hybrid nature means trying to sell more actually makes it a worse product. When Intel tries to sell more processors, it has to make them better and faster. It's a good thing. The incentive of profits results in something of value for consumers. When a major label tries to sell more Christina Aguilera albums, they tell her to sound more like Britney Spears. Now, without accounting for taste, it's clear that a carbon copy of something doesn't add anything to the range of musical options that consumers enjoy - especially not at $17.99 a pop over at Coconuts. A regular good is made better in the process of trying to please customers. But this mechanism does not necessarily apply to music; in fact, it applies very seldom in the major label system.

Regardless of whether the market system used to "work" for music in some ways it has become clear that it will not work in the future, certainly not in the fashion that it used to do so. Despite the perceived excitement about eliminating the major record labels and other so-called "middle men," without excludability or depletability, recorded music will have a price of zero, regardless of whether the artists or a label is selling it.

Music is Like a Public Good
There is a name in economics for a good that is neither excludable nor depletable. A public good is defined (by my handy college economics textbook) as follows: "A public good is a commodity or service whose benefits are not depleted by an additional user and for which it is generally difficult or impossible to exclude people from its benefits, even if they are unwilling to pay for them." Recorded music seems to fit this definition pretty well, though not exactly. Copyright holders are still attempting to protect recorded music from users who don't pay for it. Until music is made available in digital form by either artists or uploaders it is still excludable, for now. This is changing at a rapid clip. Maybe by observing the behavior of public goods we can provide some illustration of what to expect in the future of the music industry.

Natural resources are commonly understood as an example of a public good. For example, Lake Michigan is there for everyone to enjoy. One extra person standing on the beach looking east does not diminish the view of the lake. Nor can the city reasonably prevent anyone from looking at the lake, enjoying the sunrise over it, or feeling the breeze blowing across it. Thus, natural lakes are neither depletable nor excludable. National defense is another example. One extra person being born does not increase the cost of national defense. National defense is non-depletable. The government could not get people to pay for defense voluntarily. This is because a given person would still be protected, whether he paid or not, so long as national defense was provided to anyone in the country. National defense is also non-excludable. Thus, the government has to charge taxes to ensure that national defense will exist.

Providing for Public Goods
Ensuring that public goods are provided in adequate amounts is one of the great problems of economics. Not addressing this problem can mean that too few public parks are developed. It can mean that countries are not sufficiently defended from attack. It can mean that villages don't maintain fire departments. All of those occurrences would make the world a much worse place to live in. Public goods are, just that - good. They have value for people. It's just that, because of their very nature, it is not easy to charge a price for them and set up an adequate market for individual buyers and sellers to make exchanges. Rules of supply and demand do not apply, at least not in any normal sort of way. Because the free market does not operate well when it comes to public goods, something or someone else has to step in.

Government is the most common solution for the public good problem. The government simply buys what it thinks will be a sufficient quantity of the public good, using tax money to pay for it. Obviously, this remedy isn't likely to apply to musicians. But it could be really great - pardon me while I digress a little here. There could be a government agency that would determine which musicians would receive what level of subsidy. If the right people were working for that agency, we could deny any and all funding to Mariah Carey and give $100,000 a year to Stephin Merritt. Then again, the "right" people wouldn't be working for that agency. Mariah Carey would hire corporate lobbyists to ensure that she'd get the $100,000 and Stephin Merritt would get nothing. Government control of the music production and compensation processes is clearly not the answer that independent musicians are looking for. Actually we can see what scary things can happen in a model where art is supported only as determined by the desires of "the right" people.

Leave it Alone?
Some observers charge that no intervention is necessary. They contend that musicians should make music solely for the love of making music, not for the sake of profits. Sounds niceƒ unless you are a musician. Consider first the cost of equipment, the value of time and labor. More importantly, consider all the people - recording engineers, marketing experts, record label employees, booking agents - who work to facilitate the making and playing of music. Those people need to get paid. Who pays them? The musicians. If they don't get paid, they have to get other jobs, and the quality of recording, marketing, distribution, and booking goes way down. While some would like to believe this is a problem that will only affect musicians, they are only one part of a threatened music economy.

Opportunity Cost
And I wonder about those who think nothing about devaluing musician's labor to the sum of zero. All time has an implicit price - in economics it's known as opportunity cost. It's the amount of money a person could have made doing something else. If musicians made no money from their recordings, the cost of their time goes up. The difference in money earned between music and some other day job increases. It becomes too expensive to make music. More of them would have to get day jobs, or work even more time at their current day jobs. Some of them wouldn't have time for music at all. The economic force in this case is irresistible and undeniable. If music becomes free, it's only logical to assume less music will be made and music will be of a lower quality. Thus, the "public good" in question, recorded music will be created at a level below what society would actually want. Few individuals, and certainly no music fan, would say that "too much" music is available to them. No one wants to impose a scarcity of music. Yet, if the market system is left to handle the public good that is recorded music, that scarcity of music will occur against the wishes of individuals. I'd guess that even Adam "Invisible Hand" Smith would believe that the market system will fail here.

Addressing it in Economic Terms
The public debate about what the music industry should do about this problem has generally not addressed the issues in these economic terms. The key pair of sentences that need to be uttered more often are these: "Recorded music, though a unique phenomenon, will soon have the two main characteristics of a public good, non-depletability and non-excludability. The free market mechanism does an extraordinarily poor job in handling public goods." It is no surprise that the recorded music industry is in trouble. It has been trying to use free market capitalism to make profits on a good that is becoming more and more like a public good. It should now be apparent that an unfettered, unregulated, and unobserved market mechanism will serve recorded music - and the artists who produce it - very poorly. That, in a nutshell, is the bad news.

The good news is that concerned people - such as the independent artists and labels that will lose most of their revenues if the price of recorded music approaches zero - have some economic reasoning to call upon. I suggest the following guidelines for those who want to find a solution to musicians' big problem:

• (1) Recorded music should somehow be made to be depletable or excludable, so that it does not come to fit the definition of a public good and will not behave like one. Either its natural state as a non-depletable resource or its tendency to be non-excludable must be counteracted. Any solution that does not accomplish one of both of these is unlikely to succeed.



• (2) Recorded music must be treated as a hybrid good. It will necessarily have some aspects of a public good and some aspects of a regular consumer good. If this reality is not addressed, then the treatment of recorded music as solely one type of good could damage the quality of the good.



• (3) The free market mechanism must be acknowledged to be inappropriate and undependable to appropriately handle recorded music. Without action by society, music will begin to be produced at a level lower than the people, in aggregate, actually want.



These guidelines, based in economics, represent the beginning, not the end to this discussion. Clearly, the process of understanding music as a product is somewhat distasteful. But understanding it as a special type of good, one whose value is not measured adequately in dollars and whose exchange should not be left to a market without some special rules, is very empowering. It can frame the discussion and define the search, as everyone who loves music scrambles to imagine a way in which both the artists and the consumers can always get what they want. Despite Mick Jagger's claim to the contrary, I think it can happen. And, I suspect, so does Adam Smith.

 

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