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Economics of Extending Intellectual Property

Rights (IPR)

Yale M. Braunstein School of Information Mgt. & Systems

University of California, BerkeleyJune 2005

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Motivation Pressures to expand Intellectual Property

Rights Copyrights Patents Others, including sui generis rights

In at least two dimensions Time (duration of protection) Scope (what is protected by IPR)

Activities both in US and internationally

Economics can provide useful insights (but may be ignored)

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Economic principles that lead to the case for intellectual

property rights Difficulty in excluding non-payers

Presence of economies of scale

Together, these lead to “public goods” But this is not an all-or-nothing concept

–Difficulty in exclusion impossibility–Varying degrees of economies of scale

Possible digressions: lighthouses, libraries, toll roads,

etc.

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The “incentive effect” As a society we want to encourage the

development of the arts and advancements in technology.

There are two ways to do this: Grants to artists, scientists, and other creative

people Provide incentives via property rights

[Are these the only ways?]

How do we “know” the second approach will work? The US Constitution (Art. I., Sec. 8., Clause 8) Joseph Schumpeter

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Part 1: Optimal Duration

Two themes:

1. Incentives do matter

2. There should be a sharing of benefits

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The balancing approach“The Congress shall have the power … to promote

the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their writings and discoveries” (*)

This has been interpreted to mean that the creators of a covered work get benefits for n years and then the public gets the benefits for the remainder of the useful lifetime.

For this to work in practice, n < useful lifetime For the time being, I’ll be unclear as to

whether this should hold for all covered works or on average.(*) U.S. Constitution, Article I, Section 8, Clause 8

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Two (or Three) Recent Extensions of Duration Sonny Bono Copyright Term Extension Act

(S. 505, P.L. 105-298, 1998) Extends most copyrights by 20 years (from “life plus 50”)

Best Pharmaceuticals for Children Act (S. 1789, P.L. 107-109, 2002) Extends pharmaceutical patents by six months in

exchange for the manufacturer conducting studies of the effect of drugs when taken by children

Digital Millennium Copyright Act (DMCA) (P.L. 105-304, 1998) Anti-circumvention provisions have potential to extend

protection forever (e.g., protection of “handshakes”) 17 U.S.C. Sec. 1201(a)(1) (1998).

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The terms of the debate over the Sonny Bono Act

The “players” (copyright holders and users) focused on the massive transfers of money

Economists focused on efficiency arguments(guess who prevailed)

No likely economic justification No incentive effect for existing works The present value of the final 20 years was

likely to be too small to realistically provide any additional incentive for new works

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Empirical evidence – two studies

Kai-Lung Hui & I.P.L. Png, “On the Supply of Creative Work: Evidence from the Movies,” 92 AER Papers & Proceedings 217 (May 2002)

A. Tor & D. Oliar, “Incentives to Create under a ‘Lifetime-Plus-Years’ Copyright Duration: Lessons from a behavioral Economic Analysis for Eldred v. Ashcroft,” 36 Loyola of Los Angeles Law Review 437 (2002)

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Best Pharmaceuticals for Children Act

Costs & Benefits Congressional Budget Office analysis:“In total, CBO estimates that the act will increase direct spending of the federal government by $219 million and increase federal revenues by $15 million over the 2002-2011 period. The largest effect on direct spending will result from the act's impact on the prices of prescription drugs.”

Is extending patent protection really an efficient mechanism to encourage testing of drugs on children?

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Part 2: Economics Issues Relating to

Scope, Using Database Protection

as a Case StudyTwo themes:

1. Economics of DB Production

2. Understanding the Economics of Pricing

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The Challenge of New Technology & Markets

Throughout the history of IPR, new technologies and markets have led to a reassessment of the scope of protection. Also raised questions as to which is the

appropriate regime: copyright, patent, others

Examples: New media (player piano rolls, “phonorecords”) New manifestations (screen display “look and

feel”) New products & business relationships (cash

management accounts, databases)

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Coase’s TheoremCoase’s Theorem* is relevant as it directly provides an economic logic for a clear definition of property rights in intellectual (and all other) property. The original article actually has two conjectures:

1. Market failures arise from inadequate assignment of property rights (correct)

2. Final allocations are independent of the initial assignment of rights (probably incorrect**)

* Ronald Coase, "The Problem of Social Cost," Journal of Law and Economics, 1960

** For a proof, see: http://www.sims.berkeley.edu/courses/is231/f04/is231-Coase.htmNote the link between this second conjecture and the incentive effect.

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Why use Databases as an example?

Sui generis protection of databases in EU countries pursuant to Directive 96/9/EC Focus is on databases with “non-original” content

Proposed legislation in US following Feist decision

WTO & TRIPS

Developing countries seeking guidance from World Intellectual Property Organization (WIPO) UN-affiliated organization in Geneva; serves as

secretariat for the Berne Convention WIPO commissioned five “expert” studies

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Implications of economics for structuring protection of

databases The applicability of principles of incremental

cost pricing to the pricing of databases is severely hampered for two basic reasons:1. In most cases, the cost structure in the database

industry is generally such that with prices set at the incremental cost of providing an additional user with the use of a database, the production costs will not be covered.

2. Once a property right is granted to the producer of a database, he is vested with a certain degree of market power. A monopolist has no incentive to set prices at incremental cost. The question then arises as to the kind of pricing policies that the database producer should be allowed to set.

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Setting prices to cover costs

The solution to this problem that marginal-cost pricing is economically “efficient” but not sustainable in the presence of economies of scale is to employ what are known as “quasi-optimal” or “Ramsey” prices.

Possibly the clearest statement of the Ramsey approach comes from the pricing rule: For each product, the percentage deviation

of quasi-optimal price from marginal cost must be inversely proportional to its price elasticity of demand. [Baumol and Bradford, 1970]

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Application of the pricing rule - I Assume either of the following:

A database is sold both to profit-making firms as well as to nonprofit research institutes.

Or it is sold to users in developed countries and those in countries whose economies are still developing.

For this analysis, what distinguishes those two groups is not their financial goal or the income level of their country but the responsiveness of their demands to changes in the price for the database. In economics the measure of responsiveness

of demand to price changes is known as the elasticity of demand.

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Application of the pricing rule - II A remarkable result in economic analysis is

that the following “properties” hold for the optimal prices, regardless of whether one is seeking to maximize societal benefits OR maximize the profits of the database producer: the database should have a (non-zero)

price in each market both prices should be greater than the

marginal cost of providing the database to the user

the price should be lower in the market with the higher elasticity of demand

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Implications of the pricing rule The following principles then result:

Unless there are strong reasons to the contrary, the recovery of the fixed cost component of the total costs should be spread over as wide a set of customers and users as feasible.

Exempting some users from payment or arbitrarily restricting the charges that can be assessed against them leads to increased costs and charges to the less-favored users.

Compulsory licensing and other artificial restrictions on prices reduce the profits of those products that reach the market. Also, the uniform prices that result may not be socially desirable. Furthermore, the total effect of such restraints may be undesirable if it impairs the flow of innovations and new databases. (Larry Lessig take note.)

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Part 3: Special Areas of Concern

One basic theme:

1. Don’t mess with the general approach unless it is really necessary

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Special areas of concern

Databases with scientific and technical information (STI) or cultural content

Sole-source

Capture

Exclusive agreements for the commercial distribution of public data

Internet routing tables

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Databases with STI or cultural content - I

Each of the following arguments has been applied, in one context or another, to databases:1. “Certain types of information need to be widely

disseminated and, as a result, property rights for that information should be prohibited.”

2. “Certain information is the cultural patrimony of a nation and should not be treated as an economic commodity nor made available for commercial exploitation.”– Variations of this argument are that the

information should not be used by any commercial or for-profit entity, that it should not be used outside of the country or region from which it came, or that it should remain under the control of certain specific groups.

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Databases with STI or cultural content - II

To a large degree these questions are not about economics (and often not about databases !).

But they do have an economic dimension: In many cases, one can view them as applications

of the extremes in pricing: prohibiting protection is the analog of setting the price at zero, while blocking distribution is the analog of having an infinite price.

Intriguingly, both policies have the same effect on the revenues of the database producers—the revenues will be zero. In one case this is from no price; in the other it is from no sales or license fees.

The long-run result of no revenues, as we have discussed previously, is little or no incentive for the production of the affected databases.

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Databases with STI or cultural content - III

Some people and organizations create intellectual property for motives that are either not profit oriented or are, at most, only indirectly related to the possibility of financial reward. Others are motivated by the prospects of financial gain. It is sometimes argued that there is no need for IPR to motivate those in the first group. While this may be true, it does not mean that it is

in society’s interest to prohibit the exercise of IPR. The incentive effects lead to the creation of additional STI and cultural content by members in the profit-seeking second group, while not causing less to be produced by the first group.

Furthermore, even under a strict IPR regime, those in the first group are not prohibited from placing their output into the public domain.

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Databases with STI or cultural content - IV

Two other arguments:

1. There are few, if any, prospects for the development of databases with STI or cultural content in developing countries, or in small countries. As a result, the only beneficiaries of rights protection will be the database producers in the developed countries that have large, rich markets. – Counter: See the data– (Possible digression: parallels with the

debate over patent rights for medicines)

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Databases with STI or cultural content - V

2. Cultural patrimony and indigenous scientific knowledge are or should be the collective property of a specific culture, group, or nation, akin to communal grazing lands. Therefore, it is reasonable that members of the community use the material freely while non-members, such as those in developed countries, pay for use.

Counter: Intriguingly, this approach can be easily seen as consistent with the lessons of optimal pricing. To the extent that cultural patrimony and scientific knowledge are organized in databases of the sort under discussion, the establishment of rights in the databases can accommodate a dual market/dual price approach. This is directly analogous to having a compulsory or blanket license at a low or zero price in the home market.

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The case of genetic information

in Iceland - I Background The firm of deCODE Genetics is reported to

have a 12-year agreement for the exclusive marketing rights to the database of genetic information of the entire (rather homogeneous) population of Iceland (approx. 278,000).

If they relied solely on trade secrecy protection, the publication of parts of the database could result in the loss of their property rights. On the other hand, the EU sui generis approach allows for publication of records and sets of records without such a loss of rights. (Note: not a member of the EU.)[Other, probably less controversial, examples from ECAI

in the report]

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The case of genetic information

in Iceland - II Policy discussion An interesting example of a case where the

discussion of the desirability of DB protection has become intertwined with other political and social issues.

The creation and marketing of this database is controversial, with questions being raised about issues such as the “commodification” of genetic information, the freedom of scientific inquiry, and privacy. – The first two issues are variants of the questions raised

above about the prohibition of protection and the blocking of distribution, but they are sometimes cast in moral terms, which I shall not discuss, and sometimes linked with concerns over monopoly power, which will be addressed explicitly in the sections on sole-source and capture below.

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Sole-source - I

Important to distinguish between databases for which there is no substitute of any sort and those that have no close substitute. The two defining characteristics are the

closeness of the substitute, which can be measured in economic terms by the additional costs one might have to bear to use the substitute rather than the “original,” and the importance of encouraging widespread distribution and use.

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Sole-source - II Need to distinguish between databases

that, for some physical or legal reason, cannot be reproduced and those that are economically impractical to reproduce. Databases in the former group might

include geophysical data from a single monitoring station or the medical procedure codes required by government health agencies. – Databases of this sort might be viewed as

being comparable to the “essential facilities” of antitrust law.

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Sole-source - III Two policy options consistent with keeping the

incentives inherent in the definition of IPRs: Compulsory licensing provisions or similar

restrictions and the use of anti-monopoly laws– For the purposes of this discussion, the problem

with compulsory licensing is not so much the loss of the incentive effect but, rather, the difficulty in making a statute that is narrowly targeted to affect only databases that are truly subject to the sole-source phenomenon and, therefore, have no substitutes.

The second approach is to rely on the use of anti-monopoly laws. – Most appropriate in the case of irreproducible

databases. – Possible digression: Rule of law in developing

countries

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Capture - I

Issue: Possible “capture” of public-domain data by adding

value and including these data in a commercial database– Related to the sole-source issue in that the

existence of reasonable substitutes is a key factor.

– If the underlying data continue to remain available and are a reasonable, albeit imperfect, substitute for the commercial database, capture is of little concern in practice.

– And remember, it is the uniqueness—whether in terms of organization or ease of use—provided by the database that gives value to its users, and this perceived value is, in turn, the incentive for the creation of the database.

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Capture - II The capture problem is one of degree, as

with the sole-source problem, so there is no single solution that is guaranteed to simultaneously provide a remedy and have no detrimental effect on the desirable incentive outcomes. The best approaches seem to be

measures that insure the continued availably of the content from the original sources and requirements that database producers who incorporate substantial amounts of public-domain content provide a reasonable notice of the source to potential users.

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Exclusive agreements for the commercial distribution of

public data Government agencies and commercial database producers enter into agreements that grant the commercial entity the exclusive rights to produce a database containing certain sets of public data. One can view these arrangements as combining

features of both the sole-source and capture situations described above.

Arguments for: These agreements may be necessary and in the public interest because: the government is not capable of, or—for

philosophical reasons—should not be in the business of marketing products with commercial possibilities, and

exclusivity is required to guarantee a sufficient return to warrant the necessary investment by the private party.

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Exclusive agreements for the commercial distribution of

public data Arguments against: the government is giving away its “crown jewels” it is picking winners instead or relying on the

market this approach creates a de facto monopoly,

resulting in unnecessarily high prices to users of the database.

These are not arguments against property rights in databases, per se. Rather, they are criticisms about the contractual terms employed in the exercise of those rights. The appropriate solution is to develop contractual

and licensing terms in each situation that are consistent with national policy objectives.

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General comments Many of the problems raised in discussions

of issues related to sole source, capture, and exclusivity situations revolve around the extent to which the underlying information is available to the public.

Certain information may be formally available to the public to meet various legal obligations, but the question should be whether there is sufficient public access.

The problem often pre-dates the exclusivity agreement and should be dealt with directly rather than via limitations on database rights.

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Internet routing tables - I A set of concerns surrounding the

databases used in maintaining the Internet’s infrastructure. The specific issues are:

1. Domain name registrars will consider the data that links domain names and IP addresses proprietary

2. Backbone providers and vendors of routing hardware will …[do something bad]

3. Someone in the first group will merge with someone in the second and together they will …[do something bad]

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Internet routing tables - II Issue 1: Domain name registrars will consider the

data that links domain names and IP addresses proprietary It is difficult to imagine how this might actually

occur, as those registering their domain names do so precisely so that Internet users can find their sites.

If one or more domain name registrars refrained from making the mapping information public, users would seek out other registrars who meet their needs by freely distributing this information.

If the worry is that the existing registrars would collude by only cross-licensing each other and thus effectively barring entry of competing registrars, the solution is to address that issue either directly or via the antitrust laws.

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Internet routing tables - III Issue 2: Backbone providers and vendors of routing

hardware will use DB protection laws to control the distribution of routing tables they develop for their own use. These tables may be optimized for the specific architecture of the networks on which they are used or designed along with other firmware. This is something that should be encouraged.* One

way in which the producers of routing hardware or the operators of networks compete is by offering more efficient products and services. (* “Hot potato” problem)

It is also possible that effective protection is already available via trade secrecy and that DB protection laws will have no effect one way or the other.

In any event, so long as the original, non-optimized data remain available, this should not be a public-policy concern.

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Internet routing tables - IV Issue 3: A domain name registrar will merge with a

backbone provider and/or a hardware vendor and together they will do something exclusionary. (I have not seen this argument; it is somewhat a

“straw man”.) This also seems difficult to imagine because of

the competitive pressures described in the discussion of Issue 1. – Nevertheless, some might fear this chain of

events, citing the general reluctance of antitrust authorities to attack vertical mergers.

– But, if this situation were to arise, it seems likely that there would be strong calls for direct action on the tying and exclusive-dealing aspects of the arrangement, regardless of the general views on vertical mergers at the time.

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Conclusion - 1 Economics can be a useful tool to analyze

proposals to extend IPR But economic logic is often overtaken by money and

politics

Major considerations:1. Recognize the trade-offs between private and public

benefits.2. A clear, adequate definition of property rights can

enable markets to develop and grow.3. Strong protection of the IPRs in databases, without too

many limitations or exemptions, will encourage the growth of local production of databases, some of which already exists even in developing countries.

4. Policies designed to deal with special circumstances such as sole-source provision or the possibility of capture should be narrowly drawn.

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Conclusion - 2 Major considerations (continued):

5. Remember the original focus. For example, throughout the discussion of database rights there is an important distinction between the unoriginal databases that are the subject of the analysis, on one hand, and their content, on the other. The content in the database fields and records may be original works already subject to copyright protection or work that is in the public domain.