My own experience suggests there is no clear answer. Overall, musicians enter into business relationships at a disadvantage, and not paying musicians treads a fine line with their outright exploitation. But I've also come to learn that there are many instances when playing for free seems acceptable. So, how do we tease out the difference? It can be hard to codify exploitative behavior. I'd suggest as a starting point that when other people profit from the presence of live music but the musicians themselves don't receive compensation, they are being exploited by definition: their labor generates value that disproportionately goes to other people.
Two examples come to mind that come close to this sort of relationship. Last year I played at Make Music Denver Day, which is an annual music festival centered on the 16th Street Mall. It was sponsored by the Downtown Denver Partnership at the time, though Swallow Hill Music now runs the festival. The DDP is technically a non-proft, though its CEO took a salary of over $360,000 in 2012. It's a consortium of businesses and business leaders united to promote a healthy business environment downtown. The festival did not reimburse the musicians. I assume the DDP paid the sound engineers, the event planners, and practically everyone else who made the festival a reality. The DDP also stipulated that musicians performing were not even allowed to ask for tips, even if they weren't on the official stages. A friend of mine who was busking that day (an important source of income for him), was reprimanded by a DDP employee and told he couldn't have his hat out.
More recently, Denver's Underground Music Showcase ruffled feathers when it reduced how much it was paying some of its musicians. Some returning bands, myself included, were offered less than they were previous years despite increases in ticket prices. The annual increase in ticket prices (from $30 in 2011 to $75 this year for a four-day pass), as well as the salaries paid to those who ran the festival all stand in contrast to the withdrawal of financial support for the artists. And this is not to mention the growth of profits generated by the festival but not strictly held within it - at bars, hotels, after hours clubs, and through transportation services.
In these two instances, it seemed to me that money was in circulation, but not to benefit the artists themselves. In contrast, there are plenty of shows where the structure feels more transparent, shows where I feel fine playing at for free. Usually, these are situations where the performance is part of a community endeavor, at house parties or DIY spaces where I know a lot of people involved. The people who keep DIY spaces like Rhinoceropolis run their stages because they are interested in bringing new, often challenging, music to the public while also providing a platform for emerging artists. Importantly, they aren't profiting from a musician's labor in any sort of disproportionate way. The little money generated is used to maintain the spaces themselves or pay touring bands and sometimes to pay the local bands, too.
There are more conventional venues that compensate a musician (or not) based on his or her draw. I recall my first ever gig as Cop Circles, at the Cameo Gallery in Brooklyn. I remember peeling myself away from the five or so friends who showed up to sheepishly ask the door guy, "So, did I make anything?" Nope. The $25 bucks my pals dished out all went to cover the cost of the venue, which was disappointing but didn't seem outright abusive.
Sometimes, it has been unclear whether or not I will get paid. I assumed my payout was based on draw when I opened for Wheelchair Sports Camp at the Walnut Room a few months back. Very few people showed up for my set, so I left without a thought of money. But a few days later, I happened to be getting pizza there, and an employee walked up to me with a cash-filled envelope in hand, saying, "Hey, you forgot this!" What a pleasant surprise! Lay down some artichoke hearts and aged feta on my pie!
It isn't always clear or consistent, then, how venues value musical labor.