The Economics of Copyright

The basic tradeoff of copyright law is well-understood: It seeks to encourage investment in creation and dissemination of new works, by providing protection of intellectual property. But what is the economic evidence on whether the amount of protection provided correct and appropriate?  Ruth Towse provides a nice overview in \”What We Know, What We Don\’t Know, and What Policy-makers Would Like Us to Know About the Economics of Copyright,\” appearing in December 2011 issue of Review of Economic Research on Copyright Issues.

As Towse writes: \”Governments the world over are looking for evidence on the economic effects of copyright law, the more so since the increased emphasis in government growth policy on the role of the creative industries has led to the justification of copyright as a stimulus to the economy. What they usually get in response to calls for evidence are persuasive statements from stakeholder interest groups that have sufficient funds for lobbying.\” Here are some lessons that Towse draws from the existing evidence:

Copyright terms are too long
\”Almost all economists are agreed that the copyright term is now inefficiently long with the result that costs of compliance most likely exceed any financial benefits from extensions (and it is worth remembering that the term of protection for a work in the 1709 Statute of Anne was 14 years with the
possibility of renewal as compared to 70 years plus life for authors in most developed countries in the present, which means a work could be protected for well over 150 years).\”

Extending copyright protection retroactively never makes sense
\”One point on which all economists agree is that there can be no possible justification for retrospective
extension to the term of copyright for existing works since it defies the economic logic of the copyright incentive, something that nevertheless has been enacted on several occasions. … Perhaps the most notorious case was the CTEA (Sonny Bono or Mickey Mouse) extension in the USA [the Copyright Term Extension Act of 1998] which was also followed up by the European Union, thereby handing out economic rents to the rich and famous of the entertainment world and, more likely, to their descendants.\”

Copyright is too one-size-fits-all
\”[T]he scope of copyright is very broad and nowadays covers many items of no commercial value that were never intended to be commercialized, as is the case with a great deal of material on social-networking sites. This raises the question of the incentive role of the scope of copyright since it offers the same ‘blanket’ coverage for every type of qualifying work. In general, the lack of discrimination in this ‘one-size-fits-all’ aspect of copyright is another subject on which economists are agreed: in principle, the incentive should fit the type of work depending upon the investment required, the potential durability of the work and so on – computer software and operas do not have much in common. This applies as much to the term as to the scope of copyright; some works retain their value over a very long period while others lose it very quickly. The rationale for this lack of discrimination, however, is that ‘individualizing’ incentives would be prohibitively costly both to initiate and to enforce. As it is, that copyright is recognized to have become excessively complex and therefore very costly for users and authors.

Copyright will often be managed collectively
\”For many rights, such as the public performance right, individual authors and performers cannot contract with all users and the solution is collective rights management. That minimizes transaction costs for both copyright holders and users of copyright material but introduces monopoly
pricing and blunts the individual incentive — another trade-off. … Most economists agree that collective rights management is necessary in those circumstances in order for copyright to be practicable.\”
Only superstars profit much from copyright
\”Research on artists’ total earnings including royalties shows hat only a small minority earn an amount comparable to national earnings in other occupations and only ‘superstars’ make huge amounts. Copyright produces limited economic rewards to the ‘ordinary’ professional creator; on the other hand, what the situation would be like absent copyright protection cannot be estimated.\”

Copyright can encourage protecting rents ahead of actual creativity
\”[E]conomists have long had concerns that copyright has a moral hazard effect on incumbent firms, including those in the creative industries, by encouraging them to rely on enforcement of the law rather than adopt new technologies and business models to deal with new technologies. … It is well-known that creative industries have spent huge amounts of money lobbying governments for increased copyright protection both through strengthening the law and stronger enforcement, not only
within national boundaries but also through international treaties.\”

A Policy Proposal: Renewable Copyright
\”Copyright could be become more similar to a patent by having an initial term of protection of a work, say of 20 years, renewable for further terms. …  The advantage of this is twofold: it enables a ‘use it or lose it’ regime to function and, more relevant to the economics of copyright, it enables the market to function better in valuing a work (the vast majority of works, as we know, are anyway out of print because they are deemed to have no commercial value while the  copyright is still valid); knowing that renewal would be necessary would also alter contractual terms between creators and intermediaries, thereby improving the efficiency of contracting and the prospect of fairer contracts.\”

In my own Journal of Economic Perspectives, Hal Varian wrote a nice article on \”Copying and Copyright\” in the Spring 2005 issue. Hal discusses useful insights about the appropriate height, width, and length of copyright, and how the existence of copyright affects pricing decisions. I found especially memorable and amusing his pocket overview of the U.S. history of copyright: that is, ignoring foreign copyrights through much of the nineteenth century, because there were relatively few U.S. authors with an international reputation to protect, and pirating works from the United Kingdom was free. Here\’s Varian (footnotes omitted):

\”The U.S. Copyright Act of 1790 was modeled on the Statute of Queen Anne, and it offered a 14-year monopoly to American authors, along with a 14-year renewal. Note carefully the emphasis on American. Foreign authors’ works were not protected by the American law. In contrast, many other advanced countries, such as Denmark, Prussia, England, France and Belgium, had laws respecting the rights of foreign authors. By 1850, only the United States, Russia and the Ottoman Empire refused to recognize  international copyright.

\”The advantages of this policy to the United States were quite significant: it had a public hungry for books and a publishing industry happy to provide them. A ready supply of market-tested books was available from England. Publishing in the United States was virtually a no-risk enterprise: whatever sold well in England was likely to do well in the United States. 

\”American publishers paid agents in England to acquire popular works, which were then rushed to the United States and set in type. Competition was intense, and the first to publish had an advantage of only days before they themselves were subject to competition. As might be expected, this unbridled competition led to very low prices: in 1843, Dickens’s Christmas Carol sold for six cents in the United States and $2.50 in England.

\”However, there were some mitigating factors. Publishers sometimes paid well-known English authors for advance copies of their work, since priority was critically important for sales, and, according to Plant (1934), some English authors received more money from American sales, where they held no copyright, than from English sales, where copyright was enforced.

\”Throughout the nineteenth century, proponents of international copyright protection lobbied Congress. They advanced five arguments for their position: 1) it was the moral thing to do; 2) it would help stimulate the production of domestic works; 3) it would prevent the English from pirating American authors; 4) it would eliminate ruthless domestic competition; and 5) it would result in better-quality books.

\”The rest of the world was far ahead of the United States in copyright coordination. In 1852, Napoleon III issued a decree indicating that piracy of foreign works in France was a crime; he was motivated by the hope of reciprocal arrangements with other European countries. His action led to a series of meetings, culminating in the Bern conventions of 1883 and 1885. The Bern copyright agreement was ratified in 1887 by several nations, including Great Britain, France, Germany and Spain—but not the United States.
It was not until 1891 that Congress passed an international copyright act.

\”The arguments advanced for the act were virtually the same as those advanced in 1837. However, the intellectual climate was quite different. In 1837, the United States had little to lose from copyright piracy. By 1891, it had a lot to gain from respecting international copyright, the chief benefit being the reciprocal rights granted by the British. On top of this was the growing pride in homegrown American literary culture and the recognition that American literature could only thrive if it competed with English literature on an equal footing. Although the issue was never framed in terms of “dumping,” it was clear that American authors and publishers pushed to extend copyright to foreign authors to limit cheap foreign competition—such as Charles Dickens.

\”The only special interest group that was dead opposed to international copyright was the typesetters union. The ingenious solution to this problem was to buy them off: the Copyright Act of 1891 extended protection only to those foreign works that were typeset in the United States! This provision stayed in place until 1976.\”

Research and Development Tax Credit

Back in the mid-1980s, when the world was young and I was just leaving economics graduate school, I wrote editorials on economic and environmental issues for the San Jose Mercury News for a couple of years. (At that time, the paper was booming, because in those pre-Internet times, it carried much the help-wanted advertising for Silicon Valley.) In 1981, Congress had passed a tax credit for research and development, but it has been passed on a temporary basis. Remarkably enough, in 2011 the
the R&D tax credit still languishing in temporary status, expiring every few years and then being re-authorized, currently set to expire at the end of 2011.

The theoretical case for government support of R&D is unchanged over time: new technology provides social benefits that often greatly exceed the private benefits received by the inventor, and so society can in theory be better off by subsidizing such activity. However, two things have changed  since I was writing editorials advocating a permanent R&D tax credit back in the mid-1980s. There is now a body of research strongly suggesting that the tax credit is cost-effective at increasing research and development. And much of the rest of the world, agreeing with this research, now offers more aggressive support for industry R&D than does the United States.

Research supporting an R&D tax credit

The R&D Credit Coalition hired Ernst and Young to write a report on the evidence. Unsurprisingly, both given the parade of evidence over the years and the source of the funding (!), the report is called: \”The R&D Credit: An effective policy for promoting research spending.\”  Their overall conclusion is that an R&D tax credit could increase industry R&D spending by 10-20% over the long run, depending on design. Clearly, this isn\’t a revolutionary change–just a sensible step to take. Here\’s a useful figure summarizing the results of studies of how an R&D tax credit affects R&D spending.

International Trends

While U.S. policy on an R&D tax credit has been running in place for 30 years, many other countries have embraced such a policy. For example, here is an OECD report from 2008 on the spread of such incentives:  \”Recent years have seen a shift from direct public funding of business R&D towards indirect funding (Figure 3). In 2005, direct government funds financed on average 7% of business
R&D, down from 11% in 1995. In 2008, 21 OECD countries offered tax relief for business R&D, up from 12 in 1995, and most have tended to make it more generous over the years. The growing use of R&D tax credits is partly driven by countries’ efforts to enhance their attractiveness for R&D-related foreign direct investment.\”

Here is the Figure 3 referred to in the quotation. Cross-country comparisons of tax policy can be hazardous, because the conclusions can depend on just how certain provisions are classified. Nonetheless, it\’s striking that the U.S. ranks 24th in its tax support for industry R&D of the countries in the figure.

The Global Biomedical Industry

Ross C. DeVol, Armen Bedroussian, and Benjamin Yeo write on \”The Global Biomedical Industry: Preserving U.S. Leadership,\” which is available (with free registration) from the Milken Institute website. In this industry, they include pharmaceuticals, medical devices and equipment, and the accompanying research, testing, and medical labs. Some excerpts (footnotes deleted throughout):

The U.S. hasn\’t always been a leader in biomedical technologies

\”Prior to 1980, European firms defined the industry, both in terms of market presence and in their ability to create and produce innovative new products. Historical advantages and an enviable concentration of resources fueled the success of firms in Germany, France, the U.K., and Switzerland. Japan had a presence in the industry as well. But beginning in the 1980s, the United States surged to the forefront of biomedical innovation. This sudden and remarkable shift was no accident: It was the result of strong policy positions taken by the federal government. The absence of price controls, the clarity of regulatory approvals, a thoughtful intellectual property system, and the ability to attract foreign scientific talent to outstanding research universities put the U.S. on top.\” 

The shift to U.S. leadership in pharmaceuticals

The share of new chemical entities for the world as a whole produced by firms with a U.S. headquarters rose from about 31-32% in the 1970s and 1980s to 57% in the most recent decade. The U.S. share of global pharmaceutical R&D spending has risen to roughly half the world total over the last decade.

The U.S. has no guarantee of continuing its technological leadership

\”The dominance enjoyed by the U.S. biomedical industry does not come with a long-term guarantee. The U.S. assumed the mantle of leadership by being the first to commercialize recombinant DNA research—and that achievement was made possible only because it had built an environment and infrastructure that allowed innovation to flourish. But if another nation duplicates or improves upon this formula by building a similar ecosystem and subsequently makes a pivotal scientific breakthrough in nanotechnology, personalized medicine, embryonic stem cell research, or some other cutting-edge field, it could tip the scales in the other direction. That scenario is a real possibility: While the U.S. led with 29.7 percent of nanotech-related patents granted between 1996 and 2008 (as measured by resident country of first-name inventor), China was a close second, with 24.3 percent of these patents. … Pharmaceutical patents that credit at least one inventor in China or India rose four-fold between 1996 and 2006—China held 8.4 percent and India 5.5 percent of worldwide patents. Other countries in Asia and around the world are also making advances, among them Taiwan, South Korea, Malaysia, Australia, Canada, Brazil, and Chile. … In stem cell science, other nations with sophisticated biomedical research infrastructure in place—including the U.K., Japan, France, Switzerland, and several others—have instituted more flexible government funding guidelines than the U.S. These nations have been attracting leading embryonic stem-cell researchers from countries with more restrictive policies.\”

The U.S. advantage in regulatory processes and clinical trials is diminishing

\”While the FDA has seen an increase in average review times, the European Medicines Agency (EMA) has been streamlining. After declining to 12.3 months in 2007, the average FDA review time for new drugs increased to 17.8 months in 2008. This number does fluctuate, and while it improved in 2009, anecdotal evidence suggests that the 2010 numbers will reflect a slowdown. Meanwhile, the EMA has reduced its drug approval time to 15.8 months. … Medical device approvals from the FDA have become even more problematic than drug approvals. The EMA approves some devices in almost half the time it takes for similar approvals by the FDA. …\”

\”Innovation is the driver of ultimate market success, and the U.S. originated more than half of the leading 75 global medicines (or new active substances as measured by worldwide sales) in 2009. Clinical trials are a critical step in that process as well as a benchmark that reflects the degree of innovation taking place in a given location. As of early 2011, 50.9 percent of all clinical trials in the world were being held in the U.S. Despite the size of its clinical capacity, the average relative annual growth in the U.S. declined by 6.5 percent between 2002 and 2006. Meanwhile, trial growth, particularly among emerging nations, outpaced the U.S. during that time. In countries
like China and India, average relative annual growth increased by 47 percent and nearly 20 percent, respectively. …

Clinical trials are a lengthy and expensive step in the U.S., but other countries are finding ways to make trials faster and more cost-effective.As shown below, emerging markets such as China and India can conduct clinical trials for about half the cost of those in the U.S. Russia is even more cost-effective and offers experienced researchers trained in “Good Clinical Practice” standards set by the International Conference on Harmonization. In Russia, 8,000 (or 1 in 86) physicians are involved in clinical trials. … In addition to cost advantages, these emerging nations also have vast populations that make it faster and easier to enroll the required number of patients in a trial. According to the Association of Clinical Research Organizations, completely enrolling patients in a phase III clinical trial for a cancer treatment would take almost six years in the U.S. However, if companies have access to a global pool of patients, the process could be cut to less than two years. These new international options for clinical trials pose clear benefits to U.S. firms: They can conduct some
portions of their testing overseas, reducing their time and costs while gaining valuable knowledge about how to adjust their compounds as they move through the U.S. approval process. An estimated 40 to 65 percent of clinical trials that investigate FDA-regulated products are conducted outside the U.S.,  although many of these trials are for comparative purposes.

\”But taking a longer view, this trend raises a cautionary flag for U.S. competitiveness. Clinical trials require scientific staff, and as other nations develop this specialty, they are amassing high-value experts, infrastructure, and technical capacity. U.S. firms will increasingly have to fight for their share of a finite pool of global talent and investment dollars, and the U.S. economy may lose high-wage jobs. In 1997, according to the Tufts Center for the Study of Drug Development, about 86 percent of FDA-registered principal investigators were based in the United States, but by 2007, that was down to only about 54 percent.\”

Economic Growth: Why We Need It, What We\’re Not Doing

Michael Greenstone and Adam Looney put together a background paper for a Hamilton Project conference called \”A Dozen Economic Facts About Innovation.\”

Why is innovation and increased productivity important? Two of the main measurable reasons are how it increases incomes and life expectancy. It may be that the worst economic event to befall the U.S. economy in the last 40 years is not relatively recent shock of the Great Recession, terrible though that has been, but the productivity slowdown that hit in the early 1970s. Greenstone and Looney write: \”If TFP [total factor productivity] had continued growing at the pre-1973 trend and that productivity gain were reflected in workers’ compensation, compensation could be 51 percent higher, or about $18 per hour more than today’s average of $35.44 per hour. This calculation highlights that small changes in innovation and annual TFP growth lead to large differences in long-run standards of living.\”

Economic growth and innovation have also helped to generate longer life expectancies, partly through reductions in  infectious disease, but also through better diets and cleaner water and sanitation. The gains in health have huge value. Kevin Murphy and Robert Topel estimated the long-term value of gains in health in a 2006 article in the Journal of Political Economy (pp. 871-904).From their abstract: \”Cumulative gains in life expectancy after 1900 were worth over $1.2 million to the representative American in 2000, whereas post-1970 gains added about $3.2 trillion per year to national wealth, equal to about half of GDP. Potential gains from future health improvements are also large; for example, a 1 percent reduction in cancer mortality would be worth $500 billion.\” Here\’s a Greenstone-Looney figure on gains in life expectancy and reductions in infectious disease.

One of the most striking areas of innovation in recent years, of course, is the electronics industry. Here\’s a graph showing what it would have cost to buy the computing power of an iPad 2 over recent decades. Notice that the vertical scale is a logarithmic graph: that is, it is descending by powers of ten as the price of computing power halves and halves and halves over and over again.

What\’s to be done to improve the prospects for innovation and economic growth for the future? There is a broad productivity agenda of improving human capital, investing in plant and equipment, and getting America\’s financial and budgetary problems under control. But there is also a more narrow technology-focused agenda. For example, every politician in the U.S. talks has been talking about the importance of technology for decades–but government spending on research and development has actually been sinking. Corporate spending on R&D has taken up some of the slack, but government R&D is far more likely to be focused on the basic research that generates new industries, not the tightly-focused process companies often use to update their products.

Another issue is to have America\’s higher education system focus more heavily on the so-called STEM fields: that is, science, technology, engineering, and mathematics. The share of total U.S. degrees being granted in these fields has fallen since the mid-1980s, and compared to other countries, the U.S. higher education system grants a lower proportion of its degrees in STEM fields.

A final issue is to improve the U.S. patent system. There are lots of subtle issues about what kind of innovation deserves a patent, or what doesn\’t, and how much a patent is really worth in an intellectual property showdown. But at a more basic level, a slow patent system is less useful for everyone–and the time to get a decision from the U.S. Patent Office has been rising.