Copyright and Wireless Carterfone…

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Recently, a renewed interest in long-term contracts and the practice of locking handsets to networks has emerged from an unlikely source:  Copyright law.

Making a very long and complicated story short, under Section 1201(a)(1)(A) of the Digital Millennium Copyright Act (DMCA), it is unlawful to circumvent certain technological measures employed by or on behalf of copyright owners to protect their works.   That said, copyright law always embeds some balance between owner and user, and Section 1201(a)(1)(B) limits the prohibition for subsection (A) by exempting those persons who are “adversely affected by virtue of such prohibition in their ability to make noninfringing uses of that particular class of works….”  These exemptions from subsection (A) are determined every three years in a rulemaking under Section 1201(a)(1)(C) by the Register of Copyrights after the opportunity for public notice and comment and consultation with NTIA.  If the Library of Congress does not grant an exception, however, then an infringing party can be subject to both civil and criminal penalties under the DMCA.

As it turns out, the firmware and software that runs mobile phones qualifies as protected works under the DMCA and, as such, if a consumer unlocks the device during their contract term without their carrier’s consent, then that consumer has violated the DMCA.  However, in 2006, and again in 2010, the Register recommended, and the Librarian designated, that a consumer’s unilateral unlocking of a cellphone was exempt under the DMCA.  In its latest decision, however, the Librarian changed its mind, concluding that a customer’s unlocking of a handset without the consent of the carrier is unlawful in that it violates provisions of the DMCA.  The Librarian found that:

with respect to new wireless handsets, there are ample alternatives to circumvention.  That is, the marketplace has evolved such that there is now a wide array of unlocked phone options available to consumers. While it is true that not every wireless device is available unlocked, and wireless carriers’ unlocking polices are not free from all restrictions, the record clearly demonstrates that there is a wide range of alternatives from which consumers may choose in order to obtain an unlocked wireless phone.  (77 Fed Reg. 65265) (Emphasis in original.)

Significantly, this ruling only applies to “new” phones under contract.  Consumers remain free to unlock “legacy” handsets, including any phone not under a contract, with impunity.  (The Librarian also found it perfectly lawful to “jailbreak” phones, but that is the subject of another blog.)

At a time when legitimizing the theft of intellectual property is increasingly all the rage, I wasn’t at all surprised by the immediate “media” frenzy caused by the Librarian’s ruling.   In my opinion, the initial assault on the Librarian’s decision contained profoundly weak arguments.  Consider, for example, the op-ed by Molly Wood of CNET, who criticized the decision by lamenting the fact that

… all that a restriction on unlocking your phone really accomplishes is allowing carriers to increasingly restrict your ability to leave them… (Emphasis in original.)

Whether she understands this or not, Ms. Wood is entirely correct: curtailing exit is precisely the point of a restriction on unlocking a cellphone.  Today, and historically, most wireless customers acquire their equipment at heavily-discounted prices in return for signing a long-term contract (typically 2 years).  While consumers may choose to pay the full price for a wireless device and enter into pay-as-you go arrangements with wireless providers, very few customers do.  A state-of-the-art unlocked phone can be quite expensive—for example, a new entry-level unlocked iPhone 5 will run you about $649.  By signing a two-year contract with AT&T, however, that same phone runs you only $199, a $450 discount off the retail price for an unlocked phone.  Not a bad deal, even considering the early termination fee of $325, which declines by $10 per month of the contract and need not ever be paid by adhering to the term.  Of course, the ability to offer consumers heavily-discounted equipment requires the customer to stick around long enough to make the arrangement sensible for the carrier.  As an incentive to adhere to the agreement made between the carrier and the customer, wireless providers typically impose early termination fees and/or “lock” the device to their networks for the duration of the contract.

Accordingly, when a consumer gets a $649 phone for $199, is it that unreasonable to expect a little commitment from the consumer in return?  Most rational adults would think not, particularly when customers freely enter into that contractual arrangement.  When the contract is up, the customer is free to unlock the phone.  If a consumer doesn’t like the idea of a locked phone, then that consumer can spend $649 up-front and get an unlocked phone.  But, if the carrier hands you a $649 phone for $199, there’s obviously and reasonably a catch.  In our paper A Policy and Economic Exploration of Wireless Carterfone Regulation, we provide a formal economic evaluation of contracts, device locking, and other conditions that adhere the customer to a particular carrier.  We found that  such deals are fully compatible with competitive outcomes and that a ban on such arrangements is more likely to reduce competition than it is to increase it and will certainly increase prices for handsets without, perhaps, any offsetting price decrease for wireless network services.  Eliminating contracts and handset locking, therefore, is a bad deal for consumers.

Ms. Wood also contends that the wireless carriers engage in “wildly anticonsumer behavior.”  For me, I find the fact that there are more cellphone accounts than people in the U.S. difficult to square with the contention that those selling such accounts are engaging in “wildly anticonsumer behavior.”  And regarding Ms. Wood’s concerns about “skyrocketing early termination fees,” she might take a few minutes to compare the complexity and costs of the modern handset to those of lore.  Early termination fees for more basic mobile handsets has remained unchanged at about $150, and such fees correlate highly and sensibly with the size of the “subsidy.”

Similarly, former RSC staffer turned liberal hero Derek Khanna recently wrote in The Atlantic that the DMCA is the “most ridiculous law of 2013” because it “serve[s] to protect the interests of a few companies and create and maintain barriers to entry.”  Let’s review this logic.  Copyright law aims to “promote the progress of science and the useful arts,” and does so by protecting the creators’ right to compensation from those that use their intellectual property.  Put simply, “Intellectual property rights protect the interests of creators by giving them property rights over their creations.” Many “creators” are companies, and often companies represent creators.  So, yes, Copyright law aims to pretect the interest of companies, but these companies are simply the veil behind which lies the creators.  Equally as important, the manner in which Copyright law protects rights is to erect barriers to the use by some of other peoples’ property without permission and, in many cases, compensation.  That is, “the author has certain specific rights in his creation which only he can exercise.”  So yes, Copyright law has the effect creating and maintain barriers to entry, and rightfully so, in cases where the “entrant” is using the property of others without permission.  Accordingly, if one wants to claim the DMCA is “ridiculous,” then they will need to find reasons other than those outlined by Mr. Khanna (though, in fairness, perhaps Mr. Khanna is opposed to the notion of intellectual property in a more general sense).

I am similarly puzzled by Mr. Khanna’s claim that he is “pro-choice with regard to [his] smartphone],” since he is, after all, a self-proclaimed “conservative.”  In effect, Mr. Khanna is arguing that it is legitimate for the government to abrogate contracts between willing buyers and sellers.  Last time I checked, the regulation of private arrangements is generally not on the conservative agenda.

Mr. Khanna is also critical of the Librarian’s decision because “unelected bureaucrats” should not decide “upon what is or isn’t a felony punishable by large fines and jail time for our citizens.”  Instead, Mr. Khanna argues,

Laws that can place people in jail should be passed by Congress, not by the decree of the Librarian of Congress.  We have no way to hold the Librarian of Congress accountable for wildly unfair laws.  There are still plenty of crazy laws passed by elected officials, but at least we can then vote them out of office.

Had Mr. Khanna bothered to read the DMCA or the Librarian’s decision before finishing his article, he would have understood that in the case of the DMCA (as well as every other Federal law for that matter), it was Congress—not “unelected bureaucrats”—that passed the law setting penalties (see Section 1203 (civil) and Section 1203 (criminal)) and, under the explicit direction of such law, the Librarian determined exemptions via a proscribed and detailed process.  The smallest amount of research on this topic before contributing to The Atlantic would have spared this error.

In these difficult economic times, it is easy to see the attraction of “free” stuff:  After all, people like free stuff.  They want free music.  They want free movies.  The want free journal articles.  They want free broadband.  They want a $649 iPhone for $199 without consideration.  Unfortunately, in each case, “free” comes at the expense of someone else’s property right.  As we demonstrated in our paper Social Well-Being and IP Theft: A Dynamic Economic Analysis (and subsequently published as 2 Theoretical Economic Letters  470 (2012)), the theft of intellectual property is not costless.  Without the protection of property rights, our economy is sunk.

Whether we like it or not, all things are scarce; nothing is free.