Assessing the economic
impacts of adapting certain
limitations and exceptions
to copyright and related rights
in the EU
Prepared for
DG MARKT
European Commission
Prepared by
Gregor Langus, Damien
Neven & Gareth Shier
Charles River Associates
81 Avenue Louise
1050 Brussels
October 2013
The information and views set out in this study are those of the authors and do not necessarily
reflect the official opinion of the Commission. The Commission does not guarantee the
accuracy of the data included in this study. Neither the Commission nor any person acting on
the Commission’s behalf may be held responsible for the use which may be made of the
information contained therein.
DOI: 10.2780/90295
ISBN: 978-92-79-29919-3
© European Union, 2013.
Reproduction is authorised provided the source is acknowledged.
October 2013
Charles River Associates
TABLE OF CONTENTS
1.
2.
3.
INTRODUCTION AND SUMMARY OF RESULTS ........................................................ 1
1.1.
OBJECTIVE OF OUR REPORT................................................................................................. 1
1.2.
FUNCTIONS OF COPYRIGHT EXCEPTIONS............................................................................... 1
1.3.
THE DIFFERENT USES OF COPYRIGHTED WORKS.................................................................... 2
1.4.
THE RELATION BETWEEN EXCEPTIONS, FAIR USE AND THE STRENGTH OF COPYRIGHT .............. 4
1.5.
THE STRUCTURE AND THE MAIN FINDINGS OF THE REPORT ..................................................... 4
ECONOMIC RATIONALE FOR COPYRIGHT, AND THE CHARACTERISTICS OF
MARKETS FOR CREATIVE WORKS ......................................................................... 12
2.1.
EFFICIENT MARKETS, MARKET FAILURE AND THE ROLE OF INTERVENTIONS............................ 12
2.2.
COPYRIGHT ADDRESSES THE PUBLIC-GOOD NATURE OF CREATIVE WORKS ........................... 12
2.3.
COPYRIGHT, AND THE “COPY-PRIVILEGE” SCENARIO ............................................................ 14
EXCEPTIONS AS REMEDY FOR MARKET FAILURES IN THE MARKETS FOR
CREATIVE WORKS .................................................................................................... 18
3.1.
3.2.
TRANSACTION COSTS ........................................................................................................ 19
3.1.1.
Taxonomy of transaction costs ......................................................................................... 19
3.1.2.
Exceptions to mitigate the effects of transaction costs under copyright ........................... 19
3.1.3.
Technological advances may reduce transaction costs ................................................... 27
3.1.4.
Conclusions on transaction costs ..................................................................................... 29
MARKET POWER, PRODUCTIVE EFFICIENCY AND ACCESS VS. INCENTIVES TO CREATE NEW
WORK ............................................................................................................................... 31
3.2.1.
Monopolistic competition .................................................................................................. 31
3.2.2.
Copyright grants limited market power ............................................................................. 33
3.2.3. The role of exceptions in limiting deadweight loss and their cost in terms of reduced
incentives for creative work ........................................................................................................... 34
3.2.4. Conclusions on the role of exceptions in the trade-off between access and incentives
to produce, and productive efficiency ............................................................................................ 38
3.3.
THE ROLE OF EXCEPTIONS IN THE PRESENCE OF EXTERNALITIES .......................................... 39
3.3.1.
Why have externalities not been internalized? ................................................................. 40
3.3.2.
What is it about creative works that generates externalities? ........................................... 41
3.3.3.
The “anticommons” problem ............................................................................................ 42
3.3.4. Important considerations in the assessment of exceptions as a remedy to an
externality ...................................................................................................................................... 44
4.
5.
TECHNICAL SUMMARY OF SELECTED MODELS EMPLOYED IN THE ANALYSIS 45
4.1.
THE TRADE-OFF BETWEEN ACCESS AND PRODUCTION INCENTIVES ....................................... 46
4.2.
EXCEPTIONS AND TECHNOLOGICAL IMPROVEMENTS ............................................................ 53
4.3.
MARKET POWER AND EFFICIENT ALLOCATION OF PRODUCTION ............................................. 59
POLICY INSIGHTS FROM THE ANALYSIS................................................................ 69
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6.
5.1.
TRANSACTION COSTS ........................................................................................................ 69
5.2.
MARKET POWER, PRODUCTIVE EFFICIENCY AND THE TRADE-OFF BETWEEN ACCESS AND
INCENTIVES FOR CREATIVE WORK ....................................................................................... 70
5.3.
EXTERNALITIES ................................................................................................................. 70
5.4.
EXCEPTIONS ASSESSMENT CHART...................................................................................... 71
CONCLUSIONS .......................................................................................................... 73
BIBLIOGRAPHY ................................................................................................................ 74
LIST OF FIGURES
Figure 1: The effect of decreasing marginal costs on social welfare ................................ 33
Figure 2: Consumer benefit and copy costs in terms of quality of the version consumed 60
Figure 3: Price is constrained by the option to self-produce a fair use copy ..................... 64
Figure 4: Welfare maximising exception quality as cost of copying changes ................... 66
Figure 5: Decision Information Chart ................................................................................. 72
LIST OF BOXES
Box 1: The Coase theorem ................................................................................................ 16
Box 2: Hold-up ................................................................................................................... 21
Box 3: A note on the use of a ‘frictionless’ baseline for comparison ................................. 26
Box 4: Outline of the model applied in Landes & Posner (1989) ...................................... 50
Box 5: Outline of the model applied in Pollock (2007), extended to examine the effect of a
technological change that increases access to new and existing works .................. 57
Box 6: Outline of the model applied in Yoon (2008) .......................................................... 67
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1.
INTRODUCTION AND SUMMARY OF RESULTS
1.1.
Objective of our report
1.
The objective of this report is to develop a framework for economic analysis of copyright
exceptions from the public policy perspective. We aim to make the framework useful in
particular in the assessment of the merits of current claims for changes to the scope of
exceptions. These calls for changes have recently become louder in light of technology
improvements. The improvements allow for new channels of distribution and for new uses
of creative work. They also reduce the cost of copying and affect transactions costs. With
these changes taking place, changes in the scope of exceptions may be required.
2.
We keep the discussion at a fairly high level in order to allow the framework to be applied
to a wide a set of circumstances and to different candidate exceptions. Any actual
assessment of specific candidate exceptions will of course involve more detailed
considerations. Indeed, our analysis suggests that the case for or against exceptions can
often only be made once the specific nature of the work, the incentives of the authors and
commercial and private users, as well as the market structure and the state of technology
are explicitly considered.1 Whenever possible, such considerations should involve a
qualitative and quantitative assessment of the relevance of the different mechanisms
identified in order to determine whether the candidate exception is likely to contribute to
social welfare or not.
3.
This report neither discusses the issue of harmonization of exceptions across member
states nor the issue of harmonization of the copyright framework more generally. While
these are important topics, as indeed harmonization may contribute to the efficiency of
the market for copyrighted works through, for example reduction of transaction costs and
reduction in legal uncertainty, they are not part of our remit.
4.
We also do not address the very important question of the pros and cons of open-ended
norms, as applied in the fair use doctrine versus a closed number of specific exceptions
as codified in most of the EU.
1.2.
5.
Functions of copyright exceptions
Broadly speaking, copyright exceptions characterize the circumstances in which copyright
will not be infringed by an unauthorized reproduction or presentation of creative works. 2 In
very general terms, the role of exceptions is to increase access to existing and future
creative works where this is thought to be excessively constrained by copyright. Within
1
These parameters may change over time, in particular with the development of technology and the introduction
of new and innovative uses. This means, in turn, that it will likely be difficult to produce in advance a list of
precisely circumscribed exceptions so as to capture all the uses which should be exempted (and so as to
exclude all those uses which should not be exempted) now and in the future. To the extent possible, exceptions
should allow for a certain degree of flexibility. At the same time, it is also clear that legal certainty and a clear
allocation of rights are desirable features of the copyright system – they are important for the efficient
functioning of copyright markets. These considerations – the simultaneous need for flexibility and legal certainty
– should be kept in mind when applying the framework this report develops.
2
Note that by “unauthorized” copying we do not mean copying which necessarily infringes copyright. It is simply
copying for which no authorization from the rightholder has been obtained, perhaps because exceptions allow it.
More generally, in this report we do not deal with piracy.
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this broad objective, however, exceptions perform a range of functions: To overcome the
problem of missing markets for certain uses, to facilitate the use of the existing
copyrighted works in new creative works, to deal with the special nature of certain types
of work where copyright risks a large degree of market power (e.g. with respect to certain
uses of computer programs) or to support industry regulation (e.g. provisions relating to
broadcasting in order to support oversight by a regulatory body, retransmission and mustcarry obligations).3 Exceptions sometimes pursue other (arguably) non-economic goals:
to promote access to creative works to persons with disabilities; to promote fundamental
freedoms and social values, such as the freedom of expression and access to
information; to promote access to works of governments and so forth. Although economic
reasoning can often be applied to provide justification for such exceptions (for example,
positive externalities that they generate justifies broad access), their economic effects
may be somewhat difficult to qualify and even more so to quantify. As a result, a number
of exceptions seem to prefer to find their justification outside of the economic analysis; in
promotion of certain fundamental human rights and democratic and social values. While
such goals for exceptions are legitimate and important, we do not explicitly consider them
in this report.
1.3.
The different uses of copyrighted works
6.
Before proceeding with our analysis, it is worth highlighting that creative works are often
used in a number of different ways. This is important as the potential tax on trade that
copyright confers (and the scope for exceptions) will depend on the nature of use of
copyrighted works and on the scope of protection granted by copyright.
7.
Arguably the most obvious use of creative works is that of ‘private’ end-use; as people
watch a movie, listen to music, read a leisure book, or study for an exam. The utility that
the end-users obtain depends upon both the ideas and information embodied in the
works, as well as the artistic form that the creative work takes (henceforth ‘the
expression’).
8.
In order for a private user to access the work they will typically have to obtain (at least
partial) access to a copy or a performance (e.g. buy the book, purchase the cinema ticket,
or download the album track, etc.). Having accessed the work, the user may or may not
wish to further transmit it. New technologies that enable online sharing and copying at low
costs mean that even a few users (or a single user) that wish to distribute copies widely
can do so very effectively, reaching broad audiences. In this context, copyright effectively
defines certain acceptable limits on the relatively homogenous use of creative works 4;
essentially preventing private users from becoming copyists of the work. The
standardized ‘contract’ that copyright offers helps to ensure the transaction costs for
accessing these works for ‘typical’ use remain relatively low.
9.
The second category of uses of creative works is one in which new authors draw on
existing copyrighted materials as inputs to their creative work. In the process of such
transformative uses, authors may wish to reuse either the ideas of an existing work, (part
of) the expression itself, or both. Citation, criticism, summarization, parody, sampling of
music, mash-ups are some examples of different forms of reuse. Arguably, providers of
3
See e.g. Burrel and Allison (2005).
4
Of course individuals’ valuations of creative works differ. However, the value in some other uses is likely to differ
to a greater extent (in particular relative to transaction costs).
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some services, like the internet search services also engage in transformative use. They
access and reuse parts of different copyright content to deliver a new service.
10.
Absent an exception, and provided that they fall within the scope of copyright, such uses
of copyright content will require permissions from the authors of the relevant prior works.
However, since the nature of use of existing works as inputs varies dramatically (e.g.
depending on the purpose of new work, potential new audience, extent of reuse, etc.) it is
unlikely that a standard set of contract terms as applied to ‘private’ use would suffice.
Instead, absent exceptions, it is likely that bi-lateral negotiations would have to ensue
between the new- and prior- authors), to reach a mutually beneficial trade that accounts
for the specific circumstances of the deal. In some cases, the cost of such negotiations
may be prohibitive when compared to the often low and uncertain value-in-use of a
relevant individual piece of copyrighted material. In section 3.1 we explore how the
exclusive rights conferred by copyright may block valuable uses in such cases and how
exceptions may release social value.
11.
However, it has to be kept in mind that, unlike patents, copyright protects only the
expression of a work; that is, the form in which the author presented his idea. It places no
restriction on the reuse of the ideas or the information embodied in the expression, which
may be freely re-transmitted. Therefore, in principle, any creative reuse of just the idea or
information from an existing work does not require a permission of the original author.5 As
we explain later, this distinction is important as it (arguably) ensures that copyright
presents a relatively low barrier to the dissemination of ideas and information, whilst
remaining restrictive to the dissemination of the author’s expression. This allows new
authors to ‘borrow’ the ideas of prior work whilst avoiding the costs of developing these
ideas. They may then re-express these ideas or information to their audiences without a
breach of copyright.6
12.
A further use of creative works is as an input to various distributors and media platforms.
Cinemas, radio and TV broadcasters, online music distributors, libraries, and other
retailers are all examples of users that profit from distributing works in their full original
form. Unauthorised reproduction and distribution of works (piracy) also falls into this
category of ‘full original form’ re-use.
13.
As with creative re-use, the value-in-use of the input works can vary dramatically
depending upon the nature, timing and location of the use. For example, the first
screening of a movie in cinemas will sometimes be of a higher-value to the distributor
than the subsequent DVD rental, VOD and broadcasting releases. Similarly, online
distributors operating within a narrow market such as a single member state will clearly
have a lower valuation compared with a pan-European online distributor. Once again, it is
likely that bi-lateral negotiations would be required between rightholders and distributors
to negotiate bespoke, mutually beneficial contract terms. Although the value-in-use can
5
The EU Software Directive (Article 1.2.), for example, provides that ideas and principles which underlie any
element of a computer program, including those which underlie its interfaces, are not protected by copyright.
6
From the point of view of economics, the idea-expression dichotomy can thus be rationalized as a result of a
balancing between the opposing goals of, on the one hand, provision of incentives for the authors to produce
and disseminate creative works, and, on the other hand, securing broad public access to existing works,
including access of subsequent authors who must, at least in some part, draw from previous works, In practice,
however, it would appear that it is often difficult to draw a clear-cut distinction between ideas and expressions.
(see e.g. Rosati, 2010).
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often be expected to be significant, these bespoke negotiations may still raise the issue of
high transaction costs. For example, a platform which aggregates and distributes a wide
variety of copyrighted content may find that the negotiation costs (taken apart from the
resulting prices) might present a significant barrier to entry.
14.
1.4.
15.
We keep in mind each of these potential uses throughout this report, as we consider the
various implications of copyright and its exceptions.
The relation between exceptions, fair use and the strength of
copyright
In our analysis, we consider exceptions as permitting certain acts (uses) which would
otherwise constitute an infringement of the exclusive right granted by copyright. In this
sense exceptions to copyright as legislated in most EU countries are very similar to the
fair use doctrine in the US. The most important difference is often thought to be in the
flexibility of the two instruments: the application of fair use is guided by a set of open
norms and thus appears rather flexible, whereas exceptions are based on a more detailed
set of enumerated acts which constitute an exception. Each of these two approaches has
its merits and drawbacks (which we do not address in our analysis). 7
16.
In our analysis, one of the effects of exceptions will be conceptualized as a weakening of
copyright. To rationalise this, we take that the purpose of copyright protection is to correct
for the inherent partially non-excludable nature of creative works. In this case, granting
exceptions weakens this protection as it allows some limited degree of non-excludability.
This is significant to the extent that it interacts with the producers’ (current and future)
pricing and production decisions, and incentives. 8
1.5.
The structure and the main findings of the report
17.
This section outlines the structure of our report and its main findings. We begin by
establishing the economic rationale for copyright in section 2. There we outline how
copyright, by creating exclusive rights overcomes non-excludability, a fundamental
problem of markets for creative works. Creative work is generally relatively cheap to copy
and distribute, yet costly to develop. This invites unauthorized copying and distribution
which destroys the incentive to create the work in the first place. Copyright addresses this
problem, allowing for the formation of markets for creative works.
18.
In order to analyze exceptions from an economic perspective it is indeed important to first
establish the economic rationale for copyright. This is because, conceptually, exceptions
delineate the scope of copyright – and new exceptions change this scope. Since
copyright can be thought of as a remedy for a market failure (and it can facilitate
formation of markets for creative works), we need to understand how changing the scope
of copyright by new or broader exceptions potentially affects the performance of copyright
7
For example, it could be argued that fair use, compared to a system of explicit, statutory exceptions, adds
uncertainty for both producers and consumers of creative works but will be more efficient in hard cases and
situations which the lawmakers cannot predict in advance. Yet, in our opinion, fair use does not need to result in
excessive legal uncertainty – eventually the case law may establish reliable guidelines on what is likely to
constitute fair use. However, the difficulties of establishing such reliable guidelines not in one but in 28
jurisdictions (with different legal traditions) need to be kept in mind.
8
However, it should be kept in mind that exceptions do not weaken the copyright system as a whole. Indeed,
exceptions (and limitations) should ensure that the protection of copyright serves the public interest effectively.
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in its primary role. In section 2 we also explain that there is limited scope for exceptions in
well-functioning markets and that the rationale for exceptions should be found in a market
failure. When copyright induces formation of efficient markets there is no reason for
further interventions.9
19.
But markets for creative work based in copyright will not always function efficiently.
Broadly speaking, there are three distinct potential reasons. First and foremost, if
transaction costs (taken to be all the costs incurred in making an economic exchange,
excluding the agreed price) for certain uses are substantial, the gains from trading may be
eroded to the point that these transactions do not occur. Second, when rightholder have
significant market power and cannot effectively discriminate in prices between different
user groups, some users, who are willing to pay more than it costs to produce a copy of a
creative work, will not be served.10 This represents a loss of welfare to society and thus a
form of market failure. Third, the private value attached to the consumption of creative
work may not reflect its social value. This arises when the use of creative work generates
external effects that the owner of the copyright has no incentive to consider.
20.
Looking closely at these reasons for markets to fail to deliver socially efficient outcomes, it
becomes clear that transaction costs are the main culprit. In theory, as we later discuss in
some more detail, the potential reasons for a market failure largely disappear if
transaction costs, defined sufficiently broadly, are zero and entitlements are clearly
defined.11 With negligible transaction costs, the inefficiencies associated with, for
example, externalities will be internalized as the agents engage in economy-wide
bargaining. Agents with market power will price discriminate and supply efficient
quantities. This has a stark implication: in a world without transaction cost there is little
scope for exceptions to copyright. An even starker implication of zero transaction costs is
that in such a world there is little scope for copyright -- authors and users will always
reach mutually beneficial deals. However, the somewhat counterintuitive nature of these
findings is a good reason in itself for a pause: one should consider that even very small
transaction costs, a common feature of reality, may in some special circumstances cause
significant market failures.12
21.
We thus start with transaction costs as the source of a market failure and a justification for
exceptions in section 3.1. If transaction costs for certain uses are substantial, the gains
from trade may be eroded to the point that these transactions do not occur. In these
circumstances, exceptions may be viewed as a mechanism to enable certain uses of a
work which would otherwise be inhibited by missing markets. It might be argued that such
exceptions are ‘benign’, as they do not affect the revenues of the copyright owner –
absent the exceptions no transaction would take place anyway. More generally, it may be
9
Except, perhaps, when the policy makers pursue non-economic goals.
10
We note that the ability to price discriminate helps in restoring efficiency in the presence of market power.
11
Strictly speaking, perfect information is also needed for this result to hold generally. But conceptually limited
information can be (and has been) viewed as a form of transaction cost. Admittedly, such a broad view of
transaction costs may render the concept inoperative. In reality and for the purpose of our analysis, transaction
costs can never be thought to be zero; this is a purely hypothetical scenario. Nevertheless, it stands to reason
that as transaction costs decrease the scope for inefficiencies is typically reduced.
12
For example, in a pioneering paper, Diamond (1971) showed that a very small search cost can shift the
equilibrium price high above the competitive price. This has been termed the “Diamond paradox” in the
literature.
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that for certain uses, the social gains from reducing transaction costs with exceptions
outweigh the potential adverse effects of reduced incentives to produce new works.
22.
Technological advances have reduced transaction costs for some uses of creative works
and this arguably speaks for fewer or narrower exceptions. On the other hand, with these
advances new uses and new distribution models for creative works appeared. It is
possible that for these new models of exploitation of creative works transaction costs
remain high relative to the gains of trade and this may, in fact, justify new exceptions. 13
23.
It can be argued that a form of transaction costs, search-costs, can lead to the so called
“hold-up” problem. Because search costs are not recoverable at the time of the start of
negotiations on the terms of use between the user and the rightholder, they will not be
taken into account in negotiations. In the extreme case, the hold-up problem leads to
underinvestment.
24.
One should, however, not exclude that when new uses are valuable, innovative market
mechanisms will form in order to overcome high transaction costs. These innovative
market mechanisms might be a result of private or public initiatives and, when feasible,
may be superior to exceptions from the point of view of social welfare. This is because
such mechanisms allow the rights holders to be compensated for their creative work (and
this helps preserve their incentives to invest), whilst preventing transaction costs from
presenting a barrier to trade. Collecting societies are among the examples of such
mechanisms.14 However, it is important to keep in mind that in the real world of imperfect
contracts (for which transaction costs can again often be blamed), the intermediaries
might have incentives which are not necessarily perfectly aligned with those of the
rightholders and users, and this is another potential source of inefficiencies.
25.
In section 3.2 we outline that while correcting for non-excludability of creative works,
copyright induces market power as it protects the rightholders from competition of
copyists who might further distribute the copies of originals. 15 Market power can lead to
socially inefficient outcomes in particular in the circumstances in which perfect price
discrimination is not feasible. In such circumstances firms with market power will produce
(distribute) less than socially efficient quantities. In the markets for creative works this will
be reflected in sub-optimal number of copies of a given work in circulation. This is a
situation in which the author limits access to his work beyond what is socially optimal.
13
Indeed, Article 5 of the 2001 Information Society Directive spells out the exception for temporary acts of
reproductions which are transient or incidental, essential part of technological process and whose sole purpose
is transmission in a network between third parties by an intermediary or enabling a lawful use and that have no
independent economic significance. This exception can be rationalized by transaction costs and missing
markets.
14
In principle, technology might allow for innovative licensing mechanisms to overcome the problems associated
with high transaction costs for some uses. One example of such a development, still in very early stages, is the
“micro-licensing” initiative by the Recording Industry Association of America and the National Music Publishers’
Association. This initiative aims at providing licenses to users outside the music centred business. It is “aimed at
app developer who wants to use a clip of music in the background, or the wedding videographer who wants to
include music in his videos, or the company that wants to use music in presentations at corporate retreats.”
(http://www.musicweek.com/news/read/riaa-and-nmpa-working-on-micro-licensing-platform-that-could-unlockmillions/055036).
See also: http://savoirsoft.com/whitepapers/Micro-Licensing_SavoirSoft.pdf
15
Absent copyright, copying would not constitute an infringement. Again, we remind the reader that this report
does not deal with piracy.
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26.
Thus, in section 3.2, we address the trade-off between providing, on the one hand, the
incentives to create new works and providing broad access to creative works, on the
other. In the analysis of that section, exceptions play a dual role: they limit market power
(by limiting the scope of copyright), but they also reduce the costs involved in the creation
of new works (as they reduce certain transaction costs or eliminate the undesirable
consequences of the so-called anti-commons problem). In that section’s discussion we
rely on formal economic models from the existing literature and on our own analysis (the
technical details of which, however, are relegated to Section 4).
27.
However, before concluding that market power of the rightholders justifies broad
exceptions, some considerations have to be made. First, copyright confers only a limited
set of rights to the author in relation to his work – these rights are limited both in terms of
duration and scope. Significantly, copyright only protects expression, but not the ideas or
information expressed. It only pertains to the form in which authors of literary, graphic,
musical and artistic works express intellectual concepts. This means that an important
part of the intellectual creation is not protected by copyright and indeed this part can be
freely copied in new creative works. Second, in general, firms with market power which
can price discriminate will do so as this helps them maximize profits. With perfect price
discrimination (absent other sources of market failure) rightholders will provide socially
efficient levels of access to their works. In such circumstances, from the point of view of
economics, there is little reason for an intervention.
28.
Nevertheless, effective price discrimination is frequently not possible, so market power
may result in social inefficiency. Therefore in a world of copyright-induced market power
exceptions may have a place: they limit the scope of protection granted by copyright and
thus reduce the market power that the rightholder can exercise. This translates into lower
prices and broader access to existing creative works.16 But exceptions can also affect
(positively or negatively) the incentive to produce creative work and may facilitate
introduction of innovative uses of copyrighted works. Exceptions thus might or might not
reduce the inefficiency associated with market power.
29.
As is intuitive, exceptions are more likely to be well placed (efficiency enhancing) when
they reduce the costs of new creative work and when they promote introduction of
innovative modes of (wider) dissemination of new and previous work without affecting
(much) the incentive to invest in the work in the first place. This is the case in particular if
such exceptions are in addition not costly to administer.
30.
In section 3.2, besides explaining the mechanisms that generate these results, we also
ask the pertinent question, in a framework of a formal model, on how exceptions should
16
Here we note that rightholders, particularly those which are vertically integrated in distribution, may lack
incentives to address new forms of exploitation (e.g. distribution) of creative works brought about by new
technologies due to the so-called replacement effect (Arrow, 1962): an incumbent firm with market power has a
lower willingness to innovate than an entrant does since the innovation replaces the incumbent’s existing, sunk,
assets. Consequently, the incumbent may have relatively weak incentives to innovate. Arguably, this effect may
have slowed down launch of certain new online services (see e.g. Carrier, 2012)).This may lead to a ‘dynamic’
loss from market power which copyright grants to the rightholders and in such circumstances exceptions can
promote efficient introduction of innovative services. However we also note in relation to this mechanism, that it
would be difficult in practice to design sufficiently broad exceptions so as to capture instances in which
replacement effect will threaten efficient future innovation while keeping these exceptions sufficiently narrow to
exclude those instances for innovative uses in which there is little such risk (so that the incentives for production
of creative works are preserved). This would require an unlikely level of insight into the future innovative uses of
creative works.
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respond to technological changes. The answer is evasive. It turns out that on the basis of
theoretical analysis alone one cannot conclude that technological advances which reduce
the costs of reproductions (both authorized and unauthorized) generally justify broadening
(or narrowing) the scope of exceptions. A similar ambiguous result is obtained for
technological advances which increase the demand for creative work. Nevertheless, the
analysis should help in identifying which channels favour broader and which favour
narrower exceptions as technology advances. The policy debate should then focus on an
assessment of the relative economic significance of these channels.
31.
Next, in section 3.3 we discuss how externalities in copyright markets introduce another
potential source of market failure, and how exceptions may play a role in remedying
these. By changing the allocation and production incentives for creative work, exceptions
may lead (indirectly) to an outcome which is closer to the outcome that would be obtained
if external effects could be internalised. For example, an external effect, the so called anticommons problem, leads to inefficient outcomes in the market for creative works as
inputs into new work. If this problem is acute, most likely when it is accompanied by
pervasive transaction costs in this market, exceptions might be justified.
32.
Section 4 outlines more formally some of the models used in our analysis. As there is no
comprehensive model in the existing literature we draw upon several of them, each
focusing on a particular set of issues.
33.
Landes and Posner (1989) provide a formal economic model in an attempt to rationalize
copyright as a means for efficient allocation of resources. One of the questions they ask is
how different variables affect the optimal level of copyright protection. Their analysis can
be applied to exceptions to the extent that these can be conceptualized as a weakening
of copyright protection. Specifically, Landes and Posner consider a mechanism in which
weakening of copyright protection reduces the cost of making copies, increases access to
the body of existing work, reduces potential revenues of rightholders and decreases the
cost of creating new work. They consider how the changes in the strength of copyright will
affect allocation of existing works as well as the number of creative works that are
developed.
34.
In the model of Landes and Posner, exceptions can be interpreted as indirectly
addressing certain problems associated with transaction costs (in that the exceptions
reduce the costs of creative work which they assume builds on previous works). But,
clearly, exceptions can also reduce the profit that can be obtained for any given piece of
creative work.
35.
Landes and Posner make a number of conclusions on the basis of their analysis, some of
which we consider to be unsafe. Those conclusions which we consider robust are also
intuitive: First, the extent of copyright protection should not be such as to maximize the
number of works. In terms of exceptions, this means that some exceptions which
negatively affect profits of rightholders might well be justified. Second, exceptions which
are not costly to administer and significantly reduce the costs of creative work but do not
significantly reduce the revenues of rightholders are more likely to be justified from a
social point of view.
36.
Pollock (2007) considers a framework similar to that of Landes and Posner. In his
framework a weakening of copyright protection reduces the rents accruing to the owner of
copyrights. He also assumes that the number of creative works initially increases but
then falls with the level of protection.
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37.
Pollock uses his framework to consider how the optimal level of protection changes with
technology advances. These advances are assumed to reduce the cost of making
authorized and unauthorized copies of creative works. He argues that there are two main
effects operating in opposite directions. On the one hand, as production cost falls and
more creative works are produced, the deadweight loss arising from the exercise of
market power increases (indeed, the lower the cost, the higher the deadweight loss).
This would suggest that less protection (broader exceptions) should be granted to curb
market power. However, with a lower cost of production, the welfare that accrues from
new work increases, raising the benefit of marginal work. This calls for an increase in the
level of protection (narrower exceptions). Overall, on the basis of Pollock’s theoretical
analysis alone, it cannot be determined whether or not exceptions should be broadened
as technological progress reduces the costs of reproductions.
38.
We also provide a short extension of Pollock’s model in which we consider the effect of a
technological progress which improves users’ access to creative works. An improvement
in technology effectively expands the consumption possibilities of the users (for instance,
portable music players allow for the consumption of a greater variety of music in a wider
set of circumstances). We show that effects of technological advance go in the opposite
directions again and conclude that on the basis of this analysis alone no robust
conclusions with respect to the changes in the optimal scope of exceptions in response to
technological developments are possible.
39.
Miceli and Adelstein (2006) and Yoon (2007) consider a framework in which the effect of
exceptions is to allow for low quality copies (or partial copies) of copyrighted work. 17
Consumers are heterogeneous in terms of preferences over these alternatives (with some
consumers having strong preferences for the original quality and other willing to contend
with low quality substitutes). They show that in this framework there are two potentially
positive effects from a broader exception: insofar as it does not result in insufficient profits
to justify the creation of work, it will further constrain the market power of the owner; but it
may also lead to a greater variety of goods being produced more efficiently. In essence,
the users develop their own version of the creative work, something that the original
owner cannot efficiently undertake. Overall, exceptions which allow such limited “selfproduction” of inferior copies of the original are thus often attractive in this framework. We
note that the mechanisms that justify exceptions in this framework may become less
important if technological advances allow the rightholders to offer partial copies efficiently.
40.
It is worth noting that all of the models we have analyzed assume that creative works do
not compete. When they consider the impact of copyright on the number of works, they
merely assume that each creative work will have an identical demand (but they do allow
for cost of creation to vary across the different works). This simplification represents a
significant departure from reality. Intuitively, it would appear that competition between
alternative creative works implies lower market power, which in turn reduces the need to
weaken copyright with broader exceptions in order to curb market power. This issue
should however be analyzed formally in the future.
41.
Moreover it should be noted that in a large part of the analysis in the papers we reviewed
and in much of our own analysis the point of departure is the socially optimal level of
copyright protection. This means that the theoretical predictions on the optimal changes in
17
In the context of Miceli and Adelstein’s framework “low quality” must be understood broadly. For example, a
perfect copy of a chapter of a book would qualify as a low quality copy of the original.
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the scope of exceptions are relevant insofar as the level of copyright protection (and the
scope of exceptions) was at its socially optimal level prior to the relevant technological
advances. Clearly, if this is not the case, then the extent to which the exceptions were too
broad or numerous (or too narrow and few) to start with will have to be taken into account.
The qualitative considerations identified in this report should help in this assessment as
well.
42.
We summarize the main policy implications in section 5. Overall, the following insights
emerge from our analysis:
43.
Exceptions are likely to be justified when transaction costs prevent mutually beneficial
trade. In the extreme, this a case of missing markets. Some existing exceptions, like the
citation exception, seem to be at least in part motivated by such considerations.
44.
In the view of technological advances, which allow for new modes of exploitation of
creative works, calls for new exceptions have been made. Indeed, our analysis suggests
that in certain circumstances relatively high transaction costs associated with some new
uses may justify new exceptions. Yet, before enacting these, one should investigate
whether innovative market mechanisms will appear in the foreseeable future. A marketbased solution is often more efficient socially as it allows both the authors and users to
“negotiate” transfers thus supporting efficient allocation of creative works in valuable uses
and efficient levels of creative efforts. Moreover, before enacting new exceptions it should
be considered whether transaction costs could be reduced by legislating certain
obligations, like compulsory registration of rights for certain classes of creative works.
45.
Besides enabling new modes of exploitation and use of creative work, technological
advances may also result in a reduction in transaction costs. This tends to reduce the
optimal scope for exceptions for at least two reasons. First, with lower transaction costs, it
may very well be that transactions which would otherwise not have taken place become
feasible. For instance, if the Internet allows for a more efficient matching between owners
and users, it may be not be appropriate to increase the scope of exceptions. Second,
lower transaction costs may allow for greater price discrimination by the copyright owner
and can thus reduce the inefficiencies induced by market power. However, technological
advances also enable new uses of copyrighted works, for which transaction costs may be
significant or indeed very high (relative to the value-in-use for an individual work) despite
(or precisely because of) the advances in technology. For some such uses new
exceptions may be well placed.
46.
Assuming that markets for creative works exist but that the rightholders possess market
power – which may result in a deadweight loss and which could potentially be curbed by
broader exceptions – it cannot be at present established on the basis of the economic
theory alone whether exceptions should be narrowed or broadened in response to a
reduction of the cost of making copies of creative works (brought about by technological
advances). Furthermore, it cannot be established at present on the basis of theory alone
whether exceptions should be broadened or narrowed down as a consequence of the
expansion of the consumption possibilities of creative material (again brought about by
technological advances). Nevertheless, there may be a case for exceptions in particular
when they allow for the development of product qualities that a copyright owner could not
produce herself due to transaction costs and technological constraints. Exceptions are
also more likely justified in circumstances where hold-up problem risks introducing
dynamic inefficiencies (in terms of suppressing incentives to invest).
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47.
Externalities potentially introduce a case for exceptions. In order to identify the
circumstances in which exceptions are socially desirable it is however important to ask
whether external effects arise from the ideas or information associated with a creative
work rather than the form in which these ideas are expressed. It might well be that often
the external effects are in fact associated with the ideas and information (which are not
protected by copyright) and hence do not require new exceptions. On the other hand,
exceptions may be well placed in circumstances in which copyright can be employed to
effectively prevent access to and the reuse of the (formally unprotected) information or
ideas (thus giving the rightholders market power over access to these unprotected
elements of their creative works) - in such circumstances exceptions may be the best way
to release the potential positive externalities associated with information embodied in
creative works. Significant transaction costs which hinder ex-ante negotiations for access
further strengthen the case for exceptions in the presence of positive externalities from
new uses.
48.
The implementation of certain exceptions meant to solve problems due to transaction
costs or externalities may run into difficulty when the dissemination and efficient access to
the work requires some effort on the part of the right’s owner. It is then worth asking
whether some market mechanism, or an alternative intervention cannot overcome the
problems associated with externalities.
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2.
ECONOMIC RATIONALE FOR COPYRIGHT, AND THE
CHARACTERISTICS OF MARKETS FOR CREATIVE WORKS
49.
In order to analyze exceptions from an economic perspective, it is important to first
establish the economic rationale for copyright. This is because, conceptually, exceptions
delineate the scope of copyright – and new exceptions change this scope. Since
copyright is a partial remedy for a market failure (and facilitates formation of markets for
creative works), we need to understand how changing the scope of copyright by new or
broader exceptions potentially affects the performance of copyright in its primary role.
50.
By creating exclusive rights over some uses of creative works, copyright overcomes a
fundamental problem of markets for creative works, non-excludability.
2.1.
51.
Efficient markets, market failure and the role of interventions
One of the tenets of economics is that free markets may lead to socially efficient
outcomes. Under certain conditions, the competitive equilibrium in such markets is Pareto
optimal, meaning that no individual can be made better off without making someone else
worse off. While Pareto optimality is not sufficient for social optimality, it is necessary:
Every social optimum is Pareto optimal as well. On the other hand, under certain
conditions any Pareto efficient outcome, including the socially optimal one, can be
achieved in a market exchange by enacting only lump-sum wealth transfers.18 These two
results together suggest that there is little or no scope for interventions, in perfect, wellfunctioning markets.19
52.
The sufficient conditions for markets to deliver such efficient results are restrictive and are
very unlikely to hold in reality. Frequently free markets fail, meaning that the allocation of
goods and services in a free market is not Pareto efficient. 20 This means that there exists
another conceivable outcome in which some market participant can be made better off
without making others worse off. And this, in turn, means that market outcomes can
potentially be improved upon by an intervention including a creation or modification of
rights by a legislature. Markets for creative goods, absent copyright, are indeed prone to
market failure.
2.2.
53.
Copyright addresses the public-good nature of creative works
The two features of many creative works, (partial) non-excludability and non-rivalry
(inexhaustibility) in consumption, are perhaps the most fundamental reasons for why a
18
This is a topic discussed in more detail in graduate Microeconomics textbooks. See e.g. Chapters 16 and 17 in
Andreu Mas-Colell, Michael D. Whinston, Jerry R. Green, “Microeconomic Theory”, Oxford University Press,
1995.
19
This is the topic of the two fundamental welfare theorems. For a full analysis see e.g. Mas-Colell, Andreu,
Michael D. Whinston, and Jerry R. Green (1995), Microeconomic Theory, Chapter 16. Oxford University Press.
20
The reasons given in formal treatments of the subject for why markets may fail to deliver efficient outcomes are:
non-convexities in the production set (the supply of each good is no longer effectively continuous in prices – and
this may be the source of market power), transaction costs (which lead to incomplete markets which mean that
externalities cannot be fully internalized), and limited information (which means that true demand and supply
functions are unknown - this may lead to market power and inability to determine optimal lump-sum transfers).
In this section, in the interest of exposition, we have sacrificed some precision.
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market failure for creative works is potentially so drastic. Indeed, many creative works can
be characterized as public goods.
54.
A public good is one for which consumption by one agent does not affect the supply and
value in consumption available to other agents. Examples often given are a lighthouse,
national defence, or street lighting. This feature, sometimes also termed non-depletability
or non-rivalry in consumption, is fundamental to many types of creative works. A movie
played on a large TV screen in a living room can simultaneously be consumed by several
people sitting on a sofa but it can also be streamed or broadcast to other TV sets in other
homes. Similarly, using a personal computer, a copy of a music file can be made at very
low costs and shared with another user who can play it on her portable player (and share
it further) without any (or very low) cost to others.
55.
Another feature often associated with a public good is non-excludability; it is sometimes
not possible to prevent the users who have not paid for the good to use it. 21 This is again
the case with goods like national defence and street lighting. Many forms of information
are also thought to be in principle non-excludable.22 For example, an invention, in the
absence of a patent system, could spread and be implemented in different products for
free by anyone once it has been revealed.23 While it is possible to charge a fee for
streaming a movie to a home TV-set, in practice it is not possible to exclude the owner of
that TV set from inviting a group of friends to watch a movie with her. With the advent of
technologies like photocopying and file-sharing the extent of non-excludability has only
increased: printed books, music and e-books can now be shared simultaneously by
making a copies and distributing them at relatively low costs.
56.
The problem with non-excludable and non-rival goods is that self-interested producers in
free and uncoordinated markets lack sufficient incentives to produce them. Potential
users know that once such goods are provided (or paid for) by someone they too will
benefit (either by sharing the use directly or by obtaining a “free” copy). They thus plan to
“free-ride” on others’ purchases. Indeed, absent copyright, the author could not easily
exclude others from copying, distributing, and consuming her creative works.
57.
Non-excludability can represent a problem in particular because copiers avoid creation
costs. The problem is thus potentially serious when (1) the costs of creation are high, (2)
copiers are numerous, (3) unauthorized reproductions are good substitutes for original
reproductions and (4) the costs of unauthorized reproductions are relatively low – as is
often the case with creative works. In such circumstances, the price for reproductions will
be driven down towards marginal costs of unauthorized reproductions, and this is
insufficient for the author to recover his costs of creation. In this case, the original work
will not be produced in the first place, at a cost to society.
58.
Overall, copyright - by granting an exclusive right for certain uses of the original work to
the author for only a limited period of time - partly overcomes the problem of free-riding.
To the extent copyright is enforceable, it eliminates unauthorized access to creative works
21
Note that transaction costs are necessary for non-excludability
22
Patent systems and copyrights of course in part solve non-excludability. Note that the problem could also be
alleviated with well-defined liability rules rather than property rules such as copyright.
23
Rather generally, in order to assess the value of information, which is an important variable in transactions, it
has to be communicated. Once communicated the potential buyer has obtained the information for free. Patents
and copyright prevent certain uses of information obtained in this (or otherwise unauthorized) way.
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and thus provides appropriate incentives for creation. Absent free-riding, the market
failure is arguably less likely to be drastic. 24
2.3.
Copyright, and the “copy-privilege” scenario
59.
We have just summarized how copyright overcomes non-excludability, provides
incentives for investment in creative work, and how it promotes formation of markets.
Arguably however, in a world devoid of copyright, markets would form as well. Thus, it is
not the case that copyright in itself is strictly necessary for markets to form, although,
clearly, the markets would be organized differently in its absence. The question then
becomes whether similarly efficient outcomes would ensue in a world without copyright.
60.
Answering this hypothetical question is useful for the understanding of the economic
rationale for copyright; when (and why) is copyright the best mechanism available to solve
failures in the markets for creative work? And answering this question is also helpful in
the assessment of exceptions; when are exceptions a better solution than a blanket
prohibition of copying? As mentioned above, exceptions can be thought of as a
weakening of copyright (over certain uses) and in the extreme (and purely hypothetical
scenario) as a removal of copyright. As we explain below, in the complete absence of
copyright markets are likely to organize themselves differently and possibly less
efficiently, or may not form at all. Therefore in general, new or broader exceptions might
modify the market structure and this may result in social costs.
61.
In order to better appreciate the role of copyright in the markets for creative works, we
now briefly consider a counter-factual world in which no copyright protection exists. In this
case the technology for user-copying remains, but the legal barriers have been removed.
In this case, the copyright (literally the right-to-copy) has been implicitly assigned to the
users rather than the producer of a work.25 Gordon (1989, p.1400) labels this hypothetical
world that of “copy-privilege”.
62.
Having assigned the copy-privilege of works to users (entitlements have clearly been
assigned), the Coase theorem (Box 1) demonstrates that an efficient outcome is
achievable through bi-lateral negotiations with producers irrespectively of the initial
allocation of entitlements.26 In principle, the Coase theorem applies to creative works as
well. To explore this, in her treatment of copy-privilege, Gordon (1989) outlines various
options as alternatives to copyright that authors could in principle pursue to ensure a
profit from their works. These revolve around contractual solutions, by which authors
could stipulate do-not-copy restrictions as a condition of access to their work. However,
24
In theory, markets can be constructed so as to deliver non-rival goods efficiently, provided that consumers can
be excluded. This is a topic of the so-called Lindahl equilibrium (Lindahl, Erik (1958) [1919], "Just taxation—A
positive solution", in Musgrave, R. A.; Peacock, A. T., Classics in the Theory of Public Finance, London:
Macmillan). In a market mechanism which results in efficient outcomes each consumer faces personalized
prices and chooses among different bundles of public good. The theoretical requirements for such a mechanism
to result in an efficient outcome are very restrictive (marginal valuation of the good by each consumer must be
known and the consumers must act as price takers) and it is unlikely that it can be implemented in practice.
Note that perfect price discrimination has very similar requirements and will result in a similar outcome.
25
More accurately, we have awarded the right-to-copy to the users, and removed the right-of-excluding copying
from the producers. In both the real and counter-factual worlds the producer has the right to make copies.
However, only in the real world does he have the right to prevent others from doing so.
26
We note again that the Coase theorem is silent on the fairness or social desirability of the resulting outcome,
stating only that production will be socially efficient.
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such a solution critically depends upon an author maintaining physical control over
access to their works. Given the hypothetical copy privileges, any user that managed to
access the work outside of a contract (e.g. borrowing the work etc.) would be entitled to
make a copy. One contractual solution to this issue could be for an author to identify and
contract with every potential copier – evidently a costly, if not impossible, task. Another
might be for an author to exercise their right to withhold their work until a sufficiently large
offer for purchase is made. It might be envisaged that the aspiring users of the work could
club together to make such an offer – but again, a substantial coordination problem
remains.27 Some other alternatives for funding, though limited, are possible. In this
context it is interesting to observe that prior to the concept of copyright many works of
authorship were funded (and sometimes still are) by patronage where patrons or groups
of patrons would fund the production of artistic works, scholarly works etc. Nowadays too,
different funding sources are available in addition to patronage, like teaching jobs, grants
or stipends etc.28
63.
Returning to the world of author-assigned copyrights, the copyright in question (this time,
the right to prevent copying) has been assigned (to the authors); thus again a Coasian
bargain can be struck. This time, however, it is those users that wish to copy a work
(reuse it) who must seek a contract with its author. All other ‘normal’ users can simply
purchase the work (that is, purchase an authorized reproduction of the original) with the
statutory do-not-copy restriction. Compared to the universal contracting required in the
copy-privilege world, this potentially represents a substantial saving on transaction costs.
Firstly, it is only those users that wish to further copy (reuse the original work) who must
negotiate bespoke contracts. The statutory copyright provides what is in effect a standard
‘off-the-shelf’ contract for ordinary users, allowing for convenient wide-dissemination of
the work.29 Secondly, for those users that do require bespoke contracts, there are just a
small number of well-defined rights-holders that must be addressed. This proffers an
advantage over the copy-privilege case in terms of both search and bargaining costs.30
64.
Transaction costs are clearly present in both the copyright (ex-post, after the work has
been created) and copy-privilege (ex-ante, in order to secure the incentives for provision
of the work) scenarios. The core difference between these approaches is which party the
27
We note that technical protection measures are another way of excluding unauthorized copying by third parties,
suggesting that the author may not have to contract with all potential users in advance of creation. However,
such measures are frequently circumvented – unless this is prevented by law.
28
Kickstarter (www.kickstarter.com) is an example of “micropatronage” where individuals can pledge money to
support a creative project. To date 4.7 million people have pledged over $700 million, funding more than 48.000
creative projects.
29
Gordon (1989, p.1417) states: “…it is plausible to suggest that copyright does no more than provide a substitute
for the contractual conditions that the author would normally impose, and that users would normally accept, as a
condition of allowing access to the work.”
30
We recognise that the number of producers involved in the contracting process can change depending upon the
use and industry in question, and that the number involved can become non-negligible. Furthermore, it has been
argued by industry stakeholders that a key issue for rights clearance is that the relevant rights holders are not
always well-defined. This notwithstanding, there often remains a clear advantage over the hypothetical
alternative being considered, in which every producer must address every potential user before the work is
released.
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‘rights of copying’ are automatically assigned to. 31 Either way, a Coasian world of welldefined rights and minimal transaction costs will ensure that a socially optimal outcome is
reached. However, as we have seen, the cost of transactions in the copy-privilege world
can reasonably be assumed to be (with some important exceptions) substantially greater
than those in the copyright world. Moreover, the requirement of near-universal contracting
under copy-privilege will likely render these transaction costs prohibitively large, thus
preventing socially beneficial production and trade. Copyright in itself can therefore be
said to enable some trades that might otherwise never take place. 32
65.
Gordon & Bone (1999, p192) summarise:
“Thus, the economic case for copyright is not confined to overcoming nonexcludability and stimulating creativity. Copyright also can encourage efficient
exploitation of information assets. It does this by fashioning property rights that
minimize transaction costs and facilitate market transactions that transfer
information assets to their highest valued uses.
Box 1: The Coase theorem
In a 1960 essay, “The Problem of Social Cost”, Coase argued that, from an economic
perspective, the goal of the legal system should be to establish a structure of rights such
that economic efficiency is attained. Coase considered bargaining over an externality
from a productive activity in an example of crop damage caused by straying cattle. He
explained that negotiations among the affected parties, the rancher and the farmer, would
result in an efficient and invariant outcome as long as (1) transaction costs are zero and
(2) the rights are well-defined. In the example of a negative externality discussed by
Coase, it is necessary to know whether or not the emitter of externality is liable for the
damage caused, since otherwise negotiations will not occur. But once the entitlements
are clearly delimited, the result which maximizes the (joint) value of production, is
independent of the allocation of these entitlements (it is irrelevant whether the cattle
rancher is liable for the damage or not), as long as negotiations are costless.
As a simple example, consider a situation in which the farmer or a rancher must decide
whether to build a fence in order to restrict the damage caused by cattle. Assume that the
cost of building a fence is lower than the value of the damage caused by straying cows
and that this is the least costly solution; in this case the fence will be built. If the rancher is
liable for the damage that his cows cause to the farmer, he will pay for the fence. If the
rancher is not liable for the damage, the farmer will pay for it. Whereas the distribution of
wealth is different in these two cases (in the first case it is the rancher who pays for the
31
By ‘rights of copying’ we simultaneously refer to the ‘right-to-copy’ in the case of a user, and the ‘right-toprevent-copying’ in the case of a producer.
32
Nevertheless, it is important to keep in mind that Gordon and Bone’s conclusion may not be warranted in some
specific circumstances. When a single user or a small number of users need to access a large body of copyright
content, the rights for which are highly fragmented among many rightholders, copy-privilege may be the more
efficient allocation of rights. We address these circumstances in the next section. In a nutshell, this is more likely
to be the case when 1) the value-in-use of an individual item of copyright content contributes little to the valuein-use relative to transaction costs (and as a result, in the extreme, transactions may not take place); 2)
unauthorized use does not significantly affect the incentives of the authors to produce creative work (which
means that the use would not significantly harm creative output) and 3) when the rightholders can use
technological means to effectively exclude the users from accessing their copyright content, should they want to
do so (which additionally reduces the risk that unauthorized use would harm the incentives for creative work).
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fence and in the second it is the farmer), a fence is built whenever it is efficient to do so.
Indeed, the theorem is valid rather generally, as long as transaction costs are interpreted
broadly so as to include, e.g. limited information.
However, when transaction costs are significant, the allocation of entitlements matters for
efficiency. Then the entitlements should be assigned so that the owners of rights take
economically efficient actions.
For example, imagine that there is a single rancher whose cattle may stray on numerous
plots of crop owned by different owners who are hard to identify (as they live in different
distant towns) and do not talk to each other. Say that it is cheaper to enclose the cattle
than to enclose all the potentially affected plots and assume that the expected damage to
all the farmers is larger than the costs of building a fence to enclose the cattle. In this
case the fence to enclose the cattle, rather than the crops should be built.
In the first scenario, the rancher is not liable for the damage. Each of the plot owners
could approach the rancher and offer to pay for the fence. However, each farmer knows
that if someone else pays for the fence, he will benefit too – and so prefers to wait for
someone else to pay. The fence will never be built. Alternatively, if we assume that it is
cheaper to build a fence around an individual crop plot than it is to enclose the cattle and
the expected damage to each individual farmer is larger than this cost, then each of the
farmers, absent coordination, will build his own fence. But in total this will cost more than
the fence to enclose the cattle. Neither of the two outcomes is efficient.
In the second scenario, the rancher is liable for the damage. He will pay for and build the
fence in order to save on the expected costs for which he is potentially liable. This is the
efficient outcome.
Here it is more efficient to hold the rancher liable for the damage, as this will induce him
to build the fence to enclose his cattle. The fence is a public good in this example and
there is a free-rider problem among the farmers when the rancher has the entitlement.
Transaction costs prevent coordinated action on the side of the farmers which is needed
in order to overcome the free-rider problem. Note that, if transaction costs were small
(zero), the farmers could jointly agree on each contributing towards the costs of building
the fence to enclose the cattle and again the allocation of entitlements would not matter.
Source: CRA, Coase, Ronald H. (1960). "The Problem of Social Cost". Journal of Law and Economics 3 (1): 1–
44. and Medema, S. G. and Zerbe, R. O, “The Coase Theorem”, in Bouckaert, Boudewijn and De Geest, Gerrit
(eds.), Encyclopedia of Law and Economics, Volume I. The History and Methodology of Law and Economics ,
Cheltenham, Edward Elgar, 2000, 0730 p. ISBN 1 85898 984 1, available online at
http://encyclo.findlaw.com/tablebib.html
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3.
EXCEPTIONS AS REMEDY FOR MARKET FAILURES IN THE
MARKETS FOR CREATIVE WORKS
66.
In the above section we have explained how copyright can be viewed as a partial remedy
for a market failure, how it can facilitate the formation of markets for creative works and
why there may be little or no scope for welfare enhancing exceptions under perfectly
functioning markets. We now highlight that copyright does not correct for all market
failures and introduces new ones. In this section we analyze exceptions as a possible
remedy for the various forms of market failures that remain or are a result of copyright.
67.
Firstly, we address the issue of transaction costs in section 3.1, which are a fundamental
reason for markets not to function efficiently. In the previous section we highlighted that
whilst copyright may minimise the transaction costs associated with inefficient outcomes,
it does not remove all such costs. Indeed, copyright itself indirectly imposes additional
transaction costs upon certain users that would face no such costs under a copy-privilege
regime.
68.
If transaction costs for a use are substantial, the gains from trading may be eroded to the
point that transactions required for the use do not occur. In these circumstances,
exceptions may be viewed as a mechanism to enable uses of works which would
otherwise be inhibited. In such circumstances, it might be argued that the exceptions are
‘benign’, as they do not affect the revenues of the copyright owner – absent the
exceptions no transaction would take place anyway. More generally, it may be that for
certain uses the social gains from reducing transaction costs with exceptions outweigh
the potential adverse effects of reduced incentives to produce new works.
69.
Moreover, transaction cost may give rise to a hold-up problem. This refers to an increase
in bargaining power of the rightholders after a potential user has irreversibly invested in a
new use (service) that relies on access to existing copyrighted work. The problem may
arise, for example, due to search cost (a category of transaction costs). These cost
incurred by the potential user in identifying the rightholders are sunk by the time when
negotiations for access to copyrighted work begin. As we explain in section 3.1, this may
lead to dynamic inefficiencies.
70.
Secondly, we address the issue of the market power enjoyed by authors as a result of
copyright in section 3.2. We have already discussed how copyright corrects the problem
of non-excludability by granting exclusive rights over certain uses of creative work to the
author. However, while correcting the non-excludability, copyright creates market power
as it protects the rightholder from competition by copyists. But market power leads to
socially inefficient outcomes when perfect price discrimination is not feasible -- firms with
market power will produce less than socially efficient quantities. In the markets for
creative works this will be reflected in sub-optimal number of copies of a given work in
circulation.
71.
By limiting the scope of protection granted by copyright and, in turn, by constraining the
market power that the rightholder can exercise, exceptions may prevent some
undesirable consequences associated with the copyright system. Indeed, exceptions may
result in lower prices and broader access to creative work. At the same time, they also
affect (positively or negatively) the incentive to produce creative work. Exceptions thus
might or might not reduce the inefficiency associated with market power and our analysis
addresses some of the trade-offs involved. Here, we also address the question of efficient
allocation of reproductions between the rightholder and potential copyists.
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72.
3.1.
Finally, in section 3.3 we discuss externalities in copyright markets as another potential
source of market failure. Exceptions may play a role here as well. By changing the
allocation and production incentives for creative work, exceptions may lead (indirectly) to
an outcome which is closer to the outcome that would be obtained if external effects could
be internalised. For example, an external effect, the so called anti-commons problem,
leads to inefficient outcomes in the market for creative works as inputs into new work. If
this problem is acute and in particular if it is accompanied by pervasive transaction costs
in this market, exceptions might be justified.
Transaction costs
73.
Regardless of whether or not producers assert monopoly power, markets can fail due to
the nature of the exchange being undertaken. In this section we discuss the market failure
that arises simply due to the costs of making a transaction, and how copyright exceptions
may be used to mitigate this issue.
74.
We begin with a broad definition of transaction costs and discuss how they apply to the
market for creative works. Next, we discuss a number of cases in which exceptions may
be used to overcome those transaction costs that arise as a result of copyright. Finally,
we examine how technological changes (in particular the assent of the online
environment) might change the nature of these transaction costs and the need for
associated protections and/or exceptions.
3.1.1. Taxonomy of transaction costs
75.
The notion of ‘transaction costs’ encompasses a variety of overheads related to striking a
deal and completing a trade. Coase (1960) and Dahlman (1979) identify the following four
categories of (broadly chronological) transaction costs:
1. Search costs – as the parties to a transaction seek each other out (these costs
are sunk by the time negotiations start);
2. Bargaining costs – as the parties negotiate a mutually beneficial trade;
3. Monitoring costs – as the parties ensure their terms of trade are adhered to; and
4. Enforcement costs – if the terms are breached and legal action ensues.
76.
It is important that we make clear the distinction between the costs of conducting a
transaction and the price of the product being traded. If excessive transaction costs
prevent socially valuable trade from taking place, it might be considered a market failure
and an intervention may be appropriate. However, if a transaction does not take place
simply because the parties cannot agree a price, this represents a valid outcome of a
well-functioning market process; there has not been any market failure and an
intervention would be inappropriate.
3.1.2. Exceptions to mitigate the effects of transaction costs under copyright
77.
In section 2.3 we argued that it can be held that a copyright regime in many
circumstances offers lower transaction costs overall than one of copy-privilege, thus
delivering greater scope for trade while providing incentives for creation of new work.
78.
However, it was also recognised that copyright introduces its own set of transaction costs.
These arise as certain users must engage rightholders in bi-lateral licencing deals. For
some non-standard uses of a work, obtaining licenses is likely to involve significant
transaction costs that would be avoided under a copy-privilege regime (provided, of
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course, that in this regime the incentives to provide the work are sufficient in the first
place). In this section, we thus consider the effects of transaction costs for some nonstandard uses that are induced by copyright and analyze the use of exceptions as a
means to mitigate them.
79.
As with any market friction, transaction costs have an unambiguously negative impact on
the affected trade. As noted in Section 1.3, there are various possible uses for creative
works and this negative effect of transaction costs manifests itself differently for each of
them. In the case of works as an input to the creative process, transaction costs represent
a ‘tax’ that reduces the rate of production. Moreover, in the extreme, these transaction
costs can prohibit mutually beneficial trades, resulting in missed opportunities for a social
gain. We discuss these issues further below.
Preventing copyright from ‘chilling’ future creativity and innovative services
80.
As discussed in section 1.3, producers of new works will frequently draw upon a range of
existing work as part of their creative process. Such uses might include, for example, the
use of quotations in a written work, musical phrases in a new score, or audio-visual
snippets in a new production. Moreover, certain creations such as review or parody works
rely heavily upon the use of existing material. Providers of innovative services rely on
access to copyright content as well and arguably similarly engage in transformative use of
previous creative work. Under a strict copyright regime, the producer of the new work (or
a provider of new services) is obliged to clear the rights of each of their inputs
separately.33 Gordon & Bone (1999, §4.2) discuss “Chilling Future Creativity” as one of
the costs of implementing a copyright system. They highlight the cumulative nature of
creative works, and the upward pressure that copyright inflicts upon input prices.
81.
Importantly, we are not concerned here with the price that must be paid for the input.
Rather, we are concerned with the costs to the agents of actually undertaking the
required transactions. While in many circumstances resolving non-excludability more
efficiently than alternative allocation of entitlements, as discussed above, the copyright
system does not remove all transaction costs in the process of creation and distribution.
For some products and some uses the transaction costs induced by copyright can indeed
be very high. This results in a dead-weight loss to society. The loss, which in part might
be avoided under an alternative allocation of rights for certain uses, represents a failure of
the market.
82.
In terms of transaction costs, we primarily consider the substantial search and bargaining
costs that would be incurred for a new work that draws on a variety of sources. Even if
rights clearance is ultimately unnecessary, due for example to the expiry of the copyright
period or untraceable rights-holders, it is still the case that the producer must undertake a
diligent and costly search process. It stands to reason that such costly frictions will
dampen the process of creation of new work.
83.
What is more, users could face the additional cost of uncertainty around what exactly
constitutes a legitimate use of an existing work. Uncertainty represents an important
33
We discuss the possibility of collective management as a market-mechanism designed to help overcome some
of these costs in the following subsection.
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determinant of transaction costs, in particular when the use involves a certain degree of
relationship-specific investments (Williamson, 1979). 34
84.
In relation to uncertainty, Depoorter (2009, pp.1859-60) also discusses the “chilling effect
on creativity and authorship” that ‘over-compliance’ by risk-adverse producers can have.
In the situation he describes, under-informed producers avoid making legitimate use of
existing works for fear of copyright infringement. However, on the assumption that these
legitimate uses are in fact socially desirable (thus encouraged by law) this result is
socially sub-optimal. Indeed, uncertainty around what exactly constitutes a legitimate use
is often present for a number of reasons: for example, due to the dichotomy between the
idea and expression (where exactly would the courts draw the line between the idea and
the expression), because the legal framework (the scope of copyright) has not yet been
established through case-law (as may be the case with some new uses and services) and
because the legal framework may differ across different countries.
85.
Transaction costs, in particular search costs, may lead, in certain circumstances, to the
so-called hold-up problem. It characterises a situation in which part of the return on a
relationship-specific investment by one of the parties can be expropriated by another
party in trade. An example of such an investment in the context of our analysis is the cost
that a potential (commercial) user of copyright content incurs in identifying the
rightholder(s).35 These search cost are sunk (not recoverable) by the time the parties
begin negotiations on the terms for access to copyright content and are naturally not
taken into account in negotiations on the terms of license – bygones are bygones.
Box 2: Hold-up
86.
It is easiest to explain the mechanism of the hold-up with a simple illustration. Assume
that a commercial user, for example a potential provider of an innovative service, needs
to access a single item of copyright content in order to provide the service. Say that that
the potential service provider can extract a total revenue of 10 Euro from the final
consumers, if access is granted. However, it costs the potential service provider 3 Euro to
locate the rightholder (search costs). At the time negotiations have started, the service
provider will have thus sunk 3 Euro in search costs.
87.
What is the maximal fee that the service provider would pay for access to the copyright
content? He would pay up to 10 Euro for the right. This is easy to see. Say that the
rightholder makes a take-it-or-leave-it offer of 9 Euro. If the service provider accepts it, he
will realize a loss of 2 Euro (Revenues - Cost = 10 – 9 – 3 = - 2 ). However if he rejects it,
he realizes a loss of 3 Euro (since he has already sunk 3 Euro in search costs). A similar
argument can be made for any offer below 10 Euro. Thus, in the extreme, the rightholder
can extract the full value of its contribution to the service, ignoring the part of the costs
that has been sunk by the time negotiations begin.
88.
Knowing this, the service provider will not incur the search costs in the first place and may
34
According to e.g. Williamson, relationship-specific investments are non-redeployable physical and human
investments that are specialized and unique to a task. In other words, these are investments specific to a
particular transaction in the sense that they have a higher value to that transaction than they would have if they
were employed in other uses.
35
For a hold-up problem related to search costs see Varian (2006). For a theory of hold-up in the context of
patents see e.g. Shapiro (2010) and Shapiro and Lemley (2007). Langus et al. (2013) discusses hold-up in the
context of standard essential patents taking account of the relevant legal framework.
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forego the provision of the new service.
89.
If the rightholder could provide the new service himself (or, more generally, could
negotiate with the provider before he sank costs) the hold-up problem would disappear.
However, it is not hard to imagine a situation in which the value of the rights, individually,
is too low to justify this. As a result the rightholders might not have incentives to provide
the new services individually. At the same time, due to the problems associated with
coordination, they may not have the incentives to provide the new service collectively.
90.
While this example is admittedly extreme, it illustrates an important point: that search
costs (and transaction costs more generally) may lead to dynamic inefficiencies in terms
of depressed investment incentives.
91.
In the extreme scenario, when the rightholders possess a significant bargaining power
and the search costs are very high relative to the value of the content in the hands of an
individual rightholder, the potential user might be left with a net loss after accounting for
the sunk cost. In less extreme cases, search costs will result in a lesser degree of holdup. In general, hold up can cause a reduction in returns on investments and may thus
suppress the innovation incentives below socially optimal levels. 36 Therefore, the risk of
hold-up may reinforce the case for exceptions.
92.
In summary, the welfare-conscious policy maker faces a further trade-off when
considering copyright protection. In contrast to the access vs. production trade-off, here
the balance must be struck between promoting original creative work and promoting the
transformative use of such work.37
Preventing transaction costs from inhibiting mutually beneficial trade
93.
In a more direct sense, excessive transaction costs will necessarily inhibit trade anytime
they exceed the total expected gains of that trade. Where this is the case, neither party
has an incentive to undertake what could be (in a frictionless world) a beneficial
transaction.
94.
In this section we discuss this issue in the context of two ‘non-typical’ uses of a work
under copyright.38 First, we consider the case of low potential profits flowing to the
rightholder from the private copying of a work (e.g. for time-shift or self-study purposes).
Second, we consider the transaction costs faced by distributors, who must acquire the
necessary licences to make commercial use of the copyrighted works. In both cases, we
highlight certain market mechanisms that have developed in order to help mitigate these
costs, and discuss the appropriateness of policy interventions in light of the new
mechanisms. Third, we consider certain uses which cannot be characterized neither as
private nor redistributive use. Finally, at the end of the section we include a brief comment
36
A somewhat related problem in the context of patents is discussed in Shapiro (2010), who shows that even
when transaction costs are zero, and negotiations take place ex-ante, uncertainty with respect to outcomes of
legal actions may lead to a degree of hold-up.
37
This trade-off is captured (and plays a crucial role) in the models of Landes & Posner (1989) and Pollock (2007),
discussed in sections A.1 and A.2 of the appendix respectively.
38
As explained earlier, we take ‘typical’ use to be the private purchase and consumption of a work in its full
original form, as generally allowed for by the standard contract of copyright.
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on the relevance of a ‘zero-transaction cost’ world as a benchmark for an optimal
outcome, given that transaction costs are a reality of all commercial environments.
Transaction costs in private use
95.
Under a copyright regime, ‘standard’ use is limited to the simple private consumption of a
work. Any user wishing to make copies of a work, even for limited private purposes, falls
outside of the ‘off-the-shelf’ terms offered by copyright. Under a strict regime, such users
would be required to contract with the producer of the work in order to make their copy.
96.
However, for some beneficial uses (such as private study of journal articles, home videorecording to time-shift scheduled programming, or copying digital music to portable
devices) the imposition of transaction costs could present an insurmountable barrier to
trade. Although the aggregate benefit to society of such uses may be significant, the gain
to each individual user may be insufficient to outweigh the cost of the required
transaction. Furthermore, given the relatively low valuation by the users of some such
copying, the expected value of trade for the producer may also prove insufficient to
warrant providing a market. In such circumstances, with transaction costs exceeding the
gains from trade and the producer unwilling to provide a market, an exception may be an
appropriate way to enable the otherwise inhibited use. Since prohibiting copying for a lowvalue use does not result in returns to the producer, social benefit is lost without any of
the corresponding gains to the producer. If the use in question can be isolated, so as to
avoid spill-over into other, higher-value uses, then the exception for such a use could
represent a Pareto improvement. 39
97.
Moreover, although separate contracting processes for low-value uses may be infeasible,
producers might consider a strategy of indirect appropriation – e.g. offering the original
work at a higher price on the understanding that a limited amount of copying is expected.
Indeed, there is evidence that such strategies have been employed. Liebowitz (1985)
describes the practice of journal publishers, licencing their collections to libraries at higher
prices than they do to individuals with the understanding that patrons may make copies
for personal use. More generally, different sharing schemes whereby multiple users share
a given copy of a work may increase the profits of the rightholders by allowing them to
charge higher prices for the originals. 40
98.
In principle, if the rightholders can indirectly appropriate (at least some of) their rents
through original sales, both consumers and producers can gain from an exception.
Consumers benefit from the right to make private copies, for example by being able to
listen to their music both in their home and on their portable device. Since the consumers
enjoy a larger benefit, they have a greater willingness-to-pay for the original copy. In turn,
producers can appropriate at least some portion of this benefit through higher prices for
the originals.
99.
Considering briefly a contractual world, it seems likely that the producer would prefer to
undertake a single transaction at a higher price and permit private copying, rather than
incur separate transaction costs in bargaining over each instance of such copying. That
is to say, since both consumers and producers gain in these circumstances, a mutual
consent can be expected. It may therefore be deemed unnecessary to require the actual
39
On the other hand, technology may reduce transaction costs and allow for online licensing of certain such uses
in the future, as discussed later in this report.
40
For a discussion and a simple economic model on this topic see Varian (2000).
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transaction and associated transaction costs, which will, at best, erode and, at worst,
eradicate this benefit.
100.
However, an exception is not necessarily needed in order to overcome the need for
separate transactions when the users want to create private copies. Indeed, a limited
private copying can be permitted explicitly in the form of a “terms of use” agreement.
Indeed, a number of online providers of copyright content already explicitly allow for a
limited number of copies to be made for private use. These providers can enforce the
limitations through the use of technological protection measures. One example is Amazon
e-books. Amazon specifies in its terms of use a number of devices, on which e-books
purchased on Amazon can be simultaneously accessed.
101.
It could therefore be argued that the advent of new “private” uses of copyrighted works
could justify broader exceptions being implemented, in order to release these mutually
beneficial gains. However, before concluding so, it should be considered whether a
suitable alternative solution for the excepted use is likely to develop within a reasonable
timeframe. For example, the rightholders may recognize the value of format-shifting and
themselves grant permissions for such use (or even facilitate it) obviating the need for an
exception. The recent ‘Ultra Violet’ initiative 41 by some key industry players could indeed
be seen as recognition by the AV industry that copying for time and/or device portability
adds value to the consumer. Moreover, one could imagine a world in which the
rightholder is able to offer a ‘menu of contracts’, supported by emergent technical
protection measures. The private user could then simply select a contract with the
allowable level of copying suitable to their needs. This too remedies what was potentially
a market failure, obviating the need for an exception. 42 More generally, the advent of new
technologies has facilitated previously unviable market solutions.43
Distribution of creative works
102.
A second group of users of creative work, vulnerable to high transaction costs, are
distributors. Recent advances in technology, particularly in digital downloading and
streaming, have fundamentally altered the way in which copyright content can be
distributed. A plethora of new services have arisen with innovative business models
designed to exploit these new technologies, such as iTunes and Spotify for music; Netflix
for TV and film; and Kindle for books.44 These services are generally characterised by
41
UltraViolet (UV) is a digital rights authentication and cloud-based licensing system that allows users of digital
home entertainment content to stream and download purchased content to multiple platforms and devices.
42
The AV industry in particular had responded and continues to respond to the demand for portability first through
offering of digital copies and e-copies with DVDs and Blu-ray Discs, through platforms such as iTunes and
Amazon and now through new and innovative online offerings, such as Tesco’s Blinkbox and UltraViolet, which
allow access to private copies through the cloud as well as multiple copies downloaded to devices.
43
It is important to note that this presumes that the entitlements are clearly defined and legal uncertainty is
sufficiently low – only then can we presume that efficient Coasian bargains will be struck. As discussed earlier,
with legal uncertainty or unclear entitlements a holdup problem might reduce the incentives to provide innovative
services. In addition, in some circumstances it may still be that the structure of transaction costs and the nature
of new services imply that copyright is not the most efficient solution.
44
These services are named as prominent examples within their fields. An extensive array of similar services
covering a variety of specialties and platforms could be listed. However, an exhaustive catalogue of such
services is beyond the scope of this report.
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extensive catalogues of works, being offered in various geographical locations. Therefore,
with copyrights assigned to the producers there are, in principle, a large number of
separate parties with whom the service providers must contract, implying significant
transaction cost.
103.
Considering Dahlman’s transaction cost categories, it is easy to conceive that these
include: search, as distributors identify the relevant rights holders for the works they wish
to offer; bargaining, as the parties determine mutually beneficial terms of trade in the face
of uncertainty around demand for the new service; and monitoring and enforcement, as
the producers ensure their contractual terms are adhered to. These costs are further
exacerbated in those cases where a single work requires multiple rights clearances
(typical of Anglo-American music, for example). Indeed, many industry stakeholders have
highlighted issues around transaction costs in such circumstances.
104.
In the case of further distribution of creative works, however, the gains from trade are
often sufficiently large that a number of market solutions have already been developed to
help alleviate the transaction costs issue. One way in which transaction costs are
alleviated is by putting all the rights in the hands of the producer (e.g. film producer) or
publisher, either by contract or by law (e.g. presumptions of transfer or application of a
“works made for hire” approach). Moreover, by consolidating the management of all
relevant rights under a small number of collecting societies, the search costs involved for
distributors can potentially be greatly reduced. Nevertheless, in reality the rights remain
fragmented and transaction costs appear to persist, particularly in licensing for panEuropean online exploitation. Therefore, the music industry has recently launched a new
initiative, the Global Repertoire Database, which aims “to provide, for the first time, a
single, comprehensive and authoritative representation of the global ownership and
control of musical works.”45
105.
It is indeed important to consider the scope for industry solutions to address the failure
observed in the future, including the possibility that a viable market solution could arise in
the foreseeable future given the prevalent technological and business trends;
developments which could be stalled by the premature introduction of further exceptions.
As previously noted, a failure to agree on terms of trade is a valid outcome of a proper
market process. A market fails in this sense only if it is the cost of the process itself that
prevents the transaction and if this problem persists in the future. 46
106.
In sum, as in the case of exceptions aimed at legitimizing certain new modes of ‘private’
use, exceptions aimed at enabling new modes of distribution should only be introduced
after a careful consideration of the alternatives which would allow market-mediated
45
Quotation from http://www.globalrepertoiredatabase.com/, “Welcome”, accessed 13 June 2013.
46
Merges (1997, p.131) notes that in the case of American Geophysical Union vs. Texaco, Inc., the US Second
Circuit appeals court pointed to an existence of a copyright clearinghouse as evidence that the market had not
failed. 1. Moreover, with this in mind, there is evidence that for certain historic technologies a compromise
solution was found. One such example is with respect to the retransmission of television broadcasting on cable
and satellite networks. In the case of live broadcast, it would be prohibitively difficult for the operators of these
networks to ensure thorough rights clearance ahead of transmission. However, there is a clear benefit to both
the producer (wishing for wide dissemination at a fair price) and the consumer (wishing for a complete
programme schedule) for this re-transmission to occur uninterrupted. It is therefore laid out in the ‘Satellite and
Cable Directive’ that collective rights management is to be mandated for satellite and cable retransmission
rights. This ensures that the rights holders are duly compensated, whilst preventing transaction costs from
presenting a barrier to trade.
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transactions to take place at lower costs. Possible alternatives might include registration
of rights in comprehensive databases; consolidation and aggregation of rights in a small
number of different licensing vehicles such as collecting societies (provided that these
can be managed efficiently); and the harmonization of copyright regimes across different
member states. Such market mechanisms supported by clear allocation of rights may
result in efficient allocations of resources. Only if such solutions are found not to be
sufficient to remove the market failure, might further exceptions be justified.
Other uses of copyright content
107.
Some uses of copyright content cannot be characterized as “private” or as “distribution”,
and may be vulnerable to high transaction costs and hold-up. One such example might be
an internet search service, insofar as its use of copyright content falls within the scope of
copyright. In broad terms, a search engine processes (parses) and indexes web pages
(and documents on the web) and upon a search query returns information in the form of a
list of links ordered in terms of relevance. The results include, to a different extent, parts
of the “expression” (relevant excerpts from the text, thumbnails) and may include some
information embodied in the relevant copyright content. Search engines can thus arguably
claim transformative value as they incorporate a collection of original works into a new
service (work). The reference tool that they provide is typically used in a different way
than the original work.
Box 3: A note on the use of a ‘frictionless’ baseline for comparison
We briefly consider here the appropriateness of taking a ‘frictionless’ outcome as the
baseline for comparison when discussing the treatment of transaction costs under
copyright.
Dahlman (1979, p.152) questions the rational for this when he states “it is far from
obvious that the point of reference for the misallocation effects of externalities and other
distortions ought to be … the Pareto optimum … with zero transaction costs”.
Notwithstanding the fact that reducing transaction costs is necessarily beneficial (in the
same way as reducing any production cost), Dahlman notes that transaction costs are a
reality of all economies. He points to the logical fallacy of taking an unattainable world as
a point of reference, recommending instead that a ‘transaction-cost-constrained’ optimal
be considered. Therefore, rather than deeming a market to have failed if transaction costs
distort an otherwise optimal outcome, Dahlman’s approach would determine the optimal
outcomes in the presence of those transaction costs. Such a view militates against policy
interventions to facilitate trade: transaction costs are a natural part of the free market and
the parties should factor them in accordingly.
However, we consider the applicability of this view in the case of transaction costs under
copyright. Some transaction costs arise due to the imposition of the copyright regime and
would not be present in the copy-privilege regime. In this sense, the use of exceptions
may be considered a fine-tuning of the primary policy intervention (that being copyright) in
order to prevent certain distortive effects of copyright-induced transaction costs whilst
retaining the main policy objectives.
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3.1.3. Technological advances may reduce transaction costs
108.
In his paper, Merges (1997, p.130) discusses the central role that market failure and, in
particular, transaction costs, play as a justification for fair use exceptions. 47 Absent a
drastic market failure, Merges claims that the fair use defence becomes untenable from a
legal and economic perspective. He supports this with two examples from US case law in
which fair use defences were denied. 48 In both cases it was held that since a suitable
mechanism for purchasing the required rights existed, the market had not failed and thus
a fair use defence was inappropriate.
109.
Furthermore, taking transaction costs to be the primary cause of market failure, Merges
submits that the emergence of digital technologies will “obliterate the fair use defence
entirely”. This is predicated on the fact that such digital technologies enable a ‘frictionless’
online marketplace, creating a (near) perfect market devoid of the failures fair use (or an
exception) corrects.
110.
However, this rudimentary assessment somewhat over-generalises the effect of
technology on transaction costs and ignores the potential adverse effects of legal
uncertainty.To gain a better understanding of this issue it is necessary to consider more
closely the various forms that transaction costs can take. Merges himself provides a
partial treatment of this in his paper. As is conceptually consistent with Dahlman (1979)
and Coase (1960), he identifies the four separate categories of transaction cost.
Furthermore, he notes that digital technologies and the online environment do not
address all these factors.49 We discuss the main ones further below.
Search costs
111.
Arguably the form of transaction cost most readily addressed by digital technologies, and
by the internet in particular, is the cost of searching. Through the internet buyers and
sellers from around the globe can interact with relative ease, a phenomenon which stands
in stark contrast to the analogue world. 50 Database technologies can, in principle, provide
users with a clear identification of the rights they require, as well as a quick and easy
method of clearing these rights.51
112.
To the extent that exceptions might be used to relieve search costs as a barrier to trade
(e.g. for orphaned works), such technical advances indeed militate against their
implementation. A comprehensive database could identify the licence holder for any work
and, if a work is truly orphaned, indicate that no payment is required. This would remove
the need for users to engage in (potentially prohibitively) costly searches just to ensure a
work is truly orphaned. At the same time, this would reduce the risk of a hold-up. With
47
As we have previously explained, fair use exceptions and the exceptions as typically codified in continental
Europe can be treated as closely related for the purpose of this report: they both remedy a market failure.
48
American Geophysical Union v. Texaco, Inc., 60 F.3d 913 (2d Cir.1994); and Princeton University Press, Inc. v.
Michigan Document Service, Inc., 99 F3.d 1381 (6th Cir.1996).
49
Though, curiously, this is not later referred to in his assessment of the on-going validity of fair use.
50
Note, however, that a number of the advances that have reduced frictions in interactions between the
rightholders and potential users have arguably been enabled by services which at least in part rely on copyright
exceptions and limitations (e.g. internet search services).
51
One example of such a system is the Global Repertoire Database (GRD), the music industry initiative discussed
previously, at paragraph 104.
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such a technology available to facilitate a mutually beneficial trade, there would arguably
be no market failure to justify an exception to be imposed. However, we note a number of
possible rebuttals to the argument that technological advances have substantially
reduced search costs.
113.
Firstly, the ‘frictionless’ marketplace envisaged requires that there is indeed an
exhaustive, up-to-date, database in place. Such a system can certainly not be
implemented without (likely substantial) costs, and further costs will be incurred in its
maintenance. If it is to fall on the industry to bear this cost, the expected added value to
the industry resulting from the system must be sufficient to justify the investment. Given
that there is likely to be a substantial coordination problem in setting up and maintaining
such a system, it might never be set up.
114.
Furthermore, the anecdotal evidence from industry participants (in particular, from
international music streaming services) indicates that it is still often unclear who owns all
the relevant rights to a given work. Without a concerted approach to standardizing the
relevant data, issues will remain that technology alone cannot tackle.
115.
Overall, it is clear that digital services and the internet in particular, induced a significant
improvement over the analogue world in matching rights holders with users. However, it
would be fallacious to conclude that this renders exceptions redundant. There remain a
number of non-negligible costs in terms of providing a platform for trade and clarifying the
international rights ownership of certain works. And, in principle, as long as search costs
persist (in particular when the required rights are highly fragmented), and the parties
engage in negotiations to determine the price for access after the search costs have been
sunk, there is the familiar issue of hold-up. Therefore, technological progress alone might
not be sufficient to reject all cases for exceptions.
Bargaining costs
116.
Another significant contributor to the overall cost of a transaction is the time and
uncertainty associated with a negotiated outcome. The online environment is well suited
to match buyers and sellers of standardized products, offered on a ‘take-it or leave-it’
basis. In these circumstances, bargaining costs disappear. 52
117.
In contrast to this, many trades that may be enabled by exceptions are generally
concerned with non-standard transactions requiring specific negotiation. Examples could
include authors wishing to quote sections of a previous work; audio-visual producers
wishing to use clips from a movie or music producers wishing to sample a track. In many
such uses, a number of transactions would typically be required as the new work is
produced or a new service is provided.
118.
With this in mind, it is not immediately evident that digitisation and the online environment
have contributed significantly to the reduction of bargaining costs. Although in principle
the producer could offer standard terms for partial samples (e.g. quotations could be
extracted from an online system on a cost-per-word basis, or movie clips at a cost-perminute) and digital technologies could support this, in practice we do not often observe
such automated licensing for transformative uses. Moreover, it would appear that digital
52
Though, of course, bargaining costs may have been the very reason for the market to be organized in the form
of “take-it or leave-it” offers.
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purchases for private non-transformative uses are typically indivisible. 53 This means that
at least in principle bargaining costs may remain a relevant reason for exceptions even as
technology advances.
Moreover, technological advances have enabled some uses of copyright content for
which the rights are highly fragmented and for which access to an individual piece of
content contributes little to the otherwise significant total value of the use of content in the
aggregate. Because of the fragmentation of rights and due to the small contribution in
terms of value of an individual work to the service, the potential license fee is small as
well (or even negative, when it is in the interest of the rightholder to have its work
displayed). At the same time, search and bargaining costs remain significant. This means
that absent exceptions such uses might not materialize.
119.
In such circumstances it is not apparent that the advances in technology remove the need
for certain exceptions to overcome the market failure due to bargaining costs – in fact
they may increase this need. Thus one might consider exceptions that allow for quotation
and private study to facilitate small amounts of copying for which markets may not exist
(insofar as these exceptions do not already exist).
120.
Finally, independently of transaction costs, but particularly important when these are
significant, one might consider that some exceptions may be needed in order to
overcome technological constraints to enable an otherwise lawful use of a part of an
expression which may not be protected by copyright. 54 Absent these exceptions,
individual bargaining would be required, possibly at significant (or prohibitive) cost to both
the users and producers with little prospect for social gain.
121.
Nevertheless, it should be noted that in spite of significant bargaining costs involved in
some transactions, an exception will often not be warranted. This is the case in particular
when the potential value in use is large. In such circumstances, an exception is more
likely to reduce potential revenues of the future rightholders significantly, thereby greatly
reducing the incentives for creation of new works in the first place. Moreover, in such
circumstances, an alternative market solution for socially valuable trade is more likely to
arise in the future.
3.1.4. Conclusions on transaction costs
122.
It may be held that transaction costs are the main culprit for welfare-destroying distortions
in the markets for creative works. By the Coase theorem (discussed in Box 1), we
understand that bilateral trade alone is capable of delivering a perfectly efficient outcome
in a frictionless world, regardless of the initial allocation of entitlements. Moreover, the
issues of market power and externalities (to be discussed in the following sections) are
also resolved when transactions bear no cost. 55 However, whilst a copyright regime has
been argued to offer lower net transaction costs when compared with the alternative
(copy-privilege), certain costs do remain.
53
Formally, the purchaser faces a non-convex production set (itself a circumstance in which free markets may fail
to deliver efficient outcomes). That is to say, it is not possible to construct all partial representations of the work
that might be desired. Works are offered only in selected forms (e.g. a substantial reference book might be
offered for sale as a complete work, or by the chapter, but not on a ‘per-quotation’ basis.
54
Indeed, in part this has been acknowledged in Article 5 of the 2001 Information Society Directive.
55
In the case of market power, costless transactions facilitate perfect price discrimination, delivering Pareto
optimal outcomes. In the case of externalities, costless trade allows for the internalization of externality effects.
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123.
Clearly transaction costs reduce overall welfare when compared to a perfectly frictionless
counterfactual. However, the severity and manifestation of this effect critically depends
upon the intended use of the traded work. This section characterised three distinct uses
of creative works: private use; use of partial works as an input to further creation; and use
of full-form works as an input to distribution services.
124.
We may find that for certain private uses, practices restricted by copyright (such as
format-shifting for more convenient consumption) offer relatively little added-value relative
to transaction costs involved in securing a permission of the rightholder. It is therefore
possible that the gains from acquiring the required licences would not pass the hurdle set
by transaction costs, resulting in missing markets. In such cases, exceptions may be an
appropriate way to release social value. However, it must also be recognized that, if the
markets are truly missing, the rightholders may have incentives to overcome the problem
by explicitly permitting limited such copying, either setting a higher price for a now more
valuable product or selling more copies of it at the same price. Alternatively, the
rightholder may want to offer a menu of contracts where some options include limited
copying. If this is the case, exceptions are less likely warranted.
125.
Similarly, partial-copies as an input to further creativity may deliver uncertain value to the
acquiring party and to rightholders. This implies the probable need for bilateral
negotiations, possibly presenting an insurmountable barrier to trade. The resulting
reduction in creative output represents an undesirable social loss, and exceptions present
a remedial option. The existing exception which permits new authors to cite previous
works is one such example. On the other hand, as in the case of private end-use, here
too innovative licensing arrangements can partly overcome the problem that transaction
costs pose and when feasible obviate the need for exceptions. For example, licensing
arrangements between YouTube (as a platform for distribution of transformative and
original works) and rightholders may eventually prove to be a viable model in the long run.
126.
In the case of full-form reproductions as an input to distribution services, it would appear
that often the ultimate value to the acquiring party is sufficient to ensure the development
of a market mechanism to overcome transaction costs. That is not to say that the still noninsignificant transaction costs do not hamper the introduction of further improved
distribution technologies. It does, however, imply that a cautious approach to exceptions
might be warranted, to prevent stalling natural free-market developments.
127.
Finally, as we consider the effect of recent advancements in technology, we dismiss the
presumption that all relevant transaction costs and their associated justification for
exceptions are decreased. Transaction costs comprise a range of overheads incurred in
the completion of a trade, including at least search and bargaining costs. Whilst it is likely
the case that the online environment substantially eases the process of search, it is
unclear that it offers similar such benefits in bilateral bargaining. Once again, a balanced
approach to considering exceptions appears warranted. 56
56
The need to balance the trade-offs involved in introducing exceptions on the facts of the specific use suggests
that it might be difficult to design sufficiently broad yet precisely circumscribed exceptions with a foresight to
capture all the current and future uses in which the trade-offs involved favour an exception and exclude those
which do not.
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3.2.
Market power, productive efficiency and access vs. incentives to
create new work
128.
In section 2, we have outlined how copyright facilitates the emergence of markets for
creative works and how it can save transaction costs over alternative assignments of
entitlements. This function of copyright is crucial because it allows for the private actors,
to make independent investments in creative works. However, by granting a set of
exclusive rights over certain uses, copyright introduces market power. And market power
may be one source of market failure (in the presence of transaction costs) and a potential
justification for exceptions.
129.
In this section we thus focus on market power as a source of inefficiencies that can
potentially be alleviated by exceptions. However, when dealing with market power it is
necessary to also consider that a degree of market power is a necessary side-effect of
copyright that guarantees sufficient incentives for creation of new works.
130.
We begin by outlining a framework for an analysis of competition between different
creative works – a model of monopolistic competition. In such a framework, social loss
arises in the form of “deadweight loss”. Before concluding that market power is a problem
that requires exceptions as a remedy, a number of relevant considerations regarding the
limits on the market power from copyright should be made. After having considered these
limits we proceed with a short discussion of exceptions on the basis of three models from
the economic literature in which market power plays an important role. These models are
discussed in more detail in section 4.
3.2.1. Monopolistic competition
131.
A conceptual framework which appears to be a good fit for a number of pertinent features
of copyright markets and which is often employed in the economic literature on copyright
is “monopolistic competition”. Within this framework, there are many authors who sell
differentiated, imperfectly substitutable, creative works. There are no significant barriers
to entry and exit and the authors set their own prices, taking each other’s prices as given.
The authors incur fixed costs of production and make positive short-term profits.
However, in the long-run, entry of other authors with partial substitute works eventually
shifts demand for each individual work downwards, until it reduces economic profits of
each author to zero – the average revenue in the long-run equilibrium is equal to the
average cost. This does not mean that the authors do not have market power: they set
prices in the same way as a monopolist would, by equalizing marginal revenue and
marginal cost.
132.
The optimal pricing of a firm in monopolistic competition is illustrated in the two panels of
Figure 1. The optimal price is set at the intersection of the horizontal green line, which
represents marginal cost, and the dashed downward-sloping line, which represents
marginal revenue. Absent price discrimination, this results in a sub-optimal provision of
reproductions authorized by authors.
Social loss associated with market power
133.
A central concept in the analysis of market power is “deadweight loss”. It measures the
loss to a society from market power (or some other type of market failure), and arises
because the price for reproductions is above the costs of an additional copy. Prices above
marginal costs imply that those users who are willing to pay more than it costs to
reproduce the original but less than the uniform price set by the author will be excluded
from access to the work. Then the sum of the valuations of the un-served users (net of
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cost of reproduction), who are willing to pay at least what it costs to produce a
reproduction, represents a loss to society as depicted by the grey area in Figure 1. The
blue area in the figure depicts profits net of fixed cost of expression and the white triangle
below the demand curves depicts consumer surplus.
134.
Note that if the rightholder could perfectly discriminate in prices between different users, it
would set a different price for each individual user, equal to that individual’s valuation, so
that no deadweight loss would arise. In that case, the rightholder’s profits net of fixed
costs would be the entire social surplus. In general, the size of the deadweight loss for
each individual work increases with price elasticity of demand for creative works.
135.
The total deadweight loss in monopolistic competition is an aggregation of the deadweight
loss over all the works and it depends on the nature of competition, demand and
production technology. 57
136.
It can be shown that the deadweight loss (but not the social welfare) associated with an
increase in market power for an individual creative work increases when the costs of
reproductions decrease. This can be demonstrated graphically by comparing the two
panels in Figure 1 which depict the deadweight loss associated with two different levels of
marginal costs, high and low, respectively.
137.
Both panels depict a case of monopolistic rightholder for a particular creative work. The
scenarios of the two panels differ only in the (constant) cost of an additional copy (a
reproduction) of the work. These costs are termed “marginal costs” (abbreviated to MC in
the panels). In the left hand panel, we graphically demonstrate the pricing strategy of a
rightholder who faces high marginal costs of reproduction. In the figure on the right side of
the panel, we depict the pricing strategy of a rightholder with the same demand, but who
now faces low marginal costs of reproductions. Keeping in mind the colour coding of the
areas below the demand curve (white for consumer surplus, blue for producer’s profit,
and grey for the deadweight loss to society) one can observe the increase in the
deadweight loss to society when the marginal costs of a monopolistic producer decrease.
138.
The deadweight loss is thus exacerbated by the inexhaustibility of works of authorship –
once produced such works can be distributed for different uses and to different
consumers at very low costs. Thus while prices above marginal costs are required for the
author to recover his costs of creation and distribution, efficiency militates for very low
prices. In theory this makes market power particularly harmful for non-exhaustible goods
like creative works.
57
The actual size of deadweight loss in copyright markets is an important, but hard empirical question, in this
discussion. What matters most for our discussion is how much copyright adds to the deadweight loss. We are
aware of one attempt at estimating this contribution by Liebowitz (2009).
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Figure 1: The effect of decreasing marginal costs on social welfare
Source: CRA
3.2.2. Copyright grants limited market power
139.
The discussion above reveals that market power can lead to socially inefficient outcomes
when perfect price discrimination is not feasible. But before concluding that this means
that copyright often leads to large social inefficiencies, several important qualifications
must be made.
140.
First, copyright in fact confers a limited set of rights to the author in relation to his work –
these are limited both in terms of duration and scope. Significantly, copyright only protects
one’s expression, not the ideas or information expressed; it only pertains to the form in
which authors of literary, graphic, musical and artistic works express intellectual concepts.
This means that an important part of the intellectual creation is not protected by copyright
and indeed this part can be freely copied in new creative works. In a world of free entry
into production of creative works this gives the author the ability to recover only the costs
of expressing the intellectual concepts embodied in his creative work (cost of expression),
but not the costs of forming these concepts, ideas or the costs of obtaining information
and knowledge that are expressed in a creative work. This is significant: authors do not
have market power over the ideas that they have expressed.
141.
Second, firms with market power which can price discriminate will do so as this increases
their profits. Price discrimination can alleviate deadweight loss from market power. In
fact, as we explained earlier, with perfect price discrimination rightholders will provide
socially efficient levels of access to their works. Then, absent causes of inefficiencies
other than market power, there is little reason for an intervention from the point of view of
economics.58
142.
58
It is often the case that some degree of price discrimination is possible in markets for
copyrighted goods. For instance, movies are priced differently when provided through
different distribution channels and books tend to be first published in hard-cover copies at
higher prices than later issues of the same book in paper-back editions. Yet, for perfect
price discrimination to be feasible, the rightholder must be able to identify all the different
market segments according to their willingness-to-pay and he must also be able to
Market power does not result in underproduction if firms can perfectly price discriminate. Indeed, firms will price
discriminate if they have information about the preferences of individual users and can prevent arbitrage. But
both the lack of information and inability to contract to prevent arbitrage can be rationalized without loss of
information as consequences of positive transaction costs. This means that market power in itself is not the
problem -- unless it is associated with positive transaction costs.
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enforce his pricing scheme (which requires being able to prevent arbitrage). Limited
information and costly prevention of arbitrage (which can both be conceptualized as
instances of transaction costs) are likely to limit the effectiveness of price discrimination
and, in turn, market power will often result in some social loss. Nevertheless, what should
be understood is that market power is by itself a reason for socially inefficient outcomes,
and that the social loss due to market power is not necessarily large.
3.2.3. The role of exceptions in limiting deadweight loss and their cost in terms of
reduced incentives for creative work
143.
We have established that market power conferred by copyright may contribute to
inefficient outcomes. Exceptions may be justified in such circumstances: they limit the
scope of the rights granted by copyright thereby reducing the market power and
potentially the associated inefficiencies.
144.
There are broadly two different channels through which exceptions will affect market
power and the allocation of copyrighted work, which have been highlighted in the
literature.
145.
First, exceptions can be seen as an instrument which truncates demand for authorizations
for certain uses or demand for authorized copies. This arises naturally when, as a
consequence of an exception, a particular use of creative works is permitted. An example
is an exception which allows for a lawful production of low quality version of the
copyrighted work. For instance, a photocopy of a chapter of a book can be seen as a low
quality variant of the original. A somewhat different example is an exception which allows
the authors of derivative works to reuse, in part, previous copyrighted work. For such a
reuse, with the exception in place, the authors of new works will not need to acquire
licenses for the works they draw on. The market power of the copyright owner is then
affected by the emergence of new products which are substitutes for the creative work but
of lower quality or simply by the fact that fewer licenses will have to be sought for works
used as inputs into new works.
146.
Second, exceptions can be seen as a mechanism which reduces the cost of making
exact, unauthorized copies. Exceptions might legalize limited such copying, making it less
costly and thus more widespread. Market power is then reduced to the extent that the
owner has to contend with some supply, by others, of close (or perfect) substitutes
(available at some cost). By reducing the cost of unauthorized copies, exceptions thus
enhance the competitive constraint exercised on the owner of the copyright.
147.
Exceptions thus reduce prices of and promote access to existing creative work. At the
same time, however, exceptions also adversely affect the incentive to produce new work;
and if they are overly broad this effect will eventually defeat their purpose. Then, in the
context of our discussion of market power, exceptions will likely be justified when they
ensure a wider dissemination of creative work and its reuse in derivative works without
significantly affecting the incentive to invest in the creative work in the first place.
148.
Landes and Posner (1989) provide a formal economic model in order to rationalize
copyright (and exceptions) as a means for efficient allocation of resources in the presence
of market power and, implicitly, some transaction costs. Specifically, Landes and Posner
consider a mechanism in which weakening of copyright protection 1) reduces the cost of
making unauthorized copies (thus decreasing the incentives for creative work), 2) reduces
the costs of new creative work (thus increasing the incentives for creative work), 3)
reduces the administrative cost of the copyright system and 4) increases access to
existing works (thus decreasing deadweight loss). They then characterize the optimal
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strength of copyright under these assumptions. This optimal strength depends on a
number of different factors affecting demand and supply of works in the model. We defer
a formal analysis of the model to section 4.1. On the basis of their formal analysis,
Landes and Posner make a number of conclusions with respect to the optimal strength of
copyright, some of which we consider not to be robust. Those conclusions which we
consider to be robust are also intuitive: First, the strength of copyright should not be such
as to maximize the number of works. In terms of exceptions, this means that some
exceptions which negatively affect the profits of rightholders might well be justified. Thus,
the interests of the rightholders should not be the ultimate objective when enacting new
exceptions. Second, exceptions which are not costly to administer and significantly
reduce the costs of creative work but do not significantly reduce the (potential) revenues
of rightholders are more likely to be justified from the point of view of social welfare. 59
These are exceptions which are aimed at “transformative” creative work, that is, new work
which has to “borrow” from previous work and is only an imperfect substitute to the
existing works.
149.
Pollock (2007) considers a framework similar to that of Landes and Posner to study the
effect of technological improvements on the optimal level of copyright protection. In his
framework, a weakening of copyright protection reduces the rents accruing to the
rightholder, but increases access to existing works thus reducing deadweight loss from
market power. Pollock also assumes that the number of creative works initially increases
but may eventually start falling with increasing levels of protection. In his model,
technological improvements change the cost of making authorized and unauthorized
copies of the creative work.
150.
Pollock studies the direction of the optimal change of the strength of copyright protection
as technology reduces the costs of making reproductions. In the model, several effects
act in different directions: On the one hand, as the production cost falls and more creative
works are produced, the deadweight loss arising from the exercise of market power
increases (indeed, the lower the cost, the higher the deadweight loss accruing over a
larger number of works).60 This favours a reduction in the level of protection (as strong
copyright induces more distortion in such circumstances). In addition, new works that
partially substitute existing works contribute less to social welfare as the body of works
expands (following a decrease in costs) and this means that preserving incentives to
create new works becomes less of a priority. On the other hand, with lower costs of
production, the welfare that accrues from each new work increases, raising the benefit of
a marginal (new) work. This calls for an increase in the level of protection. Overall, due to
these opposing forces, the argument that the advent of electronic copies (which reduce
the cost of production) should lead to a reduction in copyright protection cannot be
supported on the basis of theoretical analysis alone.
151.
When transposed to exceptions, this result implies that, on the basis of theory alone, we
cannot make a case for broader or narrower exceptions as the costs of authorized and
59
Landes and Posner also discuss high-transaction costs cases, which we have addressed in the previous
section.
60
Among other factors, the extent to which deadweight loss increases will depend on the elasticity of demand. The
more elastic the demand for each individual work in equilibrium, the larger the deadweight loss for a given work
and thus an increase in total deadweight loss as the number of works increases.
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unauthorized copying decrease.61 The lack of a clear theoretical prediction is somewhat
disappointing. But the result is nevertheless important as it identifies some of the
channels through which exceptions will affect social welfare. In the assessment of
exceptions, these channels should of course be considered for their empirical relevance
along with other channels not addressed by Pollock’s model.
152.
While Pollock considers changes in the cost of reproductions (changes in production
technology), it is worth noting that technological improvements may also affect demand. It
is thus relevant to also consider this channel when assessing the optimal changes to the
scope of exceptions in the view of technological advances. An improvement in technology
effectively expands the consumption possibilities of the users (for instance, portable
music players allow for the consumption of a greater variety of music in a wider set of
circumstances). It also allows the users to obtain higher utility from consumption of such
works. The two effects, in turn, increase the potential revenues of rightholders and thus
the number of different works created. Insofar as the scope of exceptions interacts with
technological improvements to determine the ways in which works get consumed and
produced, there may be a case for changing these in the view of technological advances.
153.
In order to study these demand-side effects we introduce a small modification into
Pollock’s framework. Specifically, we consider the effect of a technological improvement
which improves the user’s access to creative work. We assume that the technology
advance directly affects the welfare function by increasing the utility that can be obtained
from existing works. However, the technology advance affects welfare indirectly as well,
by fostering the creation of new works. This is rationalized by an increase in the demand
following an improvement in technology and, thus, in an increase in the potential profits of
rightholders which, in turn, results in higher production of new creative works. Our formal
analysis is developed in section 4.2.
154.
We start from the optimal level of copyright protection and recall that a weaker copyright
protection improves access to existing works, but (for small changes) weakens the
incentives to produce new work. An increase in the benefits of each new work, following
an improvement in technology, favours an increase in optimal copyright strength in order
to promote the now more valuable creative effort. This effect is straightforward: because
new work is more valuable with improved technology, all else given, we should stimulate
more creation of new works, even at the costs of a decreased access to existing body of
works. This intuitive effect is potentially reinforced in a scenario in which an increase in
copyright protection becomes more effective in promoting the creation of new works when
technology advances. This might, for example, be the case if technology advances allow
for improved enforcement of copyright (e.g. via technological protection measures). 62
Intuitively, the case for stronger protection is also reinforced when new technologies
contribute most to welfare when combined with increased protection. This could, for
61
It should be noted that this result is silent on whether other effects, besides costs of copying, that accompany
technological improvements (like changes in transaction costs which we analyze elsewhere in this report), favor
narrower or broader exceptions.
62
If copyright cannot be effectively enforced then strengthening it will not have much effect on the incentives to
create new works.
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example, be the case because the rightholders may be able to provide and distribute
different formats (for different platforms) more efficiently than the end users themselves.63
155.
However, there are also reasons which favour a decrease in the optimal level of copyright
protection. For example, a higher level of protection may imply that the potential gains
from technology improvements can now less effectively be exploited by final users. This
may be the case, for example, because stronger copyright, combined with technological
measures effectively prevents users from shifting formats across different platforms (due
to technical protection measure) so that they cannot make best use of technology
advances. Also, as the body of works increases due to the improvement in technology,
marginal further increases to the body of work may become less and less valuable,
meriting less of an enticement of creation of new work. Moreover, the larger the number
of works, the larger the (aggregate) deadweight loss from increased protection as it
accrues over a larger number of works. Finally, it may be that due to technological
advances a marginal increase in copyright protection becomes less effective in
stimulating creative work, which may be the case, for example, when technical
improvements facilitate unauthorized copying.
156.
Thus, on the basis of theory alone, no robust conclusions with respect to the scope of
copyright protection are possible. Insofar as we interpret exceptions as a weakening of
copyright protection, these findings transpose to exceptions directly. As a result, whether
we should increase or decrease the level of copyright protection is largely an empirical
question, whose answer is likely to vary according to the kind of creative work which is
being considered. However, despite the theoretical ambiguity, a formal analysis is
necessary as it identifies some of the channels that should be considered in the
assessment of whether or not an exception is warranted.
157.
Miceli and Adelstein (2006) and Yoon (2007) consider a framework in which the effect of
exceptions is to allow for “low quality” copies of copyrighted work. Low quality is
interpreted broadly to mean a copy in an inferior format or a partial copy (e.g. a chapter of
a book). Consumers are heterogeneous with respect to preferences over these
alternatives (with some consumers having strong preferences for the original quality and
others willing to contend with low quality substitutes). This setup can be rationalized, for
example, in the context of demand for specialist textbooks: while students are satisfied
with a copy of just the chapters pertinent to their study, practitioners may want the book in
full. The key assumption in this model is that the rightholder will only offer the original in
full, perhaps because it is not profitable to offer chapters separately.
158.
The model captures two potentially positive effects from an introduction of a broader
exception: it will constrain the market power of the owner but it may also lead to a greater
variety of goods being self-produced by the user (who might be able to do that more
efficiently). In this model, in essence, the users develop their own versions of the creative
work, something that the rightholder cannot always efficiently undertake. As we explain in
more detail in section 4.3, in the model, once the work is produced, exceptions should
increase in their scope as the costs of unauthorized copying decrease relatively to the
costs of authorized reproductions. This is because private reproductions become socially
more efficient as the costs decrease. However, it is important to note that, for the
63
At the same time, if with technological improvements copyright becomes less effective in restricting access to
existing works (perhaps because enforcing copyright for existing works becomes much harder), a decrease in
the optimal level of protection is less likely.
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incentives to produce new works to be preserved, for very low cost of unauthorized
reproductions, it may be that the optimal scope of exceptions should decrease with a
decrease in the costs of unauthorized reproductions. Besides this effect, exceptions in
this model always constrain the monopoly power and thus the revenues of the rightholder.
3.2.4. Conclusions on the role of exceptions in the trade-off between access and
incentives to produce, and productive efficiency
159.
Overall, the analysis in this section suggests that it should be assessed whether the
rightholders’ market power is really significant before considering introducing new
exceptions to limit their market power. An important factor to be considered in this
assessment is the fact that ideas and information for many uses do not enjoy any
significant protection by copyright and can thus be accessed and used without a
significant deadweight loss. Still, in some circumstances and for certain uses, market
power and the associated loss from copyright may remain significant. In those
circumstances, and in particular when price discrimination is not feasible, exceptions can
be justified. This may, for example, be the case when users can self-produce lower
quality versions of the original good at significantly lower costs than the rightholder
could.64 Furthermore, it is important to note that exceptions may come at a cost in terms
of dynamic productive incentives; they may result in fewer new works. This negative
effect will be weaker for works whose authors do not respond well to pecuniary incentives
stemming from sales of their creative work or royalties, which means that exceptions for
such works are more likely to be justified, all else given.
160.
With respect to the pertinent question on how exceptions should respond to technological
changes, we have argued that one cannot conclude that in general technological
advances which reduce the costs of reproductions (both authorized and unauthorized)
justify broadening (or narrowing) the scope of exceptions. A similar ambiguous result
obtains for technological advances which increase the demand for creative work.
Nevertheless, the analysis in this section should help in identifying which mechanisms
favour broader and which favour narrower exceptions as technology advances. Our
analysis suggests that the policy debate should then focus on an assessment of the
economic relevance of these mechanisms.
161.
In transposing the results of the models discussed in this section into actual policy
recommendations it is important to be aware of an important limitation: all these models
summarize the level of copyright protection in a single variable and in our interpretation
this single variable is the proxy for the scope of exceptions. As explained, in the models a
decrease in protection results in a decrease in gross revenues for individual works, a
decrease in the cost of expression (in Landes and Posner’s models), lower deadweight
loss on existing works and (in Landes and Posner’s model) in a decrease in the costs of
the copyright system (enforcement and administration). In interpreting the results in the
context of exceptions, the first thing to keep in mind is that while most new (or broader)
exceptions will decrease the gross revenues (as some users will, instead of purchasing,
obtain the original for free under the exception) they may not do so to a significant extent.
Indeed, many exceptions are constructed so as to reduce the cost of expression but not
64
Clearly some exceptions are important in that they lower the cost of expression of new authors who must
access and draw upon existing works, and this is discussed at some length in the previous section on
transaction costs. Such exceptions are likely justified in the face of a persistent market failure. The existing
citation exception may be a good example.
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affect the revenues significantly. The second thing to keep in mind is that new (or
broader) exceptions may not reduce the administrative costs of copyright system (as does
a decrease in copyright protection in Landes and Posner), but rather increase it.
162.
Moreover, Landes and Posner’s assumption that a weakening of copyright improves the
productive efficiency of creative process may not be warranted, particularly when
transaction costs of license negotiations are low relatively to the value of the work when
used in derivative works. In such a case, the incentives for creative work would in part be
based on the expectations of future license royalties and this might result in higher
productive efficiency (so that higher protection might translate in lower cost of
expression).
163.
This indicates - as we have argued earlier - that exceptions are safest, from the point of
view of social welfare, when bargaining is costly relative to the value of the relevant
potential deal.
164.
We also reiterate that, to the extent that authors can price discriminate over different uses
and among different (groups of) individuals, higher prices as a result of stronger copyright
protection (or fewer or narrower exceptions) need not translate into an increased
deadweight loss for existing works. In other words, if perfect price discrimination is
feasible, there is no deadweight loss due to market power and there is little need for new
exceptions to curb that market power. Technological developments may allow firms to
offer different versions of the same work (for rent versus purchase, for use on different
devices, for full copies or partial copies, etc.). This also allows for a greater degree of
price discrimination and this in turn will reduce the relevance of new exceptions in curbing
market power.
165.
Before concluding this section, we remind that the hold-up problem (a source of market –
or rather bargaining – power) might be relevant in an assessment of exceptions. As
explained in section 3.1.2, hold-up is a source of market power (or rather bargaining
power) conferred on the rightholder, when negotiations for access take place after the
potential commercial user of rights has incurred some relationship-specific, unrecoverable
investments (search costs). Hold-up is most likely relevant when search costs are high
relative to the value that an individual rightholder’s content contributes to the use and
when bargaining power of the rightholders is significant. 65 As before, exceptions will more
likely be justified when access to copyrighted works is required to enable services (uses)
which create new markets (transformative use) and when these uses do not negatively
affect the incentives for creative work in a significant way (or may even increase them).
However, as is the case with other reasons for market failures, if innovative market
mechanisms are available that could facilitate licensing and reduce search costs they
may well be the preferred remedy over an exception.
3.3.
166.
65
The role of exceptions in the presence of externalities
Externalities are another set of reasons for why markets may fail to deliver efficient
outcomes. They arise when decisions of individuals regarding consumption, production
and investments positively or negatively affect consumption and production opportunities
of agents not directly involved in such transactions. When externalities are present, the
prices agreed by the parties will not reflect the full costs or benefits of a transaction or an
Note that the ability of the rightholder to price discriminate does not help in reducing the social loss associated
with underinvestment that might ensue in the presence of hold-up.
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activity. For this reason, markets will not align private returns of such transactions to
social returns and a necessary condition for social optimality will not be satisfied. 66
Broadly speaking, free markets with positive externalities will involve underproduction of
goods, whereas those with negative externalities will involve overproduction.
167.
Transactions in the markets for works of authorship tend to exhibit positive externalities.
For example, education, which of course requires access to specialized textbooks and
other works of authorships, is often believed to increase societal productivity and wellbeing beyond the well-being of students. Culture and democratic values that works of
authorship promote in the wider society, not only to direct users, are cited examples of
positive external effects as well; but we can also think of negative externalities if such
works promote hate or violence.
168.
Different remedies to the externality problem are available and they will not all perform
equally well in all situations. Traditional solutions are subsidies (taxes and quotas),
fostering bargaining over externalities by creating entitlements (property rights, liability
rule) and creation of institutions (e.g. collecting societies in the context of creative works).
All these interventions aim at increasing production and access in the presence of
positive externalities. But exceptions too, which are also a form of entitlement, have been
called for in order to address externalities. The rationale for exceptions in the presence of
externalities is no different either: to increase access to existing and future works and to
foster creative work.
169.
Since there are a number of different partial remedies available, one should not rush to
the conclusion that externalities should be remedied by any one particular type of
intervention. Instead, our analysis recommends that one should first understand (1) what
it is about the creative works that generates externalities and (2) why an externality has
not been internalized in negotiations between its emitters and its receivers in the first
place.
3.3.1. Why have externalities not been internalized?
170.
The Coase Theorem, which we outline in Box 1, provides a useful guidance in answering
the second question: why have externalities not been internalized? As explained, the
theorem predicts that when entitlements are well defined (either according to the property
rule or liability rule), enforceable, and when transaction costs are sufficiently low (zero),
bargaining in the presence of externalities will lead to efficient outcomes. 67 That is,
externalities will be internalized. This identifies either unclear, unenforceable entitlements,
or positive transaction costs as the most likely culprits.68 It could be argued that the
entitlements over the uses of creative works are well specified by copyright, its limitations
(e.g. limited term, expression – idea dichotomy) and the existing exceptions. This leaves
66
It is useful to refine the definition of externality by adding a requirement that for an externality to be relevant it
must be that it can be internalized by some intervention with a net benefit to a society.
67
Strictly speaking, perfect information is also needed for this result to hold in general. But conceptually limited
information can be (and has been) viewed as a form of transaction costs. Admittedly, such a broad view of
transaction costs may render the concept itself inoperative.
68
In the view of this result, externalities can be seen as missing markets. Indeed, competitive markets for
externalities could in principle internalize all the externalities and lead to efficient allocation in production and
consumption, and thus to efficient outcomes in the markets for creative works
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positive transaction costs as the main culprit for externalities in trade of such works.69 As
long as this view is accepted, we must conclude that a remedy will aim at addressing an
externality which is due to, once again, transaction costs.70
3.3.2. What is it about creative works that generates externalities?
171.
In the presence of positive externalities, too few creative works are produced in free
markets and these are not disseminated broadly enough. While increasing access to
existing works through the weakening of copyright protection (broader exceptions) can
solve the problem of dissemination, it may exacerbate the problem of too few new works
created due to reduced incentives to create.
172.
Thus, in evaluating whether exceptions are an appropriate intervention, it is important to
determine what it is about creative works that is the most relevant source of externalities.
If it is mostly the ideas or information embodied in the expression (as would appear often
to be the case) it may be that these can already be accessed, reproduced and
disseminated broadly at relatively low costs without infringing copyright and at low
transaction costs. A frequently cited example is the idea behind the Coase theorem:
despite copyright, it can be paraphrased, applied and disseminated in subsequent works
of expression without the cost of effort involved in constructing the argument and without
the permission of the author, as we do, for example, in this report. 71
173.
Because ideas and information are not protected by copyright and can be disseminated in
subsequent works, broadening the scope of exceptions, say by introducing new
exceptions for education, may be counter-productive. This is because many original ideas
can only be communicated through works of authorship. And to form new ideas,
particularly those which potentially have significant positive externalities, is not costless.
This means that besides the cost of forming an idea the author will incur the costs of
expressing it. Now, if the original author sets too high a price for a copy of the work which
first expresses his ideas, some other author would have simply rephrased the ideas in a
new work and sold copies at a low price. In other words, copyright does not confer market
69
An objection to such a view may be in a perceived lack of clarity in copyright. Indeed, many commentators have
complained about this problem. For example, it is often not clear where the boundaries between the idea and an
expression should be drawn (see. e.g. Landes and Posner, 1989). Also, quotation for criticism or comment is
permitted, but it is often not clear when the legal line is crossed. For example, an author of a guidebook to
modern poetry would face a difficult task in determining whether quoting two lines from a three lines poem
constitutes an infringement (See David Orr, “When Quoting Verse, One Must Be Terse”, NY Times, September
8, 2011, http://www.nytimes.com/2011/09/09/opinion/when-quoting-verse-one-must-be-terse.html?_r=2&).
70
Importantly, it must be considered that even small transaction costs can stand in the way of internalization of
externality through Coasian bargaining or through some other market mechanism – in particular when there is a
large number of potential receivers or emitters of an externality.
71
Clearly, existing exceptions allow for limited quoting which also plays and important part in dissemination of
ideas and their critique.
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power over ideas and the original author in monopolistic competition can only recover his
costs of expression, but not the costs of the formation of ideas. 72
174.
The problem in forming and expressing new ideas is analogous to the one that copyright
aims to solve: non-excludability of information. As a result, from a social perspective even
assuming that there are no externalities, too few original ideas will be expressed, resulting
in social inefficiency. With externalities, the social loss further increases. A further
weakening of copyright through new exceptions may then exacerbate, rather than solve,
the externality problem. In such circumstances, it should be considered whether, if
anything, rather than broader exceptions, further subsidies for access to copyrighted
works are needed.73
3.3.3. The “anticommons” problem
175.
A particular and somewhat different example of externality, and potentially a reason to
intervene in copyright markets, is the so-called "anticommons" problem. First described
by Cournot in 1897, the problem appears in situations in which two or more inputs are
necessary for a production of a product. In order to produce the output, consent must be
obtained from all the owners of the inputs. In theory, if these owners are independent and
cannot make side-transfers, each of them has an incentive to hold-up ultimate production
of the final good. This results in prices that are higher than an outright monopoly of a
single seller of all the essential inputs. More generally, but with less extreme
consequences, a situation where multiple independent firms control complementary
inputs leads to a similar outcome – higher prices relative to a single monopoly seller. In
both scenarios, the situation arises because the firms do not take into account the effect
that the high prices they set will have on sales of other sellers of complementary inputs.
The result is underproduction and a higher deadweight loss relative to a monopoly
situation. The externality in this mechanism is negative and it acts between the
rightholders who control the complementary inputs.
176.
Such a problem has been identified and much discussed in the economic literature with
respect to licensing of complementary patents embodied in different technologies that
form a product and coined as the "royalty stacking problem". 74 A similar problem has also
72
Note that, despite it being limited to a protection of expression rather than ideas and information embodied in
copyrighted works, copyright might still effectively prevent some uses of works for the purpose of information
extraction. This is the case, for example, with data and text mining discussed below, because a large number of
works have to be accessed and temporary copies created. The contribution of each individual work to the value
of the data or text mining project is likely to be low, whereas transaction costs of securing licenses might be
high. A similar problem may exist for internet search services.
73
Having said this, it has been argued that authors may frequently obtain substantial benefits from publications in
terms of salaries as university professors or consultants, for example. These authors publish in order to selfadvertise and self-promote (Landes and Posner, 1989). Such authors are not highly sensitive to monetary
rewards in terms of royalties. Nevertheless, the point remains valid: An exception which aims at harvesting
positive externalities through broader dissemination of existing works may not be needed while at the same time
it may have a significant adverse effect on formation and expression of new ideas and information in new works.
It is thus important to understand what in the work of authorship generates positive externalities.
74
"Royalty stacking refers to situations in which a single product potentially infringes on many patents, and thus
may bear multiple royalty burdens. The term 'royalty stacking' reflects the fact that, from the perspective of the
firm making the product in question, all of the different claims for royalties must be added or 'stacked' together to
determine the total royalty burden borne by the product if the firm is to sell that product free of patent litigation."
(Lemley and Shapiro, 2007)
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been identified by copyright commentators and academics. The problem arises with
respect to derivative works which require access to a (relatively) complete collection of
different copyrighted works which do not have good substitutes. Examples might include
production of an anthology, review, text and data mining. 75
177.
Taking text mining to illustrate the anti-commons problem, it aims at discovering new
knowledge from existing knowledge on the basis of processing of unstructured data
embodied in different works of authorship. In order for activities like data and text mining
to be successful, access to a large body of copyrighted work must be secured. These
collections must be copied and sifted through using special algorithms. This might require
licenses.
178.
Obtaining such licenses results in transaction costs which, as discussed above, are a
source of inefficiency. In addition to the problems brought about by transaction costs, the
cumulative royalties in the presence of the anticommons problem will be relatively high.76
In the context of our text mining example, even at zero transaction cost of securing
individual licenses, this might result in under-utilization of such collections of information.
As a remedy, one might consider enacting an exception which permits access for the
purpose of text mining. While such a solution potentially reduces a source of transaction
costs (cost in negotiating a license) and removes the complementarity problem, it is not
likely to always resolve the problem. This is because the owners of rights to such
collections (e.g. publishers) might have weak incentives to provide efficient access for
data mining under the exception (unless they can obtain remuneration for facilitating
access). In fact, they may make it completely impossible for researchers to mine their
collections, despite an exception.
179.
This means that other solutions would have to be considered, in particular when data
mining requires participation on the side of the publishers. One might be to foster private
collective licensing (in which the owners of collections internalize the externality). Such
licensing would reduce transaction costs, eliminate the complementarity problem and
incentivize publishers to provide a standardized access. However, such licensing may still
be inefficient if copyright imposed impractical obligations, such as a requirement for
attribution of individual authors. Then, exceptions which address such problems might
have to complement the private initiatives.
180.
Indeed, it is likely that some externalities which appear with new technologies or methods
will eventually be resolved through market mechanisms and private initiatives. This is
particularly likely when the groups affected by externalities are small. Such initiatives may
be excluded by interventions at a potential loss to society.
75
E.g. see Hargreaves (2011). Also, see Depoorter and Parisi (2002) who describe a situation in the production of
derivative copyrighted works. They give an example of a production of an anthology or a review essay on the
topic of the Coase theorem. Such works require the inclusion of passages from the relevant primary sources on
the same topic and each of these are essential for the success of such works. Some of these inputs are nonsubstitutable.
76
Note that when there are very many different owners of small collection of works and each of these individually
is not needed for the success of the text mining project, we do not have the “anticommons” problem. In such
circumstances, none of the owners has market power, which is a necessary condition for this problem to arise.
Transaction costs are still a potential problem though: the costs of securing licenses with each individual owner
may be prohibitive for the project to be feasible. This aspect is discussed in section 3.1
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3.3.4. Important considerations in the assessment of exceptions as a remedy to
an externality
181.
The discussion above identifies some considerations in deciding on what is the best
intervention, if any, in the presence of externalities.
182.
Before intervening it should be established that the externality is significant. In
order to do so the receivers of external effects should be identified – is the group large or
small? The larger the group, the more important the external effects likely are and the
more likely it is that some form of (more or less costly) intervention is justified. Answering
this question will be easier if we clearly identify the emitters of an externality as well as
the source of externality.
183.
Regarding the receivers of external benefits, it is easy to overestimate the size of the
recipient group or the extent of external benefits that they receive. Take for example a
book on infectious diseases written specifically for a course work in med schools.
Students who purchase the book, study from it and pass exams to become doctors
obviously benefit significantly from the knowledge obtained from the particular book but
they should not be treated as the recipients of a positive externality. This is because their
benefits have presumably been internalized as they chose to pay for one or more books
(out of all the books available on the topic) on infectious diseases. Neither should we treat
their future patients as recipients of an externality. These patients will have to pay for the
services of the doctor and this is what the publisher and the med student will have taken
into account in setting the price and in the decision to purchase, respectively. The
externality in the case of the particular book would arguably be in that it will add to the
knowledge which will be used to help curb diseases more effectively, thus resulting in
fewer people being infected.
184.
Before concluding that an externality justifies an exception, it should be asked
whether the source of the externality is related to ideas and factual information
(which are not protected by copyright) or the way these are expressed (which is
protected by copyright). In the former case we might be able to establish that the
authors (or the publisher) have no market power over ideas and that transaction costs of
accessing these ideas are likely to be relatively low. Returning to our previous example,
as long as there is socially valuable new knowledge in the book, it will have been
communicated to the doctors in one or more ways (in classroom, at conferences, through
medical papers reporting results of new research) and most of the benefits will have been
realized. Thus it may well be that the problem is very limited. Moreover, we may actually
exacerbate the problem by enacting broader exceptions which might adversely affect the
expression of original ideas and facts.
185.
It should also be established whether the externality can be expected to be
internalized through private negotiations and creation of new private market
institutions in the near future. The prime obstacles to internalization are of course
transaction costs and non-excludability. But if the non-excludability problem is absent and
the benefits of the internalization of externalities are significant, private negotiations and
the appearance of new institutions (intermediaries) can often be expected to resolve the
externality problem eventually. Indeed, collecting societies are an example of an
institution which effectively solves the “anticommons” problem (and the problem of
transaction costs more generally) in licensing music for radio broadcasting. Collecting
societies solve this problem by centralizing licensing of complementary rights (while they
also reduce transaction costs). Conversely, if non-excludability cannot be solved,
externality will not likely be internalized in a market mechanism.
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186.
4.
The administrative costs of an intervention should be evaluated. Maintaining and
enforcing a system of exceptions may be costly. It may introduce a greater degree of
legal uncertainty and reduce the clarity of allocation of entitlement. As discussed earlier in
the context of the Coase theorem, this may result in market failure and inefficient
outcomes.
TECHNICAL SUMMARY OF SELECTED MODELS
EMPLOYED IN THE ANALYSIS
187.
In this section, we outline a formal analysis of the trade-off between access to and
production of creative works on the basis of selected economic models in the literature.
188.
As discussed above, copyright, which allows for exclusion after a work has been created,
provides expected revenues that induce agents to engage in the creation of new, socially
valuable, works. Still, in the absence of perfect price discrimination, copyright will result in
social loss. Some users will be inefficiently excluded from access to existing works
(market power leads to a lower than optimal provision of reproductions of existing creative
works) and, to the extent that the copyright owner cannot appropriate the entire surplus,
too few new works will be created. Exceptions change the nature of competition between
copyrighted materials and, thereby, affect both the extent of inefficiencies arising from
market power, the extent of certain productive inefficiencies and the incentives to develop
new creative works. Two mechanisms can be highlighted.
189.
Firstly, an exception can allow for the emergence of partial (or low quality) substitutes,
which do not transform the expression (also referred to as non-transformative copying).
This arises when, as a consequence of the exception, (partial) copying for certain uses of
existing creative works is permitted. For instance, a photocopy of a chapter of a book can
be seen as a non-transformative low quality variant of the original. This is the mechanism
central to Miceli and Adelstein (2006) and Yoon (2008), but is also consistent with the
models of Landes and Posner (1989) and Pollock (2007). With an exception which allows
such copying, welfare may increase for two reasons: First, such unauthorized copying
(permitted under the exception) introduces competition with authorised reproductions of
the work. This reduces the inefficiency arising from the exercise of market power: the exception will reduce the incentive for creative work, but there is no presumption that overall, welfare cannot be increased by introducing competition ex-post. Second, the exception allows for the emergence of variants of the products that would not arise otherwise.
Due to transaction costs and specific production technologies, it may be that the
rightholder will find it optimal to produce only one version of reproductions, when consumers in fact require and can self-produce a variety of different versions. If the users can
produce the versions they require at low costs it may be optimal, from a social perspective, to allow them to do so up to a point.
190.
Secondly, exceptions may facilitate further transformation of existing creative works. This
adds a dynamic element to the trade-off between inefficiencies due to market power and
the incentive for creative work in the first place. Here we have in mind exceptions which
allow the authors of derivative works to reuse, in part, previous copyrighted work. Such
exceptions reduce the cost of creation of new works and this means that the number of
new works increases. The market power of the rightowners is then affected by the
emergence of new products which are imperfect substitutes for the existing creative
works. More specifically, the increased availability of these substitutes curbs rightholders’
market power and may reduce their incentives for creative work ex ante, because it leads
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to a lower expected profit, but concurrently leads to a greater reuse of existing works. In
turn, welfare may very well increase.
191.
4.1.
192.
Note that once the work is produced, given that the rightholder has market power but
provided he does not engage in price discrimination, it would be socially efficient to allow
many and broad exceptions to increase access to his work. Of course this would reduce
demand for authorized reproductions and for licenses for some uses, which would
decrease the rightholder’s revenues and potentially profits. And this, of course, would
adversely affect the incentives to create new works. Yet, new works are socially valuable,
so that welfare may also very well decrease.
The trade-off between access and production incentives
Landes & Posner (1989) is a classical analysis of the trade-off between the costs of
limiting access to the existing body of works against the benefits of providing incentives to
create new (original) works. The paper draws out this trade-off in a formal model which is
consistent with monopolistic competition77 and captures the supply of first-expressions
(production), and of reproductions (access).
Framework for analysis
193.
In the model of the paper, an author creating a first-expression incurs a fixed cost that
depends upon the level of copyright protection. Since new works typically draw inspiration
from existing works, Landes and Posner assume that the costs of the creative process
increase with the strength of copyright. The author creates a first-expression if and only if
his gross-profit from supplying reproductions is greater than or equal to the fixed-cost
investment. It is further assumed that for a given level of protection, the fixed-cost of firstexpressions varies between authors. That is to say, certain authors are able to produce
an equivalent quality of work at a lower cost than others. The marginal author is assumed
to attain a gross-profit exactly equal to their fixed-cost, and any decreases in fixed-costs
or increases in revenues will attract further authors into the production of firstexpressions.
194.
Note that the assumption that the costs of creative process increase with the strength of
copyright is not innocuous in this framework. In effect, Landes and Posner assume that a
weakening of copyright improves the efficiency of the process of creation of new works
(through a reduction in costs). However, this is not generally a safe assumption. First, as
we have explained in section 2.3, granting the right to exclude to the author (copyright)
can be more efficient than granting the right not to be excluded to the users, as it
minimizes transaction costs. In such circumstances, a weakening of copyright would
reduce the efficiency of the creative process, rather than improve it, as Landes and
Posner assume. Second, absent the anti-commons problem (and more generally, the
hold-up problem), if rightholders could discriminate between different subsequent authors
who draw inspiration from previous works, they would not exclude any of the works which
contribute to overall social welfare. In fact, authors would take the fact that subsequent
authors will require licenses to build upon their work into account efficiently when deciding
on the efforts to create new works (and they would have little incentive to raise the costs
of subsequent authors as their works are in a somewhat different market). It must be the
case, then, that Landes and Posner are implicitly assuming that a weakening of copyright
77
They set up a model in which the author competes with fringe copyists. Works are partial substitutes, but the
authors do not take each other’s prices into account in their pricing decisions.
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protection either significantly reduces transaction costs, reduces the so-called
“anticommons problem” or significantly reduces the inefficiency stemming from market
power in the market for creative works as inputs in production of new works. Though
possible, none of this is guaranteed to be always the case in reality.
195.
In the model, following the first-expression, a work is reproduced and sold by both the
original author and third-party copiers. The copiers are assumed to behave as a
competitive fringe, supplying reproductions until their (increasing) marginal cost equals
the market price set by the author. Their supply, known to the author prior to the firstexpression (the model abstracts from uncertainty considerations), depends positively on
the price and negatively on the level of copyright protection. The author incurs a constant
marginal cost for reproductions, and sets price to maximise his profits.
196.
Consumers obtain some surplus, which for a given work, assuming that it is produced,
decreases in the level of protection. This follows from the fact that copiers exert an
increasingly weaker constraint on the rightholder as copyright is strengthened. As a result
prices increase in the strength of copyright.
197.
Landes & Posner capture all aspects of copyright, such as originality requirements,
duration of protection and fair use considerations, in a single parameter. 78 This enters
their model in two ways, as stronger copyright:
1. Limits unauthorized non-transformative copying (copying for which a license does
not need to be obtained due to fair use exceptions) and, thus, reduces the supply
of the competitive fringe; and
2. Limits the creative process, by increasing the cost of first expression.
198.
Consider first the supply of authorized and unauthorized reproductions of existing works.
Production by the competitive fringe copyists declines as increased copyright protection
raises their costs. This reduces the competitive constraint on the author, resulting in an
increased price (and profit) of reproductions and associated decline in demand. Total
output (access to work) thus decreases. This reduction of supply is a necessary cost that
comes due to market power that the copyright confers upon the rightholder.
199.
Consider now the supply of first-expressions. The net effect of an increase in copyright
protection on this depends on relative forces of two factors. On the one hand, the
increased copyright protection positively affects the gross profits of the authors (defined
as profits before fixed costs of expression) when it increases the costs of copiers. The
increased gross-profits the author earns on sales of reproductions lead to an increase the
number of new first-expressions. On the other hand, the direct effect of increased
protection on costs of first expressions results in a decrease in the number of new firstexpressions.
200.
For low levels of protection it is assumed that the first effect dominates. This is indeed
likely to be the case: Starting from zero protection, with extensive third-party copying, a
small increase in copyright results in a significant boost to production incentives (as it acts
on a large number of copyists in the market at low levels of protection), with a relatively
low impact on creation costs. However, as the level of protection increases further and
less third-party copying remains, an increment in copyright provides less of a boost to
78
Note that in the context of this study, we implicitly hold all other dimensions of copyright protection constant, and
consider only changes in the ‘fair use’ aspect (that being the US legal provision for allowable uses of
copyrighted materials, closely related to the European concept of exceptions).
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production incentives. It is assumed that for a sufficiently high level of protection, the
costs of unauthorized copying are so high that a further increase in protection represents
no constraint on the prices of authorized reproductions. Increasing protection beyond this
level is never optimal as it results in no gain in gross profits or consumer welfare, while it
hurts net profits.
201.
Total welfare is an aggregation of welfare obtained from (assumed to be equivalent)
individual works (which is composed of consumer and producer surplus). The total
welfare decreases in total costs of expression incurred by the authors. It also decreases
with costs of the copyright system (enforcement and administration) and increases in the
number of works. Landes and Posner show that, under mild additional assumptions about
the aggregation of welfare, at very low levels of protection, a marginal increase in
protection will increase the total welfare as more new expressions are produced. At very
high levels, a marginal increase in protection will decrease the total welfare as the costs
of expression increase and copyists exert an increasingly weaker constraint.
202.
On the basis of a formal analysis in their framework, Landes and Posner reach a number
of conclusions. However, we consider a number of these not to be robust as they contain
implicit and hard-to-verify assumptions.
203.
For example, Landes and Posner conclude that the optimal level of copyright protection is
greater for classes of works that are more socially valuable. They explain that this is
because the higher the value of an individual work, the larger will be the rate of increase
in social welfare from additional work induced by an increase in protection. At the
optimum, this rate is balanced against the rate of increase in costs to total welfare from
the increase in protection. The costs of increased protection are due the loss in consumer
surplus implied by higher prices for all works, higher total costs of expression of authors,
as well as due to the loss of surplus of copyists and increased costs of the copyright
system. Landes and Posner are essentially suggesting that for classes of works that are
more socially valuable, higher benefits of marginal work have to be balanced against
higher rate of changes in costs and assume, implicitly, that this will be the case at higher
levels of protection. However, this result rests on the assumption that the rate of change
in welfare from an individual work with respect to the level or protection is invariant (or at
least not very sensitive) to the level of welfare from the work. But this is often not the
case. Indeed, we believe that it is likely that some variables that potentially positively
affect the level of welfare from an individual work (demand or cost parameters) may easily
increase the sensitivity of welfare to the level of protection in the same direction,
invalidating the result. We discuss this problem more formally in Box 4.
204.
Before summarizing the results that we consider robust and explaining how they are
related to exceptions, it is important to understand the relation between the level of
copyright protection as defined in Landes and Posner and exceptions.
205.
In Landes and Posner, a decrease in copyright protection results in a decrease in gross
revenues for individual works, a decrease in the cost of expression, a lower deadweight
loss on existing works and a decrease in the costs of the copyright system (enforcement
and administration). The first thing to keep in mind is that while most new (or broader)
exceptions will decrease the gross revenues (as some users will, instead of purchasing,
obtain the original for free under the exception) they may not do so to a significant extent.
Indeed, many exceptions are constructed so as to reduce the cost of expression but not
affect the revenues significantly. The second thing to keep in mind is that new (or
broader) exceptions may not reduce the costs of copyright system (as does a decrease in
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copyright protection in Landes and Posner), but rather increase it. 79 Having said this, we
now apply Landes and Posner’s results.
Interpretation of results
206.
The analysis of Landes and Posner demonstrates that the optimal level of protection does
not maximize the number of works. At the level which maximizes the number of works,
further increases in the level of protection bring about no benefits (as for a given large
number of works, increases in copyright are assumed to be detrimental to total welfare).
Here a small decrease in the level of protection has no impact on the number of works
while at the same time it decreases costs of expression and increases access to existing
works. Thus, it cannot be that the level of protection that maximizes the number of works
is socially optimal. This means that optimality requires a policy towards copyright that
should not exclusively focus on the interests of authors. This applies also to
considerations regarding changes to (the scope of) exceptions.80
207.
Moreover, the more sensitive the cost of expression is to the level of protection, the lower
the protection should optimally be. On the basis of this straightforward result, Landes and
Posner suggest that the level of enforcement of copyright against those individuals who
create new, derivative works, should be lower than against those who make exact
unauthorized copies. Landes and Posner arrive at this conclusion on the reasonable
assumption that literal copyists do not incur (or incur small) fixed costs of expression.
Conversely, the cost of expression for new works whose nature is such that they must
draw heavily from existing expressions is more likely to be sensitive to the level of
protection. Indeed, Landes and Posner argue that the fair use as applied by US courts
correctly distinguishes between what they term productive fair use and reproductive use.
A productive use is one which increases the number of new works, whereas a
reproductive use simply increases the number of “copies”. The relevance of this result to
exceptions is straightforward: if exceptions can significantly reduce the costs of
expressions, then they are more likely to be welfare enhancing.
208.
Finally, as is obvious, Landes and Posner suggest that the lower the costs of the
copyright system (administration and enforcement) the greater should be the level of
copyright protection.
209.
Landes and Posner’s results must be further qualified. We have already explained that
they assume that a weakening of copyright improves the static productive and dynamic
efficiencies of the creative process. This assumption may not always be warranted,
particularly when transaction costs of license negotiations are low relative to the value of
the work when used in derivative works. In such a case, the incentives for creative work
would in part be based on the expectations of future license royalties and this might result
in higher productive efficiency and eventually higher social welfare. Exceptions should
thus be limited, as Landes and Posner themselves argue, to situations in which
bargaining is costly relatively to the value of a potential deal.
79
Obviously, and this follows also from Landes and Posner’s framework, exceptions which do not significantly
affect the potential gross profits of the authors, significantly lower the costs of expression and do not increase
the costs of the copyright system should be enacted.
80
Some exceptions may effectively reduce the costs of expression of the future authors but do not (significantly)
reduce the gross profits from sales of authorized reproductions. Such exceptions should obviously be enacted.
However, most exceptions will potentially reduce the gross profits.
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210.
Also, to the extent that authors can discriminate in prices for different uses and among
different individuals, higher prices as a result of stronger copyright (or fewer or narrower
exceptions) need not translate into increased deadweight loss for existing works. In other
words, if perfect price discrimination is feasible, there is no market failure due to market
power and there is no need for new exceptions in such circumstances. Technological
developments may allow firms to offer different versions of the same work (for rent versus
purchase, for use on different devices, full copies and partial copies). This also allows for
a greater degree of price discrimination and this, in turn, will reduce the relevance of the
results just discussed.
211.
Moreover, as we discussed earlier, adding new works to the total body of works
increasingly constrains market power of the authors and this may in itself reduce welfare
loss and the need to counter the market power of rightholders through exceptions.
212.
Despite these qualifications, the considerations we have described remain relevant for the
assessment of exceptions.
Box 4: Outline of the model applied in Landes & Posner (1989)
Structure of the model
The variable
encapsulates in a single index all aspects of copyright protection. An
absence of copyright protection is indicated by
.
Copies of a work are supplied by both authors and the ‘competitive fringe’ copiers, at
price , to the certain market demand
. Authors produce copies of their work, whilst
copiers produce perfectly substitutable ‘quality adjusted’ copies of the same work (e.g.
two works of ½ quality = 1 quality adjusted perfect substitute). Therefore, the total copies
produced of a given work is
.
Copiers act as fringe firms, and supply until price is equal to their marginal cost. It is
assumed that this marginal cost increases (though not necessarily steeply) with both the
number of copies and the level of copyright . The supply of copies can therefore be
written
, with (subscripts denote partial derivatives)
and
.
Authors incur the constant variables cost for producing copies, as well as the fixed cost
for the original expression. Author’s profits are thus
. Substituting
[
]
for , this gives
. The author’s problem is therefore to
select price so as to maximise this profit. Taking the first order condition of profit, this is
shown to be when:
Furthermore, it is assumed that
. That is to say, the fixed cost of an original
expression increases with copyright protection.
The author’s gross profits,
, represent the sales profits earned from supplying
copies of the work. Landes & Posner show that gross profits increase with copyright
protection, that is to say
. For an author to undertake the development of a work,
the (expected) profit from sales must outweigh the costs of expression. Therefore, a given
work is produced only if
.
It is further assumed that the cost of expression
for equivalent works differs between
authors. New authors enter into production until the marginal author earns a gross profit
exactly equal to their cost of expression,
. The supply of works may therefore
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be expressed
, with
and
.
The effect of changes to copyright on the supply of new works
Take the total derivative of
( )
with respect to :
.
This reveals interplay of two factors. Firstly, the revenue enhancing effect of reduced
copying,
( ), increases supply (recalling both
and
). This may be
assumed dominant for small as a reduction in copying allows more producers to cover
their fixed costs. Secondly, the cost-of-expression effect
reduces supply. This is
assumed to become dominant for large , as few copiers remain to be constrained by the
added protection. At some level of
̅ these two effects are equal. Therefore, the effect
of a change in copyright on the supply of new works may be expressed as:
̅
{
̅
̅
The effect of changes to copyright on the supply of copies of existing works
From the first-order condition of the author’s problem, take the full derivative of price with
respect to , to obtain:
,
since
by assumption, and
from the second-order condition for profit
maximisation. That is, prices for copies increase with copyright protection. Moreover,
since
, the supply of copies of existing works unambiguously declines as copyright
protection increases.
Welfare per work, net of costs is the sum of consumer and producer surplus (including the
surplus of the copiers):
∫
[
Taking the derivative with respect to
on total welfare we obtain
]
∫
to study the effect of change in copyright protection
∫
In this expression the first, positive, term characterizes the author’s surplus change as the
level of protection changes, the second term, ∫
, is negative because an increase
in increases the total cost to copiers and the last term is negative as well, as the cost of
expression increases in . This expression suggests that for a given work, assuming it is
produced, welfare is likely to be reduced as copyright protection increases. Note that the
decrease in welfare from stronger copyright comes from the increase in costs of
unauthorized copying and increased costs of expression. The factor that counters this
decrease is the cost savings that come through the shift of producing unauthorized copies
to authorized copies. But because these savings are likely to be small (they are only
obtained on the additional authorized copies), while an increase in protection affects the
costs of all unauthorized copies as well as the cost of expression, the net effect will rarely
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be positive.
Total welfare
Total welfare is written as a function of the number of works
and total cost
(
, welfare from a given work
)
It is assumed that the marginal utility of works is positive but decreasing (
and
) and that total costs increase with respect to the number of works and strength of
protection (
and
).
Maximizing total welfare, the following condition obtains
or
At , the optimal level of protection, the right hand of the equation above is positive
(insofar as
, which is likely to be the case -- this is the partial derivative of welfare
obtained from a given work). This means that
at the optimal level of protection,
which means that optimal level of protection does not maximize the number of works.
It also follows from the above expression that the greater the responsiveness of to the
level of protection (the greater
at each ), all else given, the greater is the optimal level
of copyright protection. This is the case when revenues respond strongly to a marginal
increase in copyright protection and when unauthorized copiers respond strongly by
greatly decreasing their output in response to a marginal increase in the strength of
copyright). Note that this also implies that in reducing protection for the classes of works
where the authors’ revenues are not very responsive to it, such a decrease is more likely
to increase welfare.
Landes and Posner derive some further implications from the optimality condition above
(as discussed in the main text), some of which we consider not to be robust because they
contain some implicit and hard-to-verify assumptions. For example, they suggest that the
optimal level of copyright protection is greater for classes of works that are more valuable
socially, that is works with higher . They explain that this is because the higher the value
of an individual work, the larger will be the rate of increase in net social welfare from
additional work induced by an increase in protection. However, this conclusion rests on
an assumption that all other elements of the optimality condition do not change when
changes. This implicit assumption is hard to maintain.
To see the problem, consider a change in exogenous variable, call it , which positively
shifts demand (or in other words, increases
In order to determine whether the optimal
level of protection increases or decreases as
increases, differentiate the optimality
condition,
, to obtain
.
It follows from the implicit function theorem and the second order condition for optimality
that, if the latter expression is negative, the optimal level of protection decreases in
response to an increase in (which increases ).
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Indeed, the expression above could easily be negative, implying a decrease in optimal
level of protection as
increases and thus overturning Landes and Posner’s claim. By
Landes and Posner’s assumptions it is clear only that the first term is positive and that the
sixth term is negative. However, all the remaining terms might be negative (or not
sufficiently positive) as well and might outweigh the effect of the first term.
Source: Adapted from Landes & Posner (1989)
4.2.
213.
Exceptions and technological improvements
Technological improvements have decreased the costs of both authorized or
unauthorized copying and distribution, and have resulted in new opportunities for authors
and users to produce, distribute and access creative works in new ways. These new
opportunities for use and distribution have exposed further limitations of the market
mechanisms supported by copyright. It is thus natural that technological changes have
been accompanied by calls for changes to the copyright framework, including for
introduction of some new exceptions. While it is easy to understand such a reaction, we
note that the calls for changes are sometimes grounded in an informal or partial analysis
or loosely formulated intuitions. In this section, we formally investigate a potential
rationale for changing the scope of exceptions in the face of technological improvements
which is based on the interaction between market power (access) and the scope of
exceptions. We first follow and then expand slightly the formal analysis of Pollock (2007).
The framework
214.
Pollock builds upon the work of Landes & Posner, but highlights the effect that
technological improvements and the associated falling production costs can have on the
optimal level of copyright protection. As in Landes and Posner, the production of firstexpressions depends upon the level of copyright protection as well as the respective
costs of authorised and unauthorised reproduction. 81 As in Landes & Posner’s model, the
effect of a marginal increase in copyright protection changes as the level of protection
increases. Although the exact mechanism is not specified, at low levels of protection a
small increment is assumed to increase the number of first-expressions, but at a
diminishing rate. Furthermore, it is (optionally) assumed that at some level of protection,
further increases result in a decline in first-expressions.
215.
Moreover, changes to respective production costs are assumed to have opposing effects
on the number of first-expressions created. A decrease in the cost of producing
authorised reproductions increases the supply of new works. Conversely, a decrease in
the cost of producing unauthorised copies reduces the supply of new works, as increased
copying reduces the original author’s production incentives.
216.
Pollock defines total welfare as a function of the total body of works available (number of
first-expressions); the level of copyright protection; and the respective costs of authorised
and unauthorised productions. Welfare is assumed to increase with the number of works
available as new works provide increased variety to the consumer, though at a
81
Authorised reproductions represent sales of ‘originals’ by the author, or agents acting on his behalf.
Unauthorised reproductions represent any other third-party supply of the work, not benefiting the original author.
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diminishing rate;82 and decrease with production costs (as is obvious). Moreover, the
direct effect (which holds the number of works fixed) of an increase in copyright protection
is assumed to be a decrease in welfare, as the monopoly power granted to the author
results in a deadweight loss to society. However, the net effect of increased protection is
ambiguous, due to the opposing effect of increased new works, as production increases
with protection. As is natural, Pollock defines the optimal level of copyright as that which
maximises welfare, given these countervailing effects.
Optimal copyright protection as technology improvements reduce the costs of
reproductions
217.
Using this model, Pollock studies the effect that an improvement in technology which
reduces the costs of authorized and unauthorized reproductions has on the optimal level
of copyright protection. As noted above, both these costs and the level of copyright
protection enter the welfare function directly and through their effect on the production of
first-expressions. At the optimal level of protection, the countervailing effects of protection
are balanced. The question therefore becomes how decreased costs of authorized and
unauthorized reproductions disturb this balance and thus change the optimal level of
protection.
218.
Pollock identifies different channels that act in different directions to determine the overall
direction of a change of optimal level of protection. The net effect is in general
ambiguous.
219.
The main trade-off can be summarized as follows:
220.
On the one hand, a technological change which reduces costs increases profits, thereby
inducing an increase in the body of works and, thus, diminishing marginal value of new
work. This favours a decrease in the level of protection. A weakening of copyright will
result in smaller deadweight loss from existing works due to a decrease in market power
of the rightholder, and when the benefits of new works are small we should focus on
curbing market power rather than increasing the body of existing works.
221.
On the other hand, such a technological change, precisely because it reduces the cost of
reproductions, also increases the marginal value of a new work. This supports the
provision of stronger incentives for creative work through stronger copyright protection.
Other effects are at play and they too work in opposite directions or cannot be signed
unambiguously. For example, with a decrease in marginal costs of authorized
reproductions following a technological advance, the deadweight loss increases (as
explained above) and with it the potential gains in terms of its reduction as the level of
protection is reduced. This argues for a reduction of protection. However, this increase in
deadweight loss may be more then outweighed by a reduction in the cost of unauthorized
copying (which reduces deadweight loss as unauthorized copies constrain the market
power of the rightholder). This effect then argues for an increase in the level of copyright
protection.
82
The assumption of diminishing returns to new works may not be completely self-explanatory. This may be
thought of in terms of the ‘proportional increase’ in variety that the new work offers. In the extreme, the second
work ever created added 100% more variety to the ‘pool’ of works, thus adding substantially to the (variety
loving) consumer’s welfare. Following that (and ignoring for now the depreciation of works, for the sake of
simplicity) the third work adds 50% more variety, the fourth work 33.33%, the fifth just 25%, etc. It stands to
reason that as the body of works grows and additional works add proportionally less variety their marginal
contribution to welfare (whilst always positive) must decline.
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222.
This ambiguous result is disconcerting as it precludes strong conclusions on how the level
of copyright protection should respond to technology improvements based on theory
alone. Nevertheless, the result is informative: the arguments for or against weakening of
copyright should not be accepted without a further comparison, best based in empirics, of
the likely strength of the countervailing effects.
223.
In Pollock’s model, technology only affects welfare through costs of reproduction and
distribution of creative works. However, it should be noted that in reality it is likely that
technology improvements will not only affect the costs but will also allow for new ways in
which such works are consumed with a clear benefit to the user. We deal with this issue
below.
An extension for technological changes that improve access to works
224.
New technologies like digitalization and the appearance of portable media devices, such
as portable computers and tablets, allow users to store at low costs large collections of
music, movies and e-books and consume this content anywhere. This has potentially
significant consequences for the benefits derived from consumption and thus for the
optimal level of copyright protection.
225.
The net utility from consumption of a given creative content is the difference between
utilities of such and the next best alternative way of spending time. Once this is
understood, it is easy to appreciate the value of technology improvements. Compare
listening to music on a gramophone to listening on a portable music player. One can only
listen to music on a gramophone while at home. On the other hand, on a portable device
the music can additionally be listened to while travelling, doing sports and the like –
practically at any time one chooses. When a user can carry her content and consume it at
the time and place of her choosing, she will obtain a higher total lifetime utility from
owning it (because she will be able to listen to it whenever this is her best way to spend
time – not only on the condition that she is also at home). The demand both in terms of
quantity for a given work as well as in terms of variety is likely to increase.
226.
While Pollock analyzes the effect of a change in technology that impacts on the costs of
reproduction (both authorised and unauthorised), we use his framework to analyze
improvements in access to both new and existing works. To capture this effect, we
introduce a parameter, , which measures the state of technology. This parameter
directly affects the welfare function (increases the utility from accessing existing works).
However, it affects welfare indirectly as well: affects the demand (as explained earlier)
and thus the potential profits and production of new creative works. We abstract from the
potential effect of this parameter on the cost of reproductions (as this is analyzed by
Pollock and summarized above).
227.
We identify several channels through which our hypothesized technology improvement
(an increase in ) affects the optimal level of protection. The formal analysis is in Box 5.
228.
Arguably, for a given body of works, welfare will respond more strongly to a marginal
improvement in technology if the level of protection marginally decreases. In contrast, an
increase in protection could restrain the ability of users to harvest technological gains in
consumption. This would for example be the case if digitalization of content (and its use of
on different devices) would be restricted due to transaction costs or high prices of
licenses for such a use. This mechanism favours a decrease in the optimal level of
protection in response to technology advance. In terms of exceptions, one might consider
introducing one for private copying to address the effect. On the other hand, the
reasoning above might have to be reversed. Indeed, in principle, the rightholders will have
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themselves incentives to migrate and distribute existing creative work specifically for the
uses with new technologies if they can recover their costs of doing so. Such participation
in format shifting by the righholders may easily be socially efficient if it further improves
the user experience beyond what they could secure themselves by ‘private’ format
shifting. As it would have to be done once only by the rightholder (rather than many times
as each private user shifts format individually) it is also likely to reduce the total costs of
migrating creative work across different platforms. But it may be that proper incentives for
the rightholders to participate in this can best be secured if no exceptions which allows for
private format shifting are enacted and, perhaps, if technical protection measures are
allowed. In such a scenario, private copying exceptions might thus result in a loss of
welfare. We do not have a strong prior on which of the two effects generally prevails.
Indeed, this may be different for different types of work.
229.
Second, given the state of technology, the larger the body of works, the more harmful the
increase in the level of protection is likely to be to the aggregate welfare in this
framework. This is because the deadweight loss, a result of market power granted by
copyright, accrues over a larger number of works 83, and an improvement in the state of
technology causes an increase in the body of works (due to expansion of demand).
Similarly as before, this effect favours a decrease in the optimal level of protection or
introduction of exceptions such as private copying. The effect is likely to be strong if both
the technological progress provides strong incentives to increase the number of works
(expansion of demand) and if deadweight loss from additional market power conferred by
a marginal increase in copyright strength is large. This is more likely the case when the
cost of reproductions is low and when demand is elastic.
230.
Third, given the state of technology and the level of protection, the gains to welfare from
additional works decrease with increasing body of works, and technology advance indeed
increases the body of works because it increases demand (as we assumed). Together,
this implies that increasing protection marginally in order to stimulate creative work
becomes increasingly less effective in terms of contribution to welfare. This favours a
decrease in the optimal level of protection or broader exceptions. This effect is strong
when the effect on welfare of a marginal work decreases at a high rate (for example as
new works are increasingly substitutable or because there are limits to how many works
can be consumed in a lifetime).
231.
Fourth, given the level of protection, an improvement in technology increases total welfare
per individual work, which results in an increase in the gain to welfare of a marginal
increase in the body of works. This militates for an increase in the optimal level of
protection in response to a technology improvement. This channel is more likely to be
important if the authors respond well to pecuniary incentives and if new technology very
significantly improves welfare from the use of new works.
232.
Fifth, an improvement in technology may cause that a marginal increase in copyright
protection becomes more effective in stimulating creative work (this might be the case for
example if the new technology also improved enforceability of copyright, through technical
protection measures) and this would argue for an increase in the level of protection (fewer
or narrower exceptions). At the same time, the technological improvement may cause a
marginal increase in protection to become less effective in stimulating creative work, if, for
83
This must be true in the current framework as the works are assumed to each be in their own markets. It is not
necessarily true more generally.
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example, it is much easier to produce unauthorized copies and distribute them without
being detected and this would argue for a decrease in the level of protection (more
numerous or broader exceptions). We do not have a strong prior on which of the two
effects prevails and this may depend on the type of work.
233.
In sum, technological improvement increases the benefits of new works and this favours
increased copyright strength in order to promote creative work. This effect is potentially
reinforced in a scenario in which copyright protection becomes more effective in
promoting creation of new works with improvements in technology. Intuitively, the case for
stronger protection is also reinforced when new technologies contribute most to welfare
when combined with increased protection (as may be the case when participation of
rightholder in terms of tailoring creative works for distribution on new platforms is
important) . However, there are also reasons which favour a decrease in optimal level of
copyright protection: Higher level of protection may imply that the potential gains from
technology improvements cannot be fully exploited. Also, as the body of works increases
due to the improvement in technology, marginal further increases to the body of work
become less and less valuable. Moreover, the larger the number of works, the larger the
deadweight loss from increased protection. Finally, it may be that due to technological
advances a marginal increase in copyright becomes less effective in stimulating creative
work, which may be the case, for example, when technical improvements facilitate
unauthorized copying. Whether the effects which dictate increase in protection prevail
over those that dictate a decrease an empirical question and the answer is likely to be
different for different types of works.
Box 5: Outline of the model applied in Pollock (2007), extended to examine the
effect of a technological change that increases access to new and existing works
Structure of the model
As in Landes & Posner (see Box 4), all aspects of the strength of copyright are captured
in a single variable , with greater representing stronger protection. 84
The number of first-expressions produced
depends upon the strength of protection ,
the cost of authorised reproductions , and the cost of unauthorised reproductions by
third-party copiers . That is,
, with
for small ,
and
for sufficiently large ;
; and
(subscripts represent (cross) partial
derivatives).
Once produced, each work contributes welfare to society, depending upon the level of
copyright protection. Less protection results in greater access and consumption, and thus
a greater welfare contribution. The welfare from all individual works is aggregated, giving
total welfare
as a function of the strength of protection , authorised reproduction costs
, unauthorised reproduction costs , and the number of works . Total welfare is
therefore expressed as
, with
(welfare decreases as copyright
protection increases);
(welfare declines as reproduction costs rise);
(welfare increases with new works); and
(diminishing returns from new works).
Optimal copyright protection as technology improves
Pollock establishes a relation between optimal protection
84
and an exogenous variable
In the context of this study, stronger copyright protection can be taken to imply fewer/weaker exceptions.
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which affects the welfare function either directly or through its effect on production . He
⁄
shows that starting from a finite optimal level of protection,
, if
is
positive then an increase (decrease) in the variable implies an increase (decrease) in
⁄
the optimal level of protection. Substituting with , it follows that if
,
then an improvement in technology of unauthorized originals implies an increase in the
optimal level of protection. The converse holds as well.
In order to study the effect of changes in costs of reproductions (due to technology
improvements) on optimal protection, Pollock assumes that the technological progress, ,
reduces the costs of authorized and unauthorized reproductions of originals in the same
direction (
), but does not direcly impact welfare. Thus total welfare can be
written as
. In order to
establish the direction of a change of optimal level of protection Pollock takes the cross
derivative, and obtains:
Pollock signs the terms of the expression above and it is clear that they the sign of the
derivative cannot be unambiguously established. It follows that we cannot unambiguously
conclude whether the optimal level of protection decreases or increases in response to a
technology improvement. For details on how the terms are signed we refer the reader to
the original paper and proceed now to our extension of Pollock’s analysis.
An extension for technological change that improves access
Consider a technological change that improves a user’s access to both new and existing
works. We denote this change
(as in access improvement) and it enters the welfare
function both directly and via the production of new works. Therefore, we write
, with
; and
.
We proceed by taking the cross derivative of the welfare function in order to study the
direction of the optimal change of copyright protection level. We obtain
If this expression is negative (positive), the optimal level of protection decreases
(increases) with technological advances.
We do not have a strong prior on the sign of
. A negative sign means that a marginal
improvement in the state of technology contributes to welfare increasingly as protection
marginally decreases. One reason for why this might be the case is in the increasing
transaction costs of licenses needed for digitalization and migration of content into digital
forms and across different devices at higher levels of copyright protection. This might
restrain the effect of an increase in technology level, for a given number of works. On the
other hand,
will be positive when a marginal increase in the level of technology
contributes to welfare increasingly as the level of protection marginally increases. This
might be the case, for example, when additional participation of rightholders is needed to
best leverage improvements in technology for existing works (if the rightholders will be
best placed to migrate existing works to formats tailored for new platforms and they will
be more willing to participate as the level of protection increases).
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is positive because of the demand expansion effect that new technologies bring about.
is negative because increasing reduces welfare from each individual work. Thus
increasing the number of works increases the negative effect on welfare
is positive -- higher level of protection increases the number of works.
We expect
to be positive. Given , the contribution of a marginal increase in the body
of works, , to welfare increases with . This is because the costs of storing and
consuming a marginal work for consumption at times of low opportunity costs decrease
with improvements in technology.
We do not have a strong prior on the sign of
. It will be positive when a marginal
increase in the level of protection contributes increasingly to incentives to create work as
technology marginally improves. This might be the case if, for example, technology
improvements are most effective in stimulating new work when combined with stronger
copyright. In other words, higher protection is required to best leverage the incentive for
creative work that increased demand brings about. On the other hand, it may well be
negative, if the demand expansion effect on the number of new works dominates and
demand is best stimulated at low levels of protection. This shows that we cannot conclude
on the basis of theory alone on whether the level or protection should increase or
decrease in response to a technology improvement.
Source: CRA and Pollock (2007)
4.3.
Market power and efficient allocation of production
234.
While access to creative work is typically obtained in a market-mediated transaction
(purchase), once accessed, many limited uses of creative works are permitted as
exceptions without requiring the explicit consent of the author. Citing a passage in an
article in order to illustrate an idea or to criticize it is such an example. Here, the author of
a new work has to pay for the access (or arrange it through an institution which pays for
him) but would not have to seek consent from the original rights holder in order to cite the
pertinent passage from the work. Transaction costs and other reasons for market failure
appear to be a robust rationale for such an arrangement.
235.
On the other hand, we can also think about exceptions in terms of limited access, rather
than limited use of a creative work. One example might be the copying by a student of a
single chapter of a graduate textbook for the purpose of preparing for an exam or a
copying of one chapter by a teacher in order to teach a topic. The question is whether
there are good reasons to allow the student or the teacher to copy and distribute that
single chapter without an explicit consent of the author. From the point of view of
economics, the reasons for exceptions must again be sought in missing markets or
market power. It might be that, due to transaction costs or technological constraints, the
author (or his publisher) would not offer a single chapter for purchase (printing and selling
single chapters may not be justified from a business perspective). In such circumstances,
a user may be willing to pay a sum less that the full price of the book to the author and the
rightholder might be willing to accept such sum and consent to the use – but transaction
costs and technology constraints prevent them from entering into such a transaction. An
exception might then be justified, even though it can be shown that it is likely to harm the
producer, to at least some small extent. Another reason for an exception, of course, is to
limit market power of the rightholder.
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Framework for analysis
236.
Yoon (2008), building on the work of Miceli and Adelstein (2005), presents a model in
which consumers access original reproductions and fair-use copies of a work. Copies are
assumed to be of a weakly inferior quality compared with the original, and fair use is
characterised as a quality threshold for permissible copies. The regulator’s objective is to
set the optimal fair use threshold that maximises social welfare.
237.
In the model, a consumer may obtain a copy of the work either by purchasing from the
producer at the market price, or by copying and incurring the copying cost (homogenous
across consumers). The consumer’s benefit derived from the work depends upon the
quality of the version obtained and his quality preferences. Originals, purchased from the
producer, are always of quality 1; whilst copies may be made at any quality between 0
and 1, as chosen by the consumer. Although all consumers enjoy the same marginal
return to quality, each consumer has an individual satiation point after which any quality
improvement does not increase their benefit. These consumer satiation points are
distributed uniformly across the 0 to 1 quality range. Figure 2 portrays the consumer
benefit in terms of quality of the version consumed for two example consumers.
238.
Miceli and Adelstein illustrate this point with the example of a specialist text book. Whilst
students are completely satisfied with a partial copy comprising just those sections
pertinent to their study (consumer 1 in Figure 2), practitioners in the field prefer the work
in its full, published, form (consumer 2 in the figure).
Consumer
Benefit
Figure 2: Consumer benefit and copy costs in terms of quality of the version
consumed
Max Benefit 2
Consumer 2
Cost of Copy
Max Benefit 1
0
Consumer 1
Satiation
Quality 1
Original
Quality
(=1)
Quality
Source: Adapted from Miceli & Adelstein (2005)
239.
The cost to the consumer of self-producing a copy also depends upon the quality chosen
(portrayed by the red line in Figure 2). All consumers have the same marginal cost of
quality, which is assumed to be strictly greater than the marginal reproduction cost of the
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original producer. Therefore, the producer always has a cost advantage in reproduction of
quality 1 (the only quality he produces), but consumers can make lower quality copies at
a lower cost. Additionally, the original producer must incur a fixed cost to produce the first
instance of the work, prior to any consumption. To ensure that the first instance of the
work is produced, the producer must have the expectation that this cost can be
recovered. Therefore, the profit level in equilibrium must be sufficient to cover this cost.
240.
The model results in three categories of consumers:
1. Those with lower than fair use satiation point, who produce optimal quality copies
at a cost lower than the market price;
2. Those with a higher than fair use satiation point, who produce sub-optimal quality
copies, bound by fair use, at a cost less than market price; and
3. Those with a higher than fair use satiation point, who purchase an original
reproduction from the producer at the market price.
241.
The producer’s problem is therefore to set a price for originals that allows recovery of their
investment, whilst accounting for some degree of ‘competition’ from self-produced fair-use
copies. Examining the producer’s decision, Yoon characterizes two equilibrium ‘regimes’,
depending on the interplay of copying costs and allowable exceptions quality (see Figure
2 and Box 5 for details).
242.
The first regime applies whenever the allowable fair-use quality is sufficiently low as to
offer the producer at least some degree of market power (in Figure 4 this is for
Under this regime, the producer sets price to maximise profit, accounting for the loss of
some consumers to the fair-use alternative.
243.
Regime 2, on the other hand, applies when the allowable exception quality is sufficiently
high so as not to constrain copying behaviour (
. Under this regime, replication of a
work is undertaken as if no copyright protection existed, and the degree of copying is selfregulated by its cost in relation to the price of an original. Producers are forced to price
originals taking account of the competitive constraint posed by the (less efficient) selfcopyists.
244.
The following sub-sections highlight the implications of Yoon’s modelling for producers
and for overall welfare.
All exceptions affect the producers to some degree
245.
Applying this model, Yoon finds that any exception to copyright will constrain the producer
to at least some degree, having an unambiguously negative effect on producer’s profits.85
246.
85
Assuming ‘full copyright’ protection, the monopolist producer selects a price to maximise
his profit, resulting in a ‘threshold’ satiation quality below which consumers do not buy. On
a cursory examination, it would seem intuitive that any exception applicable only to copies
of a below-threshold quality would have no impact on the revenues of producer. Absent
This is not generally true. In case there is no market for certain exempted use, perhaps due to prohibitive
transaction costs, exceptions might indeed not harm the rightholder. In principle, two conditions must be
satisfied for an exception not to be harmful to rightholders: 1) there is no market for the exempted use, 2) there
is no substitution between the exempted use and the uses for which there are markets. In the context of the
model discussed here, a copy is always (an inferior) substitute for an original, for which a market exists.
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the exception no purchase would be made by the target users anyway due to the
monopolistic pricing of the work.
247.
However, Yoon shows this to be fallacious by considering the spill-over effect of the
exceptions on the purchase decision of supra-threshold users.86 He assumes (as is
standard) that the purchaser seeks to maximise their surplus as opposed to their absolute
benefit. That is to say, they weigh the benefit they gain against the cost they expend
when making their purchase decision. Therefore, whilst a supra-threshold user may enjoy
a positive net-benefit from the full-quality purchased version, it is possible that they might
enjoy a larger surplus from the lower-quality, lower-cost copy allowed by the exception. In
this case, the supra-threshold user will switch from being a purchaser to a copier under
the excepted use, thus reducing the producer’s revenues. Even if the monopolist can
respond with an increased price for remaining customers his total revenues will
necessarily diminish. Since the monopolist was free to price at this level previously it is
necessarily sub-optimal to do so.
248.
Figure 3 portrays the intuition for this pricing constraint graphically. Arrow (a) highlights
the consumer surplus gained from a self-produced copy, of the quality permitted by the
exception; whilst arrow (b) highlights the consumer surplus from an original, purchased at
the market price. It is clear that the producer wishing to sell to the consumer portrayed in
Figure 3 must set price such that surplus (b) is at least as large as (a). For a more
rigorous and technical treatment, please refer to
Box 6: Outline of the model applied in Yoon (2008)
Structure of the model
Various qualities of the work are captured by the quality index
[ ]. Original
reproductions are of quality
, but consumers may self-produce copies at any quality.
Moreover, all consumers enjoy a homogenous return to quality , but each consumer has
a heterogeneous satiation quality (their ‘type’) ̅ after which they attain no additional
benefit. Consumer benefit, in terms of quality, may therefore be expressed as:
{
̅
̅
̅
The producer incurs a variable cost of for supplying original reproduction. The cost to
consumers for self-producing a copy depends upon the chosen quality level. Given a
constant marginal cost of quality , a copy of quality costs the consumer
. It is
assumed that
, such that the producer enjoys an advantage in original-quality
copies; and that the consumer finds copying beneficial for at least some quality range.
Exceptions (fair use, in Miceli & Adelstein’s parlance) are defined as a threshold of
allowable quality for a self-produced copy, . That is, copies of a quality
are
prohibited, and perfect enforcement is assumed.
Equilibria
Assume first that the monopolist provides the work at quality
, and that the selfproduction of copies is not feasible. In this case, the profit maximising outcome is at:
86
By ‘full’ copyright we mean sufficient protection to prevent any un-authorised copying, with no exceptions.
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price
; quantity
; and profit
.
Next, consider the case in which it is both permissible and feasible to self-produce copies
of any quality. Given
, any consumer choosing to make a copy will do so at their
satiation quality ̅. Moreover, the consumer chooses to purchase an original reproduction
if
̅
̅. Therefore, the producer selects price to maximise
,
resulting in outcomes:
price
; quantity
; and profit
.
Finally, consider the case with exceptions permitting some feasible quality of selfproduction. Consumers of type ̅ [
] will self-produce at quality ̅ if they choose to
copy, thus they purchase an original reproduction only if ̅
̅. However,
consumers of type ̅
] will self-produce at quality
, in compliance with the
exception. Thus, they purchase an original reproduction only if
̅
.
Considering the producer’s profit maximisation decision in light of this, Yoon identifies two
regimes for the equilibrium outcome:
(1) price
; quantity
when
; and profit
; and
(2) price
; quantity
; and profit
where
is the quality level such that
regimes (1) and (2).
when
;
, leaving the producer indifferent between
Consider now the equilibrium outcome in the case with exceptions. Yoon notes that
consumers of type ̅ [
] will purchase an original reproduction only if
̅
,̅ and that those of type ̅
] purchase an original reproduction only if
̅
. Rearranging, this gives the threshold price for consuming an original
reproduction of:
{
̅
̅
̅
̅
[
[
]
]
Recalling that
at the allowable exception quality level, and that consumer types
̅
, it is easily shown that demand for original reproductions is given by:
{
Firstly, these functions confirm the intuition that a demand from consumers of type
] is indeed constrained by the cost of copying, as would be expected. As copying
̅ [
cost declines, so does the demand for original reproductions from these consumers.
Most significantly, thought, they also show that both price and demand are constrained by
].
the cost of copying and allowable quality threshold for consumers of type ̅ [
Again, it is clear that demand for original reproductions declines with copying cost.
Moreover, since
by assumption, demand also declines as the quality threshold
increases.
Finally, we briefly consider the effect of copying costs and quality thresholds on the
producer’s profits. The profit function
shows that for
, profits are independent of
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the quality threshold. At this point, the allowable copy quality is so high that it no longer
presents a binding constraint. Profits do, however, remain positively related to the cost of
copying.
Again, more significant is the effect of
on profits in the case of profit function , where
it does pose a constraint. Taking the first derivative of the
function with respect to
it
may be observed that increased
has an unambiguously negative effect on producer
profits for any
.
For a discussion of the intuition behind each of these results, please see the main text.
249.
.
Consumer
Benefit
Figure 3: Price is constrained by the option to self-produce a fair use copy
Consumer surplus
from purchased version
Consumer Benefit
(b)
Cost of Copy
Price
Consumer surplus
from exception copy
(a)
0
Exception
Quality
Satiation
Quality
Original
Quality
(=1)
Quality
Source: CRA.
The optimal level of exceptions depend upon the cost of copying
250.
Recent advances in digital technologies have resulted in a rapid decline in the cost of
self-producing copies, raising the question of an appropriate regulatory response.
251.
We consider here the context of an individual creative work (as opposed to the body of
works considered by Landes & Posner, and Pollock). Yoon (2008) examines the optimal
exception quality as the cost incurred for a self-produced copy varies. His analysis,
reproduced in Figure 4 and Box 5, highlights a switch in the dominant force driving
optimal quality as copying costs fall. For high copying costs (in the figure this represents
), optimal quality is determined by allocative efficiency concerns; whilst for low
copying costs (
), the dominant effect becomes the dynamic incentive to produce.
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252.
Also highlighted is a sudden downward shift in the optimal exception quality, caused by a
switch in the optimal production regime at cost
. Working through Figure 4 (from
right to left), we examine the envelope for the optimal exception quality as copying costs
decline. The red-highlight indicates the socially optimal path.
253.
Firstly, region (a) reflects the range of copy costs for which production according to
regime 2 (copyists unconstrained by copyright) is socially optimal. To induce this,
exceptions should allow for a quality of (at least)
, the minimum required to make
producers indifferent between regimes 1 and 2. Furthermore, as copying costs decline it
is optimal to increase the allowable quality level. This reflects the fact that yet higher
qualities may now be self-produced at a cost lower than the price of an original. The
social optimum that achieves this is based on an efficient allocation of replication
technology. That is to say, any consumer willing to accept a quality level that can be selfproduced for less than the price of an original is free to do so.
254.
Moving to region (b), we observe the range of copying costs for which production
according to regime 1 becomes socially preferred. The switch in optimal regimes occurs
due to falling producer profits under regime 2 as the cost of copying declines. At the point
where profits no longer support the recovery of the original investment in creating the
work (intersection of lines
and ), the allowable exception quality must be reduced to
a level
, so as to reduce self-production and stimulate demand. Maintaining the
higher allowable quality ( ) at the same time as copying costs fall would lead to the work
not being created. The maximum quality allowable to ensure the continued creation of
new works is
(the upward sloping line in Figure 4).
255.
However, the producer will set prices and output according to regime 1 for any
.
Therefore, in search of the social optimal path, we consider the welfare maximising
exception quality under regime 1. This trades-off the deadweight loss from monopolistic
price setting with that of inefficient self-production by consumers, militating for a further
decline in the allowable quality. This leads to the break and downward shift of the optimal
path observed between regions (a) and (b). Having adjusted the allowable exception
quality down to the regime 1 welfare-maximising level of
it is again optimal to
increase the allowable quality as copy costs decline. As before, this is in recognition of
the allocative efficiency gains that result from employing the least-cost replication
technology.
256.
These allocative efficiency concerns continue until copying costs fall to the level , at
which point the socially optimal choice of allowable exception quality is dominated by the
producer’s production incentives. This is highlighted in Figure 4 as regions (c) and (d).
The curve
indicates the maximum allowable quality to ensure that producer profits at
least cover the work’s fixed development costs. This curve is increasing in copying costs,
as these will themselves provide a constraining factor on self-production and thus
preserve producer demand. For copying costs
, both regimes 1 & 2, considered
previously, demand a quality level in excess of . Were exceptions of this quality to be
permitted, the producer would have no incentive to develop the work and welfare would
be reduced to zero (in this single-work analysis). Instead, it is optimal to allow the highest
quality of exception that preserves the producer’s production incentive. This can be
verified by considering the welfare function under regime 1, which is increasing with
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quality for
. What is more, the allowable quality declines with falling copying
costs to maintain the level of constraint imposed on self-production.87
257.
Finally, we note the changing relationship between the welfare maximising exception
quality (highlighted) and the hypothetical social optimal (dotted curve ). In regions (a),
(b) and (c) the welfare maximising path lies above the social optimal
. This
demonstrates the (sub-optimal) requirement that exceptions be extended to partially
counteract the monopoly power of the producer. In region (d), on the other hand, the
quality level falls below the socially-optimal. This, again, highlights the change in
regulatory priority, from pursuing lowest-cost reproductions to ensuring sufficient
incentives for the work’s initial development.
Quality ( )
Figure 4: Welfare maximising exception quality as cost of copying changes
Maximum exceptions quality
allowing production cost recovery
1
Regime 2 minimum
exception quality
Regime 1 welfare
maximising quality
Socially optimal
Quality (for comparison)
0
Producer’s
Marginal
Cost
Consumer’s Cost of
Copying
Marginal
( )
Benefit
Source: Adapted from Yoon (2008, Fig.4).
Red highlighting indicates welfare maximising levels of allowable quality as cost of copying changes. Note: the
sharp drop in optimal exception quality shown in the transition (from right to left) between regions (a) and (b) is
illustrative only, as the analysis gives no indication regarding the actual magnitude of this shift.
258.
87
Under this framework, declining copying costs require increased copyright protection (i.e.
reduced exception quality) only if the copying costs have fallen significantly, a point on the
left of
in Figure 4. Such a large fall namely implies that without a reduced level of
exceptions, the producer’s profit will fall so low as to prevent production. We emphasise
Note, it is assumed that the producer’s reproduction cost is at all times lower than the self-production cost .
Were this not the case, though, the allowable exception would have to fall to zero at the point when
, else
all consumers will self-produce and the producer will have no production incentive.
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that this analysis is concerned with only an individual title, with a given cost of
development. More generally, as seen in the context of Landes and Posner’s and
Pollock’s models, social optimum does not necessarily require that a particular work be
created.
Box 6: Outline of the model applied in Yoon (2008)
Structure of the model
Various qualities of the work are captured by the quality index
[ ]. Original
reproductions are of quality
, but consumers may self-produce copies at any quality.
Moreover, all consumers enjoy a homogenous return to quality , but each consumer has
a heterogeneous satiation quality (their ‘type’) ̅ after which they attain no additional
benefit. Consumer benefit, in terms of quality, may therefore be expressed as:
{
̅
̅
̅
The producer incurs a variable cost of for supplying original reproduction. The cost to
consumers for self-producing a copy depends upon the chosen quality level. Given a
constant marginal cost of quality , a copy of quality costs the consumer
. It is
assumed that
, such that the producer enjoys an advantage in original-quality
copies; and that the consumer finds copying beneficial for at least some quality range.
Exceptions (fair use, in Miceli & Adelstein’s parlance) are defined as a threshold of
allowable quality for a self-produced copy, . That is, copies of a quality
are
prohibited, and perfect enforcement is assumed.
Equilibria88
Assume first that the monopolist provides the work at quality
, and that the selfproduction of copies is not feasible. In this case, the profit maximising outcome is at:
price
; quantity
; and profit
.
Next, consider the case in which it is both permissible and feasible to self-produce copies
of any quality. Given
, any consumer choosing to make a copy will do so at their
satiation quality ̅. Moreover, the consumer chooses to purchase an original reproduction
if
̅
̅. Therefore, the producer selects price to maximise
,
resulting in outcomes:
price
; quantity
; and profit
.
Finally, consider the case with exceptions permitting some feasible quality of selfproduction. Consumers of type ̅ [
] will self-produce at quality ̅ if they choose to
copy, thus they purchase an original reproduction only if ̅
̅. However,
consumers of type ̅
] will self-produce at quality
, in compliance with the
exception. Thus, they purchase an original reproduction only if
̅
.
Considering the producer’s profit maximisation decision in light of this, Yoon identifies two
88
Yoon’s results are stated here with a minimal explanation. For a full derivation of each equilibrium please refer
to Yoon (2008).
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regimes for the equilibrium outcome:
(1) price
; quantity
when
; and profit
; and
(2) price
; quantity
; and profit
where
is the quality level such that
regimes (1) and (2).
when
;
, leaving the producer indifferent between
Consider now the equilibrium outcome in the case with exceptions. Yoon notes that
consumers of type ̅ [
] will purchase an original reproduction only if
̅
,̅ and that those of type ̅
] purchase an original reproduction only if
̅
. Rearranging, this gives the threshold price for consuming an original
reproduction of:
{
̅
̅
̅
̅
[
[
]
]
Recalling that
at the allowable exception quality level, and that consumer types
̅
, it is easily shown that demand for original reproductions is given by:
{
Firstly, these functions confirm the intuition that a demand from consumers of type
] is indeed constrained by the cost of copying, as would be expected. As copying
̅ [
cost declines, so does the demand for original reproductions from these consumers.
Most significantly, thought, they also show that both price and demand are constrained by
].
the cost of copying and allowable quality threshold for consumers of type ̅ [
Again, it is clear that demand for original reproductions declines with copying cost.
Moreover, since
by assumption, demand also declines as the quality threshold
increases.
Finally, we briefly consider the effect of copying costs and quality thresholds on the
producer’s profits. The profit function
shows that for
, profits are independent of
the quality threshold. At this point, the allowable copy quality is so high that it no longer
presents a binding constraint. Profits do, however, remain positively related to the cost of
copying.
Again, more significant is the effect of
on profits in the case of profit function , where
it does pose a constraint. Taking the first derivative of the
function with respect to
it
may be observed that increased
has an unambiguously negative effect on producer
profits for any
.
For a discussion of the intuition behind each of these results, please see the main text.
Source: Adapted from Yoon (2008)
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5.
259.
5.1.
POLICY INSIGHTS FROM THE ANALYSIS
In this section we summarize the main policy implications from our analysis, roughly
grouped according to the three market failures that exceptions potentially address.
Transaction costs
260.
Exceptions are likely to be justified when transaction costs persistently prevent mutually
beneficial trade. This is a case of missing markets and in such circumstances exceptions
are likely to result in a Pareto improvement.
261.
However, before enacting exceptions aimed at such a fundamental market failure, our
analysis suggests it should be investigated whether innovative market solutions will
appear in the foreseeable future that are likely to solve the problem. A market-based
solution is often more efficient socially as it allows both the authors and users to
“negotiate” transfers thus supporting efficient allocation of creative works in valuable uses
and efficient levels of creative efforts.
262.
Moreover, before enacting new exceptions it should be considered whether transaction
costs could be reduced by legislating certain obligations, like compulsory registration of
rights for certain classes of creative works.
263.
Technological advances reduce some transaction costs, and a reduction in transaction
costs tends to reduce the optimal scope for exceptions for at least two reasons. First,
with lower transaction costs, it may very well be that transactions which would otherwise
not have taken place become feasible. For instance, if the Internet allows for a more
efficient matching between owners and users, it may be appropriate not to enact new
exceptions because this could prevent the rightowners to obtain revenues which
contribute to their incentives to create socially valuable works. Second, lower transaction
costs will allow for greater price discrimination by the copyright owner and will reduce the
inefficiencies induced by market power.
264.
However, technological advances enable some uses of copyrighted material which
require access to a large number of pieces of copyrighted material. At the same time,
access to an individual piece of such material contributes little to the otherwise significant
total value of the aggregate use. This means that transaction costs of licensing for each
individual piece of copyrighted material will be significant relative to its value. In such
circumstances it is not apparent that the advances in technology remove the need for
exceptions – they may rather increase it. In fact, exceptions may be needed in order to
overcome technological constraints to enable an otherwise lawful use of a part of an
expression which may not be protected by copyright (and indeed to some extent this has
been recognized in Article 5 of the 2001 Information Society Directive). Such exceptions
can be rationalized through transaction costs, missing markets, but also through the
limited protection that copyright grants (in which case the exception would just be an
explicit delineation of the already existing limit to copyright).
265.
The hold-up problem, which can be a consequence of transaction costs (e.g. due to the
sunk nature of search costs), represents another potential problem which has to be
considered in the assessment of exceptions. When present, the hold-up problem might
further strengthen the case for exceptions.
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5.2.
Market power, productive efficiency and the trade-off between access
and incentives for creative work
266.
Assuming that transaction costs do not prevent (imperfect) markets to form, in the
presence of market power and when price discrimination is not feasible, one might still
consider changing the scope of exceptions as costs of unauthorized and authorized
reproductions decrease with technological advances. However, there are opposing
effects simultaneously at play and, overall, the argument that the advent of electronic
copies (which reduce the cost of production) should lead to a reduction in copyright
protection cannot be supported on the basis of our theoretical analysis alone.
267.
Technological advances also effectively expand the consumption possibilities of the users
(for instance, portable music players allow for the consumption of a greater variety of
music in a wider set of circumstances). And these advances allow the users to obtain
higher utility from consumption of individual works. The two effects, in turn, increase the
potential revenues of rightholders and thus the number of different works created. Insofar
as the scope of exceptions interacts with technological improvements to determine the
ways in which works get consumed and produced, there may be a case for changing
them in the view of technological advances. However, again, there are opposing effects
simultaneously at play. Because of this, the argument that the advent of new ways of
consumption of copyrighted works warrants new exceptions cannot be supported on the
basis of our theoretical analysis alone. When enacting new exceptions it should be
considered whether these will adversely affect the incentives of rightholders or
intermediary distributors to produce new content specifically for newly emerged media
platforms and their participation in efficient format shifting as well as in new modes of
distribution.
268.
Having said this, there may be a case for exceptions when they allow for the development
of product qualities that a rightholder could not produce himself due to transaction costs
and technological constraints, while simultaneously constraining the market power of the
rightholder. An example would be an exception which allows for a limited copying of a
small part of text-books for the purpose of education. However, this result, obtained in a
model which abstracts from competition between different authors, should not be
stretched too far. The test for exceptions should involve establishing that market power
results in a significant part of the market not being served, there being significant demand
for partial (imperfect) copies of the original which the rightholder cannot offer and,
importantly, establishing that exceptions will not significantly affect the incentives of the
authors for creative work.
269.
Rather generally, exceptions which are not costly to administer and significantly reduce
the costs of creative work but do not significantly reduce the (potential) revenues (or
rather the incentive) of rightholders will more likely be justified from a social point of view.
These are exceptions for uses for which no (or poorly functioning) markets exist and
which are aimed at “transformative” creative work (or use), that is, at creation of new work
which has to “borrow” from previous work and is only an imperfect substitute to the
existing work.
5.3.
270.
Externalities
In order to identify the circumstances in which the externality problem is acute, it is
important to ask whether external effects arise from the ideas associated with a creative
work or the expression of these ideas. If these effects are deemed to be associated with
ideas (which are not protected), an increase in the scope of exceptions would not be
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necessarily justified, since the ideas and information embodied in creative works can be
used and freely disseminated.
271.
The implementation of exceptions meant to solve the anti-commons problem may reduce
the incentives on the part of the rightholders to participate in the efficient provision of
access to potential users of their copyrighted material and it is worth asking whether other
market mechanisms cannot overcome the anti-commons problem. For instance,
collecting societies (which aggregate complementary rights), or direct multi-lateral
contracting could potentially solve the issue (in particular as transactions costs would fall).
272.
Our analysis also suggests that it should be established whether the externality can be
expected to be internalized through private negotiations and the creation of new private
market institutions in the near future.
5.4.
273.
Exceptions assessment chart
The chart below portrays some of the inherent economic trade-offs associated with
deciding whether or not to implement specific copyright exceptions. We emphasize that
this chart does not include any of the non-economic, yet relevant, considerations.
Considering the many questions a copyright exception would raise, this table’s objective
is not to “approve or deny” an exceptions case but merely to catalogue some of the most
relevant considerations that we believe should be taken into account.
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Figure 5: Decision Information Chart
Q1
Yes
Are transaction costs
negligible relative to
the value of content?
Weakens the case for exceptions overall
Strengthens the
case for exceptions
Weakens the case
for exceptions
Is it likely that the markets will form
in the future?
No
Yes
Are there significant positive
externalities?
-
No
-
Yes
The way the idea or
factual information is
expressed
Ideas and factual
information1
-
No
Can the rightholders effectively
price discriminate?
No
Yes
Do the authors respond to
monetary incentives?
No
Yes
No
Yes
No
Yes
No
Yes
Yes
No
No
Q 2.a
Are there missing markets?
Yes
No
Yes
Can the externalities be expected
to be internalized in the market?
No
Source of the externality:
Q 2.b
Do the rightholders have
significant market power?
Yes
Does a derivative work have a
negative impact on the market for
the original?
Need for participation of copyright
holder? 2
Can the copyright owner or
distributor make reproductions
more efficiently?
Q3
Will exceptions reduce the
cost of "transformative" use
(including in new services)? 3
Source: CRA.
Notes:
1
On the condition that copyright does not confer market power over ideas.
2
At times participation of rightholders in format shifting for existing work is important. It may be the case that
rightholders will most efficiently format and offer works for different platforms; this is particularly relevant in the
wake of new technology and media.
3
That is, new work which has to “borrow” from previous works and is only an imperfect substitute to the existing
work.
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6.
CONCLUSIONS
274.
Technological advances have resulted in a reduction of the costs of authorized and
unauthorized copying, a reduction of certain categories of transaction costs, and in
opportunities for new uses of creative work. Against this backdrop, calls for new
(broader) exceptions have been made; but suggestions that in fact fewer (narrower)
exceptions are needed have been made as well. Copyright commentators, stakeholders
with opposing interests, policy makers and academics have sometimes taken partial and
diametrically opposing views in the debate.
275.
The objective of this report was to develop a conceptual framework for an assessment of
different trade-offs of new (and existing) exceptions from an economic perspective. In line
with the relevant economic and legal literature, we analyze exceptions as remedies for
different types of inefficiencies in the markets for copyrighted works, and identify their
potential social costs. We argue that, absent clearly identified and persistent market
inefficiencies, exceptions are not likely to be warranted from an economic perspective.
276.
We observe that inefficiencies in the markets for copyrighted work are fundamentally
caused by the existence of significant transaction costs. One justification for exceptions
can thus be found in a reduction of transaction costs for certain uses of copyrighted
material (including some new uses enabled by technological advances), as the need to
obtain licenses for exempted use is removed. In this context, exceptions are particularly
relevant if transaction costs erode the gains of trade between rightholders and potential
users to the extent that markets for these uses do not form (and likely never will);
exceptions then enable some uses without adversely affecting incentives to create new
work.
277.
Transaction costs, even when they do not prevent markets from forming, can be
associated with social loss due to market power, hold-up or due to the presence of some
positive externalities. Our analysis suggests that in these circumstances exceptions may
also contribute to social welfare: they can curb market power, thereby reducing
deadweight loss, and can improve social welfare by promoting wider access to
copyrighted material in the presence of positive externalities. Furthermore, exceptions
can foster productive efficiency by allowing some users to “self-produce” inferior copies of
copyrighted work more efficiently than the rightholder could.
278.
However, our analysis also suggests that policy-makers should take a cautious approach
when considering introducing new exceptions for such reasons: the market power of
rightholders is limited by the inherent limitations in the scope (and length) of copyright
protection and the availability of substitute creative work; and positive externalities may
easily be exaggerated. Furthermore, with technological advances rightholders may
increasingly be able to efficiently offer different, inferior versions of copyrighted work,
obviating the rationale for the users to “self-produce” them. This means that the social
loss due to market power, externalities, or productive inefficiencies, may not be as large
as to justify the social costs of exceptions.
279.
In our framework, social costs of exceptions predominantly manifest themselves in the
form of reduced incentives for creative work and in the form of reduced incentives of the
rightholders and distributors to provide access to existing and new work efficiently.
Moreover, exceptions may stall the development of future efficient markets which
technological advances may soon enable. Clearly, besides the potential benefits, the
policy maker will have to consider the likelihood and the economic significance of these
costs in the assessment of new exceptions.
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KM-03-13-080-EN-N
DOI : 10.2780/90295
ISBN : 978-92-79-29919-3