Communications - May 2012

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are, of course, bad. They raise prices and restrict output. Beyond that, they either transfer resources from buyers to sellers, or worse, they employ high prices that frustrate mutually beneficial transactions. Why do governments grant these monopoly rights? It provides an incentive for creative activity.

Napster illustrates that copyright’s effectiveness depends crucially on technology. While the recent technological challenge to copyright could have affected any product that can be digitized—text, audio, or video—in reality the recorded music industry was the first to face the new challenge. And the decade since Napster has seen a dramatic reduction in revenue to the recorded music industry.

The struggles of the recorded music industry have spawned an outpouring of research seeking to document the effect of file sharing on the recording industry’s revenue. Organizations representing the recording industry have argued that piracy is the cause of the reduction in revenue they have experienced. They further claim that their experience foreshadows in other creative industries, and that it will have serious consequences for bringing artists’ work to market.

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What Do We Know?

While the question of whether file sharing displaces legal sales and weakens copyright is interesting—and a vital question for industry—it is clearly not the only question raised by file sharing. Copyright has traditionally allowed the recording industry to generate revenue from recorded music. Weakened copyright may be bad news for sellers of recorded music, but its consequence for consumers depends on what is arguably more important:

Does piracy slow
new products
from being brought
to market?

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whether new music continues to be made available. In this column, I consider these issues in more detail.

Although stealing has long been understood to be bad, the effects of stealing on the sellers of products produced with zero marginal costs (the additional cost required to make one more unit available) are somewhat subtle. To see this, first consider the analysis of stealing music that has already been recorded. There are two separate questions: whether stealing harms sellers and whether stealing harms society as a whole.

The effects of stealing on sellers depend on its effects on consumers, who differ in their willingness to pay for the product. Some attach valuations high enough so that, had stealing been impossible, they would instead have purchased the product. When they steal, each unit of theft reduces paid consumption by one entire unit. Thus, their stealing harms sellers one-for-one.

But other consumers attach lower valuations to the product. If stealing had been impossible, they would not have purchased the product. When they steal, it brings about no reduction in revenue to the traditional sellers.

Summarizing, does stealing harm sellers? It depends on whether the instances of unpaid consumption would otherwise have generated sales. That also explains why sellers and society should not view stealing the same way. When low-valution consumers steal, their theft does not harm sellers. But their consumption does generate a gain that otherwise would not have occurred.

This is society’s paradox of piracy. If stealing could somehow be confined to these circumstances, then its effects would help consumers without harming producers. Generally, it cannot, and that is why the revenue reduction experienced by sellers can have long-term consequences beyond their direct losses. Indeed, because new products need some threshold level of revenue in order to be made available profitably, transfers from producers to consumers are not benign.