THE ECONOMICS OF IDEAS
4.3 INTELLECTUAL PROPERTY RIGHTS AND THE INDUSTRIAL REVOLUTION
87 I NTE LLE CTUAL P R O P E RTY R I G HTS AN D TH E I N D USTR IAL R E V O LUTI O N
ting price equal to marginal cost will result in negative profi ts. This fi g- ure shows the costs of production as a function of the number of units produced. The marginal cost of production is constant—for example, it costs $10 to produce each additional pill. But the average cost is declining. The fi rst unit costs F to produce because of the fi xed cost of the idea, which is also the average cost of the fi rst unit. At higher levels of production, this fi xed cost is spread over more and more units so that the average cost declines with scale.
Now consider what happens if this fi rm sets price equal to marginal cost. With increasing returns to scale, average cost is always greater than marginal cost and therefore marginal cost pricing results in nega- tive profi ts. In other words, no fi rm would enter this market and pay the fi xed cost F to develop the cold vaccine if it could not set the price above the marginal cost of producing additional units. In practice, of course, this is exactly what we see: drugs sell for tens or hundreds of dollars, when the marginal cost of production is presumably only fi ve or ten dollars. Firms will enter only if they can charge a price higher than marginal cost that allows them to recoup the fi xed cost of creating the good in the fi rst place. The production of new goods, or new ideas, requires the possibility of earning profi ts and therefore necessitates a move away from perfect competition.
4.3 INTELLECTUAL PROPERTY RIGHTS AND
idea in the fi rst place. According to some economic historians such as 1993 Nobel laureate Douglass C. North, this reasoning is quite impor- tant in understanding the broad history of economic growth, as we will now explain.
Recall from Figure 1.3 that sustained growth in income per capita is a very recent phenomenon. While the growth rate of world GDP per capita is around 2.2 percent now, between 1500 and 1750 the average was only around 0.8 percent. Furthermore, the best data we have indicate that there was no sustained growth in income per capita from the origins of humanity in one million BCE to 1500. We’ll discuss this evidence, and some explanations for the stagnation, in Chapter 8. For now, we want to concentrate on the fact that sustained economic growth only began within the last 250 years.
This raises one of the fundamental questions of economic history.
How did sustained growth get started in the fi rst place? The thesis of North and a number of other economic historians is that the develop- ment of intellectual property rights, a cumulative process that occurred over centuries, is responsible for modern economic growth. It is not until individuals are encouraged by the credible promise of large returns via the marketplace that sustained innovation occurs. To quote a concise statement of this thesis:
What determines the rate of development of new technology and of pure scientifi c knowledge? In the case of technological change, the social rate of return from developing new techniques had probably always been high;
but we would expect that until the means to raise the private rate of return on developing new techniques was devised, there would be slow progress in producing new techniques . . . [T]hroughout man’s past he has continu- ally developed new techniques, but the pace has been slow and intermit- tent. The primary reason has been that the incentives for developing new techniques have occurred only sporadically. Typically, innovations could be copied at no cost by others and without any reward to the inventor or innovator. The failure to develop systematic property rights in innovation up until fairly modern times was a major source of the slow pace of techno- logical change. (North 1981, p. 164)
A fascinating and illustrative example of this thesis is provided by the history of navigation. Perhaps the foremost obstacle to the development of ocean shipping, international trade, and world exploration was the prob-
89 I NTE LLE CTUAL P R O P E RTY R I G HTS AN D TH E I N D USTR IAL R E V O LUTI O N
lem of determining a ship’s location at sea. Latitude was easily discerned by the angle of the North Star above the horizon. However, determining a ship’s longitude at sea—its location in the east–west dimension—was a tremendously important problem that remained unsolved until recently.
When Columbus landed in the Americas, he thought he had discovered a new route to India because he had no idea of his longitude.
Several astronomical observatories built in western Europe during the seventeenth and eighteenth centuries were sponsored by govern- ments for the express purpose of solving the problem of longitude. The rulers of Spain, Holland, and Britain offered large monetary prizes for the solution. Finally, the problem was solved in the mid-1700s, on the eve of the Industrial Revolution, by a poorly educated but eminently skilled clockmaker in England named John Harrison. Harrison spent his lifetime building and perfecting a mechanical clock, the chronometer, whose accuracy could be maintained despite turbulence and frequent changes in weather over the course of an ocean voyage that might last for months. This chronometer, rather than any astronomical observation, provided the fi rst practical solution to the determination of longitude.
How does a chronometer solve the problem? Imagine taking two wristwatches with you on a cruise from London to New York. Maintain London (Greenwich!) time on one watch, and set the other watch to noon every day when the sun is directly overhead. The difference in times between the two watches reveals one’s longitude relative to the prime meridian.7
The lesson of this story for the economist is less in the details of how a chronometer solved the problem of longitude and more in the details of what fi nancial incentives led to the solution. From this standpoint, the astounding fact is that there was no market mechanism generating the enormous investments required to fi nd a solution. It is not that Harrison or anyone else would become rich from selling the solution to the navies and merchants of western Europe, despite the fact that the benefi ts to the world from the solution were enormous. Instead, the main fi nancial incentive seems to have been the prizes offered by the governments. Although the Statute of Monopolies in 1624 established a patent law in Britain and the institutions to secure property rights
7Sobel (1995) discusses the history of longitude in much more detail.
were well on their way in the late eighteenth century, they were still not suffi ciently developed to provide the fi nancial incentives for pri- vate investment in solving the problem of longitude.8
Sustained and rapid economic growth fi rst made its appearance on the world stage during the eighteenth and nineteenth centuries, after lit- erally millions of years of relative stagnation. Exactly why this change occurred remains one of the great mysteries of economics and history.
It is tempting to conclude that one of the causes was the establishment of long-lasting institutions that allowed entrepreneurs to capture as a private return some of the enormous social returns their innovations create.9