Economic and Game Theory
Why Napster is Right

by Michele Boldrin and David K. Levine

Representatives of the music industry are currently suing Napster, an organization that provides software that makes it relatively easy to redistribute music, including copyrighted music. As we are not lawyers, we cannot judge the legal issues involved. Regardless, it is reasonable to ask if existing laws and property rights should be maintained with the advent of new technology, or if it is in (almost) everybody's better interest to drop them as quickly as possible. As economists, we can use what economic principles teach us to evaluate if current copyright protection ultimately benefits consumers and music creators or if, instead, it is mainly instrumental in creating abnormal profits for intermediaries such as record companies and music publishers.

Basically, the music industry argues that giving away copyrighted music for free violates its "intellectual property," and indeed, compares the downloading of copyrighted music to "piracy" or "theft". Permitting such "theft", music producers argue, is socially very damaging. No one would have an incentive to produce music were Napster and similar organizations allowed to operate. This arguments has two parts: the first says that downloading music is theft, and the second says that if downloading is permitted the incentive to produce good music would disappear and we would all be living in a grey and sad world, instead of joying at the lyrics of the Iglesias family. The first statement is the silliest and easiest to dismiss:  it does not require a Ph.D. in economics to see that downloading music, copyrighted or not, is quite different from theft in the ordinary sense of the word. Theft, as we ordinarily mean it, amounts to depriving the owner of the use of the object of his property or, at least, greatly reducing his access to it. If you steal my MP3 player, I can no longer use it. Whether you use it, resell it, or just throw it away, it is theft. In this sense "intellectual property" is quite different than property of material objects. Indeed, the argument is not over the right of the music industry to sell its product, nobody is stealing CDs via Napster, but rather over their ability to regulate the future use of their products by those who purchase them. As far as we know, no one has accused people who make available music from their CDs on the Internet of having stolen the CDs. Rather the question is, having purchased the CDs, the music industry would like to prevent us from further distributing the music. But is there a valid economic rationale for this? If I purchase a car, I can resell it in direct competition with the manufacturer of the car. In fact, also if I purchase a CD I can resell it. I can also let other people listen to it in my home or backyard, or take it to the office and make it available to my colleagues, or play it during a gigantic party. The limit, apparently, is reached when I start making copies of it, either virtual or not. Strangely enough I can make copies of my Armani's suit, as long as I do not put an Armani label on it, but I cannot do the same with my CDs. Why?

Why indeed should I not sell on the Internet the music I have purchased, in direct competition with the "producer" (if you can call the RIAA a producer of anything except misleading hot air)? This is where the second part of the RIAA argument comes in: you should not have the right to resell the music because, by breaking the monopoly, you eliminate the incentive to produce further good music. What is at issue, then, is not "theft", but rather the legal protection of a monopoly. Naturally, if the monopolist has to compete with his own past customers then his ability to extract money from his new customers is reduced. One consequence of this is that it would be much more difficult for him to "price discriminate," charging a higher price to those customers who place a particularly high value on his product. Naturally, not having to compete with one's customers has a great deal of value, and it is not terribly surprising that the "producers" of music wish to protect it. To better protect themselves, in fact, these "un-natural" monopolies have recently (March 2000) created the Copyright Assembly, which "... enlists into its membership the vast array of American enterprises involved in sports (professional football, basketball, baseball, hockey, NASCAR, NCAA), music, song-writing, advertising, software, broadcasters, both networks and stations, cable, movies, publishing, television programs, home video," as  Mr. Jack Valenti  proudly informed us. 

Historical evidence, for starters, suggests that at least when it comes to music, literature and painting/sculpture, lack of copyright protection may not matter very much. Neither at the time of Dante nor at that of Shakespeare or Michelangelo copyright laws were available. The same applies to Homer, the Gregorian Chants, Monteverdi and almost everything worth either reading or listening to. Still, and in spite of the much less favorable economic conditions, an enormous amount of great art of all kinds was created, which we still admire, read, listen to and ... reproduce without bothering much about copyrights. After all, do you really believe that the thought of not receiving royalties for the millions of posters sold would have kept Pablo Picasso from painting "Les Demoiselles d'Avignon"? He did not get them in any case!

Let us consider next the logical soundness of the argument, given the current technological circumstances. Does the legal monopoly given to copyright holders make sense for anybody else but themselves? In what sense is the production of "music," "stories," or "movies" different from the production of laptop computers, cheese or laundry detergent, none of which are privileged by the government with a legal monopoly preventing their purchasers from reselling them? The argument that will no doubt be reiterated over and over by music producers is that the production of music, books and ideas more generally, involves a fixed cost. Somebody must sit down and write/play the music or write/type the book for the first time. This is a unique and costly event, which may take months or years of time for one or more artistic geniuses to complete. If not given a monopoly and given the right to price discriminate and engage in activities otherwise viewed as inimical to consumers, it would be impossible to cover such fixed cost (i.e. pay the likes of Julio Iglesias and Ken Follet their worth). Leaving aside the fact that very little of the money in the music industry (or the literary world for that matter) goes near those people who engage in creative effort, the fact is that the cost in music writing is not "fixed" but rather "sunk", meaning that at the time the CD is produced and the music is sold, the cost of writing/playing it the first time cannot be recovered. But the economic rationale for giving monopoly power to cover sunk cost is weak. This is because competitive markets in the ordinary sense are perfectly capable of recovering sunk costs (and indeed, almost all costs are sunk.)

Moreover, only an infinitesimal percentage of the music that is written/composed is actually produced and distributed. Record companies act as very efficient "gatekeepers," controlling production, distribution and circulation of music in the various markets and, thereby, earning huge monopoly profits by greatly undersupplying the public with musical products. The fact that less than 1% of music written/composed is ever distributed makes a strong empirical case against the incentive arguments used by the producers: The opportunity cost of  time for many artists is, clearly, very small. So a strong monopoly is hardly needed to provide them with recompense.

Let us be clear. Copyright laws historically exist to restrict the monopoly power of copyright holders and protect consumer rights. Over time these consumer rights have been whittled away, and the lawsuit against Napster is yet another such instance. We are arguing that far from being further weakened, the copyright protections given consumers should be strengthened. The computer industry, for example, issues "license agreements" binding the purchaser of software to all sorts of terms and conditions up to but not including (yet) turning over your first born child to Bill Gates. The music industry would dearly like to use similar license agreements: the user, as a condition of purchase, would never to let anyone hear the music besides themselves (and then only in the dark of night). They are prevented from doing so only by the copyright law. However, current copyright law does allow the producers to prevent consumers who had legally obtained music from copying it and redistributing it. Of course, adding such provisions to newly issued CDs reduces their market value. And room is available for other producers to sell CDs without those provisions, maybe at a higher price or maybe at the same. But the RIAA is a very effective cartel, and no producer has, so far, had an incentive to deviate from this coalitional rule.We are arguing that copyright law should be strengthened to prevent such licensing agreements. That is copyright law should explicitly allow consumers who have legally obtained music to copy and resell it. We are not of course arguing that people who illegally obtain the music could redistribute it However, in our view, the correct solution to the problem of "intellectual property" is not to protect it, but rather to force competition in the reproduction, distribution and circulation of music (and literature, movies and other artistic products that can make people's life better and be easily reproduced) by requiring that any purchaser of "intellectual property" have complete freedom to use it as she sees fit. If I buy music I should be free to listen to it, record it, sell it or give it away. (I shouldn't be allowed to claim that I created it, which is fraud.)  If I buy a computer program I should be free to use it, resell it, or reverse engineer it.

For those who are not academically trained economists, we should perhaps explain how a market could work in which original producers compete directly with the buyers of their own product. Naturally, the first CDs sold may command a rather high price, as they will be in rather short supply. The earlier purchasers will no doubt be those who value it particularly highly, or those that buy it with the intention of reproducing it and selling it. By the time all the Napster users have obtained a copy, the price will have fallen a great deal. At a low enough price, even those that do not really care about the music or that would listen to it once and then throw it away, would purchase a copy. But of course, by this time, profits (technically rents) sufficient to cover the production cost (including that famous "fixed" cost we talked about before) will have been earned. "Gatekeepers", that is cartelized monopolists such as the RIAA, will see their market power much eroded if not totally eliminated. And struggling artists will get a fair chance of circulating their music and recovering the (sunk) costs they are now prevented from recovering by the monopoly power of the RIAA.If you are interested in more details about the economics of such a market, click here.

But let us not understate the costs of what the RIAA and their ilk is trying to accomplish. There are two technologies for the distribution of music (and books, and movies and so forth): the old highly expensive technology and the new cheap internet technology. Although the new technology is vastly superior to the old, it gives the intermediaries like the RIAA less control, and threatens their monopoly. Hence their desire to suppress the new technology, for the Napster lawsuit is no less than that. The social cost of allowing monopolists to protect themselves through the suppression of vastly superior new technologies is costly indeed - in fact we do not doubt that much of the reason that the United States has pulled ahead of Europe and Japan in recent years is that European and Japanese monopolists have been more successful than American in enlisting the government to suppress new technologies. We are certainly not the first economists arguing that monopolists will gang together trying to block technological innovations that threaten their rents. Our friend and colleague  Ed Prescott, for example, has argued the same point quite convincingly in a number of his publications.

Make no mistake, some producers of "intellectual property" have done quite well from their legal monopoly. Once modern technology ends their free ride they will no longer make obscene profits - just the normal return on their investment. As economists, we understand the value of competition, and advocate measures such as those restricting the rights of "producers" of "intellectual capital" to inhibit competition through licensing agreements. We are also realists - the Sony Bono act passed Congress without a dissenting vote, although it is hard to imagine any economist not directly paid by a large copyright holder, who would have testified that this was a good idea. Fortunately for economic efficiency and the future of competition, law is made on the ground. Whatever the court decides in the Napster case, the old notion of "intellectual property" died when the cost of reproducing books, CDs and designs dropped by several orders of magnitude. While, for the time being, we can only cheer Napster and hope they win their lawsuit, if they do not, the courts and SDMI gremlins have as much chance of stopping gnutella as of declaring the tide null and void.

To participate in a discussion of these issues, click here.

Napster

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