Endogenous IPR protection, commercial piracy, and welfare implications for anti-piracy laws

ABSTRACT

In the presence of commercial digital piracy, should the government provide costly protection for intellectual property rights (IPR)? Under what conditions will government protection and private protection be substitutes or complements? We show that a product’s original developer has an incentive to bear R&D costs for private protection when the quality of a pirated copy is moderate. We consider that the welfare-maximizing government determines its costly IPR protection and commits a fraction of the pirate’s monetary fines to the developer for compensation while striking a balance in the enforcement budget. In this case, the government will not launch costly IPR enforcement unless the pirated copy’s quality is sufficiently high. Otherwise, government IPR protection is socially undesirable. These results suggest that government protection and private protection are substitutes.

KEYWORDS:

• Digital piracy
• intellectual property rights
• government protection
• private protection

JEL CLASSIFICATION:

• D23
• D43
• L13
• L86

Acknowledgments

We thank the Editor in Chief David Peel and an anonymous referee for valuable comments and suggestions, which led to substantial improvements in the paper. Any remaining errors are, of course, ours.

Disclosure statement

No potential conflict of interest was reported by the authors.

Compliance with ethical standards

The authors declare that they have no conflict of interest. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Notes

¹ Piracy of products in a digital format involves low or zero costs, creating a strong incentive to pirate digital goods. For contributions that analyse general issues on commercial piracy, see, e.g. Banerjee (2003, 2011), Andres (2006), Kiema (2008), Jaisingh (2009), Martinez-Sanchez (2010), and Lu and Poddar (2012). For studies on digital and software piracy effects on market outcomes see, e.g. Conner and Rumelt (1991), Slive and Bernhardt (1998), Shy and Thisse (1999), Yao (2005), Bae and Choi (2006), Peitz and Waelbroeck (2006), Belleflamme and Picard (2007), Cremer and Pestieau (2009), and Chang and Walter (2015). For issues on copyright laws, protection and enforcement, see, e.g. Koboldt (1995), Landes and Posner (1989), Stolpe (2000), Chen and Png (2003), Andres (2006), and Kim (2007).

² We borrow this balanced budget consideration from Banerjee (2003).

³ This is consistent with the notion of cost-raising strategies as discussed in Salop and Scheffman (1987).

⁴ We owe this valuable point to an anonymous referee who suggests that we discuss the more realistic case in which the product developer requests financial compensation from the pirate. This suggestion leads to interesting results with policy implications.

⁵ We consider the case of a fully covered market. This consideration is consistent with the literature that uses a vertical product differentiation framework (see, e.g. Crampes and Hollander 1995; Wauthy 1996; Chang and Raza 2018) to examine various issues on product quality.

⁶ The second-order condition (SOC) is satisfied when the inequality condition in (10) holds since ${\mathrm{\partial }}^2{\pi }_o/\mathrm{\partial }{x}^2=-(7-9q)/[9(1-q)]<0.$

⁷ The SOC for welfare maximization is: $\frac{{\mathrm{\partial }}^{2}SW}{\mathrm{\partial }{c}^2}=-\frac{{(1-\alpha )}^2(45q-41)}{{(9q-7)}^2}<0$ when $0.91111<q<1.$

⁸ However, If the pirated product’s quality is low, the government does not have any incentive to enforce IPR because the financial damage to the original firm is small. In this case, the government’s revenue collected from penalizing commercial piracy may not be sufficient to cover the enforcement effort, and the financial compensation to the product developer.