Texas-Size Sophistry

by on October 1, 2006 · 28 comments

The Institute for Policy Innovation has released a study on the costs of movie piracy. It’s a truly remarkable exercise in hand-waving. We’ve written before about the shoddy methodology that copyright industries often use in studies purporting to show the costs of piracy. One of the most common tricks is to assume that every person who pirates a work would have otherwise purchased the work at full price–a clearly false assumption. Some infringers would have purchased the work if they’d been unable to get a pirated copy, but a lot of others would have simply done without it. Hence these estimates are invariably inflated, and any such study funded by the affected industry should be taken with a large grain of salt.

But the Institute for Policy Innovation is a Texas think tank, and everything’s bigger in Texas. That includes sophistry. Not content with the MPAA’s official, numbers, which found that worldwide piracy costs the movie industry $6.1 billion, they’ve taken the MPAA study as a baseline, added a heaping helping of fallacious economic reasoning, and concluded that the cost of piracy is, in fact, $20.5 billion. This is complete and utter nonsense, as I’ll explain below the fold.

Here’s the example they use to illustrate the methodology of the study:

Assume that personal watercraft, like Jet-Skis® , suddenly become very popular and shortages develop. In this situation, the price of personal watercraft will rise and so will the profits of the manufacturers. However, in order to continue to earn these higher profits, the manufacturers will have to make more personal watercraft. In the process, they will buy more waterproof seats from seat manufacturers.

Of course, it doesn’t stop there. In order to produce more seats, the seat manufacturers will have to buy more plastic and more padding. And the plastic and padding manufacturers will have to buy more of the particular materials that they need.

The cascade does not end with the suppliers to personal watercraft manufacturers, but continues downstream as well. The retail sellers of personal watercraft who buy from the manufacturers will also be able to earn more money by raising prices or increasing volume. In their wake, specialty stores that customize personal watercraft or sell parts also stand to benefit.

If a foreigner gives me $1, and I turn around and buy an apple from you for a dollar, and then you turn around and buy an orange from another friend for a dollar, we haven’t thereby increased our national wealth by $3. At the beginning of the sequence, we have an apple and an orange. At the end, we have an apple, an orange, and a dollar. Difference: one dollar. No matter how many times that dollar changes hands, there’s still only one dollar that wasn’t there before.

Yet in IPI-land, when a movie studio makes $10 selling a DVD to a Canadian, and then gives $7 to the company that manufactured the DVD and $2 to the guy who shipped it to Canada, society has benefitted by $10+$7+$2=$19. Yet some simple math shows that this is nonsense: the studio is $1 richer, the trucker is $2, and the manufacturer is $7. Shockingly enough, that adds up to $10. What each participant cares about is his profits, not his revenues.

We can see this from looking at their other statistics:

Motion picture and video piracy exact a heavy toll not only on the U.S. motion picture industry, but the overall U.S. economy as well: $20.5 billion annually in total lost output among all industries, $5.5 billion annually in lost earnings for all U.S. workers and 141,030 jobs that would otherwise have been created are lost. In addition, as a result of piracy, governments at the federal, state, and local levels are deprived of $837 million in tax revenues each year.

Now, if my calculator is working correctly, $5.5 billion+$837 million is $6.337 billion, which is more than $6.1 billion. Presumably the $5.5 billion is pre-tax wages. If we looked at post-tax wages, it appears that wages+tax revenues+corporate profits would add up to approximately–surprise!–$6.1 billion. Passing dollars around doesn’t create more of them. If $6.1 billion comes into the country, the resulting net increase of wealth held by Americans will be, precisely $6.1 billion, regardless of how the dollars are spent.

IPI’s study is like the broken window fallacy on steroids. Not content to simply count “what is seen” once, they count the same dollar over and over again, counting it as a new gain for the economy every time it comes into a new person’s hands.

That IPI would publish such a study is especially ironic because the libertarian movement used to chide our friends on the left for their poor grasp of economics. One of the great libertarian heroes of the 20th Century was Milton Friedman, who stressed that pumping more dollars into the economy could not create new wealth. Free marketeers derided the Keynesian notion that the government could create new wealth through expansionary monetary policy. We stressed that money is not the same as wealth, and that putting more dollars in peoples’ pockets will not increase the number of goods and services they can consume.

Libertarians won that debate. Thanks to the Volcker/Greenspan Fed, which was firmly committed to Friedman’s monetarist ideas, we’ve enjoyed a quarter century of monetary stability. So it’s downright creepy to see a supposedly free-market organization falling so easily into the same fallacy of confusing money for wealth.

I’m annoyed but not surprised when the BSA or the MPAA puts out a shoddy and misleading study. They’re industry lobbying group. Their job is to make the best possible case for the interests of their members. I don’t think I’d have the stomach for that kind of work, but at least no one has any illusions that they’re an independent or objective source.

But IPI is a free-market think tank–similar in many respects to my employer. Much of their research is supporting causes that are near and dear to my heart, such as lower taxes, entitlement reform, and deregulation. At the Show-Me Institute, we don’t hide the fact that we’ve got a free-market agenda, but we also pride ourselves on our independence and intellectual integrity. Our first allegiance is to the truth, and we try to avoid using misleading statistics or making disingenuous arguments. Not only is that the right thing to do, but I think it makes us more effective advocates for our point of view, in the long run. When a sister think tank publishes shoddy research, it casts all of us in a bad light.

Update I see from the executive summary that the wage figure is pre-tax. $600 million of the $837 million consists of personal income taxes, implying that the total of post-tax wages and government revenue is about $5.7 billion. Presumably the other $350 million comes in the form of corporate profits. The bottom line is that when all is said and done, the increased income in Americans’ pockets is still $6.1 billion, not $20.5 billion.

Update 2: I followed up on this post here.

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