When Everything Else Is Free

Since the Great Recession in June of 2009, the United States economy has failed to produce the kind of catch up growth necessary to return to its pre-recession trend of growth (also known as potential GDP). Two percent growth in real GDP, which is roughly what we’ve experienced since we reached the trough of the business cycle, is just not getting it done. Many economists view this as a problem, and rightly so, because slow growth means fewer jobs for workers and fewer goods and services for people to enjoy. But all is not doom and gloom and, in the spirit of the holiday season, I want to point out a new economic trend that may put a positive spin on the recent sluggish growth. Put simply, we don’t pay for anything anymore. That may be a bit hyperbolic, but it gets at the core truth that “free” is an option for many more goods and services than it ever has been before.

A quick survey of a few industries will reveal the prevalence of this trend:

Entertainment: In addition to the old AM/FM radio, music listeners now enjoy free music streaming on Spotify and free custom radio stations on Pandora. Movies and shows are available to stream for free from websites like Hulu and Youtube, and sometimes even from the networks themselves. Consumers with e-readers or tablets can read almost any book in the public domain for free thanks to Project Gutenberg. Zynga is the hottest company in video games, especially social gaming, but they offer their wares for free through Facebook.

Communication Technologies: Instead of paying for postage and envelopes, we now send emails and instant messages over the internet for free. If we would rather see the people we’re communicating with, we can use the free videoconferencing service from Skype. Facebook and Twitter both allow you to stay in contact with hundreds of people simultaneously. Both are free. Text messages are now free through Apple’s iMessage app and soon people may be allowed to make phone calls over the internet for free (the technology already exists), instead of paying for a cell phone plan.

News: It’s difficult to find an industry that has been hammered harder than the newspaper industry over the last 10 years by falling revenue. Basically, their business model has imploded because the bundled product they traditionally sold is now unbundled and the new competition charges zero dollars. The old business model relied on a combination of physical newspaper sales, general advertising, and classified advertising. Craigslist has singlehandedly wiped out the classified advertising market for newspapers with its free online platform. With the rise of tablets and smartphones, it’s now much easier and more convenient to access the news on the go without actually buying a physical newspaper. And that’s only possible because they are giving away the exact same content from the physical newspaper for free online. The only major newspaper with an ironclad paywall is The Financial Times. The other major U.S. papers, such as The New York Times, The Wall Street Journal, and The Washington Post, either give away all their content for free online, or have extremely porous paywalls that are easily bypassed. That leaves the newspaper industry with only general advertising as a means of generating revenue. Worse yet, the newspapers are only able to charge a fraction of the price for the same ad in digital form than they would in print form because marketers are still skeptical of how effective online advertising is. These developments, among others, have lead to the event in the graph below:

There are two important things to consider along with this emerging trend. First, many “free” goods and services depend on the internet for delivery, so having an internet connection is necessary to access them. Though there are free places to access the internet, it is still very common for people to pay a monthly bill for the privilege. Second, and this should be the alarming part, is that all the companies that offer “free” products make their money from advertising. But the competition for advertising revenues is usually a zero-sum game. Corporations tend to set their advertising budgets for the next year in advance and they spend that money in the as advertising opportunities arise. Most new companies that have an advertising-based revenue model will be taking that money away from other businesses that also need it to survive.

Finally, the substitution effect will most likely drive down revenues in any industry with a competitor offering the good or service for free or at a low-cost. Consumers make relative comparisons on prices offered by suppliers, and it sure is hard to pass up free. This phenomenon creates a race-to-the-bottom type mentality for producers, who reasonably feel like their only option is to give away their product and make money on the backend through advertising. Furthermore, consumers who have been trained to expect free or near-free pricing may be hesitant to pay for luxury goods in other markets where they still charge you for the goods. Time is a finite asset and there are many ways to fill it with things that don’t cost any money.

This new free economy is great for consumers, who get to keep all the economic surplus of the exchanges, but it’s horrible for headline GDP numbers. After reading the news, it may feel like we’re not much better off than we were ten years ago, but don’t forgot about all the wonderful things you can get for free!

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