File sharing: Innocent until proven guilty

An economist says music piracy should be hurting the recording industry, but it isn't -- and he doesn't know why.

Published June 13, 2002 7:30PM (EDT)

Stan Liebowitz first began to attract public attention as a debunker of the idea that "network effects" could lock in winners in specific markets. The networks effects theory posits that once a certain product gets critical mass, such as, say, the VHS format or the QWERTY keyboard, it will remain supreme, even if other products might be demonstrably superior (such as, some would argue, the Betamax format or the Dvorak keyboard.) If everybody buys VHS tapes, then the studios will only release VHS tapes, and everybody will have to buy only VHS tapes, and so on.

Liebowitz, a professor of managerial economics at the University of Texas at Dallas, argued, along with his coauthor Stephen Margolis, that neither the examples nor the theory held water. Their critique had significant implications, especially when brought to bear on the Microsoft antitrust trial, since one argument put forth by the Justice Department was that "network effects" ensured Microsoft monopoly power.

Liebowitz has consistently criticized the attempt to punish Microsoft for supposed abuses of monopoly power. Two years ago, for example, he wrote a 36-page analysis concluding that a breakup of the software giant would cost U.S. consumers $50 billion over three years. Higher prices, he argued -- charged by the new companies, and by other competitors -- would be the result of regulatory intervention.

Now Liebowitz has turned his attention to another hot-button issue where law and economics intersect: file sharing. It's a logical step for the professor. He's been following copyright law and its effects since the 1970s, when audiotapes were being denounced by the recording industry as tools for theft. On May 15, the Cato Institute published a new paper by Liebowitz, "Policing Pirates in the Networked Age," that takes a comprehensive look at the history of the recording industry's battle with piracy.

In the paper, Liebowitz argues persuasively that record industry experts failed to prove their assertion that Napster was gutting industry revenues. But he also argues that eventually, digital downloading will be a serious threat to those revenues. Both topics will be part of his upcoming book, "Rethinking the Networked Economy," due to be published in August. But the specifics of those arguments may be somewhat altered from their form in the Cato paper, because when Salon caught up with Liebowitz, he was reexamining his data and wondering, Why isn't the record industry hurting more, already?

You point out in your Cato Institute article that throughout history, new technologies are always seen as a threat to copyright, but that the fears are always unfounded. Copiers actually improved the academic journal business; VCRs increased Hollywood's revenues. Yet, you maintain that peer-to-peer file sharing will severely damage the record industry. Why are you so sure that this will happen?

Actually, I'm not sure. It took six months to get [the Cato piece] out. Now I'm stepping back a bit. In the Cato piece, what I said was that [file sharing] seems like it should be causing a lot of harm. But we're not seeing it. The explanation I gave was that maybe there weren't enough people who owned CD writers during that period. In order for downloading to really have an impact on CD sales, it needs to be a substitute for CDs. If file sharing is not a good substitute, then you can download all you want and it may be a new form of listening but it may not hurt CD sales.

The problem is that the number of downloads appears to be larger than the total number of CDs purchased. Worldwide annual downloads, according to estimates from places like Webnoize, would indicate that the number of downloads -- if you assume there are 10 songs on a CD -- is something like five times the total number of CDs sold in the U.S. in a year, and one-and-a-half times the worldwide sales. That's so large that you have to say: Look, if downloads are substitutes [for CDs] in any significant way, we should see really big declines -- unless there's something else going on.

The reason I gave in the paper is that maybe people aren't shifting their music [from MP3s to CDs]. But I've also seen some recent numbers on households that have CD writers, and it's something approaching 30 percent. We should see an impact. There's a 5 percent decline in CD sales this year, but that's what you might expect in a recession. So we're still not seeing much. And what I'm beginning to suggest now is that perhaps people aren't going to replace the purchase of CDs with these MP3s.

Why not?

There are a bunch of potential reasons. It may wind up that people just like to purchase because it's the honest thing to do. There's another possible explanation though, which is something that I'm trying to get harder data on. If we had a degree of copying [now] not that different from in the past, and it's just switched from audiotapes to downloads, then we may not notice an impact on CD sales.

But then, there should have been a noticeable impact in the 1970s, when audiocassettes came along. And one of the reasons why no one has been able to do a good study on that -- the Office of Technology Assessment tried to do a study on it but they based it on surveys of users, which are not very useful -- is that it's very hard to get hard data on CD and record sales. No one was doing studies like that back then. I've seen some numbers, and I'm going to go back and take a look, but if there wasn't a major impact in the 1970s, it may just be that were not going to see much. It may just be another case of crying wolf.

It sounds like you've changed your mind ...

I try to let data tell me what's actually happening in the world. And when the theory says one thing and things don't work that way, then I say something's missing in the theory. A priori, I had a belief that [file sharing] was different and it was likely to cause real harm. That's what the Cato piece was about.

But if a year from now, when the economy picks up, we still don't see a decline of 15 to 20 percent at least, then file sharing is having a very small impact, considering how massive the downloading is. It's not that say, 10 percent of record sales is a trivial amount of money, but it's not going to be the death of the record industry.

Are you basing your shift in opinion solely on the lack of evidence showing damage to sales or is there other empirical evidence that supports the claim that downloading won't destroy the industry?

It's mainly the sales. That's where you would look, that's where there should be clear evidence. If downloading was 10 percent of CD sales, you can imagine it would be hard to notice because lots of things buffet the CD market. Is there someone who has a really hot CD this year? Have tastes changed? Things come and go and take up people's attention.

But with the amount of downloading as large as it is, if it's really going to have an impact, it should be pretty obvious. We have more downloads than legitimate sales; that's a very big market. You don't need sophisticated analysis to see a 30 percent drop in CD sales and to say that it wouldn't be due to a minor recession. And that's the kind of thing you should see if there's a massive amount of pirating that's much greater than what existed before.

So far, why do you think people are both purchasing music and downloading it?

It may be the cost of putting these collections of songs together. Even though it seems low, it's more effort than the typical person is willing to go through. That may be what the salvation of the record industry is -- that it's simply too hard to do on your own what they do for you.

Do you think that this new download use is likely to become a new revenue stream, just as videotapes were for Hollywood?

I believe it's more efficient to download music than to go to a record store. I think that digital products should be sold over the Net and they're likely to be successful. So I expect that the buying of records will eventually cease. But the tastes of consumers are a hard thing to know for sure. They like holding these things.

What do you make of the subscription services that have been popping up -- the vast majority of which don't allow for much flexibility? Are these viable alternatives to the unofficial file-sharing networks?

Certainly, if they're going to sell music that you can't make copies of, people aren't likely to pay as much for it. I don't know that the record companies really understand that. I think the pricing that they have for these services doesn't make any sense.

But again, you have to remember that what seems to take a long time while it's happening, in a historical context can occur very quickly. Videotapes when they first came out were totally mispriced. They used to sell them for about $100 because the idea was, no one really wants to have a library of videotapes. Why would you watch a movie more than once? The video rental places were going to be the ones to buy the videotapes, and since they were going to rent it over and over again, a very high price should be charged. It was only by accident that the movie industry discovered that gee, it's a much more elastic demand than we had thought.

They had a special on one of the big holidays where I think "E.T." was dropped down to $25 -- no one had ever done anything like that -- and the sales were just enormous, way beyond expectations. That's where they learned that if you lower the price, you can sell a ton of these. And now the revenues from videotape sales -- not rentals -- are larger than the revenues from theatrical releases.

Looking back, it appears that it happened quite quickly. But at the time, there were a couple years where videotape people were mispricing videotapes. So it wouldn't be surprising if we had mispricing here as well. They're learning what to do.

There's one other thing that makes it difficult for these services -- the big retailers. Stores like Best Buy should be dead set against the major record companies allowing inexpensive downloads. And it's still the case that almost all the business that the labels have will be through retailers. So they have the retailers pushing really hard -- they don't want the major companies to have affordable downloads and the labels don't want to alienate the retailers.

So if one of these companies, say PressPlay, really lowered its price, I presume that some of the major retailers would say, look, if you're going to charge such low prices, then we're going to push the other labels who aren't charging such low prices. We're going to put their CDs in more prominent locations. It will take a while for retailers to lose their power, and for legitimate downloading to get big enough. So there are some things going on that make me think it's going to be while -- maybe a decade -- before we get to reasonable pricing on downloaded music. But it should clearly be the way to do it.

At what point does the industry accept the facts that you're pointing out, and move on?

My experience with the industry is that they'll never accept it because they never accepted it with any of the other copying technologies ... I don't think they're going to back off. I'm not sure they'd believe it if you told them there wasn't any damage, even if you told them there was a statistical study that indicates no decrease in sales. What they'd say is, even if there isn't, let's just be safe.

What would it take for change to occur? Could the artists be a force for change?

If a couple years go by and the massive copying still continues while the artists see that it doesn't have a negative impact on sales -- if that turns out to be the case -- then I suspect that the level of concern will go down. They'll still talk, the record industry, but they won't be manic about it. They were concerned about audiotaping but after a while, they seemed to realize that it wasn't that bad. But it took them a long time.

Is their energy in fighting file sharing far more intense than what was expended to fight previous copying technology?

Yes, and you have to remember it's coming from multiple sources now. In the past, it was really just music. There wasn't a major concern about videotapes being copied. Now there's a concern even though it takes forever to download, that you're going to have movie file sharing. So you have the studios falling in line. And a lot of artists, in film and music, are more concerned than they used to be.

And to be honest, it looks like [file sharing] should really cause problems. I honestly believed it too. If you look at the logic of it, then you say this one is real, this one should really do damage. And I'm not willing to say that it's not going to. But I'm just saying it's beginning to look like a lie.

You also argue that the industry shouldn't have sued Napster. What should they have done?

They should have tried to negotiate with Napster to try to change the rules a bit. Number 1, they could have kept a bit of control over what was happening. They could have done a few things, like saying in order to download something you have to upload something. That would more likely make people want to buy originals. It's a more controllable form than the pure peer-to-peer without the central server.

Let's talk about digital rights management [DRM]. The idea behind DRM is that entertainment content will be delivered in a form that includes copy protection and a payment mechanism. In your paper, you identify DRM as a possible solution to the online copyright battle. Do you still stand by that?

Yes, it should still work. I got a lot of hostility to that idea from people who would normally agree with me. I got a nasty letter from someone, who said he took a videotape of his brother's wedding, and then he tried to transfer the sound to the digital audiotape that he had, and it wouldn't do it. He blamed DRM for that.

I wrote him back and said, look, be mad at the Digital Home Recording Act. That's what said you can't record from a digital source onto a digital audiotape. It has nothing to do with DRM.

DRM, as I see it, is merely the protection in the software, on a CD or whatever, that would allow micro-payments. It doesn't do this yet, but in principle it could. That's what I view as closer to ideal. They can let you do a lot and you pay a higher price, or let you do only a little in which case you'd be paying a lower price. It solves a lot of peculiar economic problems that arise when you're dealing with intellectual property. If it stopped copying, if it was fairly effective -- it will never stop all the hardcore crackers -- then the copyright owners will get a reasonably good deal and users will get a reasonably good deal.

The micro-payments idea has been floating around for years and it's never happened. Why do you think it would work and why hasn't it worked so far?

I have to believe the computer people who think that DRM is viable. The micro-payment part is the harder part because the credit card companies won't accept payments as small as micro-payments would need to be. If someone can come along who is able to accept small micro-payments -- one of the credit-card type companies -- then it could be viable. Right now, that's probably the biggest impediment: There's a fixed cost for using a credit card that's bigger than what a lot of these payments would be.

The idea has caused a fair amount of hysteria in the academic community, because they think fair use is going to disappear. I think that's totally not true. Fair use is still there. DRM can't keep you from reading the material, as long as you pay the price. Some say, Well, how can you take a paragraph and copy it anymore? That's what we normally consider to be fair use. But the fact is, you can still do that. You might not be able to cut and paste but as long as you can read it, you can type it.

But essentially, you're being forced to pay a company for a right that's protected in the Constitution ...

That's right. You might have to pay something. But you can always go to someone that has a legitimate version, or to a library or something like that. So I don't think it's really changing fair use. It's what fair use was before the copier. We certainly had fair use then, so this doesn't kill fair use. It's just not as easy as it could be but it's not any harder than it was 30 years ago.

But doesn't DRM limit the incentive to create, by making it harder for people to create works that derive from copyrighted creations?

I don't think that all that many people are going to use very much less. So you pay a little bit of money, which is all it should cost to get a copy. Academics mainly cite academic stuff and this usually goes at low prices. Everyone's putting up copies of their paper before publication for free downloads anyway. When you talk about quoting people's work, you see a lot more of that on the academic side. And they're the ones who are upset about it. There aren't that many novelists who are quoting other people.

Larry Lessig, Pam Samuelson and other legal scholars argue that the copyright balance has been shifting in favor of corporations for decades, with the extension of copyright law's term, the DMCA and other legislation. They think the balance has been upset so every issue becomes a vital opportunity to tip the scales back in the public's favor. Do you think these scholars are misreading recent copyright history?

While it's true that there's always been a balance, we don't know if it's been a particularly good or even balance. We really don't know. There's no empirical work that can tell you whether copyright is good or bad. It's one of the great problems with this area of law. And yes, copyright law has changed tremendously.

But I think there's a bit of hysteria there and part of it is self-serving. Academics have gotten a bit spoiled. These days they can copy things easily for free. If they had to pay some small amount, which is really all we're talking about, they get upset. I don't see the costs as a major problem.

I view the DMCA as draconian. I'm really quite unhappy about it. But I'm not unhappy with digital rights management, narrowly defined to software that keeps you from making copies; that doesn't extend the length of copyright; and certainly doesn't get rid of fair use.

What makes you so sure that DRM won't turn off consumers and make them focus on the rogue file-sharing services?

If it turns off consumers, they'll have to remove it or lower the price. The people selling these things want to make money, which means they want to give people whatever it is that they want to pay the most for. They want to maximize profits and if they change their product and no one wants to buy it, they'll change it back in a heartbeat. That's the beauty of the market. That's why it can't get too far afield. If they get every consumer mad at them, they'll be in big trouble.

By Damien Cave

Damien Cave is an associate editor at Rolling Stone and a contributing writer at Salon.

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