Sunday, February 23, 2003

IP and economics

Sorry for the delay in posts--I was away in warm but snowy Baltimore last week but am now back cold but snowless Chicago.

I have not read the paper by Boldrin and Levine that this article comments on, but it sounds like a mathematical treatment of how intellectual property intersects with production functions and various other standard ways economists think about firms and investment decisions. The standard economic position is that since ideas are non-rival (ie. they can be shared like smiles, not like spanners) without artificial scarcity by government fiat, there would be no incentive to create them in the first place. The paper builds models showing that things other than government fiat can create natural scarcity, allowing producers to charge for services and therefore have incentive to produce.

The brilliant Kevin Murphy of Chicago points out that Boldrin and Levine assume demand for IP is very elastic, and that record companies pricing CDs as high above marginal cost as they do argues against that. (Quick economic refresher: the monopoly price depends on how sensitive demand is to price. If demand goes way up when price falls a little, the monopoly price will be very close to the competitive [marginal] price. If demand stays the same no matter how much the price falls, the monopoly price will be much higher than the competitive price.) Robert Lucas (also from Chicago) argues that while government created scarcity might be valuable in some areas (drug patents) it seems not to be in others (music).

And I think that's exactly right. The Boldrin and Levine paper goes way to far asserting that IP protection is not necessary for innovation in all areas. The harms from IP protection are well understood by economists, but poorly by people in general (since they mostly have to do with dead weight loss from blocked transactions). The benefits of IP protection are poorly understood by everyone and philosophically driven by the lawyers representing the content industry, which is why we've seen copyrights extended retroactively, trademarks take on political dimensions in URLs, and patents covering software and business processes.

Since the Internet has lowered distribution and reproduction costs, bad IP laws are more costly now than they were in the past. 150 year copyright terms just didn't matter much before Napster. A new IP regime needs to understand the economics of production for different types of ideas and tailor the right laws for the right circumstances. Personally, I'd like to see shorter copyright, no patents on business processes or software, and longer patents for drugs.

Update: Arnold Kling comments on the same article.

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