Chris Anderson’s Voodoo Economics of Free

This evening at 7:30pm here in New York City on CUNY TV (channel 75 in most cable systems here in New York) I will be on Brian Lehrer Live talking about perhaps among other things, Internet economics. For those of you outside the city there will be a live feed at www.cuny.tv. The appearance is prompted by my recent controversial writings about the negative impact of too much free.

In speaking with the shows producer he informed me that the lead in to the show would be this Chris Anderson video, where Chris theorizes that everything digital will be free, and extols the virtue of that potential future. The video got me thinking about how I would respond, and I thought I should write it down.

What if all digital products really *had* to be free?

Based on what Chris is saying, does this mean that Microsoft, Oracle, Electronic Arts, etc. are all going out of business? Or does it mean they will all have to adopt an advertising based model and give away all their products, perhaps only charging for the manual labor of technical support? These are all digital businesses, and based on Chris’s thesis, all their products will have to become free.

I don’t think Chris is right about this, but lets just explore it as a thought experiment. What if he *is* right? Would that be a good thing for the world?

Perhaps it depends on where you live. It would be the most massive shift of wealth ever from the first world to the third world on a scale that would make Ghandi seem like Scrooge. Because what it suggests is that countries like China and other less developed countries, where their populations can’t afford to buy digital products and services, won’t have to because they will all be free. Meanwhile, the products they create, all physical, will be sellable at a reasonable margin – because they require labor on a per unit basis.

As the first world economies become increasingly knowledge based and digital, by Chris’s theory, labor in these economies will become less and less valuable. Some of you will argue that Google does fine based purely on advertising. But just because one company can commoditize everyone else’s work and make pennies on things that used to generate dollars, is that sustainable across the whole economy? Or would we really be reducing the overall amount of money flowing into the digital market and therefore to the overall labor force?

I think it is clear that the “media-ization” of digital economy has the effect of reducing the amount of actual hard dollars that flow into the economy. If less money is spent on digital and more money is spent on hard physical goods that are generally produced elsewhere, taken to an extreme that would have a horrific effect on our economy.

Ok, but does everything *have to* be free?

So it may not be good for us, but is Chris right? Chris’s argument is based on the misinterpreted economic theory that everything tends toward its marginal cost. But does this really hold up in the digital economy? The fact that there was very little marginal cost to Microsoft Office did not mean that it was tending toward free for the last twenty years, so I don’t buy this at all. The marginal cost of Office has been pretty close to zero for a long time.

The supposed economic theory behind what Chris is saying is that the marginal cost of goods really drives the price because, in theory, competition forces people to lower their prices until they absolutely can’t afford to do so any more. But this is really an economic theory that does not apply to non-commoditized markets.

For example the fact that you can play Breakout or Pong for free does not cause Microsoft to need to sell Halo cheap. Halo’s marginal cost isn’t any higher than the marginal cost of Pong. The reason it is expensive is because it has unique entertainment value to people.

Similarly, in the music business, the argument has been made that the reason that music sales are hurting is because the marginal cost of their product is zero. But this is also not true. There is no competition driving the value of a given Foo Fighters recording down. Every recording has a unique value to a given audience. What is driving the value of music down is the fact that people are stealing it with no compunction on a massive scale. The “theft effect” is not part of any economic theory I have every studied and certainly has no relationship to marginal costs.

So where is this all going?

I don’t think it would be at all good for people in America that every digital product becomes free because the digital/information world is increasingly the only type of labor we are going to be willing or able to do. If you don’t want to dig ditches making your daily bread, a free economy is not a good thing.

But thankfully, I believe the thesis is flawed. I do believe we are in an era of artificial digital abundance in large part driven by over zealous VCs and companies like Google that are supporting money losing services with their massively profitable search engine. But this cannot continue indefinitely. Google cannot do the best job of making every category of everything. Scarcity of important useful products will indeed return. These products will be designed by companies that do not want to lose money and don’t have a search engine to subsidize money-losing efforts. Therefore they will have to be supported by direct (i.e. non-advertising) revenue streams. And I do believe that they will.

We are indeed in a crazy time. But after a bit of equilibrium returns to the markets and people begin to get used to the idea that everything digital can’t be free, everything we have learned about economics, and I don’t mean Chris Anderson’s voodoo economics, will take hold and everything will be OK.