Traditional Economics Don’t Make Sense For Open Business Models

Money by Thomas Galvez CC BY.

Most traditional business models are based on market economics. As I dig in to open business models it’s becoming clear to me that market economics may not be the best framework for measuring success.

The book Free Knowledge — Confronting the Commodification of Human Discovery is a fascinating exploration of the commercialization of public knowledge for private profit. One of the chapters “The Economics of Information in a Post-Carbon Economy” by Joshua Farley and Ida Kubiszewski does a great job of describing how traditional economics work.

This week I was in Boulder Colorado as part of an awesome team of people being filmed for a course and set of resources on open policy. I spent flight time and down time reading, re-reading and thinking about why traditional economics don’t work for open business models.

Farley and Kubiszewski’s writing is tight and easy to follow. Below I excerpt portions of their writings on traditional economics which appear in plain text and intersperse my own thoughts in italics.

Economists have conventionally defined desirable ends of economic activity as utility maximization where utility is a measure of relative satisfaction or “the greatest happiness,” for the greatest number of people. Conventional economics typically assume that consumption provides utility and what we pay for the goods we consume is an objective measure of the utility they provide. The goal then becomes maximizing total monetary value in the economy.

I find this weird in so many ways. Let me highlight just one — consumption provides utility. Under this logic a tree has no utility unless it is cut down and “consumed”. I expect all of you question the logic of this. A tree can provide great utility without being consumed. It provides shade on a hot day, its leaves cleanse the air we breath, its branches provide homes for birds, its roots prevent erosion, and to many it is a thing of beauty. To assert that a tree has no utility if it is not consumed is, to me, a bizarre premise.

Then there is the assumption that consumption generates happiness, but I digress.

Let me continue with Farley and Kubiszewski.

Markets use the price mechanism to decide how to allocate resources among different products and how to allocate those products among different users. The price mechanism can be split into two parts — allocative and rationing.

Allocative pricing refers to the price of raw materials required for production. Firms compete for raw materials and whoever is willing to pay the most wins the resource. If I am able to convert the resource into a product of higher value than my competitor than I can afford to pay more than my competitor. This ensures that resources are allocated toward the highest value products.

All this is of course predicated on the presumption of scarce resources. But what if a resoure required for production is abundant and non-depletable? If we all start out with the same abundant non-depletable raw material at zero cost then allocative pricing has no impact on who can produce high value products. Zero cost abundant resources have a greater utility than scarce resources as they enable everyone to create products of high value. They don’t maximize monetary value but they do maximize satisfaction and generate social benefits for the greatest number of people.

The rationing function of price awards products to whichever consumer is willing to pay the most for them. This ensures products go to whoever values them the most in monetary terms.

But is monetary value really what we want to maximize? As Farley and Kubiszewski point out “a good meal provides more utility to a starving person than to an overfed one by almost any metric besides that of monetary value.”

If the desirable ends of economic activity is the “greatest happiness, for the greatest number of people” then greatest number of people should include future generations. If that is the case ensuring sustainability takes precedence over maximizing current monetary value. Future generations cannot participate in today’s markets and market values do not reflect their preferences. Efforts to maximize monetary value for the current generation come at the cost of sustainability.

Many of the organizations and businesses I’ve been speaking to about open business models see themselves as “social enterprises” generating social good for current and future citizens not just profits for themselves right now. They are not just trying to maximize shareholder value they are interested in making the world a better place while at the same time earning a living. The fact that traditional economics ignores those who lack monetary means, sustainability, and future generations makes a poor fit for organizations with open business model aspirations.

Economics typically focus on scarce resources. If I burn a barrel of oil then that oil is no longer available for you to burn. Economists use the terms “rival” or “subtractive” to describe such resources: use by one leaves less for others.

This seems more pertinent to the pre-digital economy. But in the digital econoomy goods can be stored, copied, and distributed for almost zero dollars. They aren’t rivalrous unless we impose restrictive artificial constraints on them. If I share a digital artifact with you we now both have it.

Information is a non-rival resource: one persons use of information has no impact on the amount of information left for others to use. More accurately information is an “additive” resource that improves through use and this additive nature of information is what led to the rapid development of technologies and civilizations. As ideas spread new users find ways to improve them. Information is like grass that grows longer and more nutritious the more it is grazed upon. In reality, however, an increasing amount of information is patented or copyrighted. People are not allowed to use it unless they pay. Accumulating evidence suggests that restricting access to information has slowed the rate of growth of knowledge.

Well thank goodness for Creative Commons which provides a dose of common sense in this whole equation by allowing people who want to share their work to do so ensuring what they have created can be improved on through use.

Competent economists recognize that the price mechanism only maximizes monetary value for resources that are competitive in use, also known as rival or subtractive resources. The rationing of non-rival resources creates artificial scarcity and actually reduces the economic value of the resources.

So what if we didn’t ration non-rival resources? What are the implications of zero cost non-rival resources on allocative and rationing practices?

Lets look at allocative practices first. What if firms didn’t have to compete for raw materials where whoever is willing to pay the most wins to the detriment of all others who also want to use the resource? With non-rival additive resources the price of raw materials required for production is zero. Everyone has access to raw materials, the playing field is level. Investments normally required for allocative acquisitions can now instead be invested in converting the raw materials into something of higher value. Customization, personalization, localization, creative extension, amplification, remix, these are the activities that generate both economic and social value. Non-rival, additive resources provide for maximum use of resources by everyone generating high value for all not just for some. In this sense non-rival additive resources can be seen as drivers of the economy.

Lets shift now from allocative to rationing. The rationing function focuses on the outputs of production awarding products to whomever is willing to pay the most for them. This side of the equation is a little trickier from an open business models perspective. Here are the questions I’m asking myself.

  • Zero cost, non-rival resources are usually digital and created by other humans. When creators make these resources freely available they forfeit potential monetary value associated with purchase of those resources. When open businesses make use of those resources as inputs how do we ensure the original creators benefit from their non-rival resources either through indirect monetary means or through non-monetary means? How can we ensure value flows back to the original creator? If we don’t isn’t this exploitive?
  • Should open business models use zero cost non-rival resources as inputs, modify and improve them, and then charge for the new improved value added resources in a traditional rationing market way? By doing this aren’t we creating artificial scarcity once again and as a result reducing the full economic value of the resources?
  • If the allocative inputs are zero cost non-rival resources and the outputs are also made into zero cost non-rival resources how can a business or organization survive?
  • What if an open business model takes zero cost non-rival resources as is, doesn’t add any new value to them, but simply provides services around their use? Or potentially the business does improve and add value to the input resources, but makes them open and non-rivalrous, and recoups costs through services? How do these mixes of non-rivalrous and rivalrous business models work?
  • Human labour continues to be a scarce rivalrous resource that requires compensation. How do we separate out the non-rivalrous abundant aspects of the business model from the rivalrous parts?

OK, I could go on and on with my questions and I expect you have many too. Ultimately though I find the assumptions and values of market based economics fall far short of being optimal for open business models, society, and the world as a whole. Strange that so much of the world is still based on traditional economics.

Surprisingly economists have focused almost exclusively on scarcity based markets. Very little is known about how abundance works.

With this open business model work we’re figuring it out for ourselves.