∗
Peer-to-Peer File Sharing and Cultural Trade Protectionism
Andres Hervas-Drane
†
Eli Noam
‡
February 24, 2013
Abstract
Governments have often intervened to increase the production and consumption of domestic lm, television, and music by instituting protectionist trade policies going back to
the 1920s and beyond. The question is now how the rapidly emerging internet-centered and
sharing-based media distribution mechanisms, such as peer-to-peer le sharing, aect these
policies and their underlying rationale. We present a model suited to explain trade and import
barriers in the media sector. We introduce political preferences for governments and characterize content quotas, a widespread form of protectionism which restricts foreign producer
access to broadcasting channels and cinema screens. We then introduce online sharing as a
mechanism that enables consumers to access media content at a low cost, and analyze the
implications for cross-border commercialization and consumption of cultural goods. We show
three main eects of online sharing. First, online sharing's impact is augmented by content
quotas in the countries that enforce them. Second, such quotas are a non-desirable status quo
if online sharing cannot be blocked or severely penalized due to technical or political reasons.
And third, online sharing creates a threat to cultural diversity in the long term.
∗
Keywords:
Cultural Industry, Digital Distribution, Cultural Diversity, Globalization
JEL codes:
F12, L16, L52, L82, L86
We thank Pol Antràs, Ramon Casadesus-Masanell, Pablo Casas-Arce, Fabrizio Germano, Avi Goldfarb, Gene
Grossman, Massimo Motta, and Morten Olsen for helpful comments and suggestions, as well as seminar participants
at the IESE SP-SP lunch seminar, UPF lunch seminar, Mannheim-ZEW ICT conference, Télécom ParisTech ICT
conference, and the EARIE 2012 conference.
†
Universitat Pompeu Fabra and Barcelona GSE (andres.hervas@upf.edu)
‡
Columbia University
1
1
Introduction
Cultural goods form the basis for artistic expression and act as a vehicle for the transmission of
social values. Traditional media channels have long played a key role in their distribution. But
online sharing of media content by consumers has become pervasive over the last decade, enabled
by advances in content digitalization coupled with the widespread adoption of high-speed Internet
access. Such online sharing has generated an active policy debate which has mostly focused on sales
displacement and the viability of traditional business models in the content industry. Traditional
media rms, in particular, have pushed legislation and litigation to limit the unlicensed sharing
of copyrighted content.
In contrast, the long-term implications for public policy and cultural
diversity have received comparatively scarce attention. What are the implications of online sharing
for traditional cultural policies? Will online sharing reinforce cultural diversity across nations or
will it concentrate national audiences on foreign media products? Because online sharing already
accounts for a signicant portion of global content distribution and consumption, the answers to
these questions are a matter of public interest.
We present a trade model to evaluate the implications of online sharing of media content for
cultural policy and diversity, and to the best of our knowledge contribute the rst formal analysis
of import barriers as they operate in the cultural sector.
We consider a two-country economy
composed of a large and a small country and model cultural goods by considering monopolistic
competition and variety-seeking consumers. We assume cultural goods are no dierent from any
other goods except for the absence of marginal costs of production and the absence of export costs,
and our framework builds on the circular model of spatial competition developed by Salop (1979)
If cultural goods portray national identity and values, as media observers have long contended,
their consumption will generate public externalities. We introduce political preferences for governments over their population's consumption of domestic and foreign cultural content and endogenize
cultural policy based on content quotas. These quotas establish a domestic market share oor for
domestic producers, or equivalently, a market share ceiling for foreign producers. Enforcing content quotas implies restricting the commercialization of foreign cultural goods in order to favor
consumption of domestic goods (e.g., foreign lms are not screened in domestic cinemas or foreign
television content is not broadcast during prime time).
Governments in the two countries face
dierent domestic tradeos, given that cultural content originating from the large country represents a larger share of consumption in both countries due to its larger industry size.
We show
that equilibrium entails a higher degree of quota enforcement in the small country and the larger
country tends to exhibit a larger share of domestic content consumption.
We introduce online sharing as a cross-border distribution channel which is broadly accessible
and resilient to outside control, allowing consumers to access any media product at a low cost. We
analyze its impact in the world economy and show that enforcement of quotas augments consumer
demand for online sharing as well as its negative impact on industry prots. We also show that
2
online sharing penalties need to be disproportionately high to curtail its use. A policy coordination
problem emerges if online sharing cannot be blocked or severely penalized by governments due to
technical or political reasons, because the main benets of eliminating quotas within each country
accrue to foreign producers, so multilateral cooperation among governments is required to confront
it.
Finally, we evaluate its long-term impact on cultural diversity applying a fractionalization
index.
1
We nd that online sharing always reduces cultural diversity in a world where it is preceded
by content quotas.
Our analysis builds on quotas applied to broadcasting channels such as television and radio
as well as cinema screens, stipulating a minimum share of commercialization slots for domestic
content (or a ceiling on the number of slots for foreign imports). By restricting the commercialization of foreign content as a function of domestic content supply, content quotas amount to an
exclusionary device that blocks foreign content varieties from the domestic market.
This is in
contrast to quantity-based quotas which restrict import quantities rather than product varieties
in other sectors of the economy (e.g., automobiles). Our model provides a rationale for content
quotas in the cultural sector and shows why they cannot be replicated with taris.
Content quotas largely emerged in the twentieth century with the expansion of cinema and then
broadcast television accompanied by the growth of cultural exports from the US, and in particular
to Europe, reversing the previous historic direction of the ow. They remain an important element
of cultural policy in many countries, as shown in Table 1. They have also proven to be a contentious
issue in trade agreements, as evidenced by the 2011 US-South Korea Free Trade Agreement which
required South Korea to halve (but not eliminate) its cinema screen quota. Puppis (2008) notes
that fewer than 30 countries would commit to free trade in the audiovisual sector at the signing
of the General Agreement on Trade in Services (GATS) in 1995, and among western democracies
only the US and New Zealand have liberalized the sector.
The core argument in our paper can be understood as driven by the technological transition
from broadcasting to on-demand access to content. Digitalization has enabled both on-demand
consumption in commercial distribution as well as consumer online sharing.
This implies that
supply restrictions in commercial distribution (which could technically be extended to on-demand
services) are no longer enforceable because the underlying technology empowers consumers to bypass them. While we recognize that parallel distribution channels have long enabled consumers to
access media content outside broadcasting (e.g., video clubs) we believe online sharing represents
a novel phenomenon given its immediacy, scale, and the breadth of content available.
Further-
more, social networks, online content databases and recommender systems (e.g., Facebook, IMDB,
Last.fm) are increasing consumer awareness of foreign content that matches their taste, and machine and community-based translation eorts are eroding language barriers. Past approaches to
cultural policy will no longer work in a digital world, and governments engaged in eorts to protect
1 Denote by
snk
n in country k , then cultural diversity index CD can
P
(1 − sn1 · sn2 ). We discuss the properties of the index in Section 5.
the market share of media product
computed across two countries as
CD =
1
N
3
be
Country
Initial
quota
Australia
1927
Brazil
1926
Canada
1956
China
1994
Domestic content quota
Cinema: 15% of screenings
Radio: 25% of airplay time
Cinema: 63 days of screening
TV: 60% of broadcast time
Radio: 35% of airplay time
Cinema: 20 foreign lms per year
TV: 75% of broadcast time
Cinema: 110 foreign lms per year
France
1920
TV: 60% of broadcast time
Radio: 40% of airplay time
Cinema: 14 days of screening
Malaysia
2005
Mexico
1949
Cinema: 10% of screenings
Nigeria
n/a
Radio: 80% of airplay time
South Africa
1997
Radio: 25% of airplay time
South Korea
1967
Spain
1955
TV: 70% of broadcast time
Cinema: 73 days of screening
TV: 80% of broadcast time
Cinema: 73 days of screening
TV: 51% of broadcast time
Table 1: Content quotas applied to cinema screens, television broadcasting and radio airplay in
several countries. Source: Compiled by the authors.
domestic cultural consumption will be forced to overhaul their policies in stepping up to the digital
challenge.
1.1
The advent of online sharing
Consumer online sharing has evolved over several generations of Internet applications.
These
include newsgroups (such as Usenet), centralized server-based exchanges on private or public hosting sites (MegaUpload), and peer-to-peer le sharing, which has emerged as the main driver of
consumer online sharing in the last decade. Peer-to-Peer (p2p) le sharing applications allow participants to supply and demand digital content from one another, enabling content exchange to
take place on a large scale and without intermediaries, as was previously required with newsgroups
and hosting sites. Peer-to-Peer le sharing is enabled by the architecture of the Internet, which
allows for data transmission between nodes connected to the network with negligible marginal
costs and irrespective of geographical distance, and has continued to improve with the increase in
4
bandwidth and computing resources available to end users.
File sharing became mainstream in 1999 with the development of the music le sharing application Napster, which allowed users to easily share songs online. Napster enjoyed an explosive user
base growth but a short life, as it relied on proprietary central servers which were shut down under
legal challenge from the music industry. But le sharing technology evolved quickly. Subsequent
generation applications are based on decentralized network architectures, oering no single point
of attack, and facilitate the exchange of any type of content with greatly improved eciency. The
technology has matured to the point that it is relatively easy for the average Internet user to
2
obtain content over p2p.
Big Champagne, a marketing research rm specializing in le sharing,
estimated that over 200 million computers worldwide had p2p software installed in 2008.
3
Accord-
ing to Cisco, le sharing accounted for almost 30% of consumer Internet trac in 2011, and is
4
forecast to grow in volume at an average yearly rate of 26% up to 2016.
that over 90% of the content exchanged (without license) is copyrighted.
It has been estimated
5
Perhaps the single most disruptive feature of online sharing is that it readily scales beyond
national borders, allowing consumers in dierent countries to seamlessly exchange content.
A
striking example of the cross-border impact of online sharing is that of American television series
Lost.
The series premiered in North America during Fall 2004 and did not broadcast outside
North America until early 2005.
Lost
was nonetheless or perhaps in consequence among
the top ten globally most downloaded television series on p2p during 2004, with roughly 90% of
downloads originating from outside North America.
6
Although online sharing viewership cannot
be accurately estimated, the reports suggest that the program met a substantial audience across
borders. Moreover, the phenomenon continues to recur in recent years. Some episodes of the most
downloaded television series in 2012,
Game of Thrones,
have been estimated to reach a higher
number of p2p downloads globally than their prime time television audience in the US.
7
Online sharing should be understood as a global distribution channel. To the extent that the
Internet is global, online sharing endows consumers with access to content that would otherwise not
be available to them through domestic commercial distribution channels. Consumers' willingness to
engage in online sharing to gain access to content is further evidenced by Internet trac activity.
Sandvine's 2012 Internet trac report notes that cross-country variations in le sharing trac
shares are due in large part to the availability of legitimate over-the-top video services in the
varying countries; based on our observations, countries with lower real-time entertainment gures
2 Half of the experts consulted in a 2005 Pew Internet survey on `The future of the Internet' believed that le
sharing would still be easy by 2015, and that forecast appears on track.
In another survey, 75% of teen music
downloaders aged 12-17 agreed that le-sharing is so easy to do, it's unrealistic to expect people not to do it. See
`Teen Content Creators and Consumers,' Pew Internet, November 2005.
3 See `The State of Music Online: Ten Years After Napster,' Pew Internet, June 2009.
4 See `Cisco Visual Networking Index: Forecast and Methodology, 2011-2016,' Cisco, May 2012.
5 See `Census of Files Available via BitTorrent,' Freedom to Tinker blog of the Center for Information Technology
Policy at Princeton University, January 2010.
6 See `TV Piracy Brieng Note,' Envisional, April 2005, as well as the release dates for Lost listed on IMDB.com
7 See `Game of Thrones tops TV show internet piracy chart,' BBC news, December 2012.
5
typically have higher le sharing trac, which leads us to believe that subscribers are likely using
applications like BitTorrent to procure audio and video content otherwise not available in their
region.
8
Unfortunately, despite the growing importance of the phenomenon, disaggregated data
of the content exchanged over online sharing and its geographical location is not publicly available.
This is due to both the technical complexity of tracking decentralized le sharing networks as well
as the proprietary value of the information, which is mainly collected by marketing research rms
for media company clients.
Online sharing has proven exceptionally resilient to both technical and legal attacks.
Since
le sharing technology has lawful applications beside the unauthorized distribution of copyrighted
content, such as the distribution of media content in the public domain, attempts to restrict or
block p2p trac need to be selective. Copyright holders have inltrated le sharing networks with
spoof content to discourage users, but with little success. Attempts by Internet Service Providers
to curb le sharing trac they seek to reduce trac ows that do not contribute to their revenues
have triggered an arms race between network engineers and p2p application designers. Recent
rounds of ltering attempts have resulted in updated le sharing protocols that encrypt trac
and make its identication more dicult.
Users are increasingly rerouting their Internet trac
to bypass monitoring, with VPN services for international p2p users ourishing in some countries
(the Swiss government, for instance, has vocally refrained from regulating personal le sharing).
Perhaps in advance of the next steps, computer scientists have already explored mechanisms to
obfuscate p2p trac patterns.
9
And in the US, network neutrality proponents have taken action
against ISPs attempting to lter p2p trac, with the FCC pressing Comcast to abandon the
practice.
10
Legal attacks against p2p have failed to curb le sharing. Major legal cases against proprietary
p2p applications Napster and Grokster have led to the successful development of open source p2p
software initiatives. Copyright holders have sent warning letters and prosecuted le sharing users
in several countries, with the media often describing large damage claims, but these initiatives have
failed to signicantly reduce online sharing trac. Some countries have enacted laws to penalize
online sharing and copyright infringement, such as France, Sweden, Spain, the UK, South Korea,
New Zealand, and Japan, with users mostly risking nes and temporal Internet disconnection.
These initiatives have seen short-term falls in domestic le sharing trac, but public resistance,
technical workarounds by users, and legal procedures requiring judicial oversight on a case by case
basis are perceived as blocks to their eective application. So inammatory have these challenges
been that they contributed to the emergence of new political parties founded to defend the interests
of le sharing users, in particular the Pirate Parties in Europe. Further evidence of the social and
technical resilience of online sharing was provided by the 2011 Sendai earthquake and tsunami in
8 See Sandvine's Global Internet Phenomena Report 2H 2012 p. 17
9 See the SwarmScreen plugin designed by the Aqualab Project at Northwestern University, accessed at:
http://aqualab.cs.northwestern.edu/projects/SwarmScreen.html
10 See `Comcast loses: FCC head slams company's p2p ltering,' Ars Technica, July 2008.
6
Japan, with p2p trac activity recovering to earlier levels within 24 hours.
1.2
11
Literature
A growing strand of literature in the last decade has considered the economic impact of online sharing by analyzing the empirical evidence on sales displacement.
Liebowitz (2006) and
Oberholzer-Gee and Strumpf (2010) provide an overview of the academic literature.
There is
evidence supporting sales displacement for commercially available content, though there is not a
consensus on the size of the eect. Closer to the focus of our paper, Ferreira and Waldfogel (2010)
analyze music charts from 22 countries to evaluate the impact of digitalization on trade patterns
for popular music. Their analysis nds that foreign content has decreased in the chart rankings of
most countries over the past decade, and they observe that cultural policies such as content quotas
in radio may contribute to explain the trend. It is worth noting that the dataset used in their study
does not cover online sharing activity, so the ndings are not inconsistent with those presented
here. Preferences for music may also have a stronger domestic bias than those for other cultural
goods, due to technical barriers to translation and the complementarity of live performances.
Few papers have considered the implications of trade on culture. Francois and Ypersele (2002)
show that in the presence of strong scale economies and variations in the valuations of consumers
for dierent types of cultural goods, those enjoying more uniform valuations can drive others out of
the marketplace. Rauch and Trindade (2009) evaluate trade dynamics when cultural goods dier
in their style owing to distinct national traditions. They show that styles originating from large
countries which enjoy larger network externalities can crowd out production of other styles in the
long term, so targeted subsidies promoting national styles in small countries can increase world
welfare. Bala and Long (2005) consider the dynamic eects of trade on cultural diversity based on
price changes and the product preferences of consumers, and argue that smaller countries can lose
their cultural identity when engaging in trade with larger countries. Olivier, Thoenig and Verdier
(2008) analyze a dynamic model where cultural identity is also a consumption externality that
consumers derive utility from, and show that both social and product market integration between
countries aects the evolution of cultural identity. The above contributions show that protectionist
policies for cultural goods can be welfare-enhancing under certain circumstances. Our contribution
in this paper is complementary in the sense that we show that online sharing severely limits the
eectiveness of protectionist policies based on import barriers.
Online sharing has similar properties to smuggling or parallel imports, as it enables consumers
to access foreign product varieties that would otherwise not be accessible to them or to do so
at a lower cost.
Bhagwati and Hansen (1973) rst analyzed smuggling based on the evasion
of trade barriers, and Malueg and Schwartz (1994) analyze the case of legal parallel imports that
restrict price discrimination by producers. An important distinction that sets online sharing apart,
11 See `Japanese earthquake and p2p disruption,' Northwestern AquaLab blog, March 2011.
7
however, is the fact that it is not executed by intermediaries for prot but directly by consumers
themselves. For this reason, consumers benet the most from online sharing in our model.
Online sharing also relates to the literature on private copying by consumers and its impact
on copyright holders. Liebowitz (1985) observed that copying technologies increase the value of
copyable originals. Besen and Kirby (1989) consider varying degrees of substitutability between
originals and copies as well as the respective marginal costs of producing them. Bakos, Brynjolfsson
and Lichtman (1999) examine the size of consumer sharing groups such as households or clubs when
copies are perfect substitutes and copying costs fall to zero. Noam (2008) analyzes online sharing as
a mechanism for creating a critical mass and as a step towards commercialization. This literature
nds that private sharing can either harm or benet copyright holders. For digital media content,
online sharing exhibits high substitutability of originals and copies as well as large scale sharing,
so we should expect it to harm copyright holders as is the case in our model.
The fundamental value generation process in our model is the introduction of new varieties
of content (or new content-ideas) that meet the taste of specic audiences. A series of papers in
the economics literature has analyzed the hit culture in artistic markets, which exhibit highly
concentrated sales with a minority of bestselling titles. Pioneered by Rosen's (1981) classic superstars model as well as later contributions, such as MacDonald (1988), this literature has explained
the phenomenon by assuming that higher talent commands larger prots and market shares than
lesser talent. This interpretation of talent provides valuable insights on artistic markets, yet artistic
appeal may not be measurable independently of taste. Consumers acknowledge that dierences in
talent are important but have a hard time evaluating talent or agreeing on it: no superstar appeals
to all consumers, and lesser talented artists generally have a niche audience of followers. We take
the view in this paper that the horizontal dierentiation dimension is most relevant to understand
the aggregate properties of the sector, and in doing so acknowledge that we are simplifying other
important dimensions.
12
The next section presents the building blocks of our trade model and characterizes the benchmark cases of autarky and free trade. Section 3 introduces political preferences and characterizes
equilibrium cultural policy with content quotas. We then introduce online sharing in Section 4. We
examine the impact of online sharing in the context of legacy cultural policy and then characterize
the optimal policy response. Section 5 evaluates cultural diversity in the world-economy before
and after the advent of online sharing. We conclude in Section 6.
12 From an aggregate perspective of the sector, superstars represent a localized eect within genres. Rosen (1981)
noted in his seminal paper that the denitions of markets are left somewhat vague: for example, for some purposes
it is sucient to think about the market for novels as a whole and for others distinguishing between mysteries,
romances, and so forth is necessary (p. 847)
8
ui , j  u  t di , j  p j
i
di, j
u
t
di, j
pj
j
Figure 1: Utility of consumer
i
utility from content
taste parameter
perimeter distance
price of product j
when purchasing product
j
depicted over the circle of a given
country. Consumers and products in each country are located on the perimeter of a circle, and
the taste proximity between a consumer and a product is a function of the perimeter length that
separates them.
2
Trade model
We consider a world economy composed of two countries and a single media sector, such as the
motion picture industry.
13
Both countries dier in their size, and this reects on the size of both
their consumer population and their cultural industry. We denote country size by
the size of the large country to one,
zs < 1.
zl = 1,
z
and normalize
and let the small country be characterized by size
The preferences of consumers in each country are spatially dened over the perimeter of
a circle, where the respective consumer mass and perimeter length of the circles in the large and
the small country are given by
zl
and
zs .
The circles provide a space understood to capture the
spectrum of consumer taste for media content and where products will occupy distinct locations.
Consider the case of an individual consumer in country
k ∈ {s, l}
located at a specic point of
the country's circle perimeter, as illustrated in Figure 1. The utility derived by the consumer from
a product is given by utility
u
and
taste proximity,
a measure of the t between the consumers'
taste and the particular product. This is calculated as the distance that separates the location
of the consumer and the product on the perimeter of the circle multiplied by taste parameter
t.
Thus a consumers' ideal product is located at the exact same location as the consumer (maximum
taste proximity), and yields full utility
purchasing product
j
at price
pj ,
u.
More generally, the utility derived by consumer
denoted by
ui,j ,
di,j
when
is given by
ui,j = u − t di,j − pj ,
where
i
(1)
is the distance separating the respective locations of the consumer and the product on
the perimeter of the circle, and
pj
is the price of the product. The outside utility of not consuming
is normalized to zero. Consumers have unit demand, and will either purchase a single product or
13 A single-sector economy implies that we are ignoring the impact of the sector on consumers' income, a simplication which is sensible if the sector represents a small share of the economy. Cultural industries have been
reported to generate a GDP share of 5 percent in most developed countries, and the gure is lower for the content
industries properly considered here. See Towse (2003) pp. 171-172.
9
stay out of the market.
The unit demand assumption is a strict interpretation of the fact that
media consumption is limited by the time constraints of consumers.
Consumers in each country are uniformly distributed over the perimeter of the country's circle
with respect to their ideal media product.
That is, each consumer's ideal product is unique.
The uniform distribution implies that, other factors equal, consumer surplus in each country will
increase with the supply of a larger number of product varieties (spread over the perimeter of
the circle) as this will increase the average taste proximity of consumers and products. Thus the
consumer population as a whole exhibits preference for variety, beneting from consuming several
products varieties rather than concentrating consumption on a single variety.
On the supply side, industry size is characterized by parameter
in the large country,
fl = f , and a pool of fs =
f.
There is a pool of
f
producers
zs2 f producers in the small country. The specication
implies that the number of producers in the small country is below its relative size, and captures
14
the presence of economies of agglomeration in the sector.
We assume industry sizes are viable
in both countries and, without loss of generality, normalize the xed costs of producers to zero.
Each producer supplies a unique dierentiated content variety in the world economy and incurs
zero marginal costs to distribute it to consumers. Producers commercialize their content in their
domestic country and may export it to the other country without incurring additional costs.
When positioning their product on the perimeter of the circle in each country, producer prots
will be determined by their proximity to neighboring varieties rather than their absolute position.
We assume the maximum dierentiation principle where producers locate their content varieties
15
equidistantly along the perimeter of the circle in each country.
When the set of content varieties
supplied in both countries coincides, each variety can be interpreted to occupy the same relative
position in both circles.
When the set of content varieties supplied in both countries diers,
producers ne-tune the location of their products in each country's circle in order to maintain
equidistance with respect to neighboring varieties on its perimeter, so their relative position in
14 Producers of cultural goods benet from a shared pool of talent, infrastructure, and know-how, and as a result
the sector exhibits production clusters which benet from a larger domestic market.
We adopt the assumption
that industry size is an exogenous function of country size for tractability purposes, and acknowledge that a richer
framework may consider producer entry as a strategic choice under free entry conditions. Under such conditions, it
can be shown that agglomeration economies that allow producers to benet from shared infrastructure imply that
2
equilibrium entry is a function of country size squared (z ), which motivates our specication. Nonetheless, our
main results also hold in the case where industry size scales linearly with country size. We have analyzed models
with free entry extensively, but unfortunately the problem of determining the unilateral policy equilibrium becomes
intractable. Therefore, given that the focus of our analysis is cultural policy and online sharing, we simplify the
problem by abstracting from the underlying determinants of industry size and cross-border relocation of production.
15 Economides (1989) analyzes the problem faced by rms choosing where to locate their products and shows that
in the presence of quadratic transport costs, which can be introduced in our model by substituting
in (1), maximum product dierentiation is a perfect equilibrium outcome.
ui,j = u−t d2i,j −pj
We have analyzed the model with
quadratic transport costs and found that our qualitative results are unaected, and present our results with linear
transport costs for simplicity. The equidistance result also relies on the uniform distribution of consumers, which
simplies content diversity by ensuring that the distance between products is a function of the number of producers.
See Noam (1987) for an analysis of both content variety and diversity in a Hotelling model where consumers are
normally distributed.
10
both countries may dier.
Although the motivation for location ne-tuning is of a technical
nature in our analysis, the marketplace suggests it is a common phenomenon. Movie trailers and
posters tend to vary by country, for instance, and it is not infrequent for country dubbing or
post-production cuts to cater to national tastes.
2.1
Autarky and trade benchmarks
We begin our formal analysis by considering the case of autarky. Few countries present a media
sector operating under autarky, where no foreign content is commercialized and domestic producers
do not export their content, but the case serves as a benchmark to introduce our model.
16
The
solution follows that of a standard Salop model, and we include it below to keep our analysis
self-contained. The timing of the game is as follows. In the rst stage, producers set prices for
their content in their domestic country. In the second stage, consumers observe content varieties
and prices available in their country and consumption decisions take place.
Consumer demand. We solve the game by backwards induction, and start by considering
the second stage purchasing decision of consumers in country
k
varieties commercially supplied. Consider the demand of producer
surrounded by neighboring varieties
z
of size
j + 1 and j − 1 priced at pj+1,k
j
when there are
n
when quoting a price
and
pj−1,k .
content
pj,k
and
When all consumers
purchase and producers directly compete for market share, we can determine the demand for
each content variety by comparing the utility that dierent varieties deliver to consumers.
consumer located at
x
between varieties
j
and
j+1
17
The
and which is indierent between purchasing
either is given by
u − t (x) − pj,k = u − t (
A symmetric condition identies consumer
Solving for
between
x
x
and
and
x,
x,
that is
Content pricing.
n
x which
(2)
is indierent between varieties
and given that total demand for content variety
j
j
and
j − 1.
is driven by all consumers
x + x,
Dj,k =
when
z
− x) − pj+1,k .
n
n(pj−1,k + pj+1,k − 2pj,k ) + 2 t z
.
2tn
(3)
Consider next the rst stage pricing problem of producers in country
k
content varieties are located equidistantly over the perimeter of the circle and consumers
16 Even in North Korea, Supreme Leader Kim Jong-il owned 20,000 home movies, most of them imports such
as
Rambo, Godzilla,
and all Elizabeth Taylor and Elvis Presley lms. To jumpstart the country's lm industry, a
noted pair of South Korean lm makers was imported by force in 1978. In 2012, the North Korean lm
Kim goes ying
Comrade
was shown at the Pusan lm festival, promoted for export.
17 We restrict our analysis to the market conguration where producers price competitively. The condition for
this market conguration to arise can be derived by equating
ui,j
in (1) to zero for the consumer in the middle
who is strictly indierent between the two neighboring varieties given equilibrium prices in (4). The condition can
be expressed as a lower boundary on small country size, such that
11
z ≥ z̄
where
z̄ = 3 t/2 f u.
are uniformly distributed.
maximize revenues
Given that marginal costs are zero, producers choose price
Dj,k · pj,k .
pj,k
to
Solving for the optimal price and equating prices across producers
for a symmetric pricing equilibrium yields
p(z, n) =
Autarky welfare.
tz
.
n
(4)
Under autarky, the number of content varieties commercialized in each
nak = fk .
The market is of size zk , each
a
producer obtains a market share 1/nk , and prices are given by (4). Industry prots are therefore
country is determined by the number of domestic producers
given by
Πak (zk , nak ) = fk [zk
1
p(zk , nak )]
nak
(5)
t
= .
f
We can write consumer surplus in a country of size
prices
p
z
where
n
content varieties are available at
as
ˆ
z/2n
u − t di − p(z, n) ddi ,
CS(z, n) = 2 n
(6)
0
and plugging in
nak
for the case of autarky in country
CSka = u zk −
k
of size
zk
obtains
5t
.
4f
(7)
Under autarky, producers commercialize their content exclusively in their home country, nak = fk , and prices are given by pak = t zk /nak .
Lemma 1.
Each country is an isolated market under autarky. Consumers compare the prices and their
taste proximity to available content varieties when realizing their purchasing decisions, and producers compete against each other by accounting for the price of neighboring varieties in consumers'
taste space (the perimeter of the circle in each country) when pricing their content. In equilibrium, all consumers purchase and all producers quote the same price for their content within each
country.
Consumer surplus increases with country size
z,
content utility
u,
industry size parameter
f,
and is decreasing in taste parameter t. Industry prots are increasing in consumer taste parameter
t and decreasing in industry size parameter f , as the former increases the willingness of consumers
to pay higher prices for varieties that better match their taste and the latter intensies competition
reducing market shares and driving down prices. Industry prots are invariant to country size
z
because demand shifts driven by variations in consumer population size are oset by shifts in the
intensity of competition driven by variations in industry size. This implies that there are increasing
social welfare returns to country size, with the benets of increased content variety and lower prices
accruing to consumers.
12
Producers are homogeneous in our model, quoting common prices and deriving equal market
shares and prots in equilibrium. Vogel (2008) considers a richer circular model with heterogeneous
producers that invest in the quality of their products, and shows that more ecient producers with
lower marginal costs choose higher qualities and set higher prices, deriving higher market shares
and prots than less ecient producers. Our model is simpler because producers are homogenous.
Nonetheless, we expect our main ndings to hold in a model with heterogeneous qualities as long
as the distribution of qualities is common across producers in dierent countries.
We next turn to the case of a free trade regime as a rst step to introduce cultural policy in the
next section. Under free trade, there are no restrictions to trade and producers commercialize and
price their content in both countries. Recall that in our trade model producers incur no costs to
commercialize their content in the foreign country, so all producers prefer to export. The timing
carries over from the autarky case. We have already characterized consumer demand and content
pricing in a country where
n
content varieties are commercialized (the second and rst stages of
the game, respectively), and those results carry over.
Free trade welfare.
Under the free trade regime all producers commercialize their content
ft
in both countries, nk = fl + fs . In each country, the market is of size zk , each producer obtains
ft
market share 1/nk , and prices are given by (4). The prots of the industry based in country k
are then
Πfk t = fk [zk
=
1
p(z , nfk t ) + z−k
k
nfk t
t zk2
.
2
f (zk2 + z−k
)
Consumer surplus in country
k
1
t
nf−k
t
p(z−k , nf−k
)]
under free trade can be derived by plugging
(8)
nfk t
in (6), which
obtains
CSkf t
5 t zk2
= u zk −
.
2
4f (zk2 + z−k
)
(9)
Under free trade, producers commercialize their content in both countries, nfk t = fl. +fs ,
and prices are given by pfk t = t zk /nfk t . Compared to the autarky equilibrium in each country, free
trade increases the number for content varieties commercialized and reduces prices. This increases
consumer surplus and reduces industry prots in both countries.
Lemma 2.
Free trade increases social welfare in both countries and consumers appropriate the benets.
Free trade also benets the small country the most, and this is driven by two eects. On the one
hand, the increase in the number of commercialized content varieties is larger in the small country
given that the domestic industry is smaller. On the other hand, competition is more intense in
the small country because producers compete for a smaller consumer population and this implies
lower content prices than in the large country (also note that the large country is more protable
for producers than the small country). Figure 2 depicts social welfare under autarky and free trade
13
Autarky social welfare
Free trade social welfare
W
W
CSftl
CSfts
CSak
Pak
z
Pftl
1
Pfts
zk
z
1
zs
Figure 2: Consumer surplus and industry prots in the small country (left) and under free trade
for both countries (right) as a function of small country size.
in both countries.
The fact that the price of foreign content varieties is lower in the small country is reminiscent
of the cultural dumping concern which has been expressed against US cultural exports. It is worth
noting that this eect in our model is intensied by the cost structure of the sector.
Because
there are no export costs, producers are always willing to export their content and face no cost
disadvantage in foreign markets. Furthermore, product prices are given entirely by markups due
to the absence of marginal costs, so smaller audiences command a stronger reduction in prices
than would the case for goods with positive marginal costs of production. Both factors suggest
that larger variations in the prices of cultural goods across countries with respect to other goods
can be (partially) attributed to the underlying cost structure of the sector.
Consumers in our model care about their taste proximity to content and not about its origin, so
domestic and foreign varieties derive equal market shares in each country. If consumer preferences
exhibit domestic bias, consumers derive higher utility
ones.
u from domestic products than from foreign
Producers then quote higher prices and obtain higher market shares in their domestic
market than in the foreign one. The analysis becomes more complex because of the asymmetries
that arise, but the qualitative results of our base model hold as long as the domestic bias (the
utility dierential) is not too large. If domestic bias is large in our model, content quotas such
as those introduced in the next section are unnecessary because producers always perform well
in their domestic market. Francois and Ypersele (2002) show that cultural policies may still be
justied with some instances of domestic bias, however. The argument relies on the existence of
dierent types of content, with consumers exhibiting high variability in their valuation of some
types and low variability in others (e.g. auteur cinema and Hollywood blockbusters)
14
3
Cultural policy
We introduce political preferences in our model to explain policy intervention in the cultural sector.
We adopt the view that governments set cultural policy to maximize both social and cultural
welfare within their country. The former is given by consumer surplus and industry prots. The
latter is given by the political preferences of governments, which are dened to depend on the
aggregate market shares of domestic and foreign producers inside the country, or equivalently, the
domestic audience's exposure to domestic content.
Several arguments have been proposed to explain the incentives for governments to increase
exposure to domestic content. As pointed out by Noam (1991), these arguments are rarely framed
in economic terms. A central argument in the debate relies on the fact that media content can
portray national identity and values, so consumption of domestic content exhibits positive spill-
18
overs for society and increases social cohesion.
The European Union's audiovisual media services
Directive 2010/13/EU, for instance, states that audiovisual media services are as much cultural
services as they are economic services. Their growing importance for societies, democracy [. . . ],
education and culture justies the application of specic rules to these services. Nonetheless,
countervailing factors suggest that the extreme case where no foreign content is consumed is
unlikely to be desirable from a social perspective either. Exposure to foreign content can foster
cultural openness, which facilitates human capital, mobility and trade. In what follows, we adopt
the simplest specication for cultural welfare that captures this tradeo.
19
CWk be a function of the aggregate market share of
domestic producers inside the country qk ∈ [0, 1], which we refer to as domestic cultural share.
We assume that CWk is inverse U-shaped in qk with a maximum at q̂ and consider the simplest
Let cultural welfare in each country
specication that meets these properties,
CWk (qk ) = 2 q̂ qk − qk2 .
(10)
18 A stark reminder of the prevalence of national identity and values in recreational media content was provided
by
Zero dark thirty,
an action lm produced by Sony Pictures in 2012 depicting the hunt for terrorist Osama Bin
Laden. Several US Senators wrote a letter to Sony Pictures denouncing the lm for being grossly inaccurate and
misleading in its suggestion that torture resulted in information that led to the location of Osama Bin Laden,
according to the Wall Street Journal.
The director denied endorsement of torture stating that depiction is not
endorsement. And if it was, no artist could ever portray inhumane practices. No author could ever write about
them, and no lmmaker could ever delve into the knotty subjects of our time. The Wall Street Journal summarized
the controversy noting that if you were looking for a case of Washington politicians trying to intimidate Hollywood
with narrow moralisms and Congressional investigations, it would be hard to nd a better one than this.
(`The
Bigelow Snub,' January 2013)
19 Political preferences in our model can also be interpreted to originate from political economy tradeos. On the
one hand, the dispensation of protectionism may allow governments to manufacture political consent domestically by
providing leverage in the production of opinion-making content. On the other hand, strong cultural intervention can
compromise international diplomacy and trade negotiations in other areas. The relative merit of public externalities
vs. political economy factors in explaining incentives for cultural intervention remains a contentious issue, and for
the purpose of our analysis it is sucient to note that both interpretations are compatible with the model.
15
k by Gk . Governments maximize the sum
Gk = CSk + Πk + CWk , and we will assume
Denote the objective function of government in country
of their country's social welfare and cultural welfare,
that
f > 2t
ensures that
so that
CWk
Gk
is concave in
qk
and interior equilibria exists. The parameter restriction
is suciently large to aect the policy choices of governments in equilibrium.
We introduce content quotas to analyze import barriers in the cultural sector.
quota
qk
(we denote quotas and domestic cultural shares in distinctively by
qk )
cultural share oor for domestic producers, or equivalently, a market share ceiling
A content
sets a domestic
1 − qk
for foreign
producers. If market conditions drive the total market share of domestic producers below
qk
in
their home country, a quota is enforced by restricting the number of content varieties supplied by
foreign producers until domestic cultural share
qk
is met. Enforcement implies that some foreign
producers are excluded from the domestic market but others retain access. Because producers are
homogeneous in our model, we sidestep selection mechanisms and assume that exclusion is applied
randomly across foreign producers.
Alternatively, enforcement can be interpreted as exclusion
rotating over products across time, with foreign producers having similar access windows to the
market. For simplicity, we focus our analysis on the impact of content quotas on domestic cultural
shares and ignore the revenues that may be raised from auctioning slots to foreign producers,
though we further discuss this aspect of the problem below.
We next characterize both the unilateral regime where governments set quotas independently
as well as the multilateral regime where governments jointly set quotas to maximize world welfare
Gl + Gs .
The latter is equivalent to the social planner's solution and can be interpreted as the
desirable outcome of trade agreements among governments, where losers may be compensated in
other areas. For example, in their 2011 Free Trade Agreement, South Korea lowered import quotas
on lm and on broadcasting channels while the US lowered taris for textiles and electronics.
We modify the timing of the game accordingly. In the rst stage, governments set quotas
and
qs
ql
either unilaterally or multilaterally. In the second stage, producers price their content in
each national market where it is commercialized. In the third stage, consumers observe content
varieties and prices available in their country and consumption decisions take place. Note that our
characterization of consumer demand in (3) and content prices in (4) carry over from the previous
section, so we start by characterizing industry prots and consumer surplus with quotas before
proceeding to the rst stage of the game.
Cultural policy welfare.
Consider the impact of quotas
ql
and
qs
given the presence of
fl = f and fs = z 2 f producers in both countries. In country k , the quota is not enforced when
qk ≤ fk /(fk + f−k ) and all producers commercialize their content. When qk > fk /(fk + f−k ) the
quota is enforced, and the number of foreign producers allowed to commercialize their content in
country
k
is restricted to ensure that
nqk = fk /qk .
This implies that
(fk /qk ) − fk
foreign producers
are randomly selected to commercialize their content and the remaining are excluded. Note that
nqk
is a function of
qk ,
and the binding quota level for enforcement
16
q̄k
is given by
q̄k =
fk
.
fk + f−k
(11)
qk ≤ q̄k are
qk ∈ [q̄k , 1] where nqk is
Quotas below the binding level in each country
not enforced and therefore equivalent
q̄k , so we restrict our analysis to
well dened. In particular, note that
q
nk (q̄k ) = fk + f−k , so the binding level characterizes the case of no enforcement.
to
ql
We next characterize industry prots as a function of
and
qs .
Exclusion implies that a
zk ,
q
producers with market access obtain market share 1/nk , and prices are given by (4). The prots
producer derives no revenues from the foreign country. In each country, market size is given by
of the industry based in country
Πqk
k
are given by
nq−k − f−k
1
1
q
= fk [zk q p(zk , nk ) +
· z−k q p(z−k , nq−k )]
nk
fk
n−k
2
2
(q + q−k − q−k )t
= k
.
f
Consumer surplus in country
k
under cultural policy can be derived by plugging
CSkq = u zk −
Cultural welfare in country
k
(12)
is a function of
qk
nqk
in (6),
5 t qk
.
4f
(13)
and is given by
CWk (qk ).
Cultural policy. Consider the problem of governments in the rst stage under the unilateral
regime.
Each government unilaterally sets
Maximizing
Gk
with respect to
qk
qk
for both governments
unilateral quotas, which we denote by
qu
Gk = CSkq + Πqk + CWk given q−k .
and solving for qk identies optimal
to maximize
and are given by
qu =
8f q̂ − 5t
.
8(f − t)
Recall that the solution is well dened in the range
(14)
qk ∈ [q̄k , 1]
for each country, where
qk = q̄k
implies no quota enforcement.
Consider next the problem of governments in the rst stage under the multilateral regime.
Governments jointly set
and
qs
ql
and
qs
to maximize
Gl + Gs .
identies optimal multilateral quotas, denoted by
qm =
where the solution is well dened in the range
Maximizing
Gl + Gs
ql
qm,
8f q̂ − t
,
8f
qk ∈ [q̄k , 1]
with respect to
(15)
for each country.
Content quotas under the unilateral (qku ) and multilateral (qkm ) cultural policy
regimes in each country are given by
Proposition 1.
17



q ∈ [0, q̄k ] if q m ≤ q̄k (no enforcement)


qkm = q m
if q m ∈ (q̄k , 1)(enforcement)



1
if q m ≥ 1(cultural autarky)



q ∈ [0, q̄k ] if q u ≤ q̄k (no enforcement)


qku = q u
if q u ∈ (q̄k , 1)(enforcement)



1
if q u ≥ 1(cultural autarky)
and the number of content varieties commercialized in country k is given by nqk = fk + f−k when
there is no quota enforcement and nqk = fk /qk under enforcement, with prices given by pqk = t zk /nqk .
Compared to the free trade equilibrium, quota enforcement in each country reduces the number
of foreign content varieties commercialized and increases prices. This reduces domestic consumer
surplus, increases domestic industry prots, and increases national cultural welfare.
To understand the result, it is useful to consider rst the eect of quota enforcement by one government. Enforcement restricts domestic supply by excluding foreign producers from the domestic
market, reducing the number of varieties accessible to consumers. This increases the domestic cultural share, allowing governments to increase cultural welfare when
q̂
is above that derived under
free trade. Note that free trade is the special case of no enforcement in both countries,
and
ql ≤ q̄l ,
and autarky is the special case where
qs = ql = 1 .
qs ≤ q̄s
Because countries dier in their
industry sizes and the number of varieties they produce, the domestic cultural share of the large
country is higher than that of the small country under free trade. Therefore, achieving the same
domestic cultural share will require enforcement in the small country. Both countries can increase
their domestic cultural share by enforcing quotas, and achieving high domestic cultural shares will
generally require enforcement in both countries.
In the unilateral regime, each government weighs the potential domestic gains in cultural welfare
derived from quota enforcement against its domestic impact on social welfare.
Because quota
enforcement softens competition in the domestic market and drives up prices, it reduces domestic
consumer surplus and increases domestic industry prots. Equilibrium quotas therefore depend on
consumer taste parameter
t and industry size parameter f .
When
t is small or f
is large, implying
that the relative impact of quota enforcement on social welfare is low with respect to its cultural
welfare impact, equilibrium quotas ensure that domestic cultural shares are close to the cultural
welfare optimum
q̂ .
Larger values of
t or smaller values of f
imply that the social welfare impact of
enforcement is larger, so governments are willing to deviate from
higher quotas when
q̂
q̂
q̂ .
In equilibrium, this results in
is high, because of their impact on industry prots, and lower quotas when
is low because of their impact on consumer surplus.
In the multilateral regime, equilibrium quotas are generally below the cultural welfare opti-
mum
q̂ .
Note that quota enforcement generally reduces foreign industry prots, generating nega-
tive externalities across countries. Because both governments internalize these externalities in the
multilateral regime, multilateral quotas are generally below those set in the unilateral regime. An
exception arises, however, when the size of the small country and the cultural welfare optimum
18
q̂
Commercialized varieties Hql =qsL
Quota enforcement
qk
1
nk
qul
ql
qm
l
fl + fs
q
nl
qm
s
fl
nqs
qus
qs
fs
0
1
`
q
qs
ql
1
qk
Figure 3: Equilibrium quotas under the unilateral and multilateral regimes (left) and number of
content varieties commercialized in each country under quota enforcement (right)
are suciently low. In this case, quota enforcement benets foreign producers because the intensity of competition in the small country is high enough that foreign industry prots increase with
enforcement (though the benets of enforcement are derived exclusively by foreign producers retaining market access). In this case only, the large country benets from higher quota enforcement
in the small country, so the multilateral quota in the small country is higher than the unilateral
solution. Figure 3 depicts equilibrium quotas in both regimes to illustrate the above arguments.
When the cultural welfare optimum
q̂
is high, both countries enforce symmetric quotas and
achieve the same level of cultural welfare. It is important to note that symmetric quota equilibria
implies a higher degree of intervention in the small country, because a larger number of foreign
content varieties need to be blocked to achieve the same domestic cultural share as the large
country. When cultural welfare optimum
q̂
is low and equilibrium entails no enforcement in the
large country (but may entail or not enforcement in the small one), the small country achieves a
higher level of cultural welfare than the large one. This follows from the fact that content quotas
are an eective policy tool to increase domestic cultural shares but not to reduce them.
They
enable governments to avoid the free trade outcome where domestic consumption is too outwards
looking from a cultural welfare perspective.
The large country may experience the contrary
eect in equilibrium, however, remaining too inwards looking due to the large relative size of its
cultural industry; its consumption of foreign content varieties is too low from a cultural welfare
perspective.
20
Our results contribute to explain the prevalence of content quotas in the cultural sector as
opposed to taris, which are common in other sectors. We have argued that two dening properties
20 Although country size determines both audience and industry size and in our model, note that the important
underlying driver for quota enforcement is industry size, which determines the domestic cultural share under free
trade. For example, our model suggests that China may enact screen quotas because of the small relative size of
its industry with respect to the foreign one rather than due to market size considerations.
19
of the cultural sector are government preferences over domestic cultural shares and the absence
of marginal costs of production or export costs.
Although taris have been considered a proxy
for modeling content quotas in some instances of the literature, our model explains why content
quotas are an eective policy tool in this context and traditional taris are not. The intuition is
simple: rate-based taris do not aect equilibrium prices in monopolistic competition when rms
face zero marginal costs. In our model, taris reduce the prots of foreign producers but do not
aect their willingness to export their content nor their foreign sales, and are therefore ineective
to protect the sales of domestic producers and increase domestic cultural shares.
In our above analysis, we have considered the simplest exclusion mechanism where commercial
slots are randomly assigned to foreign producers.
slots are auctioned.
A richer model may consider the case where
Our assumption that slots are assigned randomly allows us to ignore the
question of how the revenues from such an auction may be used.
For example, France levies
a tax on cinema admissions and redirects the revenues to subsidize domestic production.
Such
mechanisms appropriate welfare from foreign producers, and therefore increase equilibrium quotas
in the unilateral regime. Furthermore, the selection mechanism has no impact in our model because
producers are homogeneous. If producers were heterogeneous in the quality of their content, we
should expect an auction to select content varieties of higher quality for commercialization. Foreign
varieties would then derive higher average market shares than domestic varieties, and the quota
level required to meet a certain domestic cultural share target would also be higher than in our
analysis above.
4
Online sharing
We next introduce online sharing into our model of the cultural sector. This form of sharing is an
ecient distribution mechanism that scales beyond borders and enables consumers to access any
content variety produced. It presents non-negligible costs for consumers in the form of computing
resources and bandwidth as well as risk of legal sanctions in several countries. We assume that
consumers accessing online sharing incur an exogenous cost
ok
in country
k , where variations in ok
across countries are mainly driven by dierences in legal sanctions. We assume that online sharing
costs are below commercial distribution prices in both countries, in particular
the upper boundary is given by prices under free trade,
ōk = pfk t .
ok < ōk
where
This captures the empirically
relevant case where the eciency of online sharing is a threat to commercial distribution and
simplies the analysis by ensuring that content prices are symmetric in equilibrium. We abstract
from modeling the precise exchange mechanism that underlies online sharing and simply assume
21
that it is self-sustainable and ecient.
21 For a detailed analysis of the underlying mechanism and a characterization of its performance, see CasadesusMasanell and Hervas-Drane [6]. File sharing networks are shown to be sustainable in the presence of selsh participants who care only about their own access to content, and the decentralized architecture of the networks implies
20
Our next proposition describes the impact of online sharing on consumers and producers under
legacy cultural policy, that characterized in Proposition 1 and established (either unilaterally or
multilaterally) before the advent of online sharing. This scenario is of interest given that the rst
decade of online sharing has witnessed little in the form of cultural policy change in most countries.
Legacy quotas are given by
ql ≥ q̄l
and
qs ≥ q̄s ,
with equality in each country for the case of no
enforcement. The timing carries over from the previous section taking government decisions in the
rst stage as given.
We proceed to characterize demand indepen-
Consumer demand with online sharing.
dently of how it is served, either through commercial distribution or through online sharing. If
content variety
j
is distributed commercially in country
product in country
k
will compare price
pj,k
k
pj,k , consumers demanding the
cost ok . If pj,k ≤ ok , consumers
at price
with online sharing
will prefer to purchase the product through the commercial channel (assuming tie-breaking in
favor of commercial distribution), and if
pj,k > ok
they will prefer to obtain the product through
pmin
j,k identify the lowest eective price of content variety j in country k for
min
consumers, pj,k = min[pj,k , ok ]. If content variety j is not commercially distributed in country
k due to quota enforcement, then pmin
j,k = ok . Following our earlier derivation of demand in (3),
demand for content variety j in country k when n varieties are accessible to consumers will be
online sharing.
Let
given by
os
Dj,k
=
min
min
n(pmin
j−1,k + pj+1,k − 2 pj,k ) + 2 t z
.
2tn
(16)
Content pricing with online sharing. Consider the pricing problem of producer
commercializing its content in country
produced are accessible to consumers,
j
when
k in the presence of online sharing. All content varieties
nos
k = fl + fs , and neighboring varieties may be available
through commercial distribution or only through online sharing (if under quota enforcement in
country
k ).
Clearly, producer
j
pj,k ≤ ok , as otherwise demand for variety j
Producer j chooses price pj,k to maximizes revenues
will quote a price
will be fully served through online sharing.
os
Dj,k
· pj,k under the restriction pj,k ≤ ok ,
j − 1 and j + 1 yields
pj,k =
which given the eective price of neighboring varieties

o
if
k
p̂
j,k
p̂j,k ≥ ok
(17)
otherwise
where
t zk
1
min
p̂j,k = (pmin
j−1,k + pj+1,k + 2 os ).
4
nk
Consider the implications of the optimal pricing strategy of producer
that participants eectively share the costs incurred to enable the content exchange.
21
(18)
j
in country
k.
Recall
that
ōk = pfk t ,
which is present in the last term of (18). The optimal pricing strategy described by
pj,k = ok when both neighboring varieties j − 1 and j + 1 are eectively priced at
ok , because in this case p̂j,k > ok . If neighboring variety j − 1 (or variety j + 1) is priced below ok ,
min
min
then p̂j,k > pj−1,k (respectively p̂j,k > pj+1,k ). Therefore, because pricing strategies are symmetric
across producers, a symmetric pricing equilibrium implies that pj,k = ok for all producers. That
(17) implies price
is, producers choose to match online share cost when pricing their content.
Welfare with online sharing. In the presence of online sharing, all content varieties obtain
an eective market share
1/nos
k
in each country but producers only derive revenues from the foreign
country when not excluded due to quota enforcement. Prices are given
the industry based in country
k
pos
j,k = ok .
The prots of
are given by
nos
1
1
−k − f−k
· z−k q o−k ]
o
+
k
os
nk
fk
n−k
3
3
q−k ok zk + (1 − q−k )o−k z−k
=
.
2
q−k (zk2 + z−k
)
Πos
k = fk [zk
(19)
Consumer surplus in the presence of online sharing can be written following our earlier derivation in (6), which implies
ˆ
CSkos
=
2 nos
k
zk /2nos
k
u − t di − ok ddi
0
(20)
2
zk [(u − ok )(zk2 + z−k
)4f − zk t]
=
.
2
4f (zk2 + z−k
)
Cultural welfare in country
k
in the presence of online sharing is given by
CWk (q̄k ).
The advent of online ensures that all content varieties are consumed in all coun= fl + fs , and producers match online sharing cost when commercializing their content,
tries,
pos
j,k = ok . Online sharing redistributes welfare from producers to consumers within and across
countries and reduces national cultural welfare in countries where legacy cultural policy mandates
quota enforcement. Furthermore, enforcement reinforces the redistribution and generates a social
welfare loss.
Proposition 2.
nos
k
Online sharing has two main eects on the cultural sector: a content pricing eect that exerts
downward pressure on commercial prices, and a demand displacement eect that increases consumption of foreign content in countries where legacy policy mandates enforcement. The content
pricing eect arises in all countries and is driven by producers cutting prices to match the cost of
online sharing. This ensures commercial distribution remains competitive and consumers are willing to purchase content commercially distributed in their country instead of accessing it through
online sharing. The demand displacement eect arises in countries enforcing quotas and is driven
by consumers using online sharing to access foreign content varieties that better match their taste
22
and are not commercialized in their country. This eect displaces demand from domestic content
(through commercial distribution) to foreign content through online sharing, rendering content
quotas ineective.
Online sharing has several welfare implications. There is an increase in consumer surplus and a
decrease in producer prots, and in the case of quota enforcement, there is an additional welfare loss
and a decrease in cultural welfare. First, consumers are the beneciaries of online sharing, enjoying
lower eective prices and access to more content varieties in countries enforcing quotas. Second,
producers suer from lower prices and also lower market shares due to demand displacement in
countries enforcing quotas. Third, there is a welfare loss due to the online sharing costs incurred by
consumers accessing content varieties not commercialized in their country. Based on these factors,
social welfare with online sharing in country
k
decreases with domestic online sharing cost
ok
and
q−k , increases with foreign online sharing cost o−k , and is unaected by
domestic quota enforcement qk . The net impact of online sharing on social welfare can go in either
foreign quota enforcement
direction. Furthermore, because online sharing drives domestic cultural shares to the free trade
level, it reduces cultural welfare in countries enforcing quotas under legacy policy. It also has a
larger impact on the small country because of its higher intervention when enforcing quotas, as
discussed in Section 3.
Producers cannot compete against free in our model.
producers obtain zero prots.
If online sharing costs fall to zero,
As argued above, online sharing presents non-negligible costs for
consumers and should not be interpreted to be free. Nonetheless, in a richer model where consumer
online sharing costs are heterogeneous across the population, we should expect both distribution
channels to coexist and producers to continue to derive positive (albeit lower) prots even if online
sharing is free for some subset of consumers.
Optimal pricing may then tolerate some degree
of online sharing, see Casadesus-Masanell and Hervas-Drane (2009) for a pricing analysis with
endogenous market coverage and online sharing performance.
Our model assumes that consumers have widespread access to online sharing and are fully
aware of all content varieties produced in the world economy, a scenario we believe provides a
relevant benchmark to understand the long-term impact of digitalization in the marketplace. We
expect the uptake of high-speed Internet access as well as increased adoption of digital formats
in commercial distribution to facilitate online sharing, as they have done in the past. Consumer
awareness of foreign content is also bound to increase with the growth of online content databases,
user communities and social networks, as well as automated recommendation systems that help
consumers discover content that matches their taste.
Proposition 2 shows that legacy cultural policy is inadequate in the presence of online sharing.
We next analyze the optimal policy response to online sharing in the rst stage of the game when
governments set quotas
for consumers
ok
qk
and may penalize online sharing by increasing the cost of online sharing
in each country. Some countries have enacted laws that attempt to do so in recent
years. In most cases, le sharing users risk receiving cease and desist notications, nes, Internet
23
service degradation, or temporary disconnection. We focus on the case where governments cannot
block or disproportionately penalize online sharing,
ok < ōk ,
which captures the scenario where
penalties do not exceed the harm caused to producers. Because of the non-pecuniary nature of
most of these initiatives, we continue to treat
ok
as a cost incurred by consumers rather than as a
revenue source for governments.
Equilibrium cultural policy with online sharing. Consider the problem of governments
unilaterally setting quotas and online sharing penalties that increase
ok
ok < ōk .
within the range
Recall that equilibrium prices characterized in (17) imply that producers match online sharing cost
when pricing their products and all content varieties are consumed in each country irrespectively
of quota enforcement
qk .
Inspection reveals that
∂Gos
k /∂ok < 0
irrespectively of
qk ,
so govern-
ments prefer not to penalize online sharing when acting unilaterally. When setting quotas, each
os
os
os
qk to maximize Gos
k = CSk + Πk + CWk given q−k . Inspection of Gk reveals
os
that Gk /∂qk = 0, given that quota enforcement is ineective in the presence of online sharing.
u+os
Therefore, any quota level constitutes an unilateral equilibrium, qk
∈ [0, 1].
government sets
Consider next the problem of governments multilaterally setting online sharing penalties and
quotas. Inspection reveals that
os
∂(Gos
s + Gl )/∂ok ≤ 0,
with strict inequality if
qk > q̄k
in either
country, so governments have no multilateral incentives to penalize online sharing. With regards
to quotas, governments jointly set
∂(Gos
l
+
Gos
s )/∂qk
< 0.
ql
and
qs
to maximize
os
Gos
l + Gs .
Inspection reveals that
Therefore, the multilateral equilibrium with online sharing implies no
quota enforcement in both countries,
qkm+os ∈ [0, q̄k ].
If governments cannot block or disproportionately penalize online sharing, ok < ōk ,
the multilateral response to online sharing implies the elimination of content quotas. Legacy cultural
policy is an inecient status quo because governments lack the unilateral incentives to eliminate
them. Proportionate penalties for online sharing users redistribute welfare from consumers to
producers within and across countries, increasing the social welfare loss generated by online sharing
under quota enforcement.
Proposition 3.
Online sharing provides a rationale for the elimination of content quotas if such sharing cannot
be blocked or disproportionately penalized, even when cultural welfare is at stake in each country.
The elimination of content quotas is desirable because they are no longer eective to sustain high
domestic cultural shares and also generate a welfare loss in the presence of online sharing. This
welfare loss is borne by excluded foreign producers outside the country enforcing a quota, as they
could otherwise appropriate the online sharing costs incurred by consumers accessing their content
within the country. Because the welfare loss is borne by foreign producers, governments lack the
unilateral incentives to eliminate quotas. The result underscores the fact that import barriers from
legacy cultural policy are a non-desirable status quo with the advent of online sharing.
Figure
4 illustrates the impact of quota enforcement and the impact of proportionate penalties in the
presence of online sharing.
24
Enforcement with online sharing
Online sharing penalties
W
W
Gkos
Gkos
Pos
-k
Pos
-k
Ok
Ok
qk
1
Figure 4: Total welfare in country
qk
0
ok
ok
k , industry prots in the other country, and total online sharing
k (plotted as Ok ) as a function of quota enforcement (left)
costs incurred by consumers in country
and penalties that increase online sharing cost (right)
Proportionate penalties which increase expected online sharing costs for consumers within the
range
ok < ōk
redistribute welfare from consumers to producers because they allow the latter to
sustain higher prices. From a world-welfare perspective, penalties are welfare neutral in the absence
of quota enforcement. From a unilateral perspective, however, governments prefer not to penalize
online sharing because foreign producers are among the beneciaries of the welfare redistribution
they generate. The disincentives for the smaller country to penalize online sharing are stronger
than those of the large country, because the smaller size of its domestic industry implies that a
larger share of the welfare redistribution accrues to foreign producers.
In the presence of quota enforcement, proportionate penalties are ineective to reduce online
sharing trac and increase the welfare loss it generates. Consumers remain willing to use online
sharing to access content that better matches their taste and do so incurring higher costs. The
result shows that the combination of import barriers together with proportionate penalties is an
inecient policy response to online sharing, and contributes to explain why legal initiatives to
penalize online sharing have been heavily contested in European countries where import barriers
remain in place.
Our formal analysis has assumed that penalties borne by online sharing users are a source of
welfare loss, but they could alternatively be instituted as a compensation scheme for producers.
For instance by taxing broadband services. Our model would suggest that unless online sharing is
more ecient than commercial distribution in providing consumers with access to content, such an
approach is suboptimal. Social welfare is maximized when consumers do not incur online sharing
costs to access their preferred content because producers compete by pricing accordingly. We have
also restricted our analysis above to the case of proportionate penalties, which we believe is most
empirically relevant. It should be clear that if penalties were disproportionately severe or online
25
sharing were blocked altogether,
ok → ∞,
online sharing would have no impact on the world
economy and the cultural policy equilibrium characterized in Proposition 1 would continue to hold
22
in its presence.
5
Cultural diversity
If the consumption of cultural products shapes cultural identity and online sharing cannot be
blocked or severely penalized, in this section we build on our formal analysis to answer the following
question: does online sharing increase or decrease cultural diversity in the long-term? We formalize
our answer with a fractionalization index. This index provides a measure of cultural diversity and
has been readily applied in the empirical literature, see for instance Alesina et al. (2003). Denote
by
snk
the market share of product
then cultural diversity index
CD
n
N
denote the total number products,
1 X
(1 − sns · snl ).
N
(21)
in country
k
and let
is expressed as
CD =
The index is a direct extension of the Herndahl concentration index to the case of two markets,
subtracted from
1 to measure diversity (or absence of concentration) and normalized by the number
of products. It obtains a minimum value of zero when consumption is concentrated on a single
and common product across both countries (so there is no diversity) and increases when more
products are consumed or the overlap in product consumption across both countries is reduced.
To see the rst eect, consider the case where all products derive equal market shares and there
sns = snl = 1/N . Then, CD = 1 − 1/N 2 ,
N → ∞. The second eect implies that CD must
is perfect overlap in consumption across countries,
which is increasing in
N
and converges to
1
as
increase when the overlap in consumption is reduced. The simplest instance of this eect is the
case where there is no overlap in the products consumed in both countries.
verify in (21) that
CD = 1
n
when ss
· snl
= 0 for all
It is immediate to
products. The formulation of
CD
is convenient
for its simplicity and provides a straightforward interpretation: it measures the probability that
23
two consumers randomly picked from both countries consume the same product.
22 To see the eect of a large increase in
in (17) imply that
pj,k < ok
when
ok , note that equilibrium prices in commercial distribution characterized
ok ≥ ōk . Inspection of consumer demand in (16) reveals that content varieties
distributed commercially increase their market shares with respect to those available only through online sharing
when
pj,k < ok .
The eect is intensied as
ok
increases, and if
ok
is suciently high all consumers will prefer to
purchase through the commercial channel (clearly, online sharing demand converges to zero as
down market shares when
ok ≥ ōk
ok → ∞).
Pinning
is combinatorially complex, however, because producer prices depend on the
exact ordering of varieties over the perimeter of the circle and all possible orderings need to be considered.
23 Products which are consumed in a single country (having zero market share in the other country) strongly
increase the value of the index, and this case arises in our model when there is eective quota enforcement. Our
result, however, relies only on the qualitative impact on the index and not on the fact that the quantitative impact
is large due to the zero market share eect. That is, our result continues to hold if quota enforcement simply reduces
the market share of products but does not drive it down to zero; it is sucient that quota enforcement renders the
market shares of products
unbalanced
across countries (lower market share in the country where quota enforcement
26
Cultural diversity. Under all equilibria we have characterized, the total number of content
N = fl + fs and all content varieties consumed in a given country
n
n
obtain equal market shares. Note that ss · sl > 0 only when content variety n is consumed in
both countries. Denote by CDq the cultural diversity index in the absence of online sharing given
quotas qk ∈ [q̄k , 1] in each country, where qk = q̄k characterizes the case of no enforcement in
q
country k . The number of content varieties consumed in each country is given by nk = fk /qk and
varieties produced is given by
only varieties which are not subject to exclusion are consumed in both, therefore
1
1 nqs − fs 1
1 nql − fl 1
CDq =
[fl (1 − q
) + fs (1 − q
)]
fl + fs
nl
fl nqs
ns fs nql
z 2 ql (1 − qs ) + qs (1 − ql )
=1− s
.
q̄s (fl + fs )2
The cultural diversity index in the presence of online sharing when
ok < ōk ,
(22)
denoted by
CDos ,
is characterized by the fact that all content varieties are consumed in both countries,
1
1
1
[(fl + fs )(1 −
)]
fl + fs
fl + fs fl + fs
1
=1−
.
(fl + fs )2
CDos =
(23)
Online sharing reduces cultural diversity whenever legacy cultural policy mandates
quota enforcement: CDq > CDos if and only if qs > q̄s and ql > q̄l .
Proposition 4.
Under legacy cultural policy, quota enforcement in both countries implies that some content
varieties are consumed in one of them but excluded from the other.
In the presence of online
sharing, however, all content varieties are consumed and obtain equal eective market shares in
both.
Online sharing therefore increases the overlap in consumption across countries, reducing
the cultural diversity index.
In other words, cultural diversity is reduced because the share of
consumers in dierent countries consuming the same content increases.
Two additional points are worth noting. First, the result hinges on quota enforcement in all
countries because we are considering a two-country economy. More generally, the reduction in the
index arises whenever the products consumed in each country in the absence of online sharing are
not a subset of those consumed in the remaining. Thus, in a world economy composed of several
countries, it is sucient that two countries enforce quotas (not necessarily all of them) for online
sharing to reduce the cultural diversity index.
Second, a reduction in the number of available
products also reduces the cultural diversity index. For tractability, we have assumed industry sizes
to be xed throughout our analysis. But if industry sizes are reduced due to online sharing driving
producers out of the market, this would concentrate consumption on a smaller subset of products.
Such an eect would further reduce the cultural diversity index and reinforce the result.
applies, higher market share where it does not)
27
6
Concluding remarks
Our analysis suggests that confronting the online sharing phenomenon calls for governments to
dismantle import barriers in the cultural sector, as well as aggressive pricing schemes by content
producers. Online sharing presents a formidable challenge for cultural policy, and going forward
we expect innovative policies and increased spending to play an important role in confronting it.
Conventional subsidization schemes for the production of domestic content may need to be intensied and channeled to new types of producers and content providers. Novel subsidization schemes
enabled by digital distribution and on-demand access to content could also prove eective, such
as direct subsidization of consumption. This could provide selective price discounts for consumers
and be highly targeted, for example according to content type, viewer characteristics, geographic
region, etc. France, for instance, has started to experiment with initiatives to subsidize the consumption of digital music and videogames to attract the younger segment of consumers towards
commercial distribution and away from online sharing. Public initiatives to sponsor content portals
for domestic production are also under consideration in some countries, and public broadcasters
could serve as a natural platform to develop them.
Factors beyond the scope of our formal analysis will shape the cultural impact of online sharing.
Some consumer segments are more prone to engage in online sharing than others and certain types
of content foster more social than private consumption, or favor commercial venues, or depend
on real-time action.
Technological innovation could enable producers to oer experiences that
may not be replicable over online sharing, such as three-dimensional cinematography. And vice
versa, producers may tap into complementary revenue streams tied to the consumption of content
to monetize the online sharing audience, such as product placement based advertising or live
performances. Our analysis has also focused on content production driven by monetary incentives,
but non-pecuniary motives and user generated content may play an important role in the new
media environment, as they currently do in online sharing. Thus, one can think of online sharing
as an early manifestation of a dierent media environment in terms of content composition and
market characteristics.
Such a media system requires a re-thinking of policy goals, needs, and
tools.
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