I believe that this efficiency will make the economic markets they affect “shrink” in terms of economy and capital. It doesn’t mean that the number of variation of the products available will shrink, just the capital involved. Innovative deflation lets $100 Million at Craigslist undercut $100 Billion dollars that used to service the same thing in newsprint. We’re getting better and more varied services and products (especially in intellectual property) for much cheaper, but it’s also costing lots and lots of jobs without replacing them, taking money out of the economy.

Eric Reasons believes, in tune with Adam Arvidsson’s and my own “crisis of value” hypothesis, that the destruction of artificial scarcity through the internet and P2P dynamics is creating a massive deflation, i.e. capital destruction, in the current system:

“Every business model relying on intellectual property law (patent and copyright) is heading for massive deflation in our lifetimes. We’ve seen it with the music industry and newspapers already. The software industry is starting to feel it with the maturity of open source software, and the migration of applications to the cloud. Television, movies, and books are next. I’ve come to question the ability of copyright and patent law to foster innovation, but leaving that aside, the willingness of people to collaborate and share, and the tools provided for it on the internet, may render these laws obsolete.

Why is deflation a better descriptor? Because as businesses whose product is reliant on intellectual property shrink due to Internet-based efficiencies, consumers are reaping the rewards of these efficiencies.”

He explains the dynamic more in detail here:

“The knowledge based economy doesn’t follow the laws of supply and demand. (Well, sort of.) First, Intellectual property are largely non-rival goods, meaning that I can “consume” news, or music, or software, and it doesn’t get used up. Until recently, restrictions on production in the delivery medium (newsprint and CD’s) and/or licensing restrictions on consumption have kept the law of supply and demand in place for intellectual property.

The Internet first struck a blow to the restriction on production, because the copying and transmission of IP became nearly free. Now, with the maturation of open source software, social networks, and collaborative platforms, we’re moving away from licensing restrictions on consumption: social networks and news aggregators bring us news, blogs bring us opinion pieces, musicians like Nine Inch Nails and Jonathan Coulton are begging to release their music for free. Musicians don’t need the backing of recording studios any longer: They’r recording in home studios, fans spread their music via social media, and fewer people are getting new music from the radio.

Effectively, the restrictions that held supply in check for IP are slowly falling away. As effective supply rises, price plummets. Don’t believe me? You probably spend less money now on music than you did 15 years ago, and your collection is larger and more varied than ever. You probably spend less time watching TV news, and less money on newspapers than you did 10 years ago, and are better informed.

I won’t go so far as to say that the knowledge economy is going to be no economy at all, but it is a shrinking one in terms of money, both in terms of cost to the consumer, and in terms of the jobs produced in it.”

In a follow-up article, he even predicts a negative ‘spiral’:

“The culture of participation is forcing efficiencies that can have deflationary effects on our economy. This allows us to purchase more with less, but also gives us less to purchase with, if it is forcing upon us lower wages and fewer work hours. What it may give us is *more free time* (whether we want it to or not). So if that free time is part of what allows this culture of participation to help create these efficiencies, and the efficiencies create more free time… Then you have not just deflation, but a deflationary spiral that doesn’t end until the traditional economies (based on real scarcity) have absorbed the new efficiencies.”

In a commentary, Mike Masnick, argues that Eric only sees half the picture, the threat, but not the opportunities, here is his argument:

“So this is a great way to think about the threat side of things. Unfortunately, I don’t think Eric takes it all the way to the next side (the opportunity side), which we tried to highlight in that first link up top, here. Eric claims that this “deflation” makes the sector shrink, but I don’t believe that’s right. It makes companies who rely on business models of artificial scarcity to shrink, but it doesn’t make the overall sector shrink if you define the market properly. Economic efficiency may make certain segments of the market shrink (or disappear), but it expands the overall market.

Why? Because efficiency gives you more output for the same input (bigger market!). The tricky part is that it may move around where that output occurs. And, when you’re dealing with what I’ve been calling “infinite goods” you can have a multiplicative impact on the market. That’s because a large part of the “output” is now infinitely reproduceable at no cost. For those who stop thinking of these as “goods that are being copied against our will” and start realizing that they’re “inputs into a wider market where we don’t have to pay for any of the distribution or promotion!” there are much greater opportunities. It’s just that they don’t come from artificial scarcity any more. They come from abundance.”