The Limits of Law & Econ in IP: The Case of Digital Music

Once again, the folks at Truth on the Market have celebrated the recording industry’s efforts to assure perfect control over copyrighted content via Digital Rights Management. Free marketeers like Tyler Cowen are beginning to question DRM as a tax on consumers, and even one of the big four record companies is considering abandoning it. Untroubled by such doubts, Josh Wright and Geoff Manne push for ever more latitude for the dominant platform (iTunes) and dominant content providers (the big four recording companies).

Their posts provide classic examples of what Reza Dibadj has called the key shortcomings of conventional law & economics (L&E) reasoning. As Dibadj summarizes,

[T]hree of the most basic assumptions to the popular L&E enterprise–that people are rational, that ability to pay determines value, and that the common law is efficient–while couched in the metaphors of science, remain unsubstantiated.

Let’s take a look at how each of these assumptions drives the TOTM approach to digital music markets.


1) Robust Rationality Assumptions: Wright is very gifted at the delicate art of burden shifting. If I can’t show concrete, immediate consumer harm arising out of iTunes incompatibility, I can’t criticize it. Consumers are rational, they’ve chosen this platform, DRM and all, and who am I to butt in and interfere with this “market?” Two points in response:

a) Can Consumer Sovereignty Operate in a Cartelized Market?

Of course, we only reach Wright’s result if no attention is paid to network effects, and no one interrogates how iTunes as a platform may merely be an outgrowth of cartel power in the recording industry. There’s a deep irony that a scholar working in the field of antitrust somehow refuses to inquire whether the big four record companies engage in tacit collusion—even when every song on iTunes is sold for the same price! Why not take a look at the HHI for the industry (as I and coauthors did here), and wonder if past antitrust investigations (and at least one pro-FTC finding in the three tenors case) of dominant firms in the recording industry might might lead us to question their ability to leverage their copyrights into effective control over all manner of ancillary markets.

Of course, given the direction of antitrust law over the past twenty years, perhaps none of these activities is challengeable under it. But copyright misuse is an entirely distinct cause of action. So even competitive behavior wholly immune to challenge under the competition laws can be challenged under copyright—as Napster tried to do before it was bought by Bertelsmann (rich irony there), and as Judge Patel approved when she permitted discovery on that counterclaim in the Napster litigation.

b) Can we at least get transparency?

What’s more, the TOTMers even seem hostile to the idea of government helping to “make the market” for DRM. Consider this insight from Ellen Goodman’s exceptionally insightful piece on stealth marketing:

It seems natural that food manufacturers with a relatively good nutritional story to tell would disclose nutritional information. Kraft and Nabisco could then compete on nutritional value or Kraft could use nutritional information to distinguish its premium brands like Progresso. So one might think, and yet the market did not produce widespread disclosure of nutritional information until federal regulation required it. It was the regulation that created a market for nutritional information that now appears to be strong.

So I guess my question for Manne would be: would you at least consider regulation of DRM that made its terms and conditions very clear…and that helped consumers compare rival systems along understandable metrics?

2) Common Law as Deviation from Statute-Based Status Quo

I hate to break it to the laissez-faire crowd here, but IP isn’t exactly the best example of an untrammeled market. The MPAA and RIAA are persistently agitating for rent-seeking legislation. Is Wright against these interventions? It’s odd that regulatory activity to help make markets more friendly for consumers gets trashed immediately as inefficient, but the constant legislative ratchet upward of IP rights never seems to draw fire. Of course, James Boyle has understood this “bipolar economics” very well:

We appear to have a kind of bipolar disorder in our view of the state. When it comes to breaking up high tech monopolies through antitrust, we are deep sceptics. We point out the unanticipated consequences and deadweight losses to state intervention. We say the state is a blundering second or third best to the genius of the market, its efforts to establish limits and quotas will create a mess that even the Invisible Hand cannot sweep clean. But when it comes to setting up some of those same quotas, limits and monopolies in the first place – in this case, by overly broad intellectual property rights that clog the channels of competition and allow companies to leverage their existing property into a control over tied services – we are much more sanguine. This, after all, is “property”, not regulation. Here there seems to be an optimism about unintended consequences, a willingness to believe that vague state regulatory schemes have got it right – even when existing market leaders can twist them to prevent challenges to their position. In one view, the state is a bumbling idiot, in the other a scalpel-wielding genius, carving just the right pound of flesh to satisfy our debts to creators without shedding a drop of the blood of competitors and future innovators. Can this be the same state we are talking about?

Note also how Wright treats the discussion of international norms or the Norwegian attack on Apple’s contrived incompatibility: stony silence. I am always astonished by free marketeers’ supine incuriosity about how other countries manage to build their digital infrastructure. Think about how the recording industry itself forced a compulsory licensing scheme on composers and lyricists. Might a South Korean-style “all you can listen to for a low-fixed-fee” model work for us? Has that destroyed the South Korean entertainment industry? On the contrary, Seoul music and movies are extraordinarily successful. How about a British style “license fee,” like the one that funds the BBC (which is now being deemed an “unfair competitor” by industry!) The orthodox L&E fetishization of complete contractual control over IP appears to be a misguided effort to apply without remainder an assumption of common law efficiency, tenuous elsewhere, to an area where it is completely unsuitable.

3) Ability to Pay: Yu’s International Take on DRM and Anticircumvention

Why is the instinctive “free market” approach to IP issues to devise strategies for dominant firms to maximize revenue? Isn’t a larger issue the fact that people are being denied access to a resource that takes zero marginal cost to reproduce? As soon as we take a broader perspective on the situation, we can see that there are several ways to define “the problem” here. A paper like Randy Picker’s “Mistrust-Based DRM” imagines a world where decentralized enforcement (including the provision of bounties) scares everyone away from sharing songs over P2P networks. This is a great solution if you define the problem as “avoiding unauthorized uses of works.” If you define the problem as persistent deprivation of culture to LDC’s, or the potential stamping out of samizdat, the problem is very different. Consider this careful analysis from Peter Yu:

[I]nstead of providing greater consumer choices and cheaper products, the widespread deployment of DRM systems will generally reduce access to materials that are needed for education, science, and cultural development.

Now, I think one could tell another story: namely, that DRM might allow companies that maximize revenue from the first world to cross-subsidize other operations and not worry so much about “squeezing blood from stones” in the LDCs (though Yu gives several reasons to discount that optimistic scenario.) But regardless of which story plays out, this has to be a major concern in normative analysis. We cannot assume that rising revenues validate a business model when it may well be built on a high margin/low volume approach (or, even worse, amounts to a one-sided privatization of a copyright law that has tried to balance public and private interests throughout its history).

All that I’ve said so far could derive from a general critique of conventional L&E’s inapplicability to IP. We haven’t even begun to address the cultural angle here. Do we want a world where large conglomerates track our every purchase, our name and serial number are burned into every digital file we buy, etc? Do we want to continue subsidizing the hegemony of the big four vis-a-vis competitors who may not be adopting DRM, or have other business models? I’ll try to address these points in posts later this week.

Frank Pasquale

Frank is Professor of Law at the University of Maryland. His research agenda focuses on challenges posed to information law by rapidly changing technology, particularly in the health care, internet, and finance industries.

Frank accepts comments via email, at pasqresearch@gmail.com. All comments emailed to pasqresearch@gmail.com may be posted here (in whole or in part), with or without attribution, either as "Dissents of the Day" or as parts of follow-up post(s). Please indicate in your comment whether or not you would like attribution, or would prefer your comment (if it is selected for posting) to be anonymous.

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13 Responses

  1. Frank, I think this is a pretty disingenuous reading of my post and I will respond over at TOTM later. But for now, please note the following: (1) my post clearly states that its purpose is to evaluate the Norwegian attack from an antitrust perspective; (2) antitrust in the United States has adopted a consumer welfare-based approach of analysis which requires a demonstration of likely or actual competitive harm; (3) your post framed the issue in antitrust terms and thus asks for the consumer harm analysis, not mine.

    What you take as “burden shifting” (“If I can’t show concrete, immediate consumer harm arising out of iTunes incompatibility, I can’t criticize it”) is a statement about the shortcomings of your approach under the antitrust law.

    The rest of your post strikes me as inapposite. I am happy to concede, contrary to the allegations in your post, that it is quite possible that Apple’s conduct harms consumers and thus should be condemned after an appropriate antitrust analysis. My prior is that this is unlikely; but that is a separate issue from claiming that I know the answer to be true and would like to eschew real analysis. If consumers are harmed, lets conduct an analysis appropriately and *THEN* condemn the conduct. That seems to be the right sequence, no?

    As to the argument that consumer welfare is not the appropriate metric for antitrust analysis, I believe that ship has sailed. The point of the post, which appears in the title, is that substitution for non-consumer welfare elements appears to be nothing more than hand waving and imposing one’s own personal policy preference at the cost of consumers. I stand by that proposition.

    P.S. The three tenors case did not find dominance, the case was about an agreement between firms not to compete on price for a 10 week period. This has very little to do w. dominance.

  2. Frank says:

    I just find it intriguing that you dismiss ideas of fairness and other noneconomic judgments of well-being as “nothing more than hand waving and imposing one’s own personal policy preference at the cost of consumers.” I guess we can write off normative political philosophy as emotivist semaphore.

    Fortunately, as Bruce Schneier notes, even DRM’s biggest proponents are beginning to understand that the systems do little, if anything, to add to their bottom line:

    “What the entertainment companies are finally realizing is that DRM doesn’t work, and just annoys their customers. . . . It’s an arms race, and the defenders can’t possibly win.”

    From that fiery hotbed of socialism, Forbes:

    http://www.forbes.com/security/2007/02/10/microsoft-vista-drm-tech-security-cz_bs_0212vista.html

  3. Frank says:

    And a nice point from Wired:

    “[A]nother interesting side effect of losing DRM that hadn’t occurred to me yet: music could become cheaper if DRM goes away, since music fans won’t have to subsidize DRM schemes that will only grow more complicated and expensive over time. Overall, the trend seems to be away from paying people who are in the music business (including those who develop DRM) and, hopefully, towards paying people who are the music business.”

    at

    http://blog.wired.com/music/2007/02/no_drm_could_me.html

  4. Again (and again, and again) I am not dismissing the idea of fairness and other non-economic judgments of well-being altogether or in any sort of global sense (talk about burden shifting). Or political philosophy for the matter. I’m sure both are very useful though I claim no expertise in either. I dismissed them in the field of antitrust, which by the way, has also dismissed them.

    I also dismissed the utility of the notion of replacing consumer welfare with some fuzzy concepts of fairness on behalf of consumers in the antitrust context. If the folks that you quote in those clips are right that various conduct related to DRM actually does harms consumers, my position happily embraces condemning that conduct under the antitrust laws. My priors suggest to me that this is unlikely — and we clearly seem to disagree on this point. But surely even you would agree that consumer welfare metrics should matter to antitrust analysis if you were antitrust king for a day, no?

    However, I made clear in my post that I was rejecting these non-economic judgments in the *antitrust* context. But your comment suggests that maybe it is worth repeating this point and getting on my way.

  5. Bruce Boyden says:

    Frank, this post seems to buck the recommendation I made earlier on this blog:

    http://concurringopinions.com/archives/2006/07/dont_write_angr_1.html

    I’m not sure I get why DRM is so aggravating from a legal standpoint. If as you say it adds little to the bottom line, and only annoys customers, well then it will fade out, won’t it? Restaurants that serve bad food are not a violation of consumer rights, even if you are pretty steamed for having shelled out the money to eat there. Unless, of course, there’s collusion, but that hypothesis would require collusion occurring simultaneously in multiple industries (online music, prerecorded video, computer software, games), and also it’s unclear what would be motivating the collusion–why would industry players collude to provide bad service in return for no benefit? What I suspect is driving the sense of alarm instead is that many are afraid DRM *won’t* fade out, because the benefits to content owners will wind up outweighing the costs in defecting consumers. But the combination of claims that DRM is (a) utterly useless, (b) harmful to consumers, and (c) persistent, strikes me as internally incoherent.

  6. GMUSL 3L says:

    Isn’t a larger issue the fact that people are being denied access to a resource that takes zero marginal cost to reproduce?

    Now Frank, I realize that you’re not too keen on economics, but if you subtract marginal cost from total cost, what are you left with? Hint — it’s not zero, nor is it nothing.

    Moreover, the marginal cost, while negligible is not ZERO. Atoms have a negligible weight that is non-zero; objects comprised of atoms do not have a non-zero weight.

    Costs need not come in monetary varieties either — even free copying is not costless. Time is money, and waiting for massive files to upload or download (and the opportunity cost of that bandwidth) must also be considered.

    Despite what Frank thinks, even in the digital age of IP, the “free lunches” are not cost-free.

  7. Frank says:

    Bruce: Yes, perhaps this is an angry post, but the TOTM folks do not exactly treat me with kid gloves! I’d like a blogosphere that adopts Marquis of Queensbury rules, but until we have it, sarcasm, satire, and exasperation are fair modes of expression.

    (On a more philosophical note, Martha Nussbaum might suggest that emotional tones themselves disclose judgments of value, so a certain tinge of alarm or dismay is not merely gratuitous venting, but essential to conveying the urgency with which one views the situation.)

    As for the points on the inconsistency of saying DRM is “a) utterly useless, (b) harmful to consumers, and (c) persistent,” I don’t see it. I think there are all sorts of situations where we get locked into arms races we can’t control. More to the point, a sheerly economic approach is indifferent to, say, a high margin equilibrium that generates $X profits, and a lower margin (but higher volume) one that generates the same. So one could easily imagine a persistent-but-harmful DRM that persists because its adopters would rather have the proverbial “bird in hand” than two in bush.

    GMU 3L: Yes, and I’ve seen some good points to that effect on the IPCentral blog (on the “fallacy of zero marginal cost”). The question, though, is how to most efficiently to pay the “total cost” plus some reasonable profit. I think William Fisher’s “Promises to Keep” gives the best answer to that question.

    http://www.tfisher.org/PTK.htm

  8. Deven Desai says:

    This comment area seems quite enmeshed in who said what and how. So in the hope of contributing information to both sides I offer this link http://www.chiariglione.org/contrib/060209chiariglione01.htm

    The brief article A Simple Way to Skin the DRM Cat by Leonnardo Chiariglione, chair of the Moving Picture Experts Group (MPEG), responds to Steve Jobs comments on DRM. The article notes that one can manage files and then one can also protect files.

    It seems the key point is that DRM as the music industry uses it fails to capture or serve user concerns. If he is correct, that view seems to undercut the market is working view. He also offers GSM as a DRM that created a huge industry. I am not sure it is apples to apples (no pun intended) but I think both sides may want look at the article to see the full idea.

    Here are some quotes of note

    “The way to go is to have a standard, straightforward, non arcane system like GSM that anybody can practically implement and anybody can use to enjoy the content that they legitimately purchase.

    Let’s suppress the enthusiam and avoid an easy criticism: clearly a DRM standard is a different beast than most other standards. The ways people may want to apply DRM technologies for their needs are countless, starting from the management/protection varieties, continuing with the network/broadcast/unconnected varieties, supporting user privacy etc. It would be really hard to define a “one size fits all” DRM standard.”

    “Twenty years ago the mobile telephony industry barely existed and 10 years ago it was still serving a small élite community. By cleverly designing a standard – GSM – that accounted for user concerns – DRM – the mobile telephony industry has become global, multiplied its size by orders of magnitude and is poised to become the first digital technology affecting each of the six billion humans on the Earth. While getting rich that industry has made billions of people happy. In contrast with this the music industry, because of the absence of a standard that accounted for users concerns – DRM – has shrunk in size, punished its stakeholders and made millions of people unhappy.”

  9. Harry Gerla says:

    Frank:

    Very nice post. You forgot one of the key assumptions of the neoclassical law and economic types. If an actor can’t ring every last penny of rents out of an innovation, they will not bother innovating. That is a testable proposition, not a postulate. Aside from the fact that the proposition may not be true empirically, the neoclassicists use it to justify all sorts of practices that have the demonstrated effect of transferring income from buyers (consumers) to sellers (producers) under the guise of enhancing “consumer welfare.”

  10. Matthew Sag says:

    We should think about DRM the same way we (should) think about other property rights based solutions. Property rights are often an efficient solution because they reduce transaction costs – however there comes a point where further ratcheting up the scope of property rights has more costs than benefits.

    If Apple wants to drop DRM, that might be some evidence that we have reached that point.

    See Beyond Abstraction, The Law And Economics Of Copyright Scope And Doctrinal Efficiency

    81 TULANE L. REV. 187 (2006) for my further thoughts on this topic.

  11. Matthew Sag says:

    We should think about DRM the same way we (should) think about other property rights based solutions. Property rights are often an efficient solution because they reduce transaction costs – however there comes a point where further ratcheting up the scope of property rights has more costs than benefits.

    If Apple wants to drop DRM, that might be some evidence that we have reached that point. See Beyond Abstraction, The Law And Economics Of Copyright Scope And Doctrinal Efficiency

    81 TULANE L. REV. 187 (2006) for my further thoughts on this topic.

  12. Matthew Sag says:

    We should think about DRM the same way we (should) think about other property rights based solutions. Property rights are often an efficient solution because they reduce transaction costs – however there comes a point where further ratcheting up the scope of property rights has more costs than benefits.

    If Apple wants to drop DRM, that might be some evidence that we have reached that point. See Beyond Abstraction, The Law And Economics Of Copyright Scope And Doctrinal Efficiency

    81 TULANE L. REV. 187 (2006) for my further thoughts on this topic.

  13. It’s rather odd to suggest that the identical cost of songs on iTunes is evidence of “collusion” when it’s well known that the record companies want to charge different prices; it’s Apple that won’t agree to do so.