University of Chicago Legal Forum



1996 U. Chi. Legal F. 261 (1996)

Henry H. Perritt, Jr.

  At least since Blackstone and John Locke, legal and political commentators have recognized the central role that property plays in market economies and democracies. Property preserves personal autonomy and provides an incentive to produce. At the same time, public uses of resources also are necessary to well-functioning modern societies. Intellectual-property law creates property interests in commodities that derive their value from the information contained therein, rather than from tangible raw materials. But when information is subject to property interests, a variety of competing interests enter into the balance between private ownership and public use.

  New information technologies disrupt historic balances between these competing interests. Just as print technology gave rise to copyright concepts, just as phonograph recording and film technology required adaptation of copyright concepts developed for printers, just as the Xerox machine necessitated reassessment of mid-twentieth-century copyright concepts, so also does the Internet require rethinking the role and form of intellectual property in stimulating a healthy information infrastructure, in which adequate incentives exist to create and deliver quality information.

  *262 Threats to established balances do not, however, suggest that balance is no longer necessary. Owners of intellectual property should not be granted enlarged economic protection merely because they would like it. Users and exploiters of existing intellectual property should not be free of traditional intellectual-property restrictions just because they would like to be. Rather, intelligent appraisal of the role of property in an Internet-shaped information infrastructure should focus on the specific free riding and piracy risks created by the new technology.

* * *

* * *

 B.  Coase Theorem

  Utilitarian analysis argues that intellectual property may be entirely unnecessary. Thus, it relieves the law of the need to strike any balance. The Coase theorem argues that, in the absence of transaction costs, it does not matter where law places entitlements. Parties will bargain and allocate legal rights and duties according to their economic preferences. [FN23] If there were no transaction costs, intellectual property would not matter. While the originator of valuable information would not have a copyright, he nevertheless would produce the information because someone who wanted to consume the information product would pay him to create it.

  Transaction costs exist, however, in the real world of information-product creation, distribution, and consumption. [FN24] One *267 type of transaction cost arises from the public-goods character of information. Public goods are those demonstrating the characteristics of nonrivalness or nonexhaustiveness, and nonexcludability. [FN25] One person's consumption of a public good neither interferes with nor excludes another person's consumption of the same good. [FN26] Hence, a public good is nonrival. It is also impossible (for a pure public good) to exclude any one person from benefiting from that good. [FN27] The classic example of a public good is a lighthouse. [FN28] The use by one ship of its benefit, its light, does not reduce the amount available for other ships. Nor can any ships be excluded from the benefits of the lighthouse if any ship has access to the light. Any ship in the lighthouse's vicinity may use its light to keep from running aground.  [FN29]

  A private good is both rival and exclusive. [FN30] Consumption of the good excludes others from consuming the same good, [FN31] and relative to a public good, it is much easier to exclude consumers from the good's benefit.  [FN32] Most of the goods and services bought and sold are private goods.  [FN33] Gasoline, for example, is a private *268 good because each gallon can be used by one consumer only to the exclusion of another consumer.

  The nonexcludability and nonrival features of public goods threaten the ability of an original supplier of goods to recover her investment. [FN34] Nonexcludability means that she cannot systematically refuse to supply the good to nonpayers while supplying it to payers. Nonrivalness means that each customer becomes a potential competing supplier. [FN35] Thus, public goods, and goods that have some public-good characteristics, have a higher free-ride potential. [FN36] Conversely, the stronger the characterization of a product as a private good, with its commensurate increase in exclusivity, the lower the free-ride potential. A drive-in movie, for example, has public-good characteristics. It is nonrival and it is difficult to exclude viewers. Nonpaying viewers may not be able to hear the movie, but they can still see it and free ride to an extent. The same movie takes on private-good characteristics when shown in a private theater. It then becomes possible to exclude people from enjoying the movie altogether, ending the free-rider threat. Thus, as the movie takes on more private-good characteristics, its free-ride potential decreases.

  A dichotomous private/public good distinction may not be helpful in determining free-ride potential since few goods are pure public goods.  [FN37] An information product is not a pure public good, but rather a public good with private-good characteristics. The consumption of information does not necessarily reduce the amount available for another user's consumption and is therefore nonrival--a characteristic of a public good. Reading the information *269 contained in this Article, for example, does not reduce the amount available for the next reader. On the other hand, a consumer can be excluded from using an information product until he pays--a characteristic of a private good. The same reader may be excluded from reading this Article until he, or a library, has purchased the book. To determine its free-ride potential, a product's public/private good features must be evaluated carefully.

  Most information products are not perfect public goods because excludability is possible at some cost, depending on the technology. Indeed, even the light from the lighthouse--the classic example of a public good--may be handled as a private good in some circumstances. [FN38] When exclusion is feasible, it often represents a transaction cost both to producer and consumer. The originator must erect barriers, such as fences--electronic or otherwise--to keep nonpayers out, and consumers must deal with these barriers in order to strike a bargain. An example familiar to lawyers is the interposition of login routines before one can access Lexis/Nexis. Lexis/Nexis had to pay the cost of establishing and maintaining this login routine as a kind of fence around its information products. Consumers must pay the cost of remembering their login names and passwords and logging in each time they wish to consume some information.

  The nonrival feature also represents a transaction cost, but only to the producer. The first consumer, having paid only for his consumption, can transfer a copy of the information to another consumer--or would be seller-- without losing his own ability to consume. This means every consumer becomes an alternative source of supply at only the cost of copying. This transaction cost presents a challenge for the initial negotiations between originator and initial consumer to impose conditions on the consumer's transfer of a copy of the information.

  Together, the transaction costs arising from nonexcludability and nonrivalness have justified the establishment of property rights, represented by traditional copyright, patent, and trademark rights. [FN39]

 *270 C.  Information and Tomatoes

  As the preceding section noted, the features of information technology and networks complicate the utilitarian calculus. They are Coasian transaction costs. For example, suppose someone devotes much effort to discovering all of the servers on the Internet that contain information about China, believing that such information would be useful to businesses desiring to develop Chinese markets. He carefully collects the universal resource locators ("URLs") for the servers and the particular locations (files and directories) on the servers where the Chinese information may be found. He assembles the URLs into a logically organized set of Web pages so that anyone with access to his Web server can easily find and obtain copies of specific information about China.

  The entrepreneur occupies a different economic position from someone who has, for example, grown a crop of tomatoes. Like the farmer, the Web entrepreneur can deny access to his product until he is paid. Unlike the farmer, however, the Web entrepreneur faces competition from his customers. The farmer's customer, having bought one tomato, has only one tomato. While she may resell that tomato, her resale does not deprive the farmer of anything. The farmer has already been paid. This characteristic of the tomato is "rival," signifying that two persons may fight over the tomato, but that they cannot both have exclusive possession of it.

  Unfortunately for the Web entrepreneur, his products may be nonrival,   [FN40] depending on how he packages and sells them. If he transfers the entire collection of Web pointers to each customer, the customer easily can make copies of the set of pointers and sell the copies. The nature of digital technology makes the cost of copying very low. Thus, the customer can keep what she bought and also sell one or more copies. [FN41] The economic reward gives her an incentive to engage in the copying. The customer is better *271 off if she sells the copies for any amount of money greater than her cost of copying.

  The nonrival character of digital information has two implications for our Web entrepreneur, both of them bad. First, the possibility of copying means that he is deprived of the sales made by his customer. Second, because his customer did not have to incur the costs of discovering the information and assembling the pointers, she can price them much more cheaply and still cover her costs--essentially, the mere cost of copying. Either the Web entrepreneur will not be able to sell anything because he maintains a higher price, sufficient to cover his higher costs; or, in order to compete effectively, he must price below his total cost, thus eventually driving himself out of business. This teaches the entrepreneurs a lesson--do not invest your energy in creating products like this because you will not be rewarded.

  The foregoing parable explains the justification for the reproduction right in copyright law. In some respects this reproduction right seems similar to the traditional property interest that the farmer has in his tomato. Just as taking the farmer's tomato without his permission constitutes the tort of conversion, so also reproducing the Web entrepreneur's set of Web pointers without his permission may be copyright infringement.

  There are, however, two difficulties with the analogy. First, unless the reproduction right is carefully limited, it may represent a significant barrier to the very activity it seeks to encourage. [FN42] The consumer of the information product may need to reproduce the product to use it. Some reproduction of information products may be necessary to build other information products.

  Second, a special reproduction right may not be necessary. A conventional property interest, sufficient to protect the farmer *272 against the theft of his tomato, also may be sufficient to protect the Web entrepreneur against the theft of the fruits of his labors. The exclusivity characteristic concerns means employed by a producer to exclude a consumer. A theater owner, for example, excludes consumers by showing his movie only within an enclosed theater and only admitting paying patrons. The movie is nonrival, but excludable. A recent study for the Australian government identified several features of publishing markets that could allow returns for a first publisher to remain high enough to cover the costs of producing the original, thus obviating the justification for intellectual property under the public-goods rationale. [FN43] These features include lead time, costly copying, less than perfect copies, inability to use copies without support and assistance from the originator, and collusion between potential copiers and originators.  [FN44]

  Consider the efficacy of conventional property interests. The farmer benefits from these interests by fencing his tomato patch and asserting control over his stall in the marketplace. Anyone who takes tomatoes from the patch or the stall and sells them without the farmer's permission commits the torts of trespass to land, [FN45] trespass to chattel, [FN46] or conversion,  [FN47] and the crimes of theft, [FN48] burglary, [FN49] or defiant trespass. [FN50] The rationale for these torts and crimes is the prevention of conduct inconsistent with the farmer's property interests in the tomatoes. Trespass, conversion, larceny, and burglary are applicable to information resources. If one fences off the information wares in one's computer, unauthorized entry may be remediable by property-oriented torts, such as trespass or conversion, and property-oriented crimes, such as burglary or larceny. [FN51] Some new form of legal protection or property interest is necessary only when conventional property interests are insufficient. Historically, protecting against theft of the tangible object in which intellectual property was embodied, such as a book, protected the author and publisher *273 to some degree, but did not protect them against the prospect that someone would copy the contents of the book and resell it. In the electronic context, it is important to identify the difference between theft of the tangible artifact and free riding on the intangible intellectual property. If technology makes it more difficult to steal the content of the "book" after buying or stealing the book, the gap to be filled by intellectual property, as opposed to conventional property, may be smaller. [FN52]

  Regardless of the respective roles that conventional and intellectual-property concepts play, all forms of property are limited by the needs of the larger society to do things that in some sense diminish the economic expectations of the property owner. For example, owners of real property never have enjoyed the privilege of engaging in conduct that constitutes a nuisance.  [FN53] Early in the twentieth century, the common-law courts established that owners of real property do not enjoy the right to restrict flights over their property at reasonable altitudes. [FN54] More recently, environmental law has imposed further restrictions on property owners' rights and privileges. [FN55] Taking of private property, though entitling the property owner to compensation, similarly represents a limitation on uninhibited exploitation of private property. In all of these traditional examples, the law strikes a balance between the utility of private property and the utility of public use of what otherwise would be within the scope of private property.

  The same balancing occurs in an intellectual-property regime. Absolute ownership of information potentially blocks use of the owned information. Since all information in some sense is derived from other information, ownership of information must be limited in order to avoid preemption of the information base from which public debate and various economic activities can take place.  [FN56]

 *274 II.  Economics of Free Riding

A.  Coase's Caution

  Professor Coase appropriately cautioned that policy judgments about his theorem and about transaction costs should be based on real-world facts, not on theory:

  (H)ow is it that these great men have, in their economic writings, been led to make statements about lighthouses which are misleading as to the facts, whose meaning, if thought about in a concrete fashion, is quite unclear, and which, to the extent that they imply a policy conclusion, are very likely wrong? The explanation is that these references by economists to lighthouses are not the result of their having made a study of lighthouses or having read a detailed study by some other economist. Despite the extensive use of the lighthouse example in the literature, no economist, to my knowledge, has ever made a comprehensive study of lighthouse finance and administration. ( [FN57]) The lighthouse is simply *275 plucked out of the air to serve as an illustration. The purpose of the lighthouse example is to provide "corroborative detail, intended to give artistic verisimilitude to an otherwise bald and unconvincing narrative."

  This seems to me to be the wrong approach. I think we should try to develop generalisations which would give us guidance as to how various activities should best be organised and financed. But such generalisations are not likely to be helpful unless they are derived from studies of how such activities are actually carried out within different institutional frameworks. Such studies would enable us to discover which factors are important and which are not in determining the outcome and would lead to generalisations which have a solid base. They are also likely to serve another purpose, by showing us the richness of the social alternatives between which we can choose. [FN58]

  Professor Coase's caution is particularly appropriate when one thinks about new information technologies. The application of the Coase theorem to markets for information is debatable. [FN59] New information technologies may be misunderstood by policymakers and commentators. And, even if policymakers and commentators understand these technologies, the use of simplifying metaphors may obscure important realities. This Article argues that it is useful to begin with the actual transactions that occur in new cyberspace technologies. Those technological realities suggest that there may be important sources of excludability and rivalness for information products in the new environments that undercut any arguments in favor of expanding intellectual-property protection. As a recent report commissioned by the Australian government said, "(t)he . . . onus is on those advocating any expansion of copyright protection to show on a case-by-case basis that such extension would benefit producers and consumers." [FN60]

  *276 Of course, one must be careful not to build policy on transitory technology applications. For the foreseeable future, however, it is safe to assume that computers will be used to process information, that they will be connected in networks, that the networks will use open standards for their connections, and that the capabilities popularized through the Web will continue to be exploited. Thus, the Web model is not likely to become irrelevant any time in the near future.

  Technology in the Web plays two important roles in analyzing the role of intellectual property. First, it reduces the nonexcludability and nonrivalness characteristics that justify intellectual-property protection. In this role, features of the technology that impose zero or only slight transaction costs between originator and initial consumer, while imposing very high transaction costs on potential free riders and pirates, reduce the overall transaction costs justifying intellectual property. Second, because the transaction costs resulting from the Web technology are asymmetric, they may not justify new configurations of property and liability entitlements in the evolution of intellectual property.

  One justification for special property rules for information is the inability of the originator and initial owner of intellectual property to recover the cost of creation because of the potential of free riding. [FN61] This argument suggests that, absent legal protection, the market will not produce enough information. Pirates do not have to repeat the investment of the creator, and thus can sell the creator's product at the marginal cost of copying, forcing the creator to price at the marginal cost of copying in order to retain any market share. [FN62] At this price, the creator will never recover her fixed costs of creation.

  Intellectual property law remedies this problem by increasing the pirate's costs. [FN63] Under a regime of intellectual property, the pirate faces not only the marginal cost of copying, but also *277 legal costs, which represent his expected liability. [FN64] A real pirate, moreover, faces additional costs. He must acquire the pirated information, transform it into a form that he can resell, and market it.

  The costs of originator and pirate can be expressed in equation form. The originator's costs are:

  co=cc cct cm cr

  where cc is the cost of creation, for example, payments to the author; cct is the cost of chunking and tagging, or otherwise preparing the information for publication; cm is the cost of marketing, including promotional expenses, distribution costs, and costs of billing and collection; and cr is the cost of copying or reproduction.

  The pirate's costs can be expressed as:

  cp=ca ct cm cr cll

  where ca is the cost of acquisition, for example, finding and downloading the material a pirate intends to resell; ct is the cost of transformation;  [FN65] cm is the cost of marketing; cr is the cost of copying; and cll is the pirate's cost of legal liability. There is no reason to expect that the pirate's marketing or copying costs will be lower than those of the originator. [FN66]

  A free-ride problem exists only if the pirate's costs are less than the originator's costs, in other words if

  cc cct>ca ct cll.

  Professor Hardy's article, [FN67] the White Paper, [FN68] and other commentaries about property in cyberspace assume that cc cct is *278 much greater than ca ct, and therefore that the value of cll must be increased to maintain the current level of free-riding risk.

  This Article argues that that may not be so. In particular, it argues that products can be designed so as to increase ct to the point where it counterbalances any reduction in cll that results from cyberspace technology. Product design can increase the benefits of the originator's lead time, thus increasing the probability of recovering fixed costs before the pirate can establish a market presence. Finally, the Article argues that payments can be transferred from those who gained from a relatively frictionless cyberspace  [FN69] to creators who otherwise face free-riding risks.

  When fixed investment is large compared with variable costs of production, free riding on the first producer's investment becomes a possibility. The imitator free rides by producing the same product at marginal costs close to those experienced by the innovator, but avoids the fixed costs incurred by the innovator. [FN70] It is not necessary that the free rider have no fixed costs; only that the free rider's fixed costs be less than the first producer,  [FN71] and that his marginal cost not be so much higher than the first producer's [FN72] as to cancel the advantage of lower fixed costs. Accordingly, the free rider faces a lower average total cost and enjoys a price advantage over the innovator. The greater the free ride, the greater the cost advantage.

  But there are countervailing considerations. The monopolies created by intellectual property may be unnecessary where significant economic barriers to entry exist. [FN73]

  *279 First, the potential free rider may not be able to avoid fixed costs to any great degree. [FN74] An example outside the information industry is the imitation of a new aircraft technology by another producer. The detailed engineering design and tooling required by the copier potentially overshadows the original producer's investment. [FN75] Second, there are delays before any copier can realize earnings from free riding. [FN76] Third, the first innovator gains reputational advantages, which assist in differentiating that producer's product from those of imitators. Fourth, the first innovator has a head start in taking advantage of learning-curve cost advantages which can deter entry and result in supranormal profits while the technology matures. Finally, firms already in a market use existing market structures to deter new entrants who lack production facilities, managerial experience, and channels of distribution. [FN77] In one survey, being first with an innovation, moving quickly down the learning curve, and having superior sales or service efforts exceeded patents as means of appropriating the benefits from innovation.  [FN78] Similar barriers to successful entry can operate in the information industry.

  In addition to the differences between fixed and variable costs, other barriers to entry by pirates may exist. Some fixed costs may represent transferable rather than sunk costs and thus *280 be less at risk. Publishers can reduce the incidence of sunk costs by automating certain publishing processes. Lower sunk costs reduce the amount of fixed investment available for free riding.

  Fixed costs may be broken down into two separate components: sunk costs and transferable costs. [FN79] Sunk costs are product specific and the producer cannot recover them through sale or lease. [FN80] If an investment can be used for other purposes, it does not represent a sunk cost. [FN81] Only the sunk portion of that investment is free rideable, because only it represents irreversible investments. [FN82] Transferable costs, however, are not free rideable because the initial producer can sell the investment, recover its cost, and negate any cost advantage held by the free rider. Thus, free rideability depends on whether a significant part of a first producer's costs are sunk. Investment risk to an innovator decreases commensurately as it moves from irreversible to reversible investments [FN83]--from sunk to transferable costs. A first producer will be much more willing to enter into a venture with lower investment risk represented by lower sunk investment. Labor, a major sunk cost, illustrates this point. Technological *281 progress in electronic publishing has transformed labor-intensive activities into capital-intensive activities. The widespread use of computers in information production has made this apparent. When production is more labor-intensive, sunk costs are more likely because, once expended, labor cannot be used for another product.  [FN84] However, as production becomes more capital-intensive, sunk costs become less likely because capital may be more easily sold or transferred for another use. [FN85] Accordingly, as information production--that is, electronic publishing--becomes more capital-intensive, transferable capital costs replace sunk labor costs. As these sunk costs decrease, free rideability decreases accordingly. [FN86]

[FN23]. R. H. Coase, The Problem of Social Cost, 3 J L & Econ 1, 10  (1960). See also Guido Calabresi, Transaction Costs, Resource Allocation and Liability Rules--A Comment, 11 J L & Econ 67 (1968); G. Warren Nutter, The Coase Theorem on Social Cost: A Footnote, 11 J L & Econ 503 (1968).

 [FN24]. Calabresi and Melamed argue that the condition of no transaction costs

(M)ust be understood extremely broadly as involving both perfect knowledge in the absence of any impediments or costs of negotiating. Negotiation costs include, for example, the cost of excluding would-be-free loaders from the fruits of market bargains. . . . (The free loader) is the person who refuses to pay for a common part, although he wants it, because he believes that others will put in enough money to make the part available to him. . . . (T)he costs of excluding the free loader from the benefits for which he refused to pay may well be considerable . . . including the inefficiency of pricing a good, like the part once it exists, above its marginal cost in order to force the free loader to disclose his true desire to use it--thus enabling us to charge him part of the cost of establishing it initially.

Guido Calabresi and A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 Harv L Rev 1089, 1094-1095 n 13 (1972) (cited in note 7). Professor Coase himself identifies the following as possible elements of transaction cost: discovering those with whom one wishes to deal, informing people that one wishes to deal and on what terms, conducting negotiations leading up to a bargain, drawing up the contract, and undertaking the inspection needed to make sure contract terms

are being observed. Coase, 3 J L & Econ at 15 (cited in note 23).

 [FN25]. See Earl R. Brubaker, Free Ride, Free Revelation, or Golden Rule?,  18 J L & Econ 147, 148 (1975) (stating that two crucial properties distinguish goods: nonexhaustiveness and nonexcludability. "Purely non-exhaustive consumption may be regarded as the ultimate in positive eternality."). Brubaker states that "feasibility of exclusion from consumption . . . ranges along a continuum, namely, from low marginal cost to high marginal cost . . . (thus) classification of any specific good can be made according to its position along the two continua." Id at 148-149. See also Australia Office of Regulation Review and Economic Analysis of Copyright Reform 13 & n 21 ISBN0-642-233359-4, (Australian Office of Regulation Review and Economic Analysis of Copyright Reform, 1995) ("(R)ights attaching to real property are the result of scarcity, while the rights attaching to the expression of ideas create scarcity.").

 [FN26]. Brubaker, 18 J L & Econ at 148-49 (cited in note 25).

 [FN27]. Id.

 [FN28]. Other examples include clean air and the protection provided by the American military. These goods are both nonrival and do not exclude any consumer from their benefit. Most public goods are either gifts of nature or provided by the government. Werner Sichel and Peter Eckstein, Basic Economic Concepts--Macroeconomics 259 (Rand McNally, 2d ed 1977).

 [FN29]. There are, however, few pure public goods. Id. Some public goods may take on the exclusive characteristics of a private good as their use increases to the point of congestion, when an additional person's use interferes with or excludes another person's use. Id at 260. A public highway, for example, may be a public good until the point where traffic volume causes one additional motorist to exclude another motorist's use of the highway.

 [FN30]. Id at 259.

 [FN31]. Sichel & Eckstein, Basic Economic Concepts at 259 (cited in note 28).

 [FN32]. Id.

 [FN33]. Id at 260.

 [FN34]. Id. Sichel and Eckstein cite the examples of a person who listens to an open-air concert or watches a baseball game through a fence, but does not pay for these services. Sichel & Eckstein, Basic Economic Concepts at 260 (cited in note 28). The nonexclusivity of the concert and the game allow the nonpaying consumer to enjoy the good's benefit.

 [FN35]. Both nonpaying consumers and competing suppliers in the situation described can be termed "free riders" or "free loaders" or "pirates." The most significant economic threat comes from competing suppliers, and it is that type of free riding on which this Article concentrates.

 [FN36]. The potential for a free ride exists when a competing supplier gets the benefits of the originator's investment without having to pay for it.

 [FN37]. Fire protection and radio signals are examples of goods that have strong public-good characteristics, but are not pure public goods. Sichel & Eckstein, Basic Economic Concepts at 259 (cited in note 28). It is difficult to exclude the benefits of these goods from certain community members, but those living closer to their source may enjoy them more fully than others. Id. All members of a community may enjoy protection by their local fire department, but families living across from the firehouse may be safer than those living farther away. Id. Similarly, those living closer to a radio tower may enjoy a clearer signal than others.

 [FN38]. See Coase, The Lighthouse in Economics, 17 J L & Econ 357  (1974) (explaining that lighthouses in England were mainly financed by tolls collected at ports near the lighthouse).

 [FN39]. A fourth form of intellectual property, trade secret, is better understood as a liability rule under the analytical framework developed by Calabresi and Melamed. See Calabresi & Melamed, 85 Harv L. Rev at 1094-95 (1972) (cited in note 7) (explaining applicability of Coase theorem to property and liability rules).

 [FN40]. See Christopher D. Stone, What to Do About Biodiversity: Property Rights, Public Goods, and the Earth's Biological Riches, 68 S Cal L Rev 577, 580-81 nn 11-12 (1995) (discussing public-goods characteristics of nonrivalness and appropriability and comparing berry patches with private goods); Wendy J. Gordon, Assertive Modesty: An Economics of Intangibles, 94 Colum L Rev 2579, 2587-88 (1994) (explaining how public-good characteristics of intellectual property can lead to market failure); Wendy J. Gordon, A Property Right in Self-Expression: Equality and Individualism in the Natural Law of Intellectual Property, 102 Yale L J 1533 (1993) (comparing agricultural commodities and intellectual property and emphasizing public-goods characteristics of intellectual property).

 [FN41]. The nonrival character of information means she can have her cake and eat it too.

 [FN42]. Copyright seeks to encourage production of information value. See  Feist Publications, Inc. v Rural Telephone Service Co., 499 US 340, 349-350 (1991) (explaining justification for copyright). But copyright actually may have the effect of decreasing such production:

Although increased copyright protection may encourage the production of more copyrightable work, some of which might not otherwise be created, it also increases the price of intellectual works for consumers, and so reduces the dissemination and availability of such works. In some cases, those consumers may be producers of further works. Thus, the number of intellectual works in the community may be reduced and the speed at which the works are disseminated reduced. Limiting the defusion of expressions also limits the defusion of the ideas underlying those expressions.

Australian Economic Analysis of Copyright Report at 13 (cited in note 25).

 [FN43]. Australian Economic Analysis of Copyright Report at 14 (cited in note 25).

 [FN44]. Id.

 [FN45]. Restatement (Second) of Torts S 158 (1965).

 [FN46]. Id S 217.

 [FN47]. Id S 222A.

 [FN48]. Model Penal Code S 223 (1985).

 [FN49]. Id S 221.1.

 [FN50]. Id S 221.2.

 [FN51]. See Ga Code S 16-9-93 (1992) (defining computer theft); Iowa Code Ann S 716A.9 (1993) (defining computer theft); Minn Stat Ann S 609.89 (1987) (defining computer theft); RI Gen Laws S 11-52-4 (1994) (defining computer theft).

 [FN52]. Changes in technology also can change cost functions and change the relationship among fixed and variable costs and the importance of sunk costs, all of which affect free-ride potential, as explained in Part II of this Article.

 [FN53]. William Blackstone, 3 Commentaries on the Laws of England 216-19  (Callaghan & Co., 2d ed 1879) (summarizing cause of action for nuisance).

 [FN54]. See generally San Diego Unified Port District v Superior Court, 67 Cal App 3d 361, 136 Cal Rptr 557 (1977) (preempting trespass claims resulting from aircraft overflight).

 [FN55]. See Lucas v South Carolina Coastal Council, 505 US 1003, 1015  (1992) (recognizing proposition that environmental restrictions on property use could constitute a taking compensable under the Fifth and Fourteenth Amendments); Penn Central Transportation Co. v New York City, 438 US 104 (1978) (reviewing framework for analyzing regulatory-taking claims).

 [FN56]. Feist, 499 US at 349-350 (explaining why copyright must be limited); Sony Corp. v

Universal City Studios, Inc., 464 US 417, 431-32 (1984) (noting that limited scope of copyright reflects balance of competing claims on public interest; creative work must be encouraged but private motivation must ultimately serve cause of promoting broad public availability of information). See generally L. Ray Patterson and Stanley W. Lindberg, The Nature of Copyright: A Law of Users' Rights (University of Georgia Press, 1991) (arguing that copyright law should be interpreted to recognize users' rights as well as authors' rights).

 [FN57]. Professor Coase later suggested that perhaps the light from lighthouses is not a public good--at least on the excludability dimension:

The early history (of the British lighthouse system) shows that, contrary to the belief of many economists, a lighthouse service can be provided by private enterprise. In those days, shipowners and shippers could petition the Crown to allow a private individual to construct a lighthouse and to levy a (specified) toll on ships benefitting from it. The lighthouses were built, operated, financed and owned by private individuals, who could sell the lighthouse or dispose of it by bequest. The role of the government was limited the establishment and enforcement of property rights in the lighthouse. The charges were collected at the ports by agents for the lighthouses. The problem of enforcement was no different for them than for other suppliers of goods and services to the shipowner. The property rights were unusual only in that they stipulated the price that could be charged.

R. H. Coase, The Lighthouse in Economics, 17 J L & Econ 357, 375  (1974) (cited in note 38).

If a lighthouse owner knows when each ship needs the services of the lighthouse, and if only one ship is within range of the lighthouse at any moment, excludability is perfect because the light could be shut off when nonpaying ships come in range. Id at 375-76 n 43.

 [FN58]. Id at 374-75 (internal citation omitted).

 [FN59]. See Robert P. Merges, Of Property Rules, Coase and Intellectual Property, 94 Colum L Rev 2655, 2657-58 (1994) (noting difficulties in judging an argument over existence of externalities in intellectual-property field).

 [FN60]. Cover letter accompanying Australian Office of Regulation Review, and Economic Analysis of Copyright Reform (1995) (cited in note 25).

 [FN61]. David H. Kramer, Who Can Use Yesterday's News?: Video Monitoring and the Fair Use Doctrine, 81 Georgetown L J 2345, 2360 (1993) (arguing that "socially desirable transfers between copyright holders and individuals . . . might not occur through the market" because of transaction costs and the free-rider problem).

 [FN62]. Id.

 [FN63]. It may seem paradoxical that one reduces the transaction costs that justify intellectual-property law by increasing transaction costs to pirates. Two different kinds of transaction costs are involved. The first type is within the broad definition that encompasses impediments to negotiations, such as lack of excludability. The second type increases excludability and therefore decreases the first type of transaction cost by making it more difficult for a pirate to obtain and resell information without paying for it.

 [FN64]. The expected liability in turn is a function of the probability of detection, the probability that a copyright owner could prove infringement, and the expected damages resulting from a judgment for the copyright owner.

 [FN65]. In conventional publishing, this would be the cost of typesetting and manufacturing.

 [FN66]. Indeed, the originator's learning curve and lead time probably will be such that her marketing and reproduction costs will be lower at any point in time than those of a pirate. But for the purpose of simplicity, this Article initially assumes that the marketing and copying costs are the same for both originator and pirate. When the effect of the originator's lead time is considered, the assumption is relaxed.

 [FN67]. Trotter Hardy, Property (and Copyright) in Cyberspace, 1996 U Chi Legal F 217 (cited in note 8).

 [FN68]. United States Department of Commerce, Information Infrastructure Task Force, Intellectual Property and the National Information Infrastructure: Report of the Working Group on Intellectual Property Rights (Sept 1995) ("White Paper") (cited in note 5).

 [FN69]. The frictionless condition refers to minimization of transaction costs otherwise associated with complex new schemes of intellectual-property protection or technological protection for creative works.

 [FN70]. In the conventional analysis of the economics of information, fixed costs usually means cc--the originator's cost of creation--and the analysis ignores the pirate's fixed costs, ca, ct, and cm.

 [FN71]. It is also necessary that the first producer's fixed costs be sunk. Sunk costs are costs that the producer cannot recover by transferring to another through sale or lease. If the first producer has low fixed costs, relative to total costs, it becomes less likely that sunk costs are important. If fixed costs are relatively more important, the potential for important sunk-cost considerations increases.

 [FN72]. As might occur because of the learning-curve effects of the originator's lead time.

 [FN73]. See C.C. von Weizacker, A Welfare Analysis of Barriers to Entry, 11 Bell J Econ 399 (1980). A barrier to entry is defined "as a cost of producing (at some or every rate of output) which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry." Id at 399. See also Mark F. Grady and Jay I. Alexander, Patent Law and Rent Dissipation, 78 Va L Rev 305 (1992) (arguing that the purpose of patent law is to limit rent dissipation); Donald L. Martin, Reducing Anticipated Rewards from Innovation through Patents: Or Less is More, 78 Va L Rev 351 (1992) (commenting on Grady and Alexander article); Robert P. Merges, Rent Control in the Patent District: Observations on the Grady-Alexander Thesis, 78 Va L Rev 359 (1992) (commenting on Grady and Alexander article).

 [FN74]. Landes and Posner note that copiers may have positive fixed costs, though one would expect those fixed costs to be lower than those of the original publisher. William M. Landes and Richard A. Posner, An Economic Analysis of Copyright Law, 18 J Legal Stud 325, 329 (1989).

 [FN75]. Other surveys suggest that patents are very important in pharmaceuticals and other chemicals but less important in other industries, including "instruments." F.M. Scherer and David Ross, Industrial Market Structure and Economic Performance 629 (3d ed 1990). But see the "self regulating" argument in choreographic protection. One estimate, reported by Professor Scherer, suggests that research and development costs of duplicating major unpatented new products exceeds 50 percent of the original innovator's costs. Id at 627 (reporting work by Richard Levin et al, "appropriating the returns from industrial research and development," in Brooking's Papers on Economic Activity at 809 (no 3 1987)).

 [FN76]. Landes and Posner suggest that new technologies reduce the importance of this advantage because they reduce the cost of making copies and permit copies to be made more quickly. Landes & Posner, 18 J Legal Stud at 330 (cited in note 74).

 [FN77]. Scherer explains why monopolistic competition is a structure that produces more innovation faster than either pure monopoly or perfect competition, Scherer & Ross, Industrial Market Structure and Economic Performance at 630-42 (cited in note 75), and that much innovation occurs from small new entrants who apparently were able to move more quickly with fewer inhibitions resulting from existing market share. Id at 652-653.

 [FN78]. Id at 628 (citing and reporting results from Levin).

 [FN79]. Traditional microeconomic analysis characterizes costs as fixed or variable, but for our purposes of determining free-ride potential, a sunk/transferable distinction is preferable.

 [FN80]. Professors Eaton and Lipsey illustrate sunk costs with two opposing illustrations. At one extreme is a natural monopolist who has no sunk costs. This might occur "if capital were not product specific and could be bought, sold, and rented on perfect markets." B. Curtis Eaton and Richard G. Lipsey, Exit Barriers are Entry Barriers: the Durability of Capital as a Barrier to Entry, 11 Bell J Econ 721, 722 (1980). Because there are no sunk costs, the market is contestable at each moment. At the other extreme is a natural monopolist with a "permanent commitment" to the market. Id. "(A)s long as he can cover his avoidable costs he will remain in the market." Id. See also B. Curtis Eaton and Richard G. Lipsey, Capital, Commitment, and Entry Equilibrium, 12 Bell J Econ 593, 594 (1981) (explaining that sunk costs are costs invested in product-specific capital determined in larger part by its durability and divisibility).

 [FN81]. An example of a sunk cost is the cost charged to an online database subscriber for so many minutes of use of a particular Lexis or Westlaw database. Once a user's connect time has elapsed, the cost has been incurred. It is not recoverable through sale or lease since a subscriber has paid for a privilege that is no longer available. However, if a set of bound reporters are purchased instead, a transferable cost is incurred because the purchaser can readily resell the books.

 [FN82]. Most of the literature on sunk cost focuses on economic incentives and disincentives for a firm considering entry into a market in which at least one other firm is operating successfully. For such potential new entrants, the risk is greater if the investment is irreversible. Building a railroad, for example, is riskier than starting an airline or a truck line because the cost of the right of way and track are sunk, while there is no equivalent investment in trucking or airlines.

 [FN83]. Although a free rider can appropriate the value generated by an initial producer's transferable costs, there is no free riding on the transferable cost because it can be sold. This results in no cost advantage to the free rider.

 [FN84]. For example, the cost representing the labor invested in creating the content for an information product is nonrecoverable. This cost is only recoverable by selling the information product. However, the transferability of the value created by the labor does not change its sunk-cost character. When discussing sunk costs, we look at transferability of inputs, not outputs. A sunk cost is a specialized investment having no value independent of the product in which it is embodied.

 [FN85]. Agriculture exemplifies a labor-intensive activity that has become increasingly capital-intensive. Agricultural machine technologies require less labor by intensifying use of capital, thereby decreasing agriculture's sunk costs because of the transferability of farm machinery.

Electronic publishing illustrates this same shift in the information-production industry. Activities involved in information production, such as chunking and tagging or creation of internal and external pointers, were at one time labor-intensive and represented sunk costs. However, its increased capital-intensity reduces these sunk costs. To illustrate, under older technologies, the labor expended in editing a manuscript represented a sunk cost. Using word-processing technology to automate this process makes it increasingly capital-intensive, and has reduced the producer's sunk costs. The investments in the necessary desktop computers and word-processing software represent transferable costs. While actual labor, a sunk cost, has decreased, the transferable costs involved in word processing have increased.

 [FN86]. Professor Breyer noted that increased technology actually increases a subsequent producer's cost advantage because the cost of copying decreases. Stephen Breyer, The Uneasy Case for Copyright: A Study of Copyright in Books, Photocopies and Computer Programs, 84 Harv L Rev 281, 298-299 (1970). While this may be true of products with high authorship value, it does not necessarily follow for those with low authorship value.

Certain information products rely exclusively on information in the public domain and have little to no authorship value. The human labor expended on content value represents a major sunk cost because of its nontransferability (assuming the absence of copyright protection). Accordingly, authorship value is dropped from consideration for these products, leaving only the labor and resources invested in the actual production as relevant economic considerations for free-ride potential. These costs are characterized as sunk and transferable costs as well.

A typical producer of an information product would have a cost function of:


where cs represents sunk costs and ct represents transferable costs.

A producer of fiction novels, for example, faces this cost function. Using typical print-on-paper technology, a producer faces a relatively high amount of sunk costs because of the high amount of labor expended in adding content value, chunking and tagging value, external-pointers value, and so on. Accordingly, free-rider potential is high, resulting in the need for copyright protection. However, a producer of a product such as a publicly accessible database, Lexis for example, faces the same cost function, but enjoys a much lower sunk-cost investment. Technology allows this producer to expend little, if any, human labor in producing these same values. Free riding on this producer's investments is less likely than free riding on the print-on-paper producer's. Where technology decreases sunk costs, it may make copying--free riding--more difficult. It would seem, then, that new technologies affecting products with low authorship value, and a corresponding low sunk

investment, would decrease free-ride potential. However, for products with high authorship value, and relatively higher sunk investment, technology may make copying easier, as noted by Professor Breyer. Id.