This Month in IP Insanity (April 2015)

Now that the academic year is slowing down, I can start to account for all of the developments in IP law and technology again. Here are a handful of events and discussion points for the past month:

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  1. Tidal has turned out to be a bust. Predictably, Jay-Z has pulled all of his music off of Spotify and Youtube, meaning Tidal is the only place where you can access it. As I commented during the odd fanfare of its release – while we’ve certainly increased access costs, I haven’t really seen any big boon to musical innovation, and it’s not clear that any other artists (big or marginal) will flock to Tidal. It’s probably just a rent-extraction system for the musical elite.
  2. More streaming music news — Spotify is lobbyisting up (which somehow doesn’t sound as catchy as “lawyering up”, perhaps that’s for the better). I’ve reported upon Spotify before, in the context of Taylor Swift’s criticism of streaming music. Spotify seems to be preparing to go to war with Apple, the latter of which is preparing to release it’s own streaming service, the newly acquired and revamped “Beats.” At the same time, the DOJ is considering another pass at music licensing regulations, and the blue moon when Congress decides to revamp copyright laws may also be around the corner (due, no doubt, to the fact that 2018 will see the first batch of copyrights to finally expire since 1923).
  3. Another reason Spotify is lobbyisting up, and yet another music streaming news bit, is that Grooveshark has finally streamed its last. From The Atlantic’s subtitle, “Everyone knew you were probably illegal all along,” one wonders how they were able to persist for so long without properly acquiring licenses to all streamed music. Apparently it was “good lawyers,” but even that will only get you so far for so long…
  4. John Oliver set his hilarious investigative journalist sights on patents, specifically patent trolls. [I should add that I watched this live the night before my dissertation defense, taking it as a good omen.] It was a very entertaining piece, highlighting the true cost of non-practicing entities (NPEs) who extract rents from would-be users or innovators who use something the NPE holds a patent on (but the NPE does not actually produce anything). Alex Tabarrok, commenting on a further link to Timothy Lee, rightfully discuss how trolls are not the fundamental problem with the patent system, just one of the system’s most visible and absurd excesses.
  5. Not a news story, but on a related note, I recently read a dated article by Stephan Kinsella arguing that patent trolls are akin to mafioso, who don’t want to actually block competition (like actual patent holders do), but rather keep it flowing so they can just wet their beak. This framework makes actual patent holders, who would exercise their monopoly power and block future innovation for want of rents, actually seem worse than the trolls, counterintuitively. It sounds very similar to Mancur Olson’s stationary bandit being economically superior to the roving bandit model of government. I’m inclined to agree, but the point again is that the system is broken, not those who are exploiting it best.
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  7. Onto cable TV, the market for which was blown open this past month by Verizon FIOS’s announcement that it will finally will break up the famous cable bundle into smaller packages. This is far from a la carte channel purchasing, long held as the ideal from the consumer’s point of view, but not the economist’s, as Verizon will offer several slimmer packages with about 20 channels including the famous broadcasters and ESPN, etc. It will be interesting to see how this affects the cable industry: established players don’t like it.
  8. Our benevolent overlords at Google now want to get into the phone carrier business. Google’s proposed Project Fi will cost $20 a month for talk and text, beyond free Wifi, and another $10 per gigabyte of data used each month. Most interestingly, unused data can be credited to the next month’s quota. While a welcome innovation, Google will have to build up its network and reputation as a carrier beyond simply a software (and limited hardware) company, to compete with the infrastructure of Verizon, AT&T, and Sprint.
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Music Copyright’s Biggest Winners Want You to Pay More Money

Many of the music industry’s biggest stars gathered today for a unique press conference to promote Tidal, a new hi-fidelity streaming music service. On stage, an ensemble cast of promoters — Jay-Z, Beyonce, Jack White, Kanye West, Rihanna, Alicia Keys, Daft Punk, Coldplay’s Chris Martin — declared their intent to revolutionize the music industry. The key here is that Tidal is “artist-owned” and controlled, as compared to studio-managed.
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Artists have long been critical of freemium streaming services, like Pandora, Grooveshark, or Spotify. Tidal, on the other hand, has no free option, but rather a two-tier pricing option: $10/month for regular streaming and $20/month for hi-fidelity streaming. Its co-owners (the stars listed above), proclaim that this will help return music back to the artists.
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As I argued when Taylor Swift launched her tirade against “free music,” the problem with our current system — for both consumer and average artist alike — is the publisher-centric model of copyright. Publishers benefit largely at the expense of consumers and the average artist. Hence, there are reasons to believe that this new service could be a welcome innovation. However, I specifically mention that copyright hurts the average artist, as, in addition to publishers, copyright’s prime winners are the superstar artists — the very ones who are launching this new service.

Thus, while I applaud a move to reduce studios’ rent-seeking capacity, I am skeptical about the effect this service alleges to cause. Without systematically changing the structure of the copyright system, we risk this firm simply becoming its own rent-seeking studio. Thus, the question of Tidal’s marginal benefit is twofold: whether it will improve the status quo of accessing existing works, and whether it will increase innovation.
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If Tidal only ends up being a “big boys (and girls) club” for the superstars (so far, the only artists appearing on it are in Jay-Z’s inner circle), it will simply be a new $20/month toll. Should all of the major artists pull a Taylor Swift and eject from the free streaming services to exclusively list on Tidal, then this certainly is a loss for consumers and a transfer to the elite artists. It will be much less an artists’ revolution in the music industry than the artist elite forming their own rent-seeking studio. Meet the new boss, same as the old boss.

One is also reminded of Neil Young’s recent flop with the “revolutionary” crowdfunded Pono service. Young’s service turned out to be pure snake oil not worth the cost — I wonder if Tidal consulted him on its own potential coup.
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Among artists, copyright primarily benefits only those 1% superstars that made it big. Smaller acts are probably harmed by copyright on net. Everyone involved in the copyrighted entertainment business, from consumer to artist to publisher, has to put up with higher transactions costs arising from the need to search for existing copyright holders, negotiate with them, and license their own work downstream in a tangle of red tape. However, those that have the most socially valuable (highest grossing) works can justify the cost of copyright because it helps them minimize their losses from piracy.

This is for two reasons: First, people primarily want to pirate the biggest stars. On average, consumers would rather illegally download Interstellar and Beyoncé than Final Destination 12 and your friend’s cousin’s high school cover band.* Second, those big stars have greater bargaining power with their publishers. Established musical artists with immense clout can demand higher advances and royalty rates from their record labels. These are precisely the people seen on the stage for Tidal.

Now, if there was evidence that this increase in price would stimulate greater innovation in the field, this might be justified on efficiency grounds. There is a well-noted tradeoff between innovation and access: ceterus paribus, the more you increase copyright, the less access there is to existing works, complements of added monopoly power, but it makes acquiring copyrights more profitable and hence gives a greater incentive for artists to produce new works. There are certainly diminishing returns at the extremes, particularly in a 100% copyright world, which becomes a pure tragedy of the anti-commons. The effects of a 0% copyright world are still up for debate.

If new independent or unknown artists support Tidal and begin to use it, then the new service might justify the added cost to users. These lesser known artists, however, are more likely to support piracy and streaming as free advertising to help them churn out the real money made by (non-superstar) artists — merchandising and concert revenues. Thus, unless they find that Tidal gives them a bigger boost relative to other methods, odds are this system will not stimulate much musical innovation. Should that be the case, then it seems like this move is just to raise rents for existing copyright holders, rather than stimulate a new music revolution.
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Let’s not also forget the obvious fact that raising the price for music services makes piracy all that more attractive to many consumers, should popular bands emigrate exclusively to Tidal. It was arguably Spotify and co.’s freemium model that dissuaded many would-be pirates in the first place such that nobody really talks about song piracy anymore (it’s video these days).

– – – – – – –
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* The modern age of Bittorrent, however, provides a potential caveat. One could argue that people who have diverse interests might be more likely to illegally download movies and songs that aren’t superstars to save money. Consider “I don’t want to waste my time at the movie theater to see that crappy horror flick X, I’ll just download it; but the new action [franchise] blockbuster movie in 3D, that’s something we have to go see!”

This Month in IP Insanity (January 2015)

In keeping with my new monthly feature, here is this past month’s IP news:

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  1. We know Tom Petty won’t back down. He just won a lawsuit against Sam Smith for infringing Petty’s copyrights on the song “Stay With Me,” requiring Smith to give Petty royalties. This is the third time Petty has sued someone for copyright infringement over similar sounding songs. Perhaps it is because Petty’s music is so fundamental as a building block for Rock n’ Roll that everything starts sounding the same. Either way, looks like Tom Petty is okay with free fallin’, not so much free ridin’.
  2. Not quite a story on the intellectual property wars, but I find it relevant. A Harvard Ph.D student had a manuscript of complete gibberish (literally written with Random Text Generator) accepted in seventeen medical journals. Granted, they are lower-tier journals who spam out email solicitations, and he would have to pay $500 to “process” them, so this isn’t Nature or the New England Journal of Medicine. His paper is entitled “Cuckoo for cocoa puffs? The surgical and neoplastic role of cacao extract in breakfast cereals” and you can read the whole “paper” at the link. Reminds me of the heroic Sokal affair.
  3. Another offbeat story but I find it interesting, television producers no longer focus on the first season as a metric for deciding to produce future seasons. With more people cutting cords, binge watching on their own schedule, and simply waiting for word of mouth to rate shows they’ve “gotta see,” the real money is now in the second season.
  4. If you needed a new casebook study of what was once an innovative industry giant turning to rent-seeking and the political process once they lose their competitive edge, look no further than BlackBerry (formerly RIM). The company wants Congress to pass a law mandating that all app developers must develop a BlackBerry version to go with the more popular iOS and Android versions. Their argument? We should broaden the definition of “net neutrality” to “application neutrality,” meaning developers should be forced to produce for all platforms, no matter how irrelevant and obsolete, in the name of openness. Maybe BlackBerry forgot about the Open Source movement.
  5. As if they were trying to make it harder for me to begrudgingly root for them tomorrow, the Seattle Seahawks are trying to trademark the words “boom,” “go hawks,” and the number “12.”
  6. Taylor Swift, who is transforming me into a hater for her views on music, is trying to trademark “this sick beat” and other catchphrases from her 1989 album, like “Party Like It’s 1989.”  Do people say even that?
  7. Yet another trademark story, this time it’s the MPAA who forced a local Minneapolis brewer to stop selling “Rated R” beer. Apparently, as long as the beer contained the trademarked word ‘rated’ it would still be liable, according to the MPAA. Frankly I don’t really see how consumers are likely to be confused, deceived, or mistaken about the source of the goods or services. Does the MPAA even sell beer?
  8. Torrentfreak posted a link to a new art project out of Australia, Pirate Cinema, which livestreams a collage of videos that people are streaming simultaneously on Bittorent. If you want to try to watch 3 or 4 movies at the same time, try this.
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  10. A revealing natural experiment in Norway. From 2009-2014, Norwegians under 30 dramatically stopped illegally downloading music, from 80% of those surveyed saying they did download, to just 4%. Yet, in that same period, despite the collapse of music piracy (mostly due to legal streaming services), Norwegian music revenues increased just 1.5% in nominal terms (likely negative when including inflation). Maybe piracy isn’t the real problem in the media industries?
  11. Lastly, like a Phoenix rising from the ashes, the Pirate Bay is back. It’s apparent return will disrupt the innovation and competition that’s been going on between spinoffs and rivals like Kickass Torrents and isoHunt, the latter of which recently offered $100,000 to the old Pirate Bay’s most active contributors to boost its publicity. Also, apparently not all of the former TPB staff are happy about TPB’s return.
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Patronage as a Mechanism for Socialism?

It has become quite clear to me in my research that most expressive works (art, literature, music, film, science, etc) always have been, and probably always will be, funded by patronage. The key question, which has been answered differently according to the historical evolution of culture, technology, and the extent of the market, is who should be that patron? Wealthy elites, as in the Duke of Tuscany sponsoring Galileo or Pope Julius II sponsoring Michelangelo? The government, as in the National Endowment for the Arts or the National Science Fund politically allocating grants? Publishers, as in the Big Six movie studios or the Big Five record labels who buy copyrights from artists to distribute their work? The crowd, as in Kickstarter and Indiegogo who collectively chip in small donations?
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I only recently realized that there is an obvious parallel here between the temporal structure of patronage and the temporal structure of wages in production. In patronage, the patron pays the artist’s fixed costs up front, the artist takes time to produce, and then the work is finally sold and distributed (depending on the type of patronage above, either by the artist or patron). In exchange for covering the artist’s expenses, the patron contracts for some portion of the gains, either in royalties, merchandising rights, prestige, rewards (on crowdfunding sites), etc, until the fixed costs have at least been recouped by the patron. During the time of actual production (days, months, years), the artist sustains him or herself on the advance furnished by their patron.
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This might seem somewhat trivial to economists, as obviously the patron-client relationship is a form of entrepreneur-laborer relationship and is just a firm by another name. But I find it interesting that a lot of the crude arguments for socialism emerge from misunderstanding this critical market relationship (of employer-employee). When I say socialism, I do not mean a superior, comparable economic system to replace capitalism (such as what emerged from the socialist calculation debate), but that emotionally-charged pseudo-economic lamentation of the ills of capitalism we are all viscerally familiar with. Our hearts may sympathize, yet those trained in economics know to trace out incentives and consequences and recoil from the fallacies of such undisciplined thinking.

Socialists, particularly of the Marxian variety, argue in this fashion that (1) workers are the ones who make all of the goods, and (2) do not even receive enough wages to buy back the product, hence (3) capitalists are exploiting them by appropriating “surplus value” generated beyond what laborers are paid.
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These claims, of course, misunderstand the time structure of production: {Econ 101 lecture} Laborers, just like other owners of the factors of production (landowners, and capitalists), demand to be paid wages before the product is ultimately sold in the market. Imagine a world where nobody is paid until products were finally finished and sold on the market, years later — nobody would work because nobody could pay the bills. Thus, laborers are paid wages regularly, landowners are paid rent regularly, and capitalists (anyone who lends money) are paid interest regularly for their time services. There is little risk that these factors will not receive their payment (assuming the business at least breaks even). All of these are treated as costs to the entrepreneur (which is functionally, if not personally, different from the capitalist) who manages the enterprise and bears all of the risk. After all of these costs are paid, if (and that’s a big if, as the overwhelming majority of businesses have costs exceeding revenues) there is any revenue left over, they are earned as profits for the entrepreneur. That is, the entrepreneur (aside from their own laboring wages) only earns a return if the product is successful and society values the product more than its inputs. As for buying back the product, laborers marginal productivity contributes only a fraction of the total market value, combined with the shares going to the marginal productivity of landowners, capitalists, and entrepreneurial stewardship. Further, the incomes of workers allow them to purchase other products, as one is required to produce something (at minimum, rent out one’s labor services) in order to exchange with others to acquire the goods they desire. {\Econ 101 lecture}.

It is also a common trope that artists do not like capitalism because it is exploitative. Blake gave us the bleak view of “those dark satanic mills,” Dickens caricatures greedy capitalists like Scrooge in stark contrast to the wretched underclass of industrial England, and Sinclair churned our stomachs at the “Jungle” of working at a meat processing plant.

In more modern times, we have everything from the modern hippy/hipster subculture to Rage Against the Machine to Picasso. If we were feeling charitable, we could extend the definition of “artist” to Chomsky, Derrida, and all those philosophers of the varying branches of postmodernism that deconstruct modern capitalist society from all angles. Perhaps everyone has different experiences, but to think of the average “artist,” the mind’s eye tends to conjure up some combination of a bohemian “misunderstood” young 20-something, weighing invectives against the corporate media, industrial exploitation, or environmental degradation by unregulated free markets running amok.
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Might the patronage relationship be a mechanism by which artists and other bohemians, who are popularly known to identify with the political left, discover or craft their ideologies and identities against capitalism/the system/the man? Artists are, from their perspective, actually the ones doing all the work and producing the final product (be it a painting, a novel, a song, their part in a film, etc), and yet serve their bosses (patrons, studio executives) who dictate the direction of their work, sitting high and mighty on a paycheck probably much larger than their own (for apparently doing nothing of value in view of the artists). Would not this relationship color how they view value, production, and markets?
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I am not saying that all artists are political leftists, or even if they were that it is wrong, or that all artists misunderstand how economies operate. I don’t know, or think, that artists historically hated their patrons, that Da Vinci hated the de Medici. It’s perhaps more plausible today where artists become managed by faceless megastudios with political leverage, who start to look more and more like “the man.” But this seems to me to be a plausible mechanism for how art and artists tend in the aggregate, to take leftist views on culture and economics.
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Is it plausible? Or am I being just as apophenic and myopic as I am claiming some artists are?

This Month in IP Insanity

Partially because it’s too difficult to keep up with complete and snarky commentary every time there is a development or anecdote of intellectual property’s use and abuse, and partially because it seems more asinine and important when these anecdotes are collected together, I will start a monthly (maybe weekly in the future) list of IP developments. In this past month:nike air jordan 16

  1. Keurig automatic coffee machines copyrighted their coffee packets and implemented DRM software to ensure that no non-Keurig-licensed coffee packets can be used. In response, copyright hacktivists uploaded a video detailing a simple fix to trick the machine into accepting generic coffee, to some appropriate music.
  2. As part of an obvious ploy for protectionism, the Spanish government passed a new law requiring Google to pay domestic content producers to include their content (local news). Google announced it would cancel its Spanish news service. The rest of Europe, struggling to keep up with U.S. tech firm dominance, is paying close attention to the results. Speaking of which…
  3. This is from November, but important for its sheer ridiculousness: Taking a photo of the iconic Eiffel Tower in Paris at night is a criminal violation of copyright. During the day, you’re good. Good thing international copyright law is becoming increasingly based off of the French conceptions of copyright…
  4. NASA recently emailed a wrench to the International Space Station. “Emailing,” means emailing the design for the wrench, which was fed into and printed from a 3D printer in the ISS. How long until consumers have 3D printers, and the copyrights and copyfights over the “blueprints” become the next legal arena?
  5. In the aftermath of the Sony hack attack, we find out that the company itself violates copyright while producing movies, and would face the same punishment as a pimply teenager downloading a few songs. The system works!
  6. Apple has recently patented a “pen-like device” indicating they may try to get into the note-taking business.
  7. We find out that Miley Cyrus’ famous “Party in the USA” was actually written by Jessie J, who was able to pay her bills for 3 years with the rights to those transcendent lyrics.
  8. The big kahuna, the galactic haven for filesharers, the Pirate Bay has been taken down after a raid by Swedish police. The actual domain remains online, with a pirate flag waving defiantly along with a clock counting the days since the raid. Of course when you take down one head of the Hydra, two more appear, though it’s anyone’s guess which ones are good and not malware-plagued. TPB themselves finally made a statement saying their future is uncertain, but their original task was accomplished, hopefully a new and better system can take its place. They opened up the source and made it freely available to all, so that millions of people can make their own “Open bay.”
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  10. And, what else is new, Game of Thrones is the most pirated show of 2014.
  11. If you’re a more legal minded court-follower, here’s a list of the top 10 major IP cases of 2014 from someone more qualified than me.

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Hidden Assumptions of Public Goods and Information

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This is another post on public goods inspired in part by Santiago’s previous post on the under provision of entrepreneurship as a public good argument. I admit that this post does not fully respond to the precise argument, as that would require a more fundamental critique of equilibrium analysis (hence, a potential future third post on this), but it’s still necessary to flesh out a more robust view of public goods.
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Here, I want to focus on another aspect of public goods theory, as applied to a particular type of “good” – information. This is equally applicable to things that would today be patented (inventions) or copyrighted (creative expressions) under intellectual property laws, my research area, but also to information itself, as is disseminated via the price system.

In many ways, information is the purest (only?) public good. If we apply Samuelson’s (1954) typical public goods analysis, we find that once information is produced, it is instantaneously available for everyone to use simultaneously (non rivalry) and it’s damn near impossible to contain the spread of information to prevent others from using it (non excludability).
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Now, to be complete, both the inputs to producing information (the research and development expenditure, the erection of a specific complementary capital structure), and oftentimes, the products that result from produced information (physical products born of invention, CDs, DVDs) are excludable, if not also rivalrous. There are complications, but it’s largely the information itself that is the “messy” part of the economic analysis. Thus, following traditional public goods/welfare economics theory, the market will under-provide information (and inventions and creative expressions, etc).
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Naturally, any of us at this blog and many of our colleagues, friends, and readers would turn to public choice (sure government could try to correct this under-provision, but is the benefit not outweighed by the cost and risk of the system being abused/captured/used for rent-seeking?) or market process analyses (how such interventions would distort the price system’s ability to disseminate distributed knowledge by affecting entrepreneurship). For the first, you could look at Boldrin & Levine’s masterwork, for the second, might I humbly suggest my forthcoming article.
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However, I want to see if we might address the common argument with a neoclassical framework before resorting to these other (valid and complementary) perspectives. As I argued previously, the traditional theory is exogenous, where the conclusion of under provision logically follows from the way we define goods as inherently possessing particular qualities. Likewise, in this case, producing information supposedly exhibits a free rider problem because the non rivalry and non-excludability prevents the producer (discoverer/inventor/artist) from capturing the full social value of their information, as it is largely dissipated away amongst the rest of society (including rival producers).

Yet, as Richard Wagner (2012, 2013) argues, the free rider problem is not inherent in the provision of the good itself, but is an “artifact of particular institutional assumptions.” The true problem is that there is some inalienability of ownership over the good, which is often the result of some institutional failure, often in the public realm.

In the traditional view of information, there seem to be a number of implicit assumptions that are unwarranted and must be jettisoned. The usual story seems to assume two things (in addition to non-rivalry & non-excludability):

1. Once an idea is discovered, it is instantly and costlessly broadcasted anonymously to everyone

This statement has a lot of moving parts to it that need to be dissected. First, ideas are rarely broadcasted like a TV-show over the air out of NBC to all who have a (legal or illegal) receiver. Furthermore, those ideas that are broadcasted do not reach everyone. Take blogs for example, the paramount form of hailed modern citizen-journalism, open to all who have internet access (assuming it is not passworded or private). Most blogs will ultimately be accessed by a select group of people.
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This leads to the second point, that only some interested minority will receive any given idea. Tune into C-Span at any random time during the day. This is the Samuelsonian ideal type: a speaker is literally broadcasting ideas to everyone watching. But notice how many empty seats there are in Congress, not to mention the millions of Americans (I venture to say 99%) who chose not to watch C-Span, even if they were somehow all made aware of the schedule of speakers and topics.

Third, ideas are rarely anonymously spawned and disseminated. One can think of “memes” on the internet. Few people know who started the “Doge” meme (though Know Your Meme is doing the Lord’s work trying to find out). It obviously passed through a network of people commenting and sharing jokes on places like Reddit, which got out to 9Gag, and Facebook, and finally even U.S. Senators start using it (when you know it’s time to abandon ship). Though, in principle, anyone with internet access could potentially discover it, it is not until it flows through channels of social networks that it becomes “a thing” and is copied, remixed, and parodied.

Finally, ideas are not disseminated costlessly. Perhaps this is not a large effect, and there are plenty of cases where they could be diffused at negligible cost, say if J.K. Rowling stood on a soapbox in Trafalgar Square and shouted out the text of Harry Potter to passersby. But there still needs to be strong investments to generate hype and advertising. Imagine how much harder it would be for her, further, if she did this before anyone had heard of Harry Potter. The most obvious example of this effect for us is our capacity as educators. The failures of us economists to inform and teach the public about economics, despite our massive investments in teaching capital makes this plainly obvious. Any of us will tell you that getting our students interested and having them actually absorb and learn the information is not easy or costless.

We also have to worry about potential distortion from transmission. This is the classic “telephone game” dilemma we all played in elementary school: – in sending a complex message across many people, the message gets distorted, misremembered, ad libbed, or even (from the joksters) intentionally altered for comedic effect. Take a look at news reporting of major events and scandals. Often the news media (whether intentionally for ratings or genuine mistakes) focuses on some sound clip or particular aspect of a message and distorts it. The missteps of the news media and social media in identifying the 2013 Boston bombing suspect are instructive here. Even in the internet world of costless CTRL-C CTRL-V, there are problems.

2. Once aware of the idea, all people value it highly enough to costlessly consume it

I already mentioned that not all people are going to value the information highly enough to use it (let alone highly enough to find it profitable to use when its use comes with a significant cost). Even once information is spread to another person, it is not costless to consume and utilize it. Suppose Apple plans to produce a new i-Hologram which creates an internet-connected personalized avatar of yourself in 3-D space. It’s going to revolutionize the market and everyone will want one. That sounds like a nice profitable idea, let’s get in on that, you say. Well how would you go about doing that? Even if you got your hands on one legally before it hit the market, you would have to reverse engineer it. That’s not to say it can’t be done, even done easily, since this clearly happens in the real world. But it is not costless. 

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Once information is reverse-engineered and replicable, it still has to be produced, which requires high investments in a complementary structure of capital with specific uses directed at producing that new product. Again, these costs are not always prohibitive. If Merck reverse-engineers the formula for Phizer’s secret new diet pill, they probably have the machinery and the human capital to replicate it soon enough. But again, it is not costless. And Merck will still be the first-mover in the industry. While they will not be able to capture all of the potential profits of their new diet pill (because of Merck and generic knockoffs), they still may capture enough to make the pill profitable and worth producing for the public.

And to return to the Apple example for a moment. Even if your startup company is able to copy and produce the new hologram device and cut into Apple’s profits, many people will still want to buy Apple’s polished product with an established brand and reputation. Who the hell are you?

Lastly, one reason that discovering and using ideas is not costless is precisely because firms recognize the possibility of lost profits from reverse-engineering and have made contingency plans. To say nothing of patents or copyrights, firms use contracting devices such as non-compete clauses and non-disclosure agreements, and make other attempts to keep their discoveries from spilling out by keeping trade secrets.

In the end, relaxing these assumptions and including a number of types of information and transaction costs can lead to a more robust understanding of public goods problems and information. These also give rise to a number of institutional forms which manage these issues to overcome the free rider problem. Ultimately, our view will not be complete until we address these institutions, as Wagner puts it best through example (2013, 13-14):

Suppose, for instance, that a mayor forms the idea of hosting an open-air music and arts festival under the presumption that residents of the city would value that festival sufficiently highly to make the event worthwhile. Institutionally, how might the mayor go about doing this? Within the spirit of anonymity and free riding, the mayor might install collection boxes in private places and ask residents to make donations. How much or how little a person donates would be known only to that person…

Yet no sensible mayor would operate in such a fashion. The mayor would enlist allies who were of a similar mind about the festival, and these people would in turn establish an architectural pattern of participation that would be far removed from anonymity. That architecture could entail cellular patterns of discussion and contribution where friends ask friends for contributions. It could also entail publicity regarding the identity of contributors, perhaps even ranking them by contribution. In these and numerous other possible ways free riding would be obviated. In any event, an entrepreneurial mayor would never elicit anonymous donations. Instead, sponsors might be solicited, with those sponsors given various forms of publicity. While the festival might be open to all, there could also be places where seating was reserved for patrons who made significant contributions to support the festival. We would also expect to find that those who made larger contributions were those who valued the festival and the associated activities more highly. Under an entrepreneurial institutional arrangement, organization of the festival is possible according to the benefit principle, and the free-riding problem is avoided. Whether the resulting pattern would correspond to some presumptions of postulated equilibrium is impossible to determine because those postulated conditions are just theoretical constructions that do not have existence independently of the relevant process of social organization.

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Samuelson, Paul A. (1954). “The Pure Theory of Public Expenditure,” Review of Economics and Statistics, 36, 387–389.

Wagner, Richard E. (2012). “The Institutional Framework for Shared Consumption: Deemphasizing Taxation in the Theory of Public Finance,” Public Finance and Management, 12, 5–20.

_______. (2013). “Public Finance without Taxation: Free-Riding as Institutional Artifact,” George Mason University Department of Economics Working Papers, 13-05.

T-Swift and Spotify are Never Ever Ever Getting Back Together (?)

This comes as a little late, but since I am the occasional fan of T-Swift (much to the chagrin of my girlfriend; haters gonna hate…) and an enormous fan of Spotify, I feel the need to comment. Recently, Taylor Swift has pulled all of her music off of Spotify. She has also taken what appears to be the moral high ground, claiming in a prior op-ed, as so many others have, that music should not be free, and that streaming services like Spotify, Pandora, Grooveshark, and the like are contributing to the music industry’s decline.
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Some have argued that Swift’s move is a shrewd monetary calculation. Billy Bragg argued that she is merely a part of a corporate stunt to exclusively join Google’s new streaming service, though the facts don’t seem to line up. Others say this benefits Apple, who is supposedly about to launch its own streaming service to rival Spotify. In any case, let’s take T-Swift at her word.
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In response, Spotify has published a website detailing how its royalty payments work, and how it contributes to the music industry by monetizing would-be pirates. Spotify has already paid about $2 billion in royalties to rights-holders.
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Roughly, Spotify pays artists a royalty of between $0.006 and $0.0084 per instance played. (In truth, it’s not a flat rate, but is adjusted for certain factors like popularity and country of origin.) Let’s do a few back-of-the-envelope calculations: Take the conservative estimate of Spotify paying artists 0.6 cents per play. Let’s further make the best-case assumption for the artist by saying that if you were to buy that same song on iTunes for $1.99, the artist gets that entire $1.99. Assuming people actually like the song and will replay it on Spotify, it would take about 332 plays to equal that revenue from one person. The upside for Spotify, however, is potentially limitless – assuming someone will play that song many many times over their lifetime, as opposed to the one-time fee for iTunes.
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When we relax the assumption that the artist gets all iTunes revenue, and bring it down to a realistic 10%, that one-time purchase gives the artist about $0.20 per person. This would only require about 33 plays to match. Granted this is a highly simplistic analysis which would obviously differ with bands and their popularity.
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Is this enough for the artist? Probably not. A lot of people have complained about Spotify’s paltry revenue to artists. I don’t know what the “optimal” price for a song is, much less how much is “fair.” But it is clear that Spotify’s model clearly adds value to the industry, and probably even to artists.
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What Spotify is actually hinting at, is that artists are not being hurt as much by streaming services or even by pirates, as they are by their own studios. Artists taking only 10% of the revenues of digital sales is a pretty raw deal. As I mentioned before, perhaps studios serve a legitimate economic function of lowering transactions costs of tapping into economies of scale for distribution. The problem is by concentrating all the money and power into a small handful of firms that control all of the distribution rights in our crazy copyright system is that they end up having the influence to negotiate their massive cut of the rents (and use the political system to do so when the market won’t oblige). This is precisely why Spotify (and iTunes for that matter) can only pay artists such a low royalty. Spotify pays 70% of its revenues to rights-holders, who are are often the studios, with artists getting whatever is left. Despite the value that Spotify seems to be bringing, the company allegedly has yet to make a profit because of these immensely high costs, and some say their model could be inherently unprofitable no matter how many subscribers they win.
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Which brings us back to Taylor Swift’s stand. Time correctly argues that even if Swift’s strategy works, it will not have a wider impact on the music industry. Only someone with who is already successful and has the level of clout equal to Swift’s could hope to make a living solely on digital sales. Streaming helps bands get discovered, and tap into the real money which comes from touring and merchandise. More fundamentally, however, is that streaming services like Spotify are actually incentivizing people to switch from openly pirating music. Forcing people to return to paying for downloads will encourage them to return to piracy, whereas the “freemium” option to stream music for no monetary cost (but suffer through ads) encourages legal discovery and consumption. The sheer convenience might even convince many consumers (as it did for me) to pay for the premium subscription, where Spotify actually earns revenues to pay to artists. Hell, even Pink Floyd, Led Zeppelin, Metallica (!) are now on Spotify.

Interstellar Blasts Out of the Hollywood Distribution Mold

The recent Christopher Nolan blockbuster Interstellar is grabbing headlines all over the internet for its scientific innovation and uniqueness within Hollywood. This post isn’t a review of Interstellar–suffice it to say you need to go see it, I’m still debating with my friends exactly what happened in the movie (and for what it’s worth, here’s a theory that I find most plausible). What is interesting and novel, about Interstellar, and Christopher Nolan, is just how the film was made, namely how atypical it was in the usual Hollywood scramble for copyrights and control between studios and the artist.
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A number of news articles came out profiling the cult director and describing just how unusual this process was. This post is an opportunity for me to point out the role copyright has the on economic structure of the film industry, and highlight Christopher Nolan’s success as one of the exceptions that prove the rule.
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The average Hollywood film follows a pretty common formula in terms of both subject area and distribution mechanism. Despite all the rhetoric that copyright ensures the independent artist she can put bread on the table for her work by giving her recourse against ungrateful pirates, the entertainment industry in the 21st century really is just a continuation of ancient patronage of the arts in modern form. Instead of wealthy elites sponsoring an individual artist like the Medici did for da Vinci, the Pope for Michelangelo, and the Duke of Tuscany for Gallileo, we have large movie studios bearing the cost of producing movies for artists and filmmakers in exchange for copyrights and a cut of the profits. In the U.S., there are the “Big Six” film studios–Warner Brothers, Disney, Universal, Sony, 20th Century Fox, and Lionsgate, which collectively accounted for over $8 billion, or 75% of all industry revenues in 2013. Independent filmmakers do exist, of course, but in the end often cut deals with the Big Six and turn over their copyrights in exchange for tapping into the big boys’ distribution network in hopes of reaching an audience of more than just midnight viewings staffed by hipsters.
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Maybe that’s all well and good, assuming the goal is simply to “promote the Progress of Science and useful Arts” for the public welfare, as Article I §8 of the U.S. Constitution mandates. Economies of scale allow for a more efficient distribution mechanism to serve consumers, if not always the artists. The problem is that in the process, the rights to display the film, as well as the right to prevent others from viewing the film without authorization (i.e. “copyright”) are always transferred to the film studios. These firms, rather than the artists, are the ones with both the financial resources and the political muscle to hunt down infringers and to capture the regulatory process to put these copyrights to work maximizing their rents at the expense of consumers and taxpayers. But that’s for another post.
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Naturally, the Big Six aren’t going to accept any “I’ve got a brilliant idea!” pitch willy-nilly. Often they will seek a movie idea that is safe, and simply hire out the director to produce their movie. Sometimes this reaches absurd levels, where simply to protect a right from expiring, they will intentionally produce an awful B-movie version, like the 1994 Fantastic Four film. Furthermore, in the midst of the threat of internet piracy, studios and producers now demand control over a wider swath of revenue streams than just box office ticket sales: merchandise. And what produces merchandise like no other? Franchises full of sequels, plots ripped off of books, and reboots of sequels of plots ripped off of books. For better or worse, studios stick to the conservative revenue-maximizing formula of big action blockbusters with little arete but lots of explosions capable of spawning sequels with rapid diminishing returns to substance.
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This is where Nolan and Interstellar come in to kick things apart, rather than kick the can down the road. Love or hate his movies, he, along with James Cameron, or Steven Spielberg, is one of the few artists who can pitch a standalone movie to a studio and get wide liberties to produce it. Interstellar is (so far as we know), like Nolan’s previous Memento, The Prestige, and Inception (though notably the Batman trilogy was a franchise/reboot cash cow), a standalone movie without a big opportunity for franchising or sequels, and is original content rather than a rehash of a book (though some Heinlein fans may be shaking their fists). In fact, the prospect of this one film captivated Warner Brothers so much that in exchange

For the right to distribute Interstellar internationally, Warner Bros traded the rights for two of their franchises, Friday the 13th and South Park, plus “a to-be-determined A-list Warners property”, while its subsidiary, Legendary, agreed to trade Batman v Superman: Dawn of Justice for a further piece of the pie. To say this disregards the reigning economic logic of modern Hollywood is not quite right – it reverses the normal logic by which Hollywood operates. Franchises are the lifeblood of the studios. For Warner Bros to hand over the rights to two of its well-known properties, representing money in the bank, for the opportunity to take a spin on an original idea – a film with no sequel potential and few merchandising opportunities, based on the dimly understood recesses of quantum physics – speaks both to the value placed by the studios on Nolan, and also the extent to which he has become a franchise unto himself. (Guardian)

Nolan is also very strategic about his expenditures: he always comes in under-budget. This is a big plus for Big Six in seeking him out, but there’s also an ulterior motive that benefits Nolan:

“What he realised very early on was that the moment you give the studios an excuse to come in, you’ve lost it,” said Emma Thomas, Nolan’s wife and co-producer…“We watched it happen,” Thomas said. “The moment you go over budget, you’ve lost the creative control than an obsessive director like Chris needs.” (WSJ)

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While perhaps people value Nolan’s movies as art for art’s sake, what really helps them stand out is the rest of the noise in Hollywood. Now if only people who appreciate movie substance can find an alternative mechanism to raise films to the same level of success– crowdfunding perhaps? Then again, maybe what makes indie films indie is the fact that they’re not Hollywood blockbusters…