Prof. Stan Liebowitz, University of Texas – Dallas
May 20, 2009

Economists and non-economists alike tend to be familiar with the phrase “creative destruction” and its implications that, although established firms may bemoan new innovation upsetting apple carts in their industry, and government may try to protect them from those changes, in the end we are all better off because of the creative commotion which is part and parcel of the competitive process and the march of invention.

When, for example, television became popular, movie admissions shrank by 80 percent as the new, superior (the convenience of being entertained in one’s living room) technology usurped a large portion of the market from the older technology.  This was a good thing for consumers even if it was harmful to the movie studios (which would eventually produce many television programs, ameliorating some of the harm).

Unfortunately, not all destruction that occurs in markets is of the creative variety.  Unfortunately, confusion between good destruction and bad destruction is especially problematic in markets dominated by intellectual property.

The reason for this profound confusion in the case of intellectual products is that property rights are less well protected for many intellectual products as compared to their real-property alternatives.  The lack of property rights will cause just about any market to fail, as is normally understood.

The problem for intellectual products is that it is often a new technology that weakens the property rights and that new technology is confused with a technological improvement.  It is easy to demonstrate that not all new technology is necessarily good.  A new, cheap and easy-to-build device that destroys all computer chips hooked up to a power grid would not be creative destruction although it would be destructive and the innovation itself might have been “creative.”  The same would be true for the creation of a new virus that killed everyone on the planet.  Creative, yes.  Destructive, yes.  But not a good thing.

Of course, these are the easy cases.  The more difficult cases, and the ones in which I am interested, are those where it is less clear that the creative component is actually harmful.

Take TIVO, for example, and a simplified version of its history that I am going to provide.  It provided a new and superior method of recording television programs for later playback.  It also, at least for a while, allowed the removal of commercials.  These two characteristics, recording and removal of commercials, are not inseparable and are best thought of as two distinct “improvements.”  On the recording side, there is little to disagree about.  If the TIVO were superior to video recorders and other recording devices of the time, it would all be for the better if the TIVO replaced the outmoded and inferior recording technologies.  This would be creative destruction at work.

But what about the ability to skip commercials?  Viewers certainly value that characteristic.  But is that an improvement?  The answer is “no.”  The reason is relatively straightforward, although the point seems to be lost surprisingly often and by persons who should know better.

Someone has to pay for the television programming.  That someone in the non-subscription television market happens to be the community of advertisers.  Viewers are given the ability and the choice to watch television with its commercials or not, but this option depends on advertisers being able to communicate their advertisements to viewers.  Sitting through the commercial is essentially the price of admission for watching television.

It is theoretically possible that potential viewers would find advertising so annoying that they would prefer to give up watching the programs or would cover their ears and eyes during commercials. But we know that this was not the case for the great majority of viewers because almost everyone used to watch advertising-based television, and advertisers found their commercials to be effective. Viewers revealed, through their behavior, that they valued the programming more than they disliked the advertising.

Of course, even the viewers who value the programs more than they dislike the commercials would prefer not to have commercial interruptions.  But this is just an example where consumers would prefer a better deal.  I would prefer new Lexus automobiles to cost $5.  But, even without that option, I am still better off being able to purchase one for $50,000 as long as my value of the car is significantly higher than the price.  The fact that consumers would prefer television without advertising is predictable and tells us nothing useful regarding the value of TIVO.

Early adopters of the TIVO commercial-deletion function hoped to free ride off of other viewers who still saw the commercials.  But it is clear that removal of commercials jeopardizes the financial model of broadcast television.  If everyone skips the commercials, broadcast television as we know it would end since there would be no funding mechanism.

If given the choice between no television or not being able to skip advertisements, most TIVO owners would accept the commercials – but these owners were not being given that choice.  Eventually, TIVO owners and other potential consumers of broadcast television would be worse off when broadcast television disappeared.  The innovation of seamlessly skipping commercials would have destroyed the market.  Creative destruction?  Obviously not.

This point has been missed even by some trained economists.  It appears to me that these economists focus on the fact that when consumers are given the choice to zap the commercials, they choose to zap them.  Thus, these economists conclude that preventing consumers from doing something that they wish to do (zapping commercials) infringes on consumer sovereignty.  But that is missing the forest for the trees.

If consumers are better off without TIVO commercial-zapping abilities, then preventing these abilities from coming to market should be encouraged.  That would probably mean legislation against devices to zap commercials.

Although this seems hard to stomach for some, it really is no different than having a collective decision that it is a good idea to have traffic lights to help speed up driving and prevent accidents.  Surely, most drivers would prefer to be able to go through red lights when they thought it was safe.  One might conclude, therefore, that drivers should be allowed to cross intersections at their own discretion and traffic lights should be eliminated.

But this is not how we structure traffic rules for the simple reason that a breakdown in traffic would occur at all busy intersections if drivers were left to their own devices.  Drivers would be worse off.  We restrict driver sovereignty because, in this case, it makes drivers better off.

We should be equally realistic when it comes to behavior that encourages free riding and the destruction of markets.  Thus, it is not only commercial zapping that should be banned but file-sharing as well, which has the same “free-riding” motif whereby the pirates get the music (without paying) only because there are still individuals willing to pay for it.

But the library of new music is smaller than it would be due to the free riding of pirates, and if everyone were a pirate the creation of new music would diminish significantly. Other technologies that threaten other markets in the same way by allowing free riding should be similarly discouraged.