Of the many shortcomings of the digital economy bill, one of the most egregious is the treatment of music lovers who download songs from the internet.

The music industry and the government need to understand that sharing music is not stealing, and I would happily debate Lord Mandelson, anytime, anywhere, on this question. Filesharing is a business model issue, not a legal issue. Done properly, encouraging the downloading of songs would help the industry flourish.

The labels' current attitude causes them to do one irrational act after another. For example, when DJ Danger Mouse created the Grey Album – which consists entirely of contorted samples from the Beatles' White Album mashed together with vocals from Jay-Z's smash hit The Black Album – the labels should have rejoiced, as sales of White and Black albums went up. Instead he was served with a cease-and-desist notice from EMI. This is lunacy.

The labels' fundamental problems predated the internet. Recorded music has been a bloated industry. To take a band from obscurity to popularity is hugely expensive, but that's what companies have had to do to be given coveted shelf space at the record store. So record companies seek out only potential superstars, since less than 10% of CDs are profitable. Revenues from the best sellers cover the losses of all the rest.

In this context, the internet should have been a godsend. It can distribute a digital copy of a song to hundreds of millions of listeners at virtually no cost. By sidestepping the industrial age infrastructure, many more musicians can be profitable. It would be smart business for companies to nurture many small artists, rather than focusing all energies on just potential superstars. As a society and culture, we would be much better served by such an approach.

There are many alternatives to ensure that everyone gets fairly compensated for their work. One solution is to stop trying to sell songs at a set price. The music industry needs to think Wikinomics. Music should be a service, not a product. Here's one scenario: instead of purchasing tunes, you would pay a small monthly fee for access to all the songs in the world – say €5 per month. Recordings would be streamed to any appliance when you want them – your laptop, mobile device, car, home stereo, via the internet.

Call it Everywhere Internet Audio. Every customer has the Me Channel and could slice and dice the massive musical database anyway you like – by artist, by genre, by year, by songwriter, by popularity, and so on. The Me Channel would know what you like, based on what you've chosen in the past. You could even ask your Everywhere Internet Audio service to suggest new artists that resemble your known favourites or to create a new playlist called "Mick Jagger's current favourites". Musicians, songwriters and the record labels would be compensated through systems that track their popularity. Technologies and companies already exist that can do this.

Everywhere Internet Audio would make the problem of copyright protection vanish. No one would ever "steal" music. Why would you take possession of a song when you can listen to any song at any time on any device?

Other approaches could solve the industry's problem, but they also require Wikinomics thinking – experimentation and a spirit of collaboration, traits the labels have failed to demonstrate. Intellectual property scholars William Fisher and Neil Netanel argue that peer-to-peer music sites should be allowed to distribute music for free. But the providers of such services, including internet service providers and device manufacturers would be charged a fee. Like Everywhere Internet Audio, artists would be compensated according to the popularity of downloads.

Alternatively, the Electronic Frontier Foundation has proposed a "voluntary collective licence" that would give the purchaser immunity from prosecution for non-commercial filesharing. Again the fees from the licence would be pooled and divvied out to artists.

Internet activist Cory Doctorow says approaches like these are better than streaming.

I'm not enthusiastic about music being streamed to me over a corrupt, expensive, unreliable 3G network with no roaming capability, heavy tracking and censorship. It's better to simply collect money for the MP3s that are traded.

But rather than explore bold new approaches for digital entertainment, the industry persists in a business model that turns their customers into criminals. And the industry that brought us the Beatles is now hated by its customers and is collapsing.