Peter Orszag: Taylor Swift has an economics lesson for you

What if the music industry could be used as a guide to important principles in business and the economy? It would sure make introductory economics courses more fun. The idea is not as fanciful as it might sound: As Alan Krueger shows in "Rockonomics," music is a microcosm of the wider business world and provides all sorts of insights into today's economy.

Most fundamentally, music embodies the “paradox of value.” We spend a lot of time listening to music — an average of three to four hours a day — and doing so makes us significantly happier. Krueger and Daniel Kahneman, the Nobel-winning behavioral economist, have found, for example, that adding music to an otherwise miserable commute lifts the experience to the average non-commute happiness level.

In spite of this, we spend very little money on music — an average of 10 cents a day. That’s only 2% of overall spending on entertainment and media. Total spending on music globally in 2017 was $50 billion, or about 0.06% of gross domestic product. That makes music, in Krueger’s words, “one of the best bargains human society has ever conceived of — and it is getting better by the day.” So there’s lesson number one: The value consumers derive from a product or service can’t be discerned from total spending. (Water is an even more extreme example of this.)

The music industry also vividly illustrates the "economics of superstars." The returns for being a top performer, as opposed to a very good one, have only grown with digital technologies that allow songs to be heard around the world. In 2017, the top 0.1% of musicians represented more than half of album sales and a similarly disproportionate share of streamed music. As for concerts, the top 1% earned 60% of revenue (up from 26% in 1982). Meanwhile, the typical musician in 2016 earned $20,000.

So why do some performers wind up at the top? Talent clearly plays a role, but so does luck. We all tend to be influenced by the music others like, and that creates a positive feedback loop for fortunate artists. The result is that initial success (which may depend on the luck of the draw) builds on itself and makes a small number of musicians enormously popular, thereby producing a “power law” phenomenon, a dominant feature of modern economics. You can see this cycle in reverse when a famous musician plays incognito in an unexpected location — and the crowd barely appreciates it.

A third lesson is that technology can shift rapidly, with enormous consequences. In music, two recent waves have occurred. In the early 2000s, digitization and file sharing drastically reduced sales of physical albums. That in turn caused musicians to raise prices for live performances — so that concerts have become a more dominant source of income for most artists. In 2017, concert revenue represented 80% of income for the top 48 musicians, while recorded music accounted for only 15%.

More recently, the marketplace has been disrupted by paid streaming, boosting revenue from recorded music after years of decline. But Krueger argues that for musicians, "live concerts pay the bills" and streaming probably won't change that. He also points to the way musicians such as Taylor Swift, Radiohead and Garth Brooks are experimenting with new models that include both concert sales and streaming strategies. In the future, fans may increasingly pay to live-stream concerts (as they do sporting events).

Another crucial takeaway, which may be particularly salient to Econ 101 students, is that the simple answer may turn out not to be the right one. Consider how standard economic thinking would assume that the secondary market is efficient, since it ensures that people who most value the performance are able to attend by paying a market-clearing price. But professional ticket brokers extract most of the benefit from the secondary market — and for this reason Krueger argues that efforts to constrain the secondary market do not violate basic principles of economics.

Finally there is the interesting way in which the music market is growing rapidly in China: Despite the dominance of digital payments in most Chinese markets, concert tickets remain almost exclusively paper-based. Indeed, music is one of the few industries in which the U.S. may be more digital than China. Chinese consumers are streaming some seven billion songs a day, but their system is funded by advertising rather than paid subscriptions.

So there you have it — the paradox of value, the role of power laws, the impact of evolving technology, the dangers of oversimplified models, and the rise of China — all delivered in a wrapper of popular music. I would have taken that class in college.

Unfortunately, Alan Krueger won't be teaching it. The book was published this month posthumously. Alan taught me labor economics as an undergraduate, he was the reason I won a Marshall Scholarship, he gave good advice at crucial moments in my life, and he was a mentor and friend for almost 30 years. The book is, in a sense, a final gift from him, and demonstrates what is lost by his death.

Peter Orszag is a Bloomberg Opinion columnist. He is the chief executive officer of financial advisory at Lazard. He was director of the Office of Management and Budget from 2009 to 2010, and director of the Congressional Budget Office from 2007 to 2008.