Economics of Extending Intellectual Property Rights (IPR)

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					     Economics of Extending
Intellectual Property Rights (IPR)

          Yale M. Braunstein
    School of Information Mgt. & Systems
      University of California, Berkeley
                   June 2005

 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)
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.
               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
     The US Constitution (Art. I., Sec. 8., Clause 8)
     Joseph Schumpeter
              Part 1:
         Optimal Duration

Two themes:
1.   Incentives do matter
2.   There should be a sharing of benefits

            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
 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
  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).

         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
  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)

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?                                  10
              Part 2:
Economics Issues Relating to Scope,
    Using Database Protection
         as a Case Study

Two themes:
1.   Economics of DB Production
2.   Understanding the Economics of Pricing

 The Challenge of New Technology &
 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)

                   Coase’s Theorem
Coase‘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
     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:
Note the link between this second conjecture and the incentive effect.

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


 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

       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
  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.
      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]
  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
 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
 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
    the price should be lower in the market with
     the higher elasticity of demand
    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
   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.)                                19
              Part 3:
     Special Areas of Concern

One basic theme:
1.   Don‘t mess with the general approach
     unless it is really necessary

     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

            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
     –   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.
             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.                23
              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
      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
 Furthermore, even under a strict IPR regime, those in
  the first group are not prohibited from placing their
  output into the public domain.                       24
            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)
              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.
      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.
     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]
       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.
              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.

                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

                  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
        – Possible digression: Rule of law in developing
                       Capture - I
 Issue:
      Possible ―capture‖ of public-domain data by adding
       value and including these data in a commercial
        – 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.
                 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.

   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.                                                34
   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
    The appropriate solution is to develop contractual
     and licensing terms in each situation that are
     consistent with national policy objectives.
            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.
       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]

        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.                                 38
         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 39
       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.                     40
                       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.

                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