Computing Applications Economic and business dimensions

Digitization and Copyright: Some Recent Evidence from Music

Examining the effects of stealing on producers and consumers.
  1. Introduction
  2. Napster Started It
  3. What Do We Know?
  4. New Products
  5. The Debate Continues?
  6. References
  7. Author
  8. Figures
logo for an anti-copyright infringement campaign
The original logo for a 1980s anti-copyright infringement campaign by the British Phonographic Industry (BPI), a British music industry trade group.

Copyright-related industries have been threatened by technological change in the past decade. Events raise questions about whether copyright policy, or its enforcement, requires rethinking. Evidence-based policy-making requires, of course, evidence. That begs the question: what do we really know about piracy and its effects?

As it turns out, there has been an outpouring of research on some copyright-related issues in the past decade. The results may surprise some readers. Reports of shrinking revenue in the copyright-protected industries are a cause for concern and further exploration, but many of the answers needed to inform sensible policy are not yet available. Sensible policy has to ask the right questions, and it has to inform the answers with the right data.

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Napster Started It

Much of what is known about copyright concerns the recorded music industry. Yet, recorded music makes up a relatively small part of the copyright-dependent sectors of the economy, which includes motion pictures, software, video games, and publishing, among others.

Why is the music market the favored topic among researchers even though music itself is not intrinsically important? Blame it on Napster. Because file sharing has been widespread since Napster, the music market has experienced a shock with observable effects, namely, a weakening of copyright protection. Most observers agree that technological change has sharply reduced the effective degree of protection that copyright affords since 1999.

From an economist’s perspective, copyright is the grant of a monopoly right as a reward—and inducement—for creative innovation. Monopolies are, of course, bad. They raise prices and restrict output. Beyond that, they either transfer resources from buyers to sellers, or worse, they employ high prices that frustrate mutually beneficial transactions. Why do governments grant these monopoly rights? It provides an incentive for creative activity.

Napster illustrates that copyright’s effectiveness depends crucially on technology. While the recent technological challenge to copyright could have affected any product that can be digitized—text, audio, or video—in reality the recorded music industry was the first to face the new challenge. And the decade since Napster has seen a dramatic reduction in revenue to the recorded music industry.

The struggles of the recorded music industry have spawned an outpouring of research seeking to document the effect of file sharing on the recording industry’s revenue. Organizations representing the recording industry have argued that piracy is the cause of the reduction in revenue they have experienced. They further claim that their experience foreshadows in other creative industries, and that it will have serious consequences for bringing artists’ work to market.

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What Do We Know?

While the question of whether file sharing displaces legal sales and weakens copyright is interesting—and a vital question for industry—it is clearly not the only question raised by file sharing. Copyright has traditionally allowed the recording industry to generate revenue from recorded music. Weakened copyright may be bad news for sellers of recorded music, but its consequence for consumers depends on what is arguably more important: whether new music continues to be made available. In this column, I consider these issues in more detail.

Does piracy slow new products from being brought to market?

Although stealing has long been understood to be bad, the effects of stealing on the sellers of products produced with zero marginal costs (the additional cost required to make one more unit available) are somewhat subtle. To see this, first consider the analysis of stealing music that has already been recorded. There are two separate questions: whether stealing harms sellers and whether stealing harms society as a whole.

The effects of stealing on sellers depend on its effects on consumers, who differ in their willingness to pay for the product. Some attach valuations high enough so that, had stealing been impossible, they would instead have purchased the product. When they steal, each unit of theft reduces paid consumption by one entire unit. Thus, their stealing harms sellers one-for-one.

But other consumers attach lower valuations to the product. If stealing had been impossible, they would not have purchased the product. When they steal, it brings about no reduction in revenue to the traditional sellers.

Summarizing, does stealing harm sellers? It depends on whether the instances of unpaid consumption would otherwise have generated sales. That also explains why sellers and society should not view stealing the same way. When low-valution consumers steal, their theft does not harm sellers. But their consumption does generate a gain that otherwise would not have occurred.

This is society’s paradox of piracy. If stealing could somehow be confined to these circumstances, then its effects would help consumers without harming producers. Generally, it cannot, and that is why the revenue reduction experienced by sellers can have long-term consequences beyond their direct losses. Indeed, because new products need some threshold level of revenue in order to be made available profitably, transfers from producers to consumers are not benign.

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New Products

The need to cover costs motivates the biggest unanswered question in this debate. Does piracy slow new products from being brought to market? If so, and if consumers care about new products—and there is compelling evidence they do—then in the longer run, stealing can have a devastating effect on both producers and consumers. What does the evidence show?

Quantifying the effect of piracy on sales is an inherently difficult question. First, piracy is an illegal behavior and therefore not readily documented in, say, government statistics. As a result, it is difficult to get data on volumes of unpaid consumption, particularly in ways that can be linked with volumes of paid consumption (more on this later in the column). A second and equally important difficulty is the usual scourge of empirical work in the field, that is, its non-experimental nature.

Broadly, what we know about music piracy is this: the rate of sales displacement is probably far less than 1:1. Supporting this view is corroborating evidence that consumers steal music that, on average, they do not value very highly and would not otherwise purchase.

Still, the volume of unpaid consumption is quite high. So even with a small rate of sales displacement per instance of stealing, it is likely that stealing explains much if not all of the substantial reduction in music sales since Napster. That is, stealing appears to be responsible for much of the harm to the recorded music industry (for an overview, see Leibowitz3). Yet, that does not answer the whole question. Another crucial question is whether the reduction in revenue reduces the flow of new products to market.

Perhaps because this is a difficult question to study, there has been almost no research on the topic. Recorded music is the only industry that has experienced a massive reduction in revenue. This can play the role of an “experiment” to see whether the flow of new products declines following a weakening in effective copyright protection. However, it is only one experiment, and researchers do not have the option of rerunning it with slightly different circumstances, so getting definitive answers is challenging.

While some researchers have documented an increase in the number of new recorded music products and independent labels since 2000, this evidence is ambiguous. Most of these products are consumed little if at all (for example, see Handke1,2 and Oberholzer-Gee and Strumpf4).

The stable flow of new products appears to be a puzzle when set against the sharply declining revenue.

It is tempting instead to ask how many products released each year sell more than, say, 5,000 copies. But not so fast! That approach is undermined entirely by the fact that stealing is on the rise, so that the meaning of selling a particular number of copies changes over time.

In recent work I took a new approach (see Waldfogel5,6). I document the evolution of quality using critics’ lists of the best albums of various times periods (for example, best of the decade). Any album on one of these lists surpasses some threshold of importance. The number of albums on a list released in each year provides an index of the quantity of products passing a threshold over time. I “splice” nearly 100 such lists, and I can see how the ensuing overall index evolves over time, including—importantly—during the “experimental” period since Napster. The index tracks familiar trends in the history of popular music: it rises from 1960 to 1970, falls, then rises again in the early 1990s. It is falling from the mid-1990s until the 1999 introduction of Napster.

What happens next? Rather than falling—as one might expect for an era of sharply reduced revenue to recorded music—the downturn of the late 1990s ends, and the index is flat from 2000 to 2009. While it is of course possible that absent Napster, the index would have risen sharply in a flowering of creative output, it nevertheless seems clear that there has been no precipitous drop in the availability of good new products.

The stable flow of new products appears to be a puzzle when set against the sharply declining revenue. Its resolution may lie in the fact that the costs of bringing new works to market have fallen. Creation, promotion, and distribution have all been revolutionized by digital technology and the Internet.

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The Debate Continues?

Beware of simple answers in debates about piracy. Our knowledge remains incomplete. Representatives of copyright-protected industries are understandably concerned about threats to their revenue from piracy. In some cases—for example, recorded music—they can point to compelling evidence that their revenues are down. That is, most evidence available so far shows harm to sellers from consumer theft.

On the longer-run question of continued supply, however, we know far less. Has the supply of quality music declined due to piracy? Probably not. Finding desirable intellectual property institutions—that properly balance the interests of various parties—requires attention to the interests of both producers and consumers. Reports of shrinking revenue in the copyright-protected industries are a cause for concern and further exploration, but they are not alone sufficient to guide policy-making.

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UF1 Figure. The original logo for a 1980s anti-copyright infringement campaign by the British Phonographic Industry (BPI), a British music industry trade group.

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    1. Handke, C. Digital copying and the supply of sound recordings. Unpublished Manuscript, 2010; http://www.acei2010.com/upload/acei/handke.pdf.

    2. Handke, C. Plain destruction or creative destruction? Copyright erosion and the evolution of the record industry. Review of Economic Research on Copyright Issues 3, 2 (Feb. 2006), 29–51.

    3. Liebowitz, S.J. File sharing: Creative destruction or just plain destruction? Journal of Law and Economics 49, 1 (Apr. 2006), 1–28.

    4. Oberholzer-Gee, F. and Strumpf, K. File-sharing and copyright. NBER's Innovation Policy and the Economy series 10. J. Lerner and S. Stern, Eds. MIT Press, 2009.

    5. Waldfogel, J. Bye, bye, miss American pie: The supply of new recorded music since Napster. National Bureau of Economic Research Working Paper 16882, March 2011b.

    6. Waldfogel, J. Music piracy and its effects on demand, supply, and welfare. Innovation Policy and the Economy 12 (June 2011), J. Lerner and S. Stern, Eds.

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