Open vs closed source software: The quest for balance

Sebastian Engelhardt, Andreas Freytag, Stephen Maurer

29 October 2010

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Open source software (OSS) like the operating system Linux is marked by free access to shared source code that is developed in a public, collaborative manner. While most of this activity was originally non-commercial, over the past decade companies have been asking themselves whether similar OSS methods can be made to earn a profit. This has led to an explosion of OSS-based business models and investments throughout the information and communications technologies sector (Ghosh et al. 2002, Dahlander and Magnusson 2005, Lerner et al. 2006).

Governments are similarly intrigued and have begun experimenting with various pro-OSS measures including procurement preferences, tax breaks, and grants (Lerner and Tirole 2005, CSIS 2008). At first, the implicit policy assumption seemed to be that OSS was inherently more efficient than proprietary, or “closed source”, software (CSS)1. This argued for almost any policy that promised to increase the amount of OSS. More recently, however, some politicians have begun to argue that society needs a “balance” of CSS and OSS firms (CSIS 2008). But how can policymakers recognise the right “balance”? Pro-OSS interventions make very little sense if there are too many OSS firms already.

The threshold question

The threshold question, of course, is whether governments can influence OSS at all. Ten years ago, most scholars were pessimistic. This was sensible in an era when OSS was driven by non-commercial incentives like altruism, reputation, and signalling. How do you influence a “movement” dominated by college students? (Schmidt and Schnitzer 2003).

Since then, however, things have changed dramatically. Deshpande and Riehle (2008) report that the OSS sector grew from about 500 projects in 2001 to 4,500 in 2007. Furthermore, this growth was dominated by business models in which companies contribute to a shared code base in hopes of increasing consumer demand for some related product (e.g. hardware, software) or service. This for-profit outlook is clearly responsive to government’s traditional tax-and-spend policy levers.

Western governments, then, should have little difficulty influencing OSS development. Governments in the developing world will, as usual, face bigger challenges. von Engelhardt and Freytag (2010) study differences in OSS activities across 70 countries. They find that the main predictors of OSS activity are generalised cultural factors like interpersonal trust, favourable attitudes toward scientific progress, and a culture of self-determination/individualism. No government can supply these preconditions overnight. More encouragingly, there is some evidence that strong intellectual property rights and/or deregulated markets promote OSS. Developing world governments will presumably find such interventions easier to manage.

Getting the right mix

But having power is only half the analysis. How, if at all, should governments use it? One important theoretical insight starts from the observation that OSS and CSS are both imperfect tools, each of which has distinct areas of advantage and disadvantage (von Engelhardt 2008). This implies that large modern economies will usually require a mix of both methods.

Furthermore, von Engelhardt and Maurer (2010) provide an important clue to choosing this mix. They point out that the existence of CSS code increases OSS output and vice versa. To see why, consider an all-OSS world in which each company offers consumers exactly the same shared code as every other company. By definition no company can then compete by writing more OSS code than its rivals. This lack of competition suppresses code production for the same reason that cartels suppress output. Conversely, a wide range of generic models predict that software production should peak when roughly 15% to 20% of all companies adopt OSS methods.

Without specific evidence to the contrary, this suggests that competition policy should not normally challenge OSS collaborations whose members comprise less than about 20% of the market. (Larger collaborations may also be acceptable and would have to be examined on a case-by-case basis). In the US, authorities have long applied a similar "Five Effort" rule to joint R&D ventures. This, then, is the “balance” that politicians speak of.

That would be the end of the story if we could rely on markets to deliver the right mix of OSS and CSS firms. However, there are at least two reasons to doubt this.

  • First, there are many cases in which would-be OSS companies cannot profitably enter all-CSS industries and vice versa. For this reason, we expect a significant number of pure-state industries to become “locked in” indefinitely.
  • Second, consider markets where OSS and CSS business models co-exist. We have already pointed out that OSS operates as a de facto cartel. This will normally make OSS firms more profitable than an equivalent number of CSS firms. As a result, we expect most markets to host far more OSS firms than policymakers would like.

How should governments intervene?

One obvious solution is to promote OSS (or CSS) development in markets that appear to be “locked in,” i.e. have remained CSS (or OSS) for a long time. These interventions will have to be made on a case-by-case basis. Much more general policies will be needed to adjust the number of OSS firms in mixed markets. Detailed analysis suggests that the best solution would be to tax OSS firms and use the funds to provide tax breaks for CSS firms. Of course, we recognise that OSS’s altruistic image may make such policies politically unrealistic. This, however, could easily change as the public learns to associate OSS with companies like IBM, Sony Ericsson, and LG. In the meantime, our analysis suggests that current proposals advocating pro-OSS procurement preferences are poorly motivated and should be viewed with suspicion.

In theory, government can also intervene by purchasing more OSS output than the private sector is willing to fund. Theory suggests that this may often improve welfare. That said, direct funding of OSS production would yield a host of familiar problems.

  • First, policymakers seldom, if ever, know which projects are likely to deliver the most social benefit per euro invested.

Historically, this has notoriously persuaded governments to invest in projects with little or no value.

  • Second, government investment inevitably breeds lobbying expenditures that offer little or no value to society.

On the other hand, the argument that government investment has been mishandled in the past is not definitive. The economics literature is filled with clever “mechanism design” papers that explain how government investment can be made to track private sector judgements about which projects do (and do not) offer value. Probably the most straightforward scheme would be for government to withhold funds unless and until companies made matching investments (Maurer and Scotchmer 2004).

Concluding remarks

Twenty years on, the OSS revolution is stronger than ever. In the meantime, scholars have learned a great deal about this new production method. Governments need to be aware of these insights.

References

Benkler, Y (2002), “Coase’s penguin, or, Linux and the nature of the firm”, Yale Law Journal, 112(3):369-437.

CSIS (2008), “Government open source policies”, Centre for Strategic and International Studies.

Dahlander, L and MG Magnusson (2005), “Relationships between open source software companies and communities: Observations from nordic firms”, Research Policy 34(4):481-493.

Deshpande, A and D Riehle (2008), “The total growth of open source”, in B Russo, E Damiani, S Hissam, B Lundell, and G Succi (eds.), Open Source Development, Communities and Quality, Vol. 275 of IFIP International Federation for Information Processing, Springer, 197-209.

von Engelhardt, S and A Freytag (2010), “Institutions, culture, and open source”, Jena Economic Research Papers 2010-010, Friedrich-Schiller-University Jena and Max-Planck-Institute of Economics.

von Engelhardt, S, SM Maurer (2010), “The new (commercial) open source: Does it really improve social welfare?”, Berkeley Goldman School of Public Policy Working Paper 10-001.

von Engelhardt, S (2008), “Intellectual property rights and ex-post transaction costs: the case of open and closed source software”, Jena Economic Research Papers 2008-047, Friedrich-Schiller-University Jena and Max-Planck-Institute of Economics.

Ghosh, RA, R Glott, B Krieger, and G Robles (2002), “FLOSS final report, part 3: Basics of open source software markets and business models”, International Institute of Infonomics, University of Maastricht.

Lerner, J and J Tirole (2005), “The economics of technology sharing: Open source and beyond”, Journal of Economic Perspectives, 19(2):99-120.

Lerner, J, PA Pathak, and J Tirole (2006), “The dynamics of open-source contributors”, American Economic Review, 96(2):114-118.

Lessig, L (1999), Code and Other Laws Of Cyberspace, Basic Books.

Lessig, L. (2006), Code: Version 2.0, Basic Books.

Maurer S and S Scotchmer (2004), “Procuring Knowledge”, in G Libecap (ed.), Advances in the Study of Entrepreneurship, Innovation and Growth: Vol. 15, JAI Press.

Schmidt, KM and M Schnitzer (2003), “Public subsidies for open source? Some economic policy issues of the software market”, Harvard Journal of Law & Technology, 16(2):473-505.


1 Such a view is to some extend based on arguments by e.g. Benkler (2002) and Lessig (1999, 2006)

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Topics:  Competition policy Productivity and Innovation

Tags:  intellectual property rights, technology, Competition policy, Open source software

PhD Student and Research Assistant, DFG Graduate School

Andreas Freytag

Professor of Economics, Friedrich-Schiller-University Jena; Honorary Professor; University of Stellenbosch

Stephen M Maurer

Adjunct Associate Professor of Public Policy and Director, Information Technology and Homeland Security Project, University of California, Berkeley

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