A new study (large PDF) from the Institute for Policy Innovation takes a different approach to quantifying the cost of music piracy. Instead of just focusing on what the lost sales cost the record labels, the new study measures the impact of piracy on the US economy. The total price tag? A cool $12.5 billion in lost output, if you trust the study's numbers.

Along with the multibillion-dollar loss, piracy also is hindering job growth, according to the IPI. The US economy will lose 71,060 jobs due to piracy, with almost 38 percent of those (26,860) in the recording industry. That amounts to $2.7 billion in lost earnings. Piracy also hits Uncle Sam—as well as state and local governments—right in the pocketbook, with at least $422 million in lost tax revenues.

Problematic assumptions

The study makes for some alarming reading, but it suffers from a few significant flaws. First and foremost, it appears to fall into the "illicit downloads == lost sales" fallacy, the view that each song obtained over a P2P network is a lost purchase. "Unfortunately, there is no precise measure of the degree to which consumers of pirated CDs would continue to purchase those CDs at legitimate prices," according to the study. "While the degree to which these legitimate purchases would occur differs by market, it appears nevertheless that such purchases would comprise a very significant fraction of the total number of pirated CDs now purchased... In this study, the weighted average substitution rate used for the physical piracy of recorded music is 65.7 percent. It is then assumed that only 20% (1 in 5) of these downloaded songs would have been purchased legitimately if piracy did not exist."

That's a bit better than the one-to-one argument, but not by much. It essentially assumes that one of every five downloaded songs would have been purchased, were it not for file-sharing. Although a 20 percent figure may not look like much, it is still a percentage not justified by our own knowledge of file-sharing trends. The study needs to make a firm argument for why this percentage is so high. It's a flaw similar to that in a 2006 study commissioned by the MPAA.

Note that the assumption cuts both ways. Not only does it assume many would-be sales, but it also ignores sales that do stem from file-sharing. P2P users buy a lot of music, after all. Three out of four P2P users said that they bought music after downloading it online, with 21 percent of the respondents to the survey commissioned by the Canadian Record Industry Association saying that they have bought previously downloaded music on more than 10 occasions. So here again, we have data which would necessarily lower the study's estimates not being taken into account.

Another study even goes so far as to argue that the effect of file-sharing on legal music sales is "not statistically distinguishable from zero." Published this past February in the Journal of Political Economy, the study tracked the effects of 1.75 million song downloads on 680 albums. The researchers concluded that the availability—and even increased downloads—of music on P2P networks did not correlate to a negative effect on music sales. "Even our most negative point estimate implies that a one-standard-deviation increase in file-sharing reduces an album's weekly sales by a mere 368 copies, an effect that is too small to be statistically distinguishable from zero," the study's authors reported.

If there was no such thing as piracy...

The IPI study also assesses the increased demand for music if piracy didn't exist and assumes the market would remain as "intensely competitive" as it is today. The problem is that music fans are largely disenchanted with the market. By and large, music fans think that music is too expensive and that much of what is available isn't very good. 58 percent of those responding to a study commissioned by Rolling Stone magazine and the Associated Press said that music is declining in quality. And although the DRM situation is looking up these days, it can still be a confusing morass with unanticipated side effects for consumers, as the recently announced closure of the Google Video Store demonstrates.

Consumer apathy aside, there are other factors at work in the music industry. One of the biggest is the transition from sales of physical media to digital media. CD sales have dropped sharply since the beginning of the decade, and projections indicate that there's no end in sight to the decline. Sure, downloads have picked up since 2004, but not at a rate that will come close to overcoming the slide in CD sales. The individual song download angle is largely ignored by the IPI's study as well, which is fixated on sales of physical media.

The IPI has a history of pushing what it calls a pro-market agenda with its research, including one study asking if open source has reached its limits and another similar to that under discussion here that attempts to quantify the economic impact of movie piracy. Given its track record (which includes this gem from the aforementioned open-source study: "Open source will go the way of other IT industry fads that were once trumpeted as the way of the future, like Macintosh computers, business AI, 4GL programming languages and Y2K") and ideological bent, the results of this study are rather unsurprising.

When the discussion over dollar figures and economic impact comes to an end, most people will agree that file-sharing is a real issue for the recording industry and that there is a financial cost that goes along with it. It's also true that piracy has something of a ripple effect, reaching beyond the artists and record labels. But studies that overstate the economic effect of piracy do little to further the discussion over issues of copyright, file-sharing, and DRM, and they obscure the fact that the music industry still has some serious work to do on its business model.