There recently has been a debate over the economic costs and benefits behind graduated response systems aimed at reducing online file sharing. Professor Geist, for example, recently posted a blog estimating the costs of a graduated response system. I believe the topic of the costs and benefits of graduated response mechanisms is an important one. Let us take a closer look at this topic and the assertion that graduated response cannot be justified because of its costs.
Until now, the roll-out of the Internet, which has contributed to the mass consumption of digital equipment at the end-user level, has ensured that digital information is the universal means through which the whole planet can easily communicate. With billions of mobile phones, hundreds of millions of PCs and tens of millions of iPods,all around the world, digital information has become the global communication standard. During its expansion, this deployment has generated strong positive externalities, such as reduced transaction costs associated with digital communications.
However, with most people having already gone digital, these positive externalities might not keep growing at the same pace. The lukewarm welcome to the new Apple iPad illustrates that new digital devices have to now compete with a very wide range of existing ones. The positive externalities which were strong in the phase of substituting digital to analogue equipment may now saturate or, at least, enter into a slower growth period.
On the other side, negative externalities associated with the use of digital devices are growing fast. An example of a negative externality is the explosion of identity theft, a crime which costs both victims and society and which increases transaction costs in the online environment. A recent study by Credoc showed that in France the number of identity thefts was over 210,000 a year (double that of car thefts) with an average cost of 2230 euros (only 30% was covered by insurance).
In addition to these costs, there were also the costs associated with legal investigations and lawsuits paid by society. Of course, identity theft is only one example of negative externalities associated with the increased use of the Internet. Fraud, IP infringement, and child pornography are examples of many others.
Confronted with the rise of these negative externalities, there are only two economic options. One is to tax the Internet with the goal to reduce its usage and to compensate for the negative externalities. The other is to internalize the externalities through innovative specific targeted measures.
Copyright infringement is a negative externality. It raises transaction costs and inhibits investment in the creative industries. Avatar would never have been able to attract a 500 million dollar investment if this 3D movie was as easy to freely copy (free-riding) as a standard 2D video.
The question is then: how to internalize copyright enforcement? The cost-benefit analysis which needs to be made is not just comparing the cost of enforcing copyright with the “savings” of not enforcing copyright. It is comparing the cost of enforcing copyright with the cost of leaving copyright unenforced. Indeed, in the phase of the digital roll-out, the benefits of the digitization could temporarily outweigh the costs of not enforcing copyright. But now that digitization is ubiquitous, there is less benefit and much higher cost with not enforcing copyright. Worse, if copyright is poorly enforced at the end user level — with free-riding going unpunished — then incentives are given to innovators to help the consumer to free-ride. The longer this signal lasts, the higher the cost of copyright enforcement.
As I have written in much more detail elsewhere, graduated response whatever its cost be and whoever pays for it is a means to bring disutility to copyright free-riding. This disutility — a fine, a suspension, and even a criminal sentence for the most egregious offenders — affects the customer of both the ISPs and the equipment manufacturers. These will then have to help their customer to avoid this disutility. In other words, graduated response acts as a means to deter free riding at the end user level which creates incentives to enforce copyright at the industry one.
The cost, as Michael Geist rightly points out, is paid the by the digital industry and by the consumer. But frankly, is there any better incentive to innovate in order to reduce it ? And when it happens, the benefits are three-fold: 1) copyright will be better enforced, decreasing the transaction costs in the creative industries and markets; 2) it will ensure that compulsory license mechanisms are not needed to compensate for the creation/ financing gap; and, 3) the cost of copyright enforcement will progressively decrease, thus raising the overall social benefits.
Graduated response restores incentives along the copyright distribution chain, (in the digital networks and equipment), to enforce copyright. Thus, it makes copyright enforcement costs decrease instead of increasing when free-riding is not deterred. The graduated response is a means to internalize in the technical chain the enforcement of the copyright.
The beauty of graduated response is that, as of today, it is the best long term means to internalize the costs of free-riding while decreasing the costs associated with copyright enforcement. Opponents of graduated response like Professor Geist look at only one economic side of graduated response. But, as stated above, the cost-benefit analysis which needs to be made is not just comparing the cost of enforcing copyright with the “savings” of not enforcing copyright. One must compare the cost of enforcing copyright using graduated response with the cost of not implementing such as system. When this analysis is done, graduated response to address copyright infringement can be fully justified from an economic perspective.