NOTES
2. The economic theory of IPRs (patents and trademarks)
2.2 THE ECONOMICS OF PATENTS
2.2.4 The Patent System
A patent system establishes property rights in inventions for a given period of time. On the one hand, it serves as an incentive for future inventive activities mainly due to the fact that a patentee has the legal right to prevent others from using his inventions without his permission. On the other hand, such a system could lead to the non-efficient allocation of new and valuable knowledge as it creates a temporary monopoly on the use of inventions. Therefore the structural conflict built into the patent system is such that, in order to increase the number of inventions, and thus knowledge, in the future, it restricts the use of existing inventions in the present. Robinson refers to this problem as the ʻparadox of patentsʼ arguing that the ʻjustification for a patent system is that by slowing down the diffusion of technical progress it insures that there will be more progress to diffuseʼ.35
The following discussion reviews some of the theoretical implications of patents on inventive efforts and on inventions, once they are developed. It seeks to emphasize the complexities and contradictions regarding patents and to argue that currently it is very difficult, if not impossible, to come up with theoretical conclusions about the social desirability of such a system. This section, therefore, considers and elaborates on some specific aspects concerning patents. First, it assesses the effects of patents on the allocation of resources to inventive activities, the allocation of resources within the sphere of inventive activities, and on the allocation of inventions as a factor of production.36 Secondly, it examines the issue of the patent term of protection. Finally, it reviews some problematical aspects regarding the system itself, such as the difficulties of
setting criteria for patentability, and the extent to which patent concentration increases the misallocation of resources in the inventive sphere.
The allocation of resources to inventive activities
The extent to which patents optimize the allocation of resources to inventive activities is not currently clear.
Some antagonists may express the view that patents are both irrelevant and inadequate regarding their ability to serve as an incentive for future inventive activities. They may argue that inventors, like artists, experience the ʻstarving artistʼ phenomenon and as such have the intellectual and emotional need to invent regardless of any potential rewards.37
Other opponents may hold the view that since social progress is much more important for the creation of inventions than the individual inventor, any system of pecuniary rewards for inventors, such as patents, is completely inadequate.
Indeed this argument has its roots in the big patent debate of the second half of the 19th century. J. L. Ricardo, an advocate of the social progress perspective, argued that since ʻnearly all useful inventions depend less on any individual than on the progress of societyʼ there is no need for it to ʻreward him who might be lucky enough to be the first on the thing (invention) requiredʼ.38 Thus, according to its opponents, a patent system is irrelevant and unnecessary mainly because the incentive to invent lies either within the inventor or within society, not in the system.39
The main problem with the ʻstarving inventorʼ and ʻsocial progressʼ arguments is that they rely on the rather outdated assumption that the bulk of inventions are developed by, or attributed to, individuals. The fact is that any attempt to understand the effect of patents on modern inventive projects must take the profit-seeking firm as its basic unit of observation. Most R&D projects, originating in the private sector and aimed at producing new inventions, are too complex, costly and time consuming to be initiated by calculations other than profits.40
Therefore, it is quite likely that patents, by allowing firms to secure commercial returns for their inventions, are important for future inventive activities. In fact, some empirical data is available to support this view. A study by Mansfield shows that several industries attached great importance to the existence of patents when deciding on developing new inventions during the early 1980s.41 He found that in the pharmaceutical industry, between 60 to 65 per cent of inventions would not have been introduced or developed in the absence of patents.42 Levin reports similar results.43
On the other hand, if patents are likely to enhance the rate of inventive activities it is important to consider whether they do so in an efficient manner.
Plant suggests that patent monopolies may lead to a state of over-investment in inventive activities.44 He argues that any benefits generated by the allocation of
additional resources towards inventive output as a result of patent protection, do not necessarily outweigh the costs of not allocating the same resources towards the production of other output.45 In other words, since scarcity implies that when more resources are diverted to inventive activities, fewer resources are allocated to other economic activities, particularly when patents are introduced. One cannot conclude that society would always benefit from higher levels of R&D expenditures.46 Indeed, Dasgupta and Stiglitz, focusing on the optimal level of R&D activities, suggest that ʻthere may be excessive duplication of research effort in a market economy in the sense that industry-wide R&D expenditure exceeds the socially optimal level even though cost reduction is lowerʼ.47
The increase in the level of inventive activities as a result of patent protection, may also lead to the problem of diminishing returns in inventive output.48 Diminishing returns are particularly relevant in cases where additional inventive efforts result in similar or even identical inventions.49 In this respect, patent advocates may argue that since inventions have the potential to shift the entire technological curve of a given industry they are too dynamic to be analysed by standard economic tools, such as diminishing returns. But the fact that some inventions in the future may revolutionize an entire technological sector does not mean that one should ignore the cost of allocating additional resources for inventive efforts in the present.50
Finally, the extent to which patents optimize the timing of inventive activities, in terms of the introduction of inventions, has also been questioned. Barzel concludes that the attempt to secure patent protection may drive firms to introduce inventions sooner than is optimally desirable.51
Although it is likely that patents increase the level of inventive activities, it is not clear whether they do so efficiently. Some scholars have suggested that patents create a tendency for over-inventing in the sense that the resources allocated to the production of inventions are in excess of the social need. As such, one cannot determine what is more costly to society: the misallocation of resources to inventive efforts when a patent does not exist, or the misallocation of resources when it does.
The allocation of resources within the scope of inventive activities
The question of whether patents have a positive or a negative effect on the allocation of resources within the scope of inventive activities is also problematic.
In the absence of patents, there would be a market bias either towards the production of inventions in industries that are less prone to competition, such as monopolistic or oligopolistic ones, or towards the production of inventions that can be kept secret.52
A patent system may solve the first problem as it increases the incentive to invent in industries under competition. Since the output of a given industry is likely to be greater under competition than under monopoly it would be more
profitable for a given firm to sell its cost-reducing invention to a competitive industry than to a monopolized one.53
As for the second problem – the market bias towards the production of ʻsecret inventionsʼ – the introduction of patents can only have a partial effect. The main question here is whether patents can be considered a sufficient incentive for the disclosure of secret inventions. Indeed, this problem has roots in the great patent debate of the 19th century. At the time its advocates argued that patents are the result of a ʻsocial contractʼ between the inventor and society in which the former agrees to disclose his secret in exchange for receiving temporary protection from the latter.54 As Penrose put it:
This theory of purpose of the patent grant has frequently been put in the form of ʻsocial contractʼ theory: Society makes a contract with the inventor by which it agrees to grant him the exclusive use of his invention for a period and in return he agrees to disclose his secret in order that it will later be available to society.55
Its antagonists, on the other hand, argued that if an inventor is able to keep his invention secret for a period longer than that granted by patent term, he would be reluctant to disclose his invention to society. Marshall, supporting this view, notes that despite the existence of patents a ʻlarge manufacturer prefers to keep his improvement to himself and get what benefit he can by using itʼ.56 A well-noted example is the case of Coca-Cola, which prefers to keep its formula secret rather than applying for patent protection.
Thus, it is more likely that an inventor will apply for a patent mainly when he believes that he would not be able to keep his invention secret for a period that is longer than, or at least equal to, that of the patent term. Resources are still likely to be invested in the creation of secret knowledge in spite of the existence of a patent system.
Finally, it is also important to consider the allocation of resources towards the production of existing inventions. Firms, in the absence of patents, may invest resources in order to reproduce existing inventions, provided that they are unable to copy them in the first place. This can lead to the misallocation of valuable resources since, from the communityʼs perspective, it is preferable that these firms invest in other projects rather than that of duplicating inventions.57
Some may argue that the allocation of resources towards the production of similar or even existing inventions may be socially desired if, as a result, new knowledge is acquired. Even so, this does not mean that the benefits to society from such knowledge exceed the costs of allocating valuable resources towards the duplication of existing inventions. As Machlup notes: ʻThe production of knowledge in how to do in a somewhat different way what we have already learned to do in a satisfactory way would hardly be given highest priority in a rational allocation of resources.ʼ58
In this respect a patent system can have both positive and negative effects on the allocation of resources towards the production of existing inventions.
Considering the positive potential of patents, firms will be reluctant to invest resources in the production of inventions that are identical to patented ones, as they would be unable to appropriate returns for these investments during the term of protection.
At the same time, however, patents can increase the phenomena of ʻinventing aroundʼ and ʻblockingʼ.59 The former occurs when firms, interested in competing against a patent owner, try to come up with alternatives to the original patent, hence inventing around it. The latter occurs when a patentee, facing the danger of inventing around, attempts to block his rivals by patenting all available alternatives to its original invention, even inferior ones.60 Gilbert and Newbery suggest that blocking can occur when firms engage in ʻpreemptive patentingʼ – securing patent protection for technologies that are neither used nor licensed to others (ʻsleepingʼ patents) – in order to raise entrance barriers.61
It is far from clear whether a patent system has a positive or a negative effect on the allocation of resources within the province of inventive activities. A patent system may increase the incentive to invent in industries that are more prone to competition, hence reducing the natural bias towards the production of inventions under a monopoly. An inventing firm would prefer to sell the rights for the use of its invention to an industry under competition rather than to one under a monopoly, particularly when that firm does not have the necessary capabilities to exploit it for production purposes.
Simultaneously, patents are much less likely to affect the disclosure of secret inventions. Large corporations that are able to keep their inventions secret for a long period of time, such as Coca-Colaʼs famous formula, would still prefer to continue doing so instead of relying on a limited protection period of patents.
Furthermore, patents may also enhance the misallocation of resources in cases where firms choose either to invent around existing patents, or to block others from doing so themselves by patenting all available alternatives to the original invention.
The allocation of inventions as factors of production
This section considers the ability of patents to optimize the allocation of new inventions as a factor of production. For the purpose of theoretical clarity it will be assumed that: patents may be the only form of monopolistic behaviour, that firms are operating in perfect competition, and that they are subject to diseconomies of scale. Furthermore, since the focus here is on inventions and not on inventive efforts one should ignore any positive or negative effects of the patent system on the latter.
The issue of secrecy, which was referred to in the previous section, is particu- larly important with regard to the allocation of inventions. Two aspects should
be explored. One is concerned with the inventorʼs ability to keep his invention secret, while the other focuses on his intentions – whether the inventor prefers to keep his invention secret or is interested in selling the rights for its use.
First, consider a case in which a firm was able to invent and to develop a cost-reducing invention, such as a process for the manufacturing of a specific product. If the transmission of the knowledge contained in the invention is both without cost and instantaneous, that is it cannot be kept a secret, and provided that a patent system does not exist, firms are likely to exploit that invention immediately for commercial purposes. If, however, a patent system does exist, then granting the invention a patent will inhibit its rapid dissemination to society and, as a result, will have a disturbing effect on its efficient use as a factor of production.
Thus, in terms of efficient allocation of existing inventions as a resource, it is preferable not to grant patent protection to inventions that can be copied easily and rapidly. Plant makes this point when rejecting claims that a patent system will have a positive effect on the allocation of inventions:
In a perfect competition all production will take place at a lower cost per unit product.
How can it be argued that any departure from such a condition, induced by the grant of monopoly power (patents) to raise prices and increase sectional income by restricting output will achieve greater general usefulness?62
This is not to say that society should not reward those firms focusing on the production of such inventions. In fact, many of the most sophisticated products and processes, such as pharmaceutical compounds and computer software, can be easily copied. Nevertheless, in terms of their ability to optimize the allocation of these products and processes, patents cannot be considered efficient.
Second, suppose now that the inventing firm is able to keep its cost-reducing process secret, yet despite its ability to do so, it is still interested in selling the rights for the use of the invention. It is quite clear that in the absence of patents the inventing firm will prefer to keep its invention secret since it will not expect to gain from an attempt to sell it to other interested parties. Given the primary assumption that there are no economies of scale, the price of the product will fall only slightly, as the inventing firm would expand its sales while those of its competitors would contract.63
If a patent system does exist, then the inventing firm could sell rights to the use of its invention (that is licensing) at a price per unit which is equal to the vertical shift in its marginal cost curve (from the use of a cost-reducing process).64 Since the cost curves of other firms would not effectively shift, the cost reducing process would affect neither the price nor the quantity of the product in question.65
In this case, granting a patent to a cost-reducing invention does essentially optimize its allocation as a factor of production, as it is now utilised across the industry. It is, therefore, possible to argue that a patent system is likely to increase social gains in cases where firms are able to keep their inventions secret but nevertheless have an incentive to sell the rights for their use.
Finally, suppose that the inventing firm is both able and willing to keep its newly invented process secret. Here, the existence of a patent makes no difference to the allocation of that process, as the inventing firm knows that by applying for a patent protection it would limit its monopolistic position for a period close to that of the patent term.
Therefore, the introduction of a patent system will have a non-optimizing effect on the allocation of inventions that can be easily and rapidly copied.
A patent system may thus improve the allocation of inventions, as factors of production, in cases where the inventor can keep his invention secret but nonetheless still be interested in selling the rights for its use to others. This conclusion is plausible as long as the invention is not subject to ʻeconomies of scaleʼ and when firms find it cheaper to buy the right to use the invention rather than to re-develop it themselves.