Assessing Economic Impacts of Copyright Reform on Selected users and Consumers

III. Extending the term of protection

The Copyright Act provides a standard protection term equal to life of the author plus fifty years. American law by contrast, typically grants protection for a period equal to life of the author plus seventy years. In 1998, the US Congress extended the term by 20 years for future and existing works. Several years earlier, the European Union extended the minimum protection period to life of the authors plus 70 years unless the country of origin provides a lesser term (i.e., Canadian works are currently granted protection of life plus 50 years). These jurisdictions now protect works for a longer period than required by the Berne Convention.

The most obvious options with respect to term extension in Canada are: 1) Extension of the term for future works only; 2) extension of the term for future and existing works not yet in the public domain; 3) and extension for future works, and works that would not presently be in the public domain if the extended term had been effective at the time they were created, fixated or published. Under the latter option, some works already in the public domain would enjoy renewed protection.²

This report looks only at options 1 and 2 for reasons that will be made clear below. It explores the consequences of extending copyright to life of the author plus seventy years.

1. Effects on creative effort

A widely shared view about copyright is that it produces the economic incentive to create. That notion is based on the idea that if authors did not have the right to prohibit copying, original work would be replicated shortly after publication. Because competition would quickly drive the prices of works towards the cost of replication, authors would not be able to recover their initial investment in creation, including opportunity cost.³ For that reason, authors endowed with economic foresight and motivated by prospects of financial reward would refrain from undertaking creative ventures, or provide too little effort.

Copyright also entails an economic cost. It is a cost that derives from a reduction in the dissemination of works. Most works of authorship are public goods. This means that their use by one person does not diminish the quantity available for use by others. Economic efficiency dictates that existing works be offered at the low cost of replication or making available. This rarely happens when sellers hold copyrights. Right holders' demand for royalties raises the price of works above the cost of replication and dissemination. This bars purchases by some individuals willing to pay an amount that exceeds that cost. The difference between the prices these individuals are willing to pay and the cost of replicating and distributing a work represents a loss to the economy.

One is therefore confronted by an economic trade–off. Increases in the scope and duration of protection stimulate creation but lessen the dissemination of existing works.⁴ While the principles underlying the optimal blend of scope and duration of protection are well understood, a lack of data makes it impossible to determine what that combination is. For that reason, this report makes no claims in regard to the optimality of a particular protection term. It provides only a qualitative assessment of likely effects of term extension on creative effort, prices, dissemination of works, and the external balance of royalty flows.

a) Term extension for future works only

Term extension affects incentives to engage in creative effort because it determines the difference between revenue and cost during the extra protection term. Because the cost of creation is incurred upfront, whereas rewards are distributed over time, one needs a common standard for comparison purposes. The most commonly used standard is expected present value.⁵

Consider a term extension that would prolong the protection period in Canada to life plus seventy years. Such extension confers a protection period of 110 years to a work authored by a forty–year–old Canadian with a life expectancy of 80 years. It is straightforward to calculate that when royalties remain constant over time and the discount rate is 7%, adding 20 years contributes a mere 0.16% to the present value of a work created by the author (See appendix 1). It is evident that such trivial increase is unlikely to encourage authors to set back their alarm clocks and subject their creative minds to additional early morning strain.⁶

Under the more realistic assumption that utilization of a work declines as the work ages, the contribution to present value of term extension becomes even smaller.⁷ Furthermore, not all revenue from creative work depends on the existence of copyright. For example, composers may earn substantial income from performing their music. If so, a 0.16% increase in the revenue derived from copyright implies an even smaller increase in the present value of all revenues derived from a work. Jointly, these observations imply that the actual increase in present value is likely not to exceed a fraction of 0.16%.

Consider now the effects on dissemination. Extending the protection term may reduce dissemination of the small portion of works remaining in circulation many years after creation. Because such reduction would take place in the distant future, welfare effects must be discounted. This means that the impact on consumers in terms of present value is insignificant.

b) Extension of the protection term for future and currently protected works

Two additional factors now come into play. First, it becomes more costly to use as building blocks in the creation of derivative works, the original pieces whose term has been extended. Second, a possible higher cost of access to works whose term has been extended may influence the demand for new creations.

Authors of derivative works would have to incur extra costs to locate the persons who hold the right in original works whose term has been extended, obtain permission, and possibly pay royalties. Lengthening of the protection term could therefore adversely affect the creation of derivative works.⁸ However, one could also argue – as American supporters of the Sonny Bono Term Extension Act have – that extending the protection term of currently protected works encourages those who hold rights in them to invest in derivative productions. Their reason is that the latter would be sheltered from competition by other works derived from the same original. Such an outcome cannot be ruled out on an A priori basis. However, a greater likelihood of increased production of derivative works by right holders must be set against a lower production of derivative works that draw on the same original by a potentially larger number of outsiders. Besides, one could argue that holders of rights in the original work have a greater incentive to produce derivative works when their copyrights are about to expire. The reason is that waiting exposes them to the risk of being beaten to the punch by outsiders.

It is impossible to assess which of the aforementioned outcomes is most likely. What can be said is that the effect on production of derivative works – whether positive or negative – could be felt as soon as term extension becomes effective.⁹ There is no slimming down of present value attributable to discounting. The reason is that some material on the verge of entering the public domain may already be slated to serve as a building block

Price is the second channel through which term extension could affect incentives to create. Because new and old works are interchangeable in certain uses, an increase in the price of older works resulting from term extension could boost the demand for new works.¹⁰ A priori, however, there is reason to believe that any shift in the demand for new works would be very small. First, copyright often accounts for a small portion of the price of a work. Any percentage change in the royalty rate therefore implies a much smaller percentage change in the price paid by the user. Second, among existing works that could substitute for a future creation, only a small portion would be accounted for by works still in use and created by an author who has died between 50 and 70 years ago. Thirdly, a substantial number of substitutes could be already in the public domain.

It is appropriate at this point to comment briefly on the effects of a retrospective extension of the protection term to works that have already entered the public domain. Analysis of this option (option 3) parallels that of option 2 with one potentially significant difference. One must consider the possibility that at the point in time extension becomes effective, some authors will have undertaken projects that draw on material that has entered the public domain. Some authors may have selected that material precisely because it was no longer protected. Returning such works under the umbrella of copyright could disrupt such projects when permission to use is refused, or when it is granted by the person who holds the rights to the original work on condition of substantial royalties.

In principle, one could infer the effects of term extension from the observation of changes in the use of copyrighted material at the time the rights expire. Unfortunately, there is very little reported evidence about such effects. The available information, all anecdotal, concerns motion pictures. Gomery relates the existence of a "vibrant marketplace for public domain films" supplied by "over 200 competing companies offering public domain motion pictures in various forms at various prices". He claims that Hollywood studios would sometimes vend public domain titles, but would only do so for big titles. Only smaller companies release the less profitable films.¹¹

The main factor contributing to a reduction in the use of existing works is probably the cost of locating right holders. That cost increases as works become older.¹² Finally, it should be noted that although effects on dissemination are likely to be small, they would be felt as soon as the protection term is extended.

2. Effect on inflows and outflows of royalties

The impact on creative effort also depends on the share of royalty revenue that Canadian authors draw from domestic sources. The impact becomes weaker when foreign uses of works produced in Canada become important relative to domestic uses. The reason is that the portion of authors' income affected by Canadian copyright law falls.¹³

In an open economy like Canada, authors' expected income depends on the scope and duration of protection in the home country and in foreign countries. An increase (decrease) in the amount of royalties paid by home–based users to foreign right holders reduces (increases) home welfare.

There are two sources of royalty inflows into Canada: 1) Service–based inflows generated by foreign uses of works to which Canadians hold rights¹⁴ ; and 2) produc–based inflows that proceed from the export of products containing Canadian copyrighted material.¹⁵

Correspondingly, there is an outflow of royalties from Canada when: 1) Residents make use of works to which foreigners hold rights; and 2) residents import goods containing copyrighted material to which foreigners hold rights.

The welfare effects of term extension depend on the impact on net inflows – i.e. inflows less outflows – of royalties from both sources.

Extension of the protection term does not influence the amount of service–based inflows originating in countries such as the US that grant national treatment with respect to works older than life–plus–fifty.¹⁶ It does increase service–based inflows from jurisdictions such as the European Union that abide by the rule of the shorter term with respect to the extra protection period not mandated by the Berne Convention.

Product–based inflows would increase as a result of term extension in Canada. They do not depend on whether the country that imports goods containing Canadian copyrighted material applies a national treatment rule or a reciprocity rule. The size of the additional inflows depends on the value of Canadian copyrighted "older" material incorporated in the exported goods.

Extension of the protection term also produces an increase in service–based outflows. However, payments of royalties to a particular country do not hinge on whether that country abides by a national treatment or a reciprocity rule. They depend in a minor way on whether Canada abides by a national treatment or a reciprocity rule. The reason is that the US which abides by a national treatment rule, accounts for 94% of total service–based payments and 72% of receipts. The EU which has adopted a reciprocity rule accounts for 5% of payments and 18% of receipts.¹⁷

Lengthening of the protection period does not produce an increase of product–based outflows. This is true whether Canada abides by a national treatment or adopts a reciprocity rule. The amounts collected by foreign authors in payment for copyrighted material contained in goods imported into Canada are determined by the rules that apply in the exporting countries.

Statistics Canada data can be used to make inferences about the magnitude of the aforesaid effects. This requires assumptions about the portion of protected works slated to lose protection within the next twenty years under current law. It also calls for hypotheses about the royalty rates applicable to these works relative to works in general.

The detail of the calculations is shown in Appendix 2. The calculations make use of the assumption that the works scheduled to lose protection within the next 20 years under the current law account for 3% of all copyrighted works. The calculations also assume that the royalty rates on these works are on average half as high as for other works.

Because the most recent data on international trade in copyright–intensive cultural goods pertain to 1997, all calculations have been carried out for that year. They show that term extension in 1997 would have produced an annual increase in net outflows from all sources amounting to 2.43–2.77 million 1997 dollars.¹⁸

3. Further effects on users and consumers

The extent to which increased royalties are passed on to final consumers depends on the intensity of competition among right holders and among the suppliers of complementary inputs used in the production of copyrighted material. The more intense the competition, the greater the portion of cost increases passed on to final consumers.

Competition appears intense in the case of photography. There are great many suppliers of photographs. Also, barriers to entry in the profession are low. Competition appears less intense in the case of makers of sound recordings where a very significant portion of the market is supplied by a few majors.

Works of recent vintage could also experience a price increase because works that would have entered the public domain and could have served as substitutes would no longer be available for free. This increase, however, is likely to be very small.

Another element of user cost is the expense of tracing right holders and negotiating with them. For older material this cost may represent a considerable portion of the benefit that the users derive from a work. It may in fact exceed that value.

The cost of tracing the owner of rights in photographs is particularly high because most photographs do not carry identifying marks. While tracing appears relatively easy in the case of sound recordings, transaction cost could still be high because users have to clear rights and make payments to a potentially very large number of stakeholders (composers, publishers, makers of sound recording, record companies, performers, etc.).

4. Harmonization issues

American supporters of the Sonny Bono Term Extension Act have argued at times that a longer protection term carries the advantage of harmonizing US and European law. It appears, however, that this claim is grounded solely in balance of payment considerations. This issue does not arise in the same way for Canada because the country is not a major net exporter of copyrighted material.

Because the issue of international royalty flows has already been dealt with, we focus on the question whether term extension could be beneficial for other reasons.

a) Transaction cost once again

On A priori basis one can argue that harmonization of protection terms produces efficiency gains that flow from a reduction in enforcement cost. There is a lower risk of non–intentional infringement of foreign works. Also, monitoring for infringement by on–line users is simplified.

However, attainment of these goals is likely to hinge on the existence of far–reaching harmonization, i.e. harmonization that extends beyond equalization of the term of protection. Certain thresholds in terms of harmonization of laws would probably have to be crossed in order to achieve the aforementioned advantages. There is no reason to believe that harmonizing the protection terms will achieve such crossing.

Calls for harmonization based on transaction cost savings must be justified by a showing: 1) The advantages of significant harmonization outweigh the losses in terms of net royalty outflows; and 2) if harmonization of the protection term and other amendments to the Copyright Act are insufficient to bring about the aforementioned crossing, it is still preferable to extend the protection term at this time as an alternative to postponement until other harmonizing amendments are made.

b) A digression on patents

The effects of term harmonization have been examined in a recent study on patents.¹⁹ The findings are relevant to this study because in qualitative terms the effect of harmonization of copyright is likely to be similar.

The study finds that a country's optimal protection term depends on the protection term chosen by its trading partner. When the term of protection is longer in the country with the comparative advantage in R&D (country A) then, extending the protection term in the other country (country B) carries a cost to that country that stems from a deadweight loss on goods invented in that country and a loss in consumer surplus on goods invented abroad. It carries a benefit that derives from the increased incentive of domestic and foreign firms to undertake research. The optimal duration of protection is attained when the two effects balance at the margin. If extension of the protection term in country B does not spur any additional innovation, there is no advantage for that country to increase the term of protection.

As already indicated, the effect of term extension on creative effort is negligible. The implication is that Canada as a net importer of copyrighted material would derive no advantage from term extension.

Empirical studies on the effects of harmonization of intellectual property laws are few. Recent work on the impact of international patent harmonization under WTO's agreements on TRIPS shows that patent harmonization may generate large transfers of income between countries. These transfers have significantly altered the perceived distribution of benefits from the Uruguay Round, with benefits significantly enhanced for the US. Developing countries and Canada have been shown to suffer losses as result of harmonization.²⁰

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² E.g. a work that had been in the public domain because the author died 55 years ago would get an extra 15 years of protection if the term were lengthened to 70 years. Options 2 and 3 may require some refinement because some rights pertaining to a work may subsist after expiration of other rights. It is more accurate to think in terms of extending the term of specific rights than extending the term of protection of a work. For the purposes of this report, however, it is adequate to reason as if all rights to a work expired on the same date.

³ To keep an author in business, a successful release of a work mu st generate enough income to cover its own cost as well as the cost of unsuccessful releases.

⁴ Such loss is not an inescapable outcome of copyright. When right holders engage in price discrimination (also called differential pricing), they may be able to tailor prices closely to the benefits that users derive from access. This allows them to serve marginal consumers at lower prices while earning higher margins from other consumers. Discriminatory pricing requires that users not be able to engage in reselling, or that the price differential across buyers be insufficient to make resales worthwhile. Discriminatory pricing is practiced by performing right societies that grant blanket licenses for which they collect royalties that correlate with the value of works to users.

⁵ The expected present value of a work is obtained by discounting the difference between present and expected future revenues from a work and the costs of producing it. Discounting is the process that determines the present value of future earnings and cost.

⁶ Appendix 1 shows that this conclusion holds for a significant range of discounts rates.

⁷ Landes and Posner estimate that the "average annual depreciation rate of copyrighted works in the US has ranged from a low of 5.4 percent in 1990 to a high of 12 percent in 1914" and that "the estimated depreciation rate for works registered in 1934 is .07, implying that of the works registered that year 50 percent had fully depreciated by 1940, 90 percent by 1970, and 99 percent by 2000; fewer than 1 in 750 works registered in 1934 will have commercial value in 2030. W.M.Landes and R.A.Posner, Indefinitely Renewable Copyright, August 2002.

⁸ The extent to which this affects overall creative effort depends on the substitutability between building blocks drawn from public domain works and building blocks extracted from older works that have not yet entered the public domain. Some authors suggest that the effortlessness of cutting and pasting digital files should increase the production of derivative works, in particular for non–commercial purposes. See Joseph P. Liu , "Copyright Law's Theory of the Consumer" Boston College Law Review, Spring 2003.

⁹The point that creative production builds on earlier production was made first with respect to patentable creations. See. S Scotchmer, Standing on the Shoulders of Giants: Cumulative Research and the Patent law, Journal of Economic Perspectives , 1991, vol. 5(1), 29–41.

¹⁰ The increase in the price of older works could be attributed to royalties payable during the extra years of protection and to the cost that users incur to locate right holders and negotiate with them. The magnitude of the shift in the demand for future works depends on: 1) The degree of substitutability between future works, older works still under protection, and works in the public domain; 2) and the number of substitutable works that would fall in the public domain within the next twenty years.

¹¹D. Gomery, (1993), The Economics of Term Extension for Motion Pictures, Research Report for the Committee for Film Preservation and Public Access , Docket No. RM 93–8 to the Copyright Office Notice of Inquiry on Duration of Copyright Terms of Protection.

¹² This sometimes serves as a justification for limiting the duration of protection.

¹³ Because the variety of works available to home consumers is less dependent on domestic creation when imported materials are readily accessible, one's view about the appropriateness of term extension also hinges on whether the only objective is to insure that consumers have access to a variety of content, or whether one is also concerned about the national origin of content.

¹⁴ E.g., broadcast by foreign radio stations of songs written by Canadian composers, or production in a foreign country of CD's containing copyrighted material to which Canadians hold rights.

¹⁵ The royalties received by Canadians are included in the prices foreigners pay for the exported goods.

¹⁶ This applies whether Canada abides by a national treatment rule for the extra years of protection or by a reciprocity rule.

¹⁷ These numbers are derived from Tables 1 and 2 in Appendix 2.The figure of 94% is obtained by dividing 385 (row 2 in Table 2) by 410 (row 1 in Table 2). Similarly, 72% is obtained by dividing 150 (row 2 in Table 1) by 208 (row 1 in Table 1). Also, 0.05= 21 (row 5 in Table 2) divided by 410 (row 1 in Table 2) and 0.18=38 (row 5 in Table 1) divided by 208 (row 1 in Table 1).

¹⁸ Appendix 2 also discusses why one must exercise great caution in interpreting these numbers.

¹⁹ Grossman G.M., International Protection of International Property, National Bureau of Economic Research, Working paper 8704, 1987.

²⁰ McCalman, Reaping what you Sow: an Empirical Analysis of International Patent Harmonization, Working paper 374 , Research School of Social Sciences, Australian National University, June 1999.