File Sharing, Copyright, and the Optimal Production of Music

Much economic, political, judicial and legal attention has been showered on the significant changes currently taking place within the music production and distribution business forced by the use of the Internet for both file sharing (of unauthorized copyrighted material) and more recent online (legal) music distribution. The strong demand for music, coupled with the low cost of distributing illegal copies via peer-to-peer (P2P) systems, is unraveling the business model by which music has traditionally been created, developed, and distributed. Application of traditional copyright law has been ineffective in stopping the loss of business in the traditional channels. Producers have implemented forms of Digital Rights Management ("DRM") in an attempt to protect their property via technologically self-enforcing contracts. Past DRM efforts have alienated customers, resulted in defective products, and, in some cases, been laughably easy to defeat by "hackers." Producers assert that if the problem isn't solved, music production will be sharply curtailed. The cost of "free" music via P2P is less music produced and fewer choices, an outcome that all seem to agree is bad. In this Article, I attempt to answer the question whether or not a reduction in music choice is, in fact, bad. I model the music industry as a Hotelling-Salop differentiated products market and, using results from Bhaskar and To, I show that significant overproduction of music may occur. The worst hypothesized loss from file sharing tends to reduce this overproduction, but does not eliminate it. Applying effective DRM simply returns the market to overproduction. Taking account of potential externalities (using rough preliminary estimates) of creative material suggests that overproduction of music is still the most likely outcome. Further empirical research is needed, but, on the basis of this model, the most likely outcome is that the displacement of CD sales by P2P file sharing actually increases welfare by constraining the overproduction of music that results from its unique market structure. The very tentative policy conclusion is that legitimizing file sharing under the doctrine of fair use is likely to be welfare enhancing.