The Economics of Copyright, Parallel Imports and Piracy in the Music Recording Industry
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The Economics of Copyright, Parallel Imports and Piracy in the Music Recording Industry. Theo Papadopoulos This thesis is presented in fulfilment of the requirements of the degree of Doctor of Philosophy School of Applied Economics Victoria University 2002 FTS THESIS 346.940482 PAP 30001008546766 Papadopoulos, Theo, 1959- The economics of copyright, parallel imports and piracy in the music recording Declaration of Authenticity I hereby certify that, unless otherwise stated, the work presented in my own and has not been submitted previously, in whole or in part, for any other academic award. eo Papadopoulos Abstract Australia has been at the forefront of trade-related copyright reform having, after almost a decade of debate and controversy, amended the import provisions of the Copyright Act 1968 to allow parallel imports of sound recordings. The related issues of the exhaustion of copyright, parallel imports and international piracy, is a complex area of international law and economics, and highlights the interplay between competition policy, intellectual property law and trade policy. We begin with an investigation of the economics of the music recording industry, encompassing the nature of demand and supply of sound recordings, profit maximising price strategies for a multi-product firm, and an investigation into the market stmcture and international distribution of sound recordings. This is followed by an investigation of the economics of copyright with respect to sound recordings and the evolution of international intellectual property rights law. This leads to a critical evaluation of the controversy surrounding the exhaustion of copyright and the case for copyright owner control over parallel imports. We then develop a model of the market for sound recordings to investigate the income redistributive effects and welfare consequences of adopting the principle of international exhaustion. We demonstrate that parallel imports, by introducing intra-title competition, can undermine a strategy of intemational price discrimination and can be welfare enhancing for a nation like Australia that is a net-importer of sound recordings. The model is extended to analyse the contention that the removal of the prohibition on parallel import would cause an increase in the level of sound recording piracy. Drawing on a review of literature on smuggling and piracy, we develop a theoretical model of intemational sound recording piracy. The determinants identified encompass both economic and institutional factors including, parallel imports, an affordability index (or price-earnings ratio), a nation's dependence on foreign repertoire, the strength of domestic IPR enforcement, the prevalence of informal (or black) markets, cormption in the civil service and membership to intemational copyright conventions. The sound recording piracy model is tested using cross-section data on sound recording piracy market shares for 84 countries. We show that the model is robust and compares favourably with other models of intemational piracy. The empirical model and the hypotheses examined are consistent with the predictions of our theoretical model. Table of Contents Abstract *^ List of Tables vii List of Figures viii Chapter 1 Introduction 1 Chapter 2 The Economics of the Music Recording Industry 7 2.1 The Market for Sound Recordings 7 2J^1 Maiket.definition.,.,,,.,,.,.,,.,^,.,,.,.,,.,,,.,,.,.,,.,,,.,,.,.,,.,,,^^ 2.1.2 The Creation and Production Process 9 2,_L3 Physi£al.an.dInteJlectual.£gi^^^^ 2.1.4 The Nature of Demand for Sound Recordings 22 2.2 Market Stmcture 35 2.2.1 Technological Change & Minimum Efficient Size 37 2.3 International Dimensions of the Distribution of Sound Recordings .. 47 2,4 Summaiy.,.,,,.,,.,.,,,,,.,,.,.,,.,,,,,,,,.,,,,,.,,,,,,.,,.,.,,.,.,,.,,.,.,,.,.,.,,.,.^^ Chapter 3 The Economics of Intellectual Property and Copyright 56 3.1 InteUectual Property Rights 56 3.2 The.Evolution of Internati^^^^^ 3.3 The Distribution Right and the Principle of Exhaustion 66 3,4 .Internatipnaj..ffR..Law 3.5 The Economics of Exhaustion and Parallel Imports: A Review of Literature 75 3.6 The Exhaustion of the Right of Distribution and Sound Recordings. 93 3.6.1 Pre-Sales Investment: A&R, Marketing and Promotion 93 3:.6,l.....Mon^Q!y.I^D]^L.^,.,,.,,,,.,,.,.,,.,,,,^^^ 3.6.3 Price Discrimination 105 3,7 Snmmaix.and.Conc!mb^ Chapter 4 Parallel Imports and Sound Recordings Ill 4.1 Australian Copyright Law Reform and Parallel Imports Ill 4.1.1 CLRC Review ofCopvright Import Provisions Ill 4.1.2 PSA Inquiry Into Book Prices Ill in 4.1.3 Inquiry into the Prices of Computer Software 113 4.1.4 Inquiry into the Prices of Sound Recordings 115 4.1.5 Senate Committee Review of Parallel Imports & Sound Recordingsl 17 4.1.6 The Copyright Amendment BilUNo. 2) 1998 120 4,.1.,.7 Xowards the.UniversaL Adp^^^^^ 4.2 Review of Related Literature 122 4,3 Cppyri^ht^.Peu:aJleL_Imp.orts..a^^^^ 4.3.1 The Australian Market for Sound Recordings 125 4.3.2 International Price Discrimination & Reciprocal Importation Rights. 127 4.3.3 The Welfare Consequences of National Exhaustion 133 4.3.4 The Welfare Consequences of International Exhaustion 136 4,.3,.5 Strategic Pph.cy.Options.for 4.4 Piracy and Smuggling 140 4,.5 IMPpstdReform.PeriM:..:..:..=....^.^ 4.5.1 Parallel Imports, CD Prices And Artist Income 143 4.5.2 Anti-Competitive Conduct: Breaches of the Trade Practices Act... 145 4.6 Conclusion 148 Chapter 5 International Sound Recording Piracy 151 5.1 The Nature of the Problem 151 5.1.1 Definitions 151 5.J.:.2.. ..MusicPfracyFonnat,.,^,.,,,,.,,.,.,,,,,,,,.,.,^ 5.1.3 International Initiatives to Combat Piracy 155 52 AReview.p£Relate4IJteratoe 5.2.1 Theoretical Models of Smuggling 159 5.2.2 Smuggling, Cormption and Informal Markets 164 5.2.3 Summary 166 5.3 A Model of International Sound Recording Piracy 167 5.3.1 Welfare Economics of Smuggling Copyright Infringing Product... 167 5.3.2 A Partial Equilibrium Analysis of Smuggling Copyright Infnngirig.Product.,.,,.,,,.,,,,.,,.,,,,,,,_,,,,,,,, ^,^,,,,^ 5.3.3 The Smuggling Firm's Decision Making Process 179 5,l:4_....£onsumeLBehavipur.aMthe.De^^^^^^^ lA Determinants of Smuggling and Piracy 196 IV 5.4.1 International Copyright Convention Membership 196 5.4.2 Domestic Law Enforcement 198 5.4.3 The Nature and Size of the Penalties 201 5.4.4 Domestic Price 202 5,4,5 InstitutionaLCprmptjpnaM^ 5.4.6 The Balance ofTrade in Copyright Product 205 54J..„„ParalIdimports,.,,,,,,,,.,,,,.,,,,..,,.,.^ 5.5 Towards a Testable Model 208 5.6 Summary and Conclusions 210 Chapter 6 An Empirical Model of International Sound Recording Piracy 214 6.1 Introduction 214 6.2 Empirical Models of Piracy 214 6.2.1 The Burke Model 215 6,2,2.....The.MMron.andStedM 6.2.3 TheRonkainen and Guerrero-Cusumano Model 221 6,3 3Re-estimationpfthe.Biur]t^.MPjM 6.3.1 Multinomial Logit Estimation 223 6.3.2 Linear Regression Model 225 6.4 A Model of Cross-Country Variations in Sound Recording Piracy. 227 6.4.1 Modelling Issues 227 .6,4..2_..... The Dependent 6.4.3 The Explanatory Variables 229 6,.5 TMEmpincaI..Model.,,,,,_,,,,,.,,,,,,,,,,^ 6.5.1 The Sample 244 6.5.2 Procedures Used to Estimate the Model 244 6.5.3 The Linear Model: From the General to Specific Model 244 6.5.4 Regression Diagnostics 246 6.6 Interpretation of the Estimated Coefficients 247 6.6.1 Property Rights, Black Markets and Cormption 247 6,6„2 Geneva. Cony entigtiMem^e^^ 247 6.6.3 Years of Membership to the Berne Convention 248 6,6^,4_ Price:^Earmngs.Rat ..,...,,,.,......:,.,.. 248 6.6.5 Sound Recording Balance ofTrade 248 6.6.6 Comparison with other Models 249 6.7 Concluding Remarks 250 Chapter 7 Conclusion 265 Bibliography 272 VI List of Tables Table 2. 1 Distribution of Income from a CD (Australia, 1999) 51 Table 2. 2 Record Company Costs 51 Table 2. 3 Cost of Production: Sample Sound Recording Title 52 Table 2. 4 Sound Recording Industry Market Shares, 2000 53 Table 2. 5 Top 10 National Markets 1999-2004 53 Table 2. 6 Record Company & Distributor Income: Australia 54 Table 2. 7 Share of Traded Goods in Total Trade in Goods and Services 54 Table 2. 8 Share in Merchandise Trade of Copyright Related Goods 54 Table 3. 1 Wholesale and Retail Price Points: Australia 110 Table 4. 1 Ratio of Australian to Overseas Prices 150 Table 4. 2 Welfare Consequences of Intra-Titie Import Competition 150 Table 4. 3 Copyright Regime and Global Profits 150 Table 5. 1 Estimated Trade Losses Due to Piracy 212 Table 5. 2 Estimated Optical Disc Manufacturing Capacity. 212 Table 5. 3 Expected Profit Matrix 213 Table 5. 4 Theoretical Model of Sound Recording Piracy 213 Table 6. 1 Summary of Empirical Piracy Models 252 Table 6. 2 Model No. 1: Burke's Multinomial Logit Model 253 Table 6. 3 Model No. 2: Marron and Steel (2000) 254 Table 6. 4 Source of Data in the Empirical Sound Recording Piracy Model 255 Table 6. 5 Re-Estimation of Burke's MLE Model 256 Table 6. 6 MulticoUinearity Diagnostics - Pearson Correlation Coefficients of Burke Regressors 257 Table 6. 7 OLS Estimation of Burke's Model (excluding squared variables) 258 Table 6. 8 Expected Sign of the Model Coefficients 259 Table 6. 9 Intemational Piracy Rates: 1998 260 Table 6. 10 Sound Recording Piracy Model 261 Table 6. 11 Parsimonious Model 262 Table 6. 12 Summary Table: Parsimonious Models 263 vu List of Figures Figure 2. 1 The Production Process 11 Figure 2. 2 Marginal Cost of Production 15 Figure 2. 3 Break-Even Sales: Scenario One 17 Figure 2. 4 Break-Even Sales: Scenario Two 19 Figure 2. 5 Probability Distribution: Sound Recording Sales 25 Figure 2. 6 Price and Profit in the Presence of Stochastic Demand 28 Figure 2. 7 The Market for an Artist Specific Sound Recording 31 Figure 2. 8 Break-Even Sales with Cross-Subsidisation 35 Figure 2.