Patents: good or bad

This podcast from Words and Numbers discusses the advantages and disadvantages of patents. The patents discussion starts around 12 minutes.

One of the few enumerated powers that the Founders granted to the federal government was the power to issue patents.

Patents are a compromise between two conflicting goals. On the one hand, we want to avoid the creation of government-protected monopolies because monopolies stifle innovation. On the other, we want entrepreneurs to have an incentive to innovate. And one way to incentivize entrepreneurs is to grant monopoly protection for their inventions.

Patent law is an attempt to balance these two conflicting goals, but the balance presents trade offs. Weaker patent laws mean cheaper goods today but a lesser variety of goods tomorrow; stronger patent laws mean more expensive goods today but a greater variety of goods tomorrow.

Patents, prizes and innovation

The use of patents versus prizes to stimulate innovation is a long debated subject. Jean Tirole has written,

"Consider the patent system. It has long been recognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come up with a superior alternative is presumably due to the fact that, first, it is difficult to describe in advance the parameters that determine the social value of an innovation and therefore the prize to be paid to the inventor, and, second, that we do not trust a system in which a judge or arbitrator would determine ex post the social value of the innovation (perhaps because we are worried that the judge might be incompetent or would have low incentives to become informed, or else would collude with the inventor to overstate the value of the innovation or with the government to understate it). A patent system has the definite advantage of not relying on such ex ante or ex post descriptions (although the definition of the breadth of a patent does) " Jean Tirole, "Incomplete Contracts: Where Do We Stand?" Econometrica, Vol. 67, No. 4 (Jul., 1999), pp. 741-781.

Another round in the debate is about to open with a new NBER working paper on the topic of Prestige and Profit: The Royal Society of Arts and Incentives for Innovation, 1750-1850.

"Debates have long centered around the relative merits of prizes and other incentives for technological innovation. Some economists have cited the experience of the prestigious Royal Society of Arts (RSA), which offered honorary and cash awards, as proof of the efficacy of innovation prizes. The Society initially was averse to patents and prohibited the award of prizes for patented inventions. This study examines data on several thousand of these inducement prizes, matched with patent records and biographical information about the applicants. The empirical analysis shows that inventors of items that were valuable in the marketplace typically chose to obtain patents and to bypass the prize system. Owing to such adverse selection, prizes were negatively related to subsequent areas of important technological discovery. The RSA ultimately became disillusioned with the prize system, which they recognized had done little to promote technological progress and industrialization. The Society acknowledged that its efforts had been “futile” because of its hostility to patents, and switched from offering inducement prizes towards lobbying for reforms to strengthen the patent system. The findings suggest some skepticism is warranted about claims regarding the role that elites and nonmarket-oriented institutions played in generating technological innovation and long-term economic development".

So maybe prizes did not stimulate innovation and possibly patents were more effective. But I'm sure this will not be the last thing we hear on this topic.

How copyright improved Italian opera

Petra Moser explains that copyright protection for 19th century Italian operas led to more and better operas being written, but the evidence also suggests that intellectual property rights may do more harm than good if they are too broad or too long-term.

So the takeaway from this video is that intellectual property rights should be narrow and short-lived. Unfortunately when you look around you you see that there is increasing pressure, mainly from the US, for copyrights to be extended and made wider. Its not clear that such expansions are socially beneficial.

The video come from The CORE Project (http://core-econ.org).

Keeping secrets: do we need patents?

Patents are the most well known way for people and firms to protect their intellectual property and gain reward for innovation. But there are well know problems with patents and other ways, such as the use of prizes, to reward innovation are often looked at.

One alternative to patents and prizes not often discussed is just to keep your innovation secret. But is it worth it? Secrets are costly to keep and can be found out.

A forthcoming paper, "Keeping Secrets: The Economics of Access Deterrence" by Emeric Henry and Francisco Ruiz-Aliseda, in the American Economic Journal: Microeconomics looks a this question.

The abstract reads:

Keeping valuable secrets requires costly protection efforts. Breaking them requires costly search efforts. In a dynamic model in which the value of the secret decreases with the number of those holding it, we examine the secret holders' protection decisions and the secret breakers' timing of entry, showing that the original secret holder's payoff can be very high, even when protection appears weak, with implications for innovators' profits from unpatented innovations. We show that the path of entry will be characterized by two waves, the first of protected entry followed by a waiting period, and a second wave of unprotected entry. (Emphasis added)

Payoffs to keeping a secret can be high even in a world where protection looks weak, so sometimes shutting the hell up is the best policy.

Of course this can't be the perfect solution to rewarding innovation since firms can always try to keep their developments secret, but they don't. In many cases they do takeout patents.

The effects of patent trolls

There is a new organisational form, called the non-practicing entity (NPE), in the world of intellectual property. NPEs have recently emerged as a major driver of IP litigation. The idea is that NPEs amass patents not for the sake of producing any actual product, but rather they aim to prosecute infringements of their patent portfolios. (rent-seeking?) The rise of NPEs has sparked a debate regarding their value and their impact on innovation. Proponents argue that imperfections in the legal system implicitly reward large, well-funded organisations, enabling them to infringe at will on small innovators’ IP and that NPEs are there to protect small innovators from such abuse. Opponents cast NPEs as organisations that simply raise the costs of innovation by exploiting the fact that an imperfect legal system will rule in their favour sufficiently often—even if no infringement has actually occurred—that the credible threat of the legal process can yield rents from producing, innovative firms.

So what are the effects of these "patent trolls"? A new NBER working paper, Patent Trolls: Evidence from Targeted Firms by Lauren Cohen, Umit Gurun and Scott Duke Kominers, tries to find out. Cohen, Gurun and Kominers add to the debate on NPEs by providing the first large-sample evidence on precisely which corporations NPEs target in litigation, when NPE litigation occurs, and the impact of NPE litigation on the targeted firms’ innovative activity.

Cohen, Gurun and Kominers argue that there are two reasons that patent trolls can prevent welfare-increasing innovation from being brought to market.

1. innovators with profitably commercialisable inventions but with a high enough probability of being sued to be deterred from production
2. innovators that decide not to commercialise because the ex ante expected profitability of becoming a patent troll is higher than that of commercialisation

In their empirical work Cohen, Gurun and Kominers

[...] link patent-level data on NPEs and their activities to data on all publicly traded firms. Using this linked data, we show that NPEs behave opportunistically; that is, typically acting as patent trolls. Specifically: NPEs target firms that are flush with cash (controlling for all other characteristics) and firms that have had recent, positive cash shocks.

Indeed, a one standard-deviation increase in cash level increases the probability of being sued by an NPE by 11% (t = 6.84). Given that the mean probability is 2%, this is more than a fivefold increase.

In fact, NPEs even target conglomerate firms that earn all of their cash from segments having nothing to do with the allegedly infringing patents. For example, an NPE is likely sue a firm regarding a technology patent even if the firm is earning all its revenue from a lumber division entirely unrelated to the allegedly infringing technology patent—even if the division holding that patent is unprofitable. Indeed, we find that profitability in unrelated businesses is almost as predictive of NPE infringement lawsuits as is profitability in the segment related to the allegedly infringing patent.

Consistent with our model, we also find that NPEs target firms against which they have a higher ex ante likelihood of winning. We demonstrate this fact using multiple measures of ex ante likelihood of lawsuit success. First, we show that NPEs are significantly more likely to target firms that are busy dealing with a number of other litigation events unrelated to intellectual property. Being tied up with outside litigation roughly doubles the probability (t = 2.87) of being sued by an NPE. Moreover, we show that, controlling for all other characteristics, firms with larger legal teams have a significantly lower probability of being targeted by NPEs, consistent with large legal teams serving as a deterrent.

Of course, the true prediction of our model is on the ex ante expected profitability of NPE litigation. To capture this, we interact our measures of expected cash payouts with our measures of expected lawsuit success. We find that, as the model predicts, NPEs systematically target those firms for which the ex ante expected profitability of litigation is large. In particular, the payout probability interaction terms are significant and economically large. Our finding suggests that nearly all the firms targeted by NPEs have large pools of cash for potential payouts and are ex ante more likely to pay off in some form (either an out-of-court settlement or an in-court loss). To further explore this connection, we construct a measure of the ex ante expected outcome if a targeted firm were to go to court. This measure relies on the assumption that defendants often make predictions about the likely outcome based on observations of other firms in the same industry and location. We find that the interaction term of this expected outcome and expected payout is again large and significant, providing further evidence that NPEs choose targets based on expected profitability: suits with high probability of payoff against firms with deep pockets.

Non-practicing entities don’t have a monopoly on IP litigation. Practicing entities (PEs), such as IBM and Intel, also sue each other for patent infringement. If our results are simply picking up general characteristics of IP litigation, then we might expect to see PEs behaving in much the same way as NPEs. In order to compare PE and NPE behavior, we hand-collected the universe of patent infringement cases brought by PEs against other PEs in the same period (2001–2011). However, we find the opposite. If anything, PEs are slightly less likely to sue firms with high cash balances and less likely to sue firms with many ongoing cases. All of the other determinants of NPE targeting have (statistically and economically) no impact on PE litigation behavior. This comparison suggests that our results on NPE litigation behavior are not just reflections of general characteristics of IP litigation. Rather, our findings are consistent with agent-specific motivations for NPEs in targeting firms flush with cash just when favorable legal outcomes are more likely.

Lastly, we examine the real impacts of NPEs’ litigation activity. Comparing firms that are sued by NPEs and go to court (and in this way controlling for selection of firms targeted by NPEs), we find that firms that lose in court have significantly lower post-litigation patenting activity and fewer citations to their marginal post-litigation patents, relative to firms whose cases are dismissed. Furthermore, after losing to NPEs, firms significantly reduce R&D spending—both projects inside the firm and acquiring innovative R&D projects outside the firm. Our evidence suggests that it really is the NPE litigation event that causes this decrease in innovation. Prior to litigation, firms that subsequently lose to NPEs are identical to those that subsequently have suits dismissed. They have the same R&D, patenting, and patent quality. Moreover, patents of firms developed pre-litigation continue to accrue citations at exactly the same rate after litigation, whether or not the suit was dismissed. This is in stark contrast to the divergent amount of citations of firms’ post-litigation patents.

In short, NPEs behave as patent trolls.

Do patents stifle cumulative innovation?

This important question is ask by Joshua Gans at the Digitopoly blog. The question is whatever other benefits and faults there might be with the patent system, a fault that really matters for the operation of the system and for growth prospects is how patents might stifle cumulative or follow-on innovation. Gans writes,

The standard, informal theory of harm here is that follow-on innovators, feeling that they can’t easily deal with the patent holder on the pioneer innovation, decide that the risks are too high to invest and so opt not to do so. To be sure, this ‘hold-up’ concern is not good for anyone, including possibly the patent rights holder who loses the opportunity to earn licensing fees from applications of their knowledge. Suffice it to say, this has been a big feature of the movement against the current strength and, indeed, existence of the patent system.

Now I'm not sure this really is a hold-up problem in the Goldberg sense, it looks more like a barrier (or a delay) to entry problem. Either way if innovation is affected then the cost could be high. A problem, however, with dealing with this issue was that the evidence on the impact of patents on cumulative innovation was weak. Gans continues,

At the NBER Summer Institute a new paper by Bhaven Sampat and Heidi Williams [...] actually found a way to examine the impact of patents on follow-on innovations themselves. Their setting was to look at precisely the area of the Myriad case. They utilised the human genome and the fact that genes that were sequenced could be patented. What’s great about this setting is that the gene itself has a unique identifier that the researchers can use to identify whether it is subject to a patent claim (and indeed a patent application that may be accepted or rejected by the USPTO) and then also identify whether that gene was the subject of publications and clinical trials. This is as good as it gets for the measurement of innovation.

But how do you find a way of comparing what happens if there is a patent on a gene sequence versus if there is no patent? After all, there may be no patent because no one things that gene is important which may also be the reason why there is no follow-on research. That means you have to find some relatively independent reason why a patent may exist or not. Sampat and Williams exploit imperfections at the USPTO that can be themselves identified to obtain that reason.

They use several methods that all give the same answer but let me explain the best one. Patents are examined by examiners that are essentially randomly assigned.

Examiners are also identified and thus it is possible to look at their history and work out if they are tough or lenient. Gans again,

The researchers worked out that this characterisation was unrelated to other things and so could use it to identify patents that might have otherwise been accepted but were given to a tough examiner and the reverse. That is not perfect but is a fairly convincing way to measure and incorporate randomness to assess causality.

Prior to this paper, had you asked the 200 economists in the room at the NBER what they thought the outcome would have been, it is fair to say, all of them (including myself) would have predicted that patents would have a negative impact of at least 10 percent. This probably included the authors. As it turned out, the paper showed that those magnitudes in reduction could be rejected statistically. But more to the point, the paper presents pretty convincing evidence that you cannot reject zero as the likely prediction. That is, the effect patents on follow-on research appears to be non-existent.

So the impact of patents on cumulative innovation may be zero. But is this surprising? If the patent holder and the follow-on innovators both gain from allowing innovation, a Coaseian bargain should be able to be agreed to which allows innovation and makes both parties better off.

The case against patents

This is the title of a new paper by Michele Boldrin and David K. Levine which appears in the latest issue (Vol. 27, Issue 1 Winter 2013) of the Journal of Economic Perspectives. Boldrin and Levine argue.

The case against patents can be summarized briefly: there is no empirical evidence that they serve to increase innovation and productivity, unless productivity is identified with the number of patents awarded—which, as evidence shows, has no correlation with measured productivity. Both theory and evidence suggest that while patents can have a partial equilibrium effect of improving incentives to invent, the general equilibrium effect on innovation can be negative. A properly designed patent system might serve to increase innovation at a certain time and place. Unfortunately, the political economy of government-operated patent systems indicates that such systems are susceptible to pressures that cause the ill effects of patents to grow over time. Our preferred policy solution is to abolish patents entirely and to find other legislative instruments, less open to lobbying and rent seeking, to foster innovation when there is clear evidence that laissez-faire undersupplies it. However, if that policy change seems too large to swallow, we discuss in the conclusion a set of partial reforms that could be implemented.

I am however reminded of a comment by Jean Tirole,

Consider the patent system. It has long been recognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come up with a superior alternative is presumably due to the fact that, first, it is difficult to describe in advance the parameters that determine the social value of an innovation and therefore the prize to be paid to the inventor, and, second, that we do not trust a system in which a judge or arbitrator would determine ex post the social value of the innovation (perhaps because we are worried that the judge might be incompetent or would have low incentives to become informed, or else would collude with the inventor to overstate the value of the innovation or with the government to understate it). A patent system has the definite advantage of not relying on such ex ante or ex post descriptions (although the definition of the breadth of a patent does). (Jean Tirole, "Incomplete Contracts: Where Do We Stand?" Econometrica, Vol. 67, No. 4 (Jul., 1999), pp. 741-781.)

So the real question is can you replace the current system with something that works better? Given how long the patent system has been around that maybe more difficult than its sounds.

Why have copyright and patents?

My previous post on the protection of intellectual property does raise an interesting question, Why have things like copyright and patents at all? An answer may be found in terms of incomplete contracts. Jean Tirole writes,

Consider the patent system. It has long been recognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come up with a superior alternative is presumably due to the fact that, first, it is difficult to describe in advance the parameters that determine the social value of an innovation and therefore the prize to be paid to the inventor, and, second, that we do not trust a system in which a judge or arbitrator would determine ex post the social value of the innovation (perhaps because we are worried that the judge might be incompetent or would have low incentives to become informed, or else would collude with the inventor to overstate the value of the innovation or with the government to understate it). A patent system has the definite advantage of not relying on such ex ante or ex post descriptions (although the definition of the breadth of a patent does). (Jean Tirole, "Incomplete Contracts: Where Do We Stand?" Econometrica, Vol. 67, No. 4 (Jul., 1999), pp. 741-781.)

One must have a prize. (updated)

Tim Harford has an interesting column at FT.com on the use of prizes rather than, say, patents to stimulate innovation. Harford points out that in the past governments used prizes as the standard way of rewarding innovators. The most famous example being John Harrison's answer to the problem of finding a way for a ship's navigator to determine a ship's longitude and therefore its position at sea. But as Harford notes such prizes fell out of fashion. Patents became the standard way to encourage and protect commercial innovators while basic research is funded more by grants than prizes.

Until now. A number of groups are beginning to use prises again to motivate innovators to find answers to the groups problems. Harford gives the examples of

The most famous innovation prize of this century, the $10m Ansari X Prize, was designed to promote private space flight. The pot went to Mojave Aerospace Ventures in 2004, after the successful flights of SpaceShipOne. And even the Ansari X Prize is dwarfed by a quasi-prize of up to $1.5bn that is about to be offered by five national governments and the Gates Foundation to the developers and suppliers of a more effective vaccine against pneumococcal diseases such as pneumonia, meningitis and bronchitis. The prize, called an "advanced market commitment" or "advanced purchase commitment", takes the form of an agreement to subsidise heavily the first big orders of a successful vaccine. Given that the top companies in the UK’s powerful pharmaceutical industry spent little more than £5bn in 2006 on research and development, a $1.5bn prize should be taken seriously on hard-nosed commercial grounds alone.

Prizes have some nice features, one of which is that they overcome the biggest problem with patents; namely the monopoly that patents provide. This downside is fundamental to the very design of a patent,

... in order to reward an innovator, the patent confers a monopoly. Economists view this as, at best, a necessary evil since monopolies distort prices. In the hope of raising profits from some customers, they will price others out of a market. The most obvious victims are consumers in poor countries.

But as Jean Tirole has explained, in a world of incomplete contracts (ie the real world) the patent system may make sense,

It has long been recognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come up with a superior alternative is presumably due to the fact that, first, it is difficult to describe in advance the parameters that determine the social value of an innovation and therefore the prize to be paid to the inventor, and, second, that we do not trust a system in which a judge or arbitrator would determine ex post the social value of the innovation (perhaps because we are worried that the judge might be incompetent or would have low incentives to become informed, or else would collude with the inventor to overstate the value of the innovation or with the government to understate it). A patent system has the definite advantage of not relying on such ex ante or ex post descriptions (although the definition of the breadth of a patent does).

But as Harford explains it isn't all or nothing, patent or prize, but rather the

[c]hampions of prizes see them as a component of a wider system to promote innovation, rather than as an outright replacement either for grants or patents. Instead, the hope is that prizes will help to compensate for the specific weaknesses of those alternatives.

Another way to reward innovation would be to grant a patent and then have the government buy it and place in the public domain. Each patent could be put up for auction and at the end of the auction ownership of the patent could be randomly determined. If the (private) winner of the auction is chosen then he pays his bid and gets the patent and if the government is chosen it pays the amount of private winner's bid and is assigned the patent.

Anyway the Harford article is worth reading.

Update: The Victory Project proposes billion-dollar prizes for

To the first person(s) that solves any of these Problems:

1. Develop a cure for breast cancer.
2. Develop a cure for diabetes.
3. Reduce greenhouse emissions from petroleum powered automobiles by 95% without increasing the cost of a normal car more than 5%.
4. Achieve 150 miles per gallon of gasoline in a 3,000 lb. car, using EPA standards; without increasing the cost of a normal car more than 10%.

(HT: Arnold Kling, EconLog)