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BOLDRIN - the case against intellectual property, Study notes of Economic Analysis

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American Economic Association
The Case against Intellectual Property
Author(s): Michele Boldrin and David Levine
Source:
The American Economic Review,
Vol. 92, No. 2, Papers and Proceedings of the One
Hundred Fourteenth Annual Meeting of the American Economic Association (May, 2002), pp.
209-212
Published by: American Economic Association
Stable URL: http://www.jstor.org/stable/3083403 .
Accessed: 11/05/2011 22:47
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American Economic Association

The Case against Intellectual Property

Author(s): Michele Boldrin and David Levine

Source:The American Economic Review, Vol. 92, No. 2, Papers and Proceedings of the One

Hundred Fourteenth Annual Meeting of the American Economic Association (May, 2002), pp.

Published by: American Economic Association

Stable URL: http://www.jstor.org/stable/.

Accessed: 11/05/2011 22:

Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at.

http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless

you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you

may use content in the JSTOR archive only for your personal, non-commercial use.

Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at.

http://www.jstor.org/action/showPublisher?publisherCode=aea..

Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed

page of such transmission.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of

content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms

of scholarship. For more information about JSTOR, please contact support@jstor.org.

American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The

American Economic Review.

http://www.jstor.org

The Case Against IntellectualProperty

By

MICHELEBOLDRINAND DAVID LEVINE*

According to a common argument,the pres-

ence of strong intellectualpropertyrights spurs

innovation leading to higher economic growth

and increasing benefits for

all. The argument

seems coherent. No economic agent exercises

productive effort without the certainty of con-

trollingits fruits.Whatis truefor physical effort

must be true for the intellectual one: if strong

propertyrights provide good incentives for the

productionof potatoes, they must also provide

good incentives for the productionof ideas.

Why then do we argue a "case against intel-

lectual property?"Are we arguing that, while

stealing potatoes is bad, stealing ideas is good?

We are not. Economic efficiency and common

sense argue that ideas should be protected and

available for sale, just

like any

other commod-

ity. But "intellectual property" has come to

mean not only the right to own and sell ideas,

but also the right to regulate their use. This

creates a socially inefficient monopoly, and

what is commonly called intellectual property

might be better called "intellectualmonopoly."

When you buy a potato you can eat it, throw it

away, plant it, or make it into a sculpture.Cur-

rent law allows producersof CDs and books to

take this freedom away from you. When you

buy a potato you can use the "idea"of a potato

embodied in it to make better potatoes or to

invent french fries. Currentlaw allows produc-

ers of computer software or medical drugs to

take this freedom away from you. It is against

this distortedextension of intellectual property

rights that we argue.

It is a long jump from the assertion that

inventorsdeserve the fruitsof theirefforts to the

conclusion that current patent and copyright

protection are the best way of providing such

reward.Statementssuch as "A patentis the way

of rewarding somebody for coming up with a

worthy commercial idea..."'' abound in the

business, legal, and economic press. In arguing

the case against "intellectual monopoly" we

will examine this argument with care.

I. Downstream Licensing

Intellectual property has two components.

One is the right

to own and sell

ideas. The other

is the rightto controlthe use of those ideas after

sale. The first,sometimes called the rightof first

sale, we view as essential. The second, which

we referto as downstreamlicensing, we view as

economically dangerous.

All producers would

impose downstream-licensingagreementsif they

could: producersprefer not to compete against

their customers. But the absence

of competi-

tion leads to monopoly.

That the downstream-

licensing provisions of patent, copyright,

and

other private

contractslead to monopoly is

well

understood. Among economists,

the argument

has been that it is only throughmonopoly that it

is possible to rewardinventive activity. There is

a seemingly compelling logic: the cost of inno-

vation is a fixed cost, and ideas are distributedat

zero, or at least constant, marginalcost. Since

perfect competitionprices at marginalcost, the

fixed cost cannot be recouped.Consequently,if

producersof intellectual propertyare forced to

compete with their customers, they will not be

able to recoup the cost of creation.This point is

forcefully made, for example, in Paul Romer

In other work (Boldrin and Levine, 2001) we

have pointed out that creationis not a fixed, but

a sunk, cost. Since only ideas embodied in peo-

ple or productsmatter,the cost of creationis the

cost of producing the first unit. Such a "sunk

cost" is very ordinaryin economics and poses

no particular threat to perfect competition.

As far as we know there is no organizedmove-

ment to provide producersof potatoes, or any

other commodity involving sunk costs, with

a

Departmentof Economics, University of Minnesota,

Minneapolis, MN 55455, and Departmentof Economics,

University of California, Los Angeles, CA 90024. Our

thanks to the NSF and the University of Minnesota Grants

in Aid programfor financial support. 1 The Economist, 23 June 2001, p. 42; italics added.

209

VOL 92 NO. 2 INTELLECTUALPROPERTY:DO WENEED IT? 211

property protection is associated with higher,

ratherthan lower levels of cooperationbetween

incumbentsand start-upinnovatorentrant."

Ultimately, the case against monopoly rests

less upon the welfare triangle from monopoly

pricing than upon the rent-seekingactivity

used

to get and keep

a monopoly.

In the brief exam-

ple of Section IV we show how, with govern-

ment enforced monopoly, the incentives for

rent-seeking

lead to large

welfare costs in the

production

of ideas.

III. Competition Without

Downstream Licensing

We provide an example to illustrate the

idea in Boldrin and Levine (2001) that inno-

vation can thrive in a competitive economy

even in the face of indivisibility. In this econ-

omy, individuals live forever. There are many

consumers, indexed by c < 0. In each period,

consumers either consume one unit of the

good, or not. The benefit to consumer c of

consuming a unit of the good is c - + with

q

  1. Consumers also prefer to consume early

rather than later: a unit of good consumed

today is worth 6 < 1 of a unit of the same

good consumed next period.

Initially, there is a single prototype of a du-

rable commoditythat generatesthe flow of con-

sumption service. The inventor or producer

owns this prototype.Once sold, no downstream

licensing is possible. At each moment of time

the prototype can either be used to generate a

flow of consumptionor be reproduced.To make

things less abstract,let us imagine that the new

good is a recordingof a new musical piece that

is embodied

in an MP3 file. Copying takes one

period,

and each MP3 that is copied produces

additional

MP3's. A technology such as

Napster increases ,B.

Under competitive conditions, in the tth pe-

riod each MP3 sells for a marketpricePt or may

be rented for one period at a rental rate rt.

Notice that consumers for whom c-+q > rt

value the song more highly than the rental cost

and will choose to listen to an MP3 that period;

consumersfor whom c

rt

will choose not

to listen to the MP3: if they have a copy, they

preferrenting

out their copy

to someone else.

In

a competitive environment,

everyone is poten-

tially a buyer and a seller.

We are interested in two questions. Is the

price of the very first copy enough to compen-

sate the producer for its sunk cost? Does the

price of the firstcopy increase or decreasewhen

new technologies increase ,B?

According to standardcompetitive theory the

sale price

of an MP3 is just the presentvalue of

the rental rates. A simple calculation2 shows

that

( 1 + ta/3-

61/t3(iI)/

)

Po=

For finite values of

po,

Po is a positive and finite

number.Since po

is what the producercan earn

from the first sale when he has no downstream

protectionat all (in practicehe should be able to

do better than this), there is money to be made

for producersof intellectual products.

Is this competitive value of intellectualprod-

ucts enough to motivate the producersto spend

the effort and time required?We do not know.

To answer this question one needs to know the

particularopportunitycost of time of the par-

ticularcreator,which clearly varies from case to

case. It seems to us, though,thatthereis no hard

empiricalevidence supportingthe view that this

value would not be enough.

We also want to understandthe social impact

of a technology that facilitates the reproduction

of "idea-goods." Does it increase or decrease

the value of intellectual productsin a competi-

tive market?Basically, received wisdom argues

that cheap copying makes it impossible for in-

novatorsto earn back their productioncosts. If,

in a competitive setting, increasing

/ lowered

po,

received wisdom would be correct:without

downstream protection, fewer "idea-goods"

would be createdas a result of the adventof the

new technology.

What does happen

to po

as / grows larger?

The answer depends on 4'.If

< 1, demandis

elastic. This is the empirically interesting

case.

As

/ grows larger, it is easy to check from the

equation above that the price of the initial copy

2

Details on this and other calculationsin this papercan

be found online at (http://Mevine.sscnet.ucla.edu)or (http://

www.econ.umn.edu/-mboldrin).

212 AEA PAPERSAND PROCEEDINGS MAY 2002

goes to infinity as more of it is allocated to

reproduction. In fact, this happens as ,B ap-

proaches a finite

value, but this is a special

implicationof the analytic forms we are using.

Notice that, in all cases,

the rate at which the

price falls over time is proportionalto ,B.Nev-

ertheless, with elastic demand and large (3,the

increase in the rate with which price falls over

time is associatedwith a higher initial price and

greaterrent for the innovator.

In summary, under competition and in the

empirically interesting case where demand is

elastic, improvingthe technology for reproduc-

tion increases the first sale price withoutbound.

The improvedtechnology makes it much easier

for a producerto recover sunk costs in a com-

petitive market. This does not mean that the

producerwill argue against downstreamlicens-

ing and in favor of increased competition. She

will still be able to earn more revenues with a

monopoly than under competition. However, it

is a good argument for not giving in to the

producersand grantingthem the monopoly: the

social benefit of the monopoly (the ability to

cover sunk costs and produce a socially desir-

able good) is reduced by the new technology.

This establishes competitive

marketsas a vi-

able institutionalsetting

for fostering

innovative

activity.3 We

move now to consider the viabil-

ity

of alternative

institutional settings.

IV. The Hidden Costs of Imperfect Monopoly

What happens when competitive rent is in-

sufficientto cover the cost of producingthe first

unit? Let us considerthe starkcase traditionally

consideredin economic theoryin which thereis

a fixed cost that must be recovered, and in

which the marginalcost of productionis zero.

With demand that is perfectly elastic up to an

upper bound, there is no cost of monopoly, so

this would seem the ideal environmentto im-

pose downstream-licensingrestrictions.

This is correct

only if it is not possible to

produce

similar items. In the case of textbooks,

for example,

it is easy to producebooks that are

sufficiently differentto be entitled to a separate

copyright,but sufficientlysimilaras to make no

difference to consumers. When there are many

firms competing for monopoly rents, and mar-

ket conditions are such that rents can be ob-

tained even with some degree of competition,

the rent-seeking behavior

of competing monop-

olists dissipates the social surplus by overpro-

duction of too many similar items. When we

allow for creativity in the use of markets by

having consumers submit contingent bids, then

no copyright is unambiguously better than

copyright.

Suppose in particular that firms are identi-

cal, face a fixed cost, and produce at zero

marginal cost. Suppose also that there are H

identical risk-neutral customers with fixed

reservation price who may reproduce the

good at marginal cost ( ' 0. When intellec-

tual monopoly is legally enforced through

copyright, we assume that the post-entry price

lies between the price needed to recover costs

(for each firm) and the monopoly price in a

way that depends on the number of firms and

consumers. This particular form of market

arrangement(call it "copyright-inducedcom-

petition for niches") results in what we de-

scribe as the Pareto worst outcome.

Without copyright

therewill be no outputand

no social surplusonly

if (H

< FN; otherwise,

social surplus

will be higher

than under copy-

right. This, however,

does not do justice

to the

competitive

instinct: we have excluded

the im-

portant possibility

that consumers may

submit

contingent

bids prior

to production.

In a sym-

metric equilibrium of a contingent-bidding

model, with copyright, the Pareto worst out-

come is still an equilibrium, while without

copyright, the first best is obtained.

REFERENCES

Boldrin, Michele and Levine, David K. "Perfectly

CompetitiveInnovation."Mimeo, University

of Minnesota, 2001.

Gans, Joshua S.; Hsu, David H. and Stern, Scott.

"When Does Start-up Innovation Spur the

Gale of Creative Destruction?"National Bu-

reau of Economic Research (Cambridge,

MA) Working Paper No. W85 1, 2000.

Romer, Paul. "Are Nonconvexities

Important

for UnderstandingGrowth?"American Eco-

nomic Review, May 1990 (Papers and Pro-

ceedings), 80(2), pp. 97-103.

'In Boldrin and Levine (2001) we develop a more

general version of this argument.