Governments must act to reduce piracy if media companies are to profit from the explosion of online music, according to the Organisation of Economic Co-operation and Development.

In a report billed as "one of the first roadmaps as to how public policy should be re-evaluated" in the wake of rapid changes in online music, the organisation said the industry would be forced to revisit its business models as online sales increase and a "new social and cultural phenomenon" emerged.

The body, which represents 30 market economies, called for fresh legislation, balancing "the interests of suppliers and users, in areas such as the protection of intellectual property rights … without disadvantaging innovative e-business models and new technologies."

Given that the online distribution of content is a relatively new phenomenon, legal frameworks involving issues such as rights protection technologies and secure online payment systems may need to be revisited, it added.

The OECD found that around one-third of internet users in OECD countries had downloaded files from peer-to-peer (P2P) networks, with the number of users on all P2P networks reaching almost 10 million last year.

However, it added that while "in principle, file-sharing software is a innovative and promising technology … many P2P users are making unauthorised copies not only of music, but increasingly also of video and software".

The record industry has claimed that sales have been hit by illegal file sharing as web users swap tunes over the internet. One file-sharing platform, Kazaa, was last year branded the world's biggest "copyright piracy engine" by five major record labels who launched a legal case against Sharman Networks, the company behind the internet file-swapping website.

In the UK, several people have agreed to pay thousands of pounds to settle cases after downloading tunes over the internet.

At a hearing before Australia's Federal Court in Sydney into alleged copyright violations, lawyers for record labels including EMI, Sony BMG and Warner told the court that Kazaa was responsible for three billion music downloads a month and the cornerstone of its popularity was unlicensed sharing of music files.

The OECD admitted that it is difficult to establish a basis to prove a causal relationship between the 20 per cent fall in overall revenues experienced by the music industry between 1999 and 2003, but "digital piracy may be an important impediment to the success of legitimate online content markets".

It added that in the online business model, it is mainly the record labels that generate direct revenues from the sale of online music, at the cost of third party services. "In the current environment, online music providers currently face low or zero margins, calling into question wholesale and retail pricing," it said.

Online music sales account for only between 1 per cent and 2 per cent of total revenues in the music industry, but they are forecast to rise by between 3 and 5 times by 2008. In addition, "there are positive and significant economic ripple effects on the consumer electronics manufacturers, the PC and telecom industries and on new digital intermediaries," the OECD said.

In terms of price, unbundling of music tracks may work to the advantage of the music consumer, the OECD said. However, it added that there may be "cultural costs of unbundling", including less access to "less commercial offerings".

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