If all goes technologically to plan, then beneath this text, we'll be running our YouTube stream of my chat with Kal Raustiala and Chris Sprigman, authors of The Knockoff Economy. The chat will happen from about 11am to 11:30am PT via live streaming. If you're tuning in late, you can watch the full recording below. If you haven't yet read the book, you should -- but first you can check out excerpts on the importance of those who "tweak" the work of others, and on what the music industry can do, based on lessons from other industries or professions that don't have monopoly restrictions on competition.

Online dating is by no means a new thing anymore, and by some counts, we're on the third iteration of improvement for internet dating. So that means we should be pretty close to perfecting these services, right? (Third time's the charm?) Matching algorithms will probably get better and better with time, but then so will expectations. Here are just a few interesting links for geeky singles out there.

• Psychologists have pointed out that matching algorithms for long-term relationships are not significantly better than random. Dating algorithms aren't actually so bad at excluding potentially "bad dates" -- but that's not what most online dating services offer. [url]
• The Secret Diamond Club takes advantage of some economic tricks to try to match up rich men with attractive women. The real secret, though, is that it probably doesn't work at all -- and it preys on lonely people with money. [url]
• Recently, the Nobel prize for economics was awarded for work on matching markets. The Gale-Shapely algorithm has been used for matching organ donors and doctors with hospitals, but maybe someday it'll be used for finding romantic partners, too. [url]

If you'd like to read more awesome and interesting stuff, check out this unrelated (but not entirely random!) Techdirt post.

Nearly six years ago, we wrote about the ridiculousness of Nick Carr's suggestion that Web 2.0 was all about "digital sharecropping", in which online service providers are somehow "exploiting" users to take the fruits of their labors. I would hope that, with six years of hindsight, people would still remember what a completely nonsensical argument this is -- based as it is on the economically clueless suggestion that the only possible benefit someone could get from using an online service is money. Of course that's not true. The reason that so many people use something like YouTube isn't because they're being exploited, but because it enables something wonderful and powerful for free. Prior to YouTube, if you wanted to put up a video, you had to install complex or expensive server software, pay a ton for bandwidth... oh yeah, and hope that whoever wanted to watch the video had the proper software to view it. YouTube took all of that away, and made it all free (and even added easy ways to monetize it). If that's exploitation, sign me up to be exploited. Similarly, look at a platform like Twitter, which has enabled amazingly powerful real time communications that has connected me with people worldwide in ways never before possible. That's not exploitation. It's called providing something of value.

So it's a shame to see the IEEE basically rehash Carr's silly argument as if it were still relevant, setting up a strawman about how "Web 2.0" (really, is anyone still using that term?) was all about empowerment, but the reality is that (*gasp*) there are companies involved. And some of them... (wait for it...) make money!

But the road to Utopia all too often ends up detouring through the business district, and Web 2.0 has been no exception. By offering the means of production free to their users, other leviathan sites, such as Facebook, Twitter, and YouTube, have generated enormous amounts of content at almost no expense. Even better, this content is a gold mine for targeted advertising.

Over in Utopia, the “workers” who generated all those articles, photos, tweets, and videos would get a cut of the profits they helped to generate. In the business district, however, users retain their amateur status, while the companies they labor for rake in billions. Worse, contributors don’t even own the content they create. The smallest of the small print in the terms of use, which you must agree to in order to get an account, states that the company can use your content as it sees fit.

Beyond the fact that this is a common misreading of the terms of service of most of the sites he's talking about (which merely request a license to make sure that their hosting of the content you put up is legit), author Paul McFedries completely ignores the tremendous value that people get for using those platforms... almost all of which is given out for free. While economic value is often measured in dollar terms, that doesn't mean that people don't get value if actual dollars aren't exchanged. The people using these platforms aren't being exploited -- they use them because they really, really value them.

Anthony De Rosa, a product manager at Reuters, calls this digital feudalism and laments that we “are being played for suckers to feed the beast, to create content that ends up creating value for others.”

And this is equally misguided. All sorts of things people do create value for others. Almost no economic activity is entirely contained so that only the person doing the initial activity retains 100% of the benefits. Concepts like externalities and spillovers exist in economics for a very good reason -- and part of the problem is people who don't understand that creating excess value that benefits others is actually a core reason we have economic growth in the first place. Creating value for others is of tremendous economic value. The problem is that people ignore the fact that those doing the creating are getting back more than enough value directly or they wouldn't be doing the activity in the first place.

It's a shame that we're still having these discussions today, after we've had many more years of experience with all of these valuable services to recognize that it's not exploitation to get a tremendously useful service for free, while also increasing value for others. It's actually how we innovate and grow the economy itself.

One of the more frustrating things about debates on copyright is how many more established lawyers in the government seem to refuse to recognize the reality of what's happening in the market and instead prefer to rely on disproved ideas such as that without strong copyright protection, we get less output or that there is no way to "compete with free." So it's a bit of a surprise to see a recent paper from John Newman, a Justice Department trial attorney discussing the nature of what he calls "copyright freeconomics."

Innovation has wreaked creative destruction on traditional content platforms. During the decade following Napster’s rise and fall, industry organizations launched litigation campaigns to combat the dramatic downward pricing pressure created by the advent of zero-price illicit content. These campaigns attracted a torrent of debate, still ongoing, among scholars and stakeholders — but this debate has missed the forest for the trees. Industry organizations have abandoned litigation efforts, and many copyright owners now compete directly with infringing products by offering licit content at a price of $0.

This sea change has ushered in an era of “copyright freeconomics.” Drawing on an emerging body of behavioral economics and consumer psychology literature, this Article demonstrates that, when faced with the “magic” of zero prices, the neoclassical economic model underpinning modern U.S. copyright law collapses. As a result, the shift to a freeconomic model raises fundamental questions that lie at the very heart of copyright law and theory. What should we now make of the established distinction between “use” and “ownership”? To what degree does the dichotomy separating “utilitarian” from “moral” rights remain intact? And — perhaps most importantly — has copyright’s ever-widening law/norm divide finally been stretched to its breaking point? Or can copyright law itself undergo a sufficiently radical transformation and avoid the risk of extinction through irrelevance?

I honestly don't think there's too much new or surprising in the report, though I'd argue that part of the problem is an improper definition of "classical economics." Though, I've long felt that the "behavioral economics" crowd tries to distinguish itself by setting up strawmen about what "classical economics" says -- and this report has a bit of that. That is, I don't think that the use of "free" in economics breaks classical economic models, unless you set up the model incorrectly, which I think Newman does a bit in this paper, leaving out additional variables beyond "cost" that go into the equation. That said, that's a nitpick: the overall point does actually stand. Free economics can well be described in classical economics or new behavioral economic models showing how free fits into a perfectly reasonable market, rather than destroying it. And, in the end, Newman seems to come to the same realization even if we disagree about how it fits into classical economics: free isn't horrifying, it's a part of the economic landscape, and there are ways that can be viewed as a good thing, and this report generally supports that view.

The other interesting bit of the report is Newman's suggestion that an interesting proposal for changing copyright laws that might actually make traditional "maximalists" and "minimalists" both happy is to increase more moral rights for copyright -- and allow copyright holders to effectively choose if they want to enforce the "economic" rights to exclude by going after statutory damages, or, alternatively, enforce the "moral" rights to protect their reputation. His argument is that this might fit better with the nature of content creation today:

Because some creators and distributors are now realistically motivated solely by non-pecuniary incentives while others are motivated by pecuniary ones, yet both groups often create the same “types” of works, segregating rights based on type of work (as does the current legal structure) is likely an inefficient means of incentivizing authorship and dissemination. Instead, copyright law could be altered such that copyright owners may choose to enforce one of two bundles of utilitarian-based rights: either the pecuniary-focused rights (reproduction, distribution, et al.) or the social-status-based rights (attribution and integrity). This structure would operate somewhat similarly to the current remedies structure, under which copyright owners can choose to pursue either actual damages (and/or lost profits) or statutory damages. Importantly, it would allow creators and distributors—who are in the best position to do so—to self-segregrate based on primary incentive type. Thus, such an enforcement structure may well be a much more efficient means of stimulating creative output than our current set of copyright laws.

I'm not convinced that this is really such a wise course of action, and I'm a bit nervous about expanding moral rights for a whole host of reasons. But it is an interesting thought exercise to wonder if a limited set of moral rights might limit crazy cases with ridiculous statutory damages -- giving copyright holders an alternative for what they're really after in at least a segment of copyright lawsuits.

But what's more interesting is that a DOJ lawyer would be exploring this topic at all. While Newman is explicit that these are his views alone, and do not represent the DOJ in any way, I think it's a good sign to see that at least one DOJ lawyer is grappling with this topic, rather than taking the traditional "the law is the law" view in which "free" is clearly bad and destructive towards the economy. Hopefully more of this kind of thinking and economic explorations filter through to others in the government as well.

Back in April, in writing about Union Square Ventures' Hacking Society event, I discussed the importance of measuring the unmeasurable, in noting that we all too often seem to be evaluating information-era economics using industrial-era metrics. That's a problem. Nick Grossman, who organized that Hacking Society session, has a great post discussing this same concept and highlighting Tim O'Reilly's discussion about this topic, in which he describes the clothesline paradox, which actually seems to come from a discussion in the early 1970s, and highlights how metrics can mislead. You can think of the clothesline paradox like this:

If you take down your clothes line and buy an electric clothes dryer the electric consumption of the nation rises slightly. If you go in the other direction and remove the electric clothes dryer and install a clothesline the consumption of electricity drops slightly, but there is no credit given anywhere on the charts and graphs to solar energy which is now drying the clothes.

In my mind, there are two "problems" associated with this, and while I think there is interest in attacking the first one, the second problem is often ignored. The first problem is that we notice that important information is measured with the wrong metrics. We see this all the time in the internet era. People talk about "the collapse" of the music industry, but miss the fact that more music has been produced, recorded and released in the last decade than in any previous decade. In fact, some of the evidence suggests more music was produced and recorded in the last decade than all other decades combined. Of course, that's an example of a metric that can be determined, but not all such metrics are that easy to pin down. For example, we talked about how Craigslist almost certainly helped contribute to the challenge that many newspapers are facing, because it undercut the cash cow that supported many of them: the classified advertising business. And if you used traditional metrics, you'd bizarrely and incorrectly suggest that Craigslist somehow "destroyed" value. But that's because no one takes into account all the value that Craigslist created, not for itself, but for its users. But how do you measure the fact that I can now find someone to take my old couch away for free? There's value in that transaction, but no one "measures" it. What about the fact that I can more efficiently rent out an apartment - without having to pay the local newspaper? Again, there's value, but it's not properly measured.

The second problem is a little trickier to understand. It's that when we have things that we can measure, we instinctively gravitate towards using those metrics, even if they're the wrong metrics! I was thinking about this as I read Paul Graham's excellent thoughts on "black swan farming," which is all about the counter-intuitive process involved in funding startups. There's a ton of tremendously thought-provoking lines in that piece, but I'm going to concentrate on one, which was really more of an aside, unrelated to the larger article (which you should go read), because it helped clarify my thinking on this point. Graham talks about not bothering to measure how many of the YCombinator companies he funds and trains later go on to raise more money after their initial fundraising efforts, noting:

I deliberately avoid calculating that number, because if you start measuring something you start optimizing it, and I know it's the wrong thing to optimize.

And here's where the problem of using the wrong metrics becomes compounded. Even if you know something is the wrong metric, just having the number almost forces you to optimize for it. So rather than looking at, say, what's best for the overall culture of music, we look at "revenue for the record labels" and decide we need to "fix" that. Or, we look at the patent system as a proxy number for "innovation" and then the focus becomes solely on increasing the number of patents we issue, rather than on actually maximizing innovation.

When you have the wrong metrics, not only do you have bad or incomplete information, but even when you know that it's almost impossible not to optimize for those metrics, because you don't have anything else to work towards.

There is a lot of new interest in quantifying all sorts of new data -- and one benefit of the information age is that it also helps to create new data that can be quantified. But not all quantified data is actually that useful, and unfortunately, we often get so focused on the fact that we have a number, we ignore the possibility that the number is not telling us anything useful.

I was recently reminded of Shelby Bonnie's opinion piece from three years ago about why we need to kill the CPM as a metric for advertising (for those who don't know, CPM -- or "cost per thousand" impressions -- is how most banner ads are sold). He noted, quite accurately, that even those with the best of intentions to get away from "CPM-based" advertising seem to end up there in the end anyway. Because we have that number. And it becomes what people optimize around, just because it's there.

All campaigns start with the best of intentions: “let’s do something creative, engaging, and unique!” But unless someone really senior from the agency or client side intervenes, the road for a campaign always leads to the media buyer and the dreaded spreadsheet, where the two most important columns are impressions and cost. Ironically, there’s usually some good stuff in campaigns, but they are thrown in for free as “value adds.” At some point, publishers decide that if all clients care about is impressions, then OK, we’ll give them impressions. The output is an industry that overproduces shallow, superficial, commoditized impressions. Why do we have so many bad sites that republish the same junky content–content that’s often made by machines or $1-per-post contractors? Why do sites intentionally try to get us to turn lots of pages with tons of top 10 lists, photo galleries, or single-paragraph summaries of someone else’s story?

The more I spend time thinking about these issues, the more I think these combined problems -- both not having the right data and then optimizing for the wrong data -- are the keys to many of the issues that we're regularly discussing around here. Figuring out ways to get beyond that, and to find the right data, and break our habits of relying on bad data are going to be increasingly important.

Amazon's recently-announced tablets are interesting for a variety of reasons, including that Jeff Bezos made it quite clear that he's taking a very different approach to the market than the one Apple has taken. Lots of attention was (quite reasonably) paid to Bezos' key line:

"We want to make money when people use our devices, not when they buy our devices."

It's a great line in so many ways, because it highlights the different philosophies of Amazon and Apple. John Gruber's summary of those differences is a really worthwhile read (you should read the whole thing). His take on that particular line is dead-on:

Bezos's we want to make money only when you use it framing works two ways. First, it explains the Kindle Fires' noticeably lower retail prices in a way that doesn't make them seem cheaper, only less expensive. It frames Apple's prices -- and profit margins -- as greedy. Second, it works as a sort of guarantee -- if you don't actually use it, we won't even make any money on it.

Later Gruber made a second point that got me thinking (and rethinking...)

Apple's goal is to sell as many iPads as it can. Amazon's goal is to sell as many Kindle Fires as it can to a specific audience: active Amazon.com customers.

I've talked in the past about how Apple's digital goods sales have really been about being the "low margin" leader (if not the loss leader) to drive more sales of the hardware. The digital goods -- content and apps -- make the hardware much more valuable and help drive up the amount people are willing to pay. And that tends to fit with the basic economics I believe in: focus on using the "abundant" (digital) to make the "scarce" more valuable, for which people will pay a premium, especially since that "scarce" can't be "pirated." Apple has, in many ways, put that particular economic concept at the center of how it does business, even if I'm uncomfortable with the closed nature of its overall setup around that.

Amazon, however, has flipped the equation. Their "low margin leader" is the hardware, and they basically appear to want to make their money up on the digital goods purchases. Just as Apple doesn't lose money on selling digital goods (it just makes a very little amount), it appears that Amazon will be making only a little bit on the hardware, but hopes to make the big money on selling the abundant: digital goods via the Kindle store.

I will admit that I struggle with this a bit. I find it hard to bet against Bezos, because on an awful lot of things I think he makes the right bet. Plus, frankly, I'm a lot more comfortable with Amazon as a platform than with Apple. Finally, from a consumer standpoint, I think Apple's hardware seems really overpriced, but Amazon's new prices are really compelling. But economically speaking, there's a voice in the back of my head that says that Apple has this right and Amazon has this wrong. Apple is betting on using the abundant to increase the value of the scarce and then selling that. Amazon is betting on using the scarce to increase the ability to sell the abundant. Perhaps it works because of Amazon's closed Kindle platform and its dominance in the market allows it to make this counter-economical bet. Artificial limitations allow for such things, and Amazon's got the power to control a large segment of the ebook market, which really helps the company out.

In the long run, though, if a competitive market is truly created, it seems more likely that there will be more pricing pressure on Amazon's bet than on Apple's. But, in the short term, Amazon's flip-flopped market certainly could make a lot of sense.

Of course, if you really want to make this fun, just add Google to the equation. It, like Amazon, seems to be focusing on cheap, barely profitable hardware, a la the Nexus 7. It's also put a big effort (recently) into selling digital goods via the Android "Play" store. But Google's business has always been about ads, so it actually adds a third factor to how it views the world, and which part of the business subsidizes which other parts of the business.

In the end, you're left with three big bets on tablets, with very different underlying business models*:

• Apple: High margin hardware (scarce); make just a little on digital goods (abundant).
• Amazon: Low margin hardware (scarce); make the real margins on digital goods sales (abundant)
• Google: Low margin hardware (scarce); make some margins on digital goods (abundant), but cross subsidize both with the ad business.

* Yes, there's also Microsoft Surface tablets. For the life of me, I can't figure out where they place in this particular chart. Which may say something all by itself.

Which strategy works in the end may say a lot about how you view the world economically.

There's been plenty of talk about HBO and its ongoing refusal to offer a standalone internet offering for its content (unless you happen to live in the lovely Nordic region). A few months ago, this discussion took something of a viral turn with the website TakeMyMoneyHBO.com, which tried to calculate how much people would pay for standalone internet/mobile access to HBO content -- which suggested people would be willing to pay an average of about $12 per month. Now, we can all take online internet surveys with a pretty big grain of salt, but there clearly is a lot of interest in people getting such a service. The straight math says that at $12, it would be a good deal for HBO, which is rumored to actually get about $7 or $8 per subscriber via cable and satellite. But... as Ryan Lawler at TechCrunch wrote at the time, it's not that straightforward, and you can show how the math doesn't quite add up:

More importantly, it wouldn’t include the cost of sales, marketing, and support — and this is where HBO would really get screwed. Going direct to online customers by pitching HBO GO over-the-top would mean losing the support of its cable, satellite, and IPTV distributors. And since the Comcasts and the Time Warner Cables of the world are the top marketing channel for premium networks like HBO, it would be nearly impossible for HBO to make up for the loss of the cable provider’s marketing team or promotions.

Think about it: Every time someone signs up for cable or satellite service, one of the inevitable perks is a free six- or 12-month subscription to HBO. And those free subscriptions are rarely, if ever, cancelled once the trial period ends.

Lawler insists the math doesn't add up because without that marketing push, the number of subscribers would be much lower. HBO claimed that Lawler's math was right. And it may be. For now. But that's really dangerous thinking.

We've pointed out before that it's quite tempting for legacy players to think that they can wait out disruptive innovation. They talk about how the new products and services aren't good enough or don't make enough money to bother getting into that space. Often they'll directly talk about how the new services don't make the same amount of revenue as the old ones (or they'll make some crack about "dollars into dimes.") And, of course, they insist that when the money is there they'll make the switch. But, if you understand anything about the history of disruptive innovation, you know that if you wait until that point, you're already behind. Someone else has already taken over that market, and your "switch" is often seen as way too little, way too late (not to mention that it's often accompanied by massive bungling, as the slow entrance also means not really understanding enough about how that market works, while all your competitors spent all that time perfecting their solutions).

MG Siegler has a great post talking about this very concept as it relates to HBO, responding to Lawler (again) and his recent interview of an HBO exec during a panel at TechCrunch Disrupt. Once again, HBO insisted that Lawler was right and that "the math didn't make sense." But Siegler points out, correctly, that innovation beats math every single time. Siegler basically highlights the key point of Clayton Christensen's Innovator's Dilemma: it's really really tough for legacy players to eat their own cash cows and bet on something new. He points to another excellent article, by Farhad Manjoo at Slate, about how Apple actually does this really well, specifically how it totally cannibalized its cash-cow iPods with the iPhone:

Put it all together and you get remarkable story about a device that, under the normal rules of business, should not have been invented. Given the popularity of the iPod and its centrality to Apple’s bottom line, Apple should have been the last company on the planet to try to build something whose explicit purpose was to kill music players. Yet Apple’s inner circle knew that one day, a phone maker would solve the interface problem, creating a universal device that could make calls, play music and videos, and do everything else, too—a device that would eat the iPod’s lunch. Apple’s only chance at staving off that future was to invent the iPod killer itself. More than this simple business calculation, though, Apple’s brass saw the phone as an opportunity for real innovation.

That, in a nuthsell, is what most companies fail to do. It's why Clayton Christensen's book sells so well, even though very, very few companies have any idea how to do what Apple did and "eat its own." But the point is there. If you focus on "the math," you're going to miss the market and be way, way too late. Back to Siegler:

Moore's statement about HBO is correct. The math is not in favor of selling HBO access directly to consumers. But if we're just thinking about this from a pure product perspective, I don’t think anyone would disagree that this is what we all want. HBO is choosing not to build the service we will love, they're choosing the short-term money. The safe bet. The math.

But if they don’t diverge from this path, it will lead to their demise. Innovation always beats math, eventually. That, you can take to the bank.

He's right. And the more you look at the economics of innovation, the easier it is to understand why innovation always beats math. It's because "the math" that people do is of a static world, for the most part. They use past performance and metrics built on a different market. They don't understand how quickly a new market grows, and how much larger its overall potential is. And that's because we have difficulty in mentally dealing with non-zero sum markets, preferring to think that it's a one-for-one switch. But, it's not. Innovation expands markets in new and unexpected ways, often quite rapidly (though also, deceptively slowly at first, because the growth is often in a tangential market that people don't even recognize).

So they come up with spreadsheets and "models" that try to predict when the math says it's time to switch. And all of that time they're not innovating. But since the disruption is brewing in a much faster manner, and in a different spot than they really think it is, the time to switch is usually as soon as you realize the innovation is happening, not when the spreadsheet tells you to. It's not just about choosing "the safe bet" vs "the service we love." It's about how disruptive innovation guarantees that those who don't build for the markets of tomorrow, don't really have much of a market tomorrow.

Yesterday, we wrote about the judge in the ebook price fixing case quickly approving the settlement the government had reached with three of the book publishers involved (Harper Collins, Simon & Schuster and Hachette). There was one side note that I thought was amusing enough to be worth a separate post. One of the stranger filings in the case was an amicus brief filed on Tuesday by Bob Kohn, protesting the settlement. After Judge Cote made it clear that such filings should be no more than 5 pages, Kohn decided to file his in a graphic novel format, that both (slightly) mocks the 5 page limit and tries to explain the basics of his argument. The full filing is embedded below, but here's a clip: Of course, much of the "argument" made by Kohn is really a thinly veiled suggestion that the judge look at the 93-page "comment" he had filed earlier in the case. The Justice Department was not impressed by Kohn's stunt. As for Judge Cote? She doesn't even mention the nature of the "graphic novel" filing -- but repeatedly addresses Kohn's points and calls him out by name. In the end, she doesn't find his theories or arguments persuasive -- noting that his comments "are insufficient to compel denial of entry of the proposed Final Judgment" -- but this may be the first time that I know of where a judge took a filing done in cartoon form seriously. That doesn't mean I would recommend it, or that I would expect to see more such filings. It's also unclear to me how what he did via the cartoon couldn't have been expressed just as easily in pure text.

Venture capitalist Fred Wilson has a typically insightful post discussing the question of whether or not being "open" conflicts with making money, building off a post by Mathew Ingram about his love/hate relationship with Twitter in which he notes:

Lastly, I hate that Twitter’s metamorphosis seems to reinforce the idea that being an open network — one that allows the easy distribution of content across different platforms, the way that blogging and email networks do –isn’t possible, or at least can’t become a worthwhile business.

Fred is a well known believer in "open" projects and has quite literally put an awful lot of money into a variety of startups that espouse a very open philosophy. So it's not surprising that he disagrees that it's not possible to make money and be open. But his view is nuanced:

I do not think open conflicts with making money and further I think there are ways to make more money by being open rather than closed, but it takes imagination and a well designed relationship between your product/service and the rest of the Internet.

I also think it is better to open up slowly, cautiously, and carefully rather than start out wide open and then close up every time an existential threat appears on the horizon.

He points to Etsy as an example of a company that has become more open over time, and to Twitter as one that started out very open and has had to close up over time (Fred is an early investor in both companies). At the end of his post, Fred tosses in an aside to the "O'Reilly Doctrine" referring to one of Tim O'Reilly's (many) great maxims:

Create more value than you capture

I've actually been thinking about this quite a bit lately, and I think that when you recognize how growing markets tend to work, and the way openness can influence markets, that the O'Reilly Doctrine explains -- in a backdoor way -- why it appears that open platforms are antithetical to making money, when the truth is often quite the opposite. I've been trying to explain this (unsuccessfully) for years, but hopefully I can express it more clearly here.

Economic growth comes from the sharing of ideas (once you get past growth through scarce resource discovery). This is the key realization of a number of economists over the past few decades, most notably, Paul Romer. As we've noted in the past, knowlege is a universal resource that does not diminish and can expand -- unlike scarce resources that are limited. Knowledge and information only expand, and in doing so they often make all of those other scarce resources more valuable. Knowledge and information makes things more efficient and makes things better, thereby increasing economic value and expanding the overall pie. Or, as Romer has said:

Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material.

Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. The difficulty is the same one we have with compounding. Possibilities do not add up. They multiply.

Possibilities do not add up. They multiply. But take that a step further. One of the ways to increase this kind of growth and to increase this kind of knowledge sharing is to be open and to allow everyone (or larger groups of people) to contribute. And that requires openness. But there's a related caveat to that. When you're open like that and allowing others to contribute, you're also "leaking" some of the benefits as well -- often a very large amount. In economic terms, these are often referred to as positive externalities or spillovers. Basically things that one party does that benefit others widely. I think both terms are slightly misleading in that when most people think about externalities or spillovers, they assume a small bit off the top.

But when it comes to knowledge and information in open systems, it's not that way at all. The vast majority of the benefit is actually going back to the public, because you don't have the walls and the gates to contain it and capture all that value directly. But that doesn't mean there isn't a tremendous amount of value that can be captured by those responsible for creating the open systems. It's just that on a percentage basis, it seems much less. They create these massive and expansive fields of value out of nothing, and only capture a small piece of it -- leaving the rest of those benefits to be enjoyed by the public. But these fields are so big that the businesses themselves can be huge and can make a ton of money (think: Google, Twitter, Craigslist, Kickstarter, etc...).

Yet, in the old, closed way of doing business, the mentality is very much about how much of the value did you capture. They're not concerned about expanding the overall market and just keeping a small part. They're focused on capturing a larger and larger piece of the existing market. It's why, for example, with the entertainment industry, we see them so focused on taking bigger and bigger licensing deals, and making it so businesses like Netflix and Pandora and Hulu have trouble building long term viable businesses -- because the old gatekeepers look at them and say they're benefiting too much from the value we created -- and we need to take our "fair share." The open systems look at the absolute amount of money they're making, and say "wow, by creating so much more value, and just taking our sliver of the proceeds, we're doing great!"

It's a completely different view of the world.

But, from the outside looking in, if you view the two using the same "metrics" as the old, closed systems, the new "open" ones don't appear to make as much money. But it's not that they can't or don't make a lot of money. They do. It's just that they make less as a percentage of the value they create. And while it's the absolute number that really matters, it seems that our brains are sometimes hardwired to focus on the relative value capture.

Open systems can and do make lots and lots of money. As Fred notes, it requires a lot more thought and planning in terms of figuring out where and how (and often it requires a much closer relationship between products/services and users). But often, looking at the wider market, it feels like those businesses must be leaving more money on the table because they capture a relatively smaller portion of those markets, even if the dollar amounts may be bigger in real terms.

In the simplest of traditional terms: it's better to capture a small slice of a massive pie then a large slice of a small (and shrinking) pie. And being open is how you grow the pie -- not incrementally or linearly, but exponentially.

For quite some time now, we've been following the bizarre effort in Germany to establish "neighboring rights." This was a plan, first floated a few years ago, to force aggregators to pay to link to news sources. This year, that effort has really ramped up. In March, news came out that such a proposal was being written, and the first draft was released in June, horrifying many who actually understand how the internet works. Basically, if you make money (say via some ads on your site) and link to a source with a short excerpt, you would have to pay. This includes those who do so via their own blog or social network site. Quote an article on a Facebook account, which you also use to make some money (say to promote your business) and you may have to pay.

As is described in a recent comment from Mathias Schindler, who has been attending the various hearings on these neighboring rights proposals, this appears to be a misguided effort by publishers, who have failed to adapt, to capture revenue from anyone who incidentally profits from the information they provide:

"The publishers argued that the bank consultant was only able to advise his clients because of the journalistic work in the published article. So that means the publisher deserves a fair share of any money made from that scenario. This was the proposal from the start."

We've seen this kind of thinking for years, and it really represents a fundamental misunderstanding of economics, driven by a variety of false assumptions, including the idea that the only way to determine value or benefits is through monetary transactions. This is obviously crazy when you put things into context. At the very same time that these publishers are demanding payment to link to their content, they and others are paying search engine optimizers to get more links, recognizing that such traffic is important. Basically, implicitly they recognize that traffic, absent money, is valuable, but they're now trying to add money on top of that.

One of the most misunderstood aspects of economics is the allocation of benefits. It's all too common for certain players in a market to assume that they should accrue money for anyone and everyone who benefits from their work. But that is not only impossible, it would actually massively limit growth. Such "externalities" or "spillovers" (depending on which economist you're talking to) have a major impact on economic growth, which often comes back to help the originator of the work, even if they don't directly receive payments for it. The research of the "new growth" economists over the past couple decades have really zeroed in on how externalities from information, such as third party benefits, are the key ingredient in economic growth. Clamp down on that, and you clamp down on the ingredient needed for economic growth.

Of course, if you want to demonstrate the fallacy of the publishers' argument, it's easy: just flip the situation around. If the publishers truly believe that anyone who uses information found in a publication to profit owes them a cut, then what if information leads to a loss? Say that I rely on information in a German publication to make an investment in a company that goes out of business. Should the publisher now repay me for my losses? Taken to the logical extreme, that's exactly what the publishers appear to be arguing. Take it one step further: let's just say that the article I read in a German publication wastes my time and provides no useful information. My time is valuable, and they've now wasted it. By their own logic, should I not be able to send them an invoice for wasting my time?

Somehow, of course, that flip side of the equation never gets discussed. Because this is not about logic. This is about publishers who don't want to adapt looking for protectionism on the upside only, against actual innovators. That the German government appears to be treating such concepts seriously suggests a significant risk for Germany to end up putting a massive chill on innovation and economic growth, by trying to tax the very beneficial externalities of information in a manner designed solely to protect one side of the market for a group of businesses who are trying to stifle competition and innovation. It's a dangerous move by a government who should be encouraging innovation and growth, not stifling it.