Deinonychus antirrhopus

What the Fuck?

James V. DeLong has gotten it wrong. DeLong has a long essay on why those who oppose intellectual property and those producing intellectual property getting the appropriate return on their property is wrong.

Unfortunately DeLong misses the point completely and totally.

This lever is a syllogism that I have now heard to the screaming point: It starts with the proposition, "Economics teaches us that in a competitive market prices equal marginal cost -- the extra costs incurred by producing an additional unit." It goes on to note that the marginal cost of an additional pill, or an additional copy of a movie or song, is close to zero. Therefore, the argument concludes triumphantly, "economics teaches us" that such products should be priced at zero. Any other condition demonstrates that undue "market power" exists, and is immoral.

Immoral? What the Hell is he talking about. Inefficient, less than optimal, the "second best" outcome, yeah, but immoral. What this lawyer doesn't realize is that economists don't use that kind of language (generally speaking). The conventional wisdom in economics with regards to intellectual property goes like this:

1. Intellecutal property has properties similar to public goods.
2. Given this it is almost impossible for the creator of intellectual property to fully recover his costs, let alone any of the "profits" of his efforts.
3. Hence an institutional framework is need in which the creator of intellectual property can assert his property rights.
4. Typically this framework grants a temporary monopoly to the creator of intellectual property.
5. This is sub-optimal, but is widely considered to be better than not having the amount of intellecutal property we do now.

So where does this nitwit get the idea that economists are clamoring for price being equal to marginal cost?

If one demurs to the logic, on the ground that it costs about $800 million dollars to produce the first pill, or $100 million to produce the first print of the movie and this initial investment -- not just the marginal cost of the second pill or the second print -- must be recovered from somewhere, the perpetrators of this logic usually shrug and talk about the need for new business models.

Wrong again (can this guy get anything right?). The new business model actually has the creator of intellectual property being paid up front the discounted value of his intellectual property and from that point on the "good" is priced at marginal cost. So not only would you get your money back, but you'd get something over and above it.¹

The pioneers of this research are David Levine and Michele Boldrin. Their initial paper on this does not support DeLong's strawman in the least.

Why then do we argue a “case against intellectual property?” Are we arguing that, while stealing potatoes is bad, stealing ideas is good? We are not. Economic efficiency, and common sense, argue that ideas should be protected and available for sale, just like any other commodity. But “intellectual property” has come to mean not only the right to own and sell ideas, but also the right to regulate their use. This creates a socially inefficient monopoly, and what is commonly called intellectual property might be better called “intellectual monopoly.” When you buy a potato you can eat it, throw it away, plant it or make it into a sculpture. Current law allows producers of a CDs and books to take this freedom away from you. When you buy a potato you can use the “idea” of a potato embodied in it to make better potatoes or to invent french fries. Current law allows producers of computer software or medical drugs to take this freedom away from you. It is against this distorted extension of intellectual property rights that we argue.

The idea is: can you get closer to the optimum outcome and still ensure that intellectual property is produced and the creators of such property are rewarded for their efforts? Boldrin and Levine argue that you can.

Back to DeLong:

If you doubt the power of the "price should equal marginal cost" mantra, or the moral component that has been infused into it, check out speeches by officials of the Antitrust Division, such as William Kolasky, former Deputy AG: "An economist would say that a market is perfectly competitive when firms price their output at marginal cost." Or a statement by Lawrence Summers, former Secretary of the Treasury and current President of Harvard: "[T]he most basic condition for economic efficiency [is] that price equal marginal cost." Or go look at almost any textbook, complete with diagrams.

I see the problem, this guy has conflated economic efficiency with moral goodness or something. Nothing could be further from the truth. It is quite possible to have an efficient outcome the is highly "immoral", for example it is entirely possible (theoretically) for an economy where one very small group (even an individual) owns 99.9% of the goods/resources. Is this a "morally good" outcome? I think most people would have a hard time saying it is.²

To be fair to these two gentlemen, they immediately move on to note that of course this principle creates problems in an investment-intensive context because it does not allow for the recovery of capital cost.

Wrong, the problem is sunk costs. What is a sunk cost? A cost that once you incur it is gone forever. Here is an example:

Suppose you are going on a trip. You had to put $100 down (via credit card) to reserve the hotel room. You get 5 miles down the road and realize, you'd just rather stay home. Now, what about the $100 dollars? Its gone no matter what you do. If you go, its spent. If you stay home, its still spent. The $100 is gone, unrecoverable, and hence should not influence your decision making.

The problem is that sunk costs are not sunk until you make them. If you fear your return will not justify making the sunk cost you wont make it. From a societal perspective, good investments might be missed out on and that imposes an opportunity cost on society.

The money spent on drug research is largely a sunk cost.

Capital on the other hand (i.e., plant and equipment) are not sunk costs, but fixed costs (i.e., fixed over a given period of time, but variable over a longer period of time). You can always sell your plant and equipment and get some if not all of the money back (you might have to factor in depreciation here).

This guy is so clueless on the issue it is almost painful for me to read the rest.

The bottom line is no economist that I know of is advocating stripping those who produce intellectual property of their property rights, but just changing the institution so that a socially more desirable outcome can result.

Ironically, in one of his examples, the creators of intellectual property rarely see all the benefits: Music. The benefits accrue not to the creators, but to the recording industry by and large. All that money you pay for a CD...almost all of it goes to the recording industry. Clearly this indicates that in that industry, the price is socially inefficient, i.e., it can come down and we can still have the same amount of music we currently do if not more.

(Via Catallarchy)
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¹Also, it should be noted that many who are looking at this issue are not sure it would apply to pharmacueticals. The costs are quite large and the current approach might be best.
²To see this go to any intermediate microeconomics text and look up a diagram of an Edgeworth Box. There will be a line connecting diameterically opposing corners, this is called the contract curve. Everypoint along that curve is efficient, clearly neither individual wants a point close to their "origin" (i.e., they have very little).

Posted by Steve at July 31, 2003 01:28 PM