تجزیه و تحلیل تعادل عمومی توسعه نرم افزار: مفاهیم حفاظت از کپی رایت و اجرای قرارداد

We develop a general equilibrium model to study the implications of a legal environment on the organization of software production. We show that contract enforcement determines the organizational mode (i.e., in-house versus outsourcing) of customized software development while copyright protection affects both packaged software as well as customized software development. We obtain some testable results: when copyright protection is weak, only customized software will be developed; when copyright protection is strong, both customized software and packaged software will be developed; environment changes in one software market affect the equilibrium in the other software market.

We are now living in the new economy in which information technology is playing a more and more important role. For example, in the United States, computer software is vital to both the domestic economy and external trade. In 1998, the software industry became the second largest industry group in manufacturing.1 In 1997, packaged software (PS) alone contributed a surplus of $13 billion to the U.S. trade balance, without which the U.S. trade deficit (excluding U.S. military and government transactions) would have been 36% higher (BSA, 1999b, p. 16). However, software development is very uneven across countries. In 1994, the U.S. controlled about 75% of the global software market. Europe had 20% of the market, and Japan had 4.3% (Fortune, 1994). Unlike most products and services, though, software is protected by copyright laws against piracy. Software piracy is a serious problem all over the world, but it varies tremendously from country to country. According to a report by the Business Software Alliance (BSA, 1999a), in 1998, 38% of the business software applications in the world were pirated, and, by countries, the software piracy rate ranged from 25% (in the U.S.) to 97% (in Vietnam). It is not a coincidence that the U.S. has the lowest software piracy rate and at the same time has the largest market share of software in the world. The BSA concludes that “[p]rotecting the intellectual property rights that are the basis of packaged software distribution is conducive to greater international trade and increased industry investment in the economies that provide such protections” (BSA, 1998, p. 24). In this paper, we develop a model to analyze software development formally with a focus on the influence of the legal environment, namely contract enforcement and copyright protection policies. Software products are commonly classified into two groups: PS which is designed for general purposes, like word processing, and customized software (CS, in short), which is designed for special use, like an accounting program for a particular company. 2 We show that the degree of contract enforcement affects the organizational mode of the CS development, i.e., whether the software is developed in-house (vertical integration) or obtained by outsourcing (contracting). We define a type-B contract (B stands for breach) as a contract that will be breached by one contracting party, and a type-H contract (H stands for honor) as a contract that will be always honored by all contracting parties. We show that as contract enforcement becomes stronger, the optimal mode of organization switches from vertical integration to type-B contract, then to vertical integration, and finally to type-H contract. For PS, since piracy reduces legitimate consumption, copyright protection is essential to ensure investment in software development. As a result, when copyright protection is weak, only CS will be developed. When copyright protection is strong, both CS and PS will be developed. Moreover, we demonstrate the cross-product effects: environment changes in one software market affect the equilibrium in the other software market. This paper makes a contribution to the literature by developing an economic model that is suitable for a general equilibrium analysis of software industry. The model developed in this paper has several distinguishing features that are crucial for analyzing software development. The industry is assumed to produce two distinct products, and we examine the implications of contract enforcement and copyright protection for these products. The production of CS and production of PS are linked via the labor (software programmers) market in a general equilibrium model. We endogenize the types of software produced as well as the organization model of production. In this way, the present study is related to but significantly different from others in the literature that we discuss below. First, consider CS. There are three alternative modes through which a piece of software is developed and later delivered to the user: vertical integration, a contract and the market. To emphasize the difference between CS and PS, we assume that any CS is so specific that it has only one user. This immediately eliminates the market as a plausible development and delivery mode. Therefore, our analysis focuses on a comparison between vertical integration and contracts. Unlike us, in analyzing upstream and downstream relationships, McLaren (2000) and Grossman and Helpman (2002) take the incomplete contract approach and assume away contracts in their models. Naturally, they do not touch on the issue of imperfect enforcement. Their focus is a comparison of vertical integration with the market.3 In the present model, contracts are complete but enforcement is imperfect, similar to the approach taken by Anderson and Young (2003). Unlike us, however, they consider contracts on trade of ordinary goods between two parties from different countries and examine the implications of imperfect enforcement for international trade. We examine whether contracts are preferred to vertical integration as an organizational mode for CS development between two parties within the same country. Second, the development of PS is similar to product innovation in that the sunk R&D costs are high, the marginal costs of production are low, and the rents legally accruing to the software developers or product innovators are easily appropriated without sufficient copyright protection. However, software development still differs considerably from innovation in many ways. For example, in product innovation, imitators are also producers who compete against the innovator in the market. In contrast, software is copied by consumers. As a result, the pricing strategy and equilibrium profit of the product innovator could be very different from those of the software developer. In a recent study, Chen and Png (2003) examine how a software publisher should optimally choose its price and degree of copyright enforcement. Our analysis of PS differs from theirs in many aspects. For example, in addition to pricing, we also consider the PS developer's entry decision in the presence of imperfect copyright protection. Third, to our knowledge, this paper provides the first general equilibrium analysis of the software industry. Software programmers are employed in both product markets and therefore environment changes in one product market can affect the equilibrium in the other product market. A general equilibrium analysis allows us to examine cross-product effects. Such an approach is important for policy analysis. For example, stronger copyright protection in the PS market may result in the firms in the CS market to switch to vertical integration from type-H contracts due to the resulting higher costs of programmers. This calls for raising the level of contract enforcement in the CS market. Similarly, as demand for CS increases, the PS market may be closed down, again due to the resulting higher costs of programmers. Strengthening copyright protection would help reduce this negative externality. Finally, the results obtained from this paper are testable and the model's prediction is consistent with many empirical observations. The U.S. is the dominant developer of PS in the world. In 1993, the U.S. producers of PS controlled about 60% of the world market (Siwek and Furchtgott-Roth, 1993, p. 60). It is also clear that the U.S. is far ahead of the EU and Japan in promoting legal protection in software innovation.4 The U.S. extended copyright protection to software in 1980 (the Software Amendment is based on the U.S. Copyright Act enacted in 1976), but it was not until 1991 that the European Commission first issued a directive concerning the application of copyright to software. All other countries, including those in the EU, more or less concentrate on developing CS. For example, CS sales accounted for 84% of total Japanese software sales according to a 1990 survey by the MITI (Ministry of International Trade and Industry).5 In-house development of CS is popular. According to another survey by MITI in 1988, 58% of software engineers in Japan worked for user companies (i.e., in-house development), and 35% worked for software houses. Among the software companies in Japan, user spin-off software houses accounted for 31.3% of market sales (representing semi-in-house development).6 Most software firms in China, India and Latin America are reported to produce primarily CS (see Zhang and Wang, 1995, for China; Correa, 1996, p. 172, for India). As described by Zhang and Wang (1995, p. 66), in China, “[m]ost of the local software companies were generally limited to developing software for individual customers according to their specifications, on a customer-by-customer basis. Consequently, these software companies had hardly any market-oriented product of their own and acted only as subcontractors.”7 Although India has a large pool of highly skilled computer programmers, the country does not develop a significant amount of PS (see Arora and Asundi, 1999 and Arora et al., 1999). This facts are consistent with the prediction of our analysis. The rest of the paper is organized as follows. The model is set up in Section 2. In Section 3, we analyze the general equilibrium under various conditions of legal protection. Concluding remarks are presented in Section 4.

We have developed a model to analyze software development. We emphasize the effects of contract enforcement on the organizational mode of CS development and the effects of copyright protection on the pattern of both PS and CS production. We also stress the importance of a general equilibrium analysis in examining cross-product effects. Software has several distinguishing features compared with common commodities like automobiles and therefore deserves special attention. In this paper, we have emphasized the product specificity of CS, which results in holdups, and the low (or zero) marginal cost of reproducing PS, which leads to piracy. Because of these features and the resulting problems, legal environments are very crucial in shaping this industry's development. As an extension to check the robustness of the results obtained in this paper and to derive new results, we could introduce some other features of software into the present model. One example is the network externality in the PS. When using the software, a user's utility, v(i)v(i), depends on the number of people who are also using it (legally or illegally). This externality will affect the PS developer's pricing strategy in an interesting way. Inevitably, the investment and entry decision will also be affected. However, it is conceivable that the results obtained in this paper about the PS are unlikely to be altered qualitatively. Another direction of extensions is to explore more closely the copyright spillover effect from PS to CS. In the present model, the cross-product effect is realized through changes in the wage rate. We could also consider the case when productivity in CS development may be enhanced by the existence and the quality of PS. The model can be easily extended to analyze international trade of software. Qiu (2004) has examined how copyright protection becomes a country's comparative advantage in producing and exporting PS.