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Giving a patentee a prize equal to the patentee’s profit is more realistic than the proposals of Shavell and Ypersele and of Kremer. The Shavell and Ypersele proposal requires the government to estimate the total surplus within the patented market and to offer that amount as a prize to the patentee. I have already noted some of the practical and public choice issues related to the Shavell and Ypersele proposal. Setting those aside, one additional issue is whether the government can estimate the total surplus reasonably efficiently. The administrative costs would be substantial. There are now roughly 160,000 utility patents granted to U.S. applicants each year. Estimating the potential market for each of these grants would require carrying out 55 of these estimations for each hour the patent office is open. The administrative burden can be lessened by limiting the prize to a narrow sector, such as pharmaceutical patents, but even this would involve a significant administrative cost. Between 2010 and 2019 an average of 38 new drugs were approved by the FDA each year.9 Estimating market surplus for 38 patented drugs in a year is a more plausible burden than doing so for 160,000 patents of all sorts, but drugs are increasingly being protected by multiple patents. The top-selling branded drug, Humira, on the market since 2002, is protected by 132 patents that block competition for nearly 40 years.10 Presumably some of the patents are being used, or may be used, to protect other drugs produced by its manufacturer, Abbvie. If so, it would be difficult to estimate the market surplus associated with the bundle of 132 patents protecting Humira.

In comparison, a prize system that allows the patentee to claim an amount equal to its own profit (or, say, half of its profit) would be much simpler to administer. The patentee would have every incentive to collect information on the total profits from his own patents, and to submit such an estimate to the government every year to gain a prize. The government would not have to expend resources on aiding or organizing patentees to seek prizes. The government would have to check that firms are submitting accurate information on profits from patents, and presumably would conduct occasional audits. But these administrative expenditures would not be different from what the government already spends in collecting and reviewing tax submissions by corporations and individuals.

I propose an alternative that does not introduce a risk of either patentee confiscation or government looting. In my proposal, the innovator receives both a patent and a prize. Under this scheme, the patentee receives the patent profit and a prize that approximates the consumer surplus. The amount of the prize would be limited, as in the Kremer proposal, to some fixed percentage (or multiple) of patentee profit. Thus, the patentee receives the patent profit multiplied by a markup factor M2, where ideally

For example, if the demand schedule is linear, the ratio of the residual consumer surplus to the monopoly profit is ½. Thus, the patentee would be given a prize equal to 50 percent of profit. In this system, the patentee cannot have his profits confiscated because he has the usual patent; the patentee can only do better than under the current system. Since there is no auction of the patent, and the government does not propose to take patents and put them into the public domain, there is absolutely no risk of confiscation.

Most prize advocates ultimately propose that the prize system be optional to avoid the expropriation problem.294 In an optional-prize system, the innovator is given a choice between a prize and an intellectual property right, allowing the firm to decline any prize that is less than what the innovator expects to earn through a monopoly. This choice can protect innovators against unduly conservative prizes offered by the government.295

The check on inadequate government rewards provided by intellectual property is similar to the imagined operation of an optional-prize system, in which the innovator has the choice of accepting either a prize or a patent for its invention. As discussed in Part I, an optional-prize system deters suboptimal government rewards by giving the innovator a choice between a patent and a prize, thereby allowing the innovator to decline any prize that is less that what it believes the public is willing to pay.296 Governments achieve a similar effect by granting an intellectual property right that will not be consulted in determining the social value and incentives for an invention. Here also, suboptimal government rewards are checked by the innovator’s right to decline to sell for anything less than what it believes the public would be willing to pay. This is true even if the government imposes price controls or prohibits sales by the patent holder to anyone but itself. So long as the innovator has an intellectual property right, it can decline to sell and prevent others from selling the invention.297 The power to deny the public access gives the patent holder a platform to challenge a suboptimal

I do not argue against either public or private prizes generally - I only address the question of whether prizes should replace prices.27 Both public and private prizes can provide incentives and information that are complements to - but not close substitutes for - the market for inventions. Gary Becker, winner of the Nobel Prize in Economic Sciences, observes that prizes may be useful because of the limited patentability of basic discoveries: "To offset the effect of this exclusion from patent protection on the incentive to discover, individuals and governments have created prizes and awards, like the Fields Medal and Nobel Prizes, for mathematical and scientific discoveries. "28 Public and private prizes can achieve various complementary objectives against the backdrop of IP rights, as long as policy makers do not seek to replace IP rights and the market for inventions.2 9 Petra Moser and Tom Nicholas find historical evidence that prizes provide publicity that encourages patenting and innovation. 30 Fiona S. Murray et al. find that Grand Innovation Prizes are not sub-stitutes for patents but instead serve such goals as awareness, education, and demonstrating the viability of alternatives. 31 Prizes can serve as an inducement to innovation when winners can patent their inventions and indeed find that winning a prize increases patenting.32 Glen Weyl and Jean Tirole provide a general model of market incentives in which public subsidies supplement market prices.33

There are significant “public choice costs” under either of the optional prize plans. By this I mean there are risks of inappropriate transfers to patentees2 – that is, looting – and of confiscation of patentees, through the conduct of or through the omissions of government agents, sometimes working at the behest of private agents. I will argue that the confiscation risk appears to dominate.

The public choice costs point to a broader set of constraints that should be incorporated into any analysis of the patent system. There are rational actors operating at all levels, from patentees to licensees, and government actors. A discretionary prize system, where the government awards prizes and no enforceable patents, would invite lobbying and third-party interference in the determination of the award. Even in a prize process effectively shielded from third-party interference, government would confiscate patents on a regular basis.

Abramowicz, elucidating Shavell and Ypersele, distinguishes mandatory and optional prize systems. In a mandatory prize system, the patentee would be required to accept the prize; there would be no option to exploit the patent in the market. To be sure, trade secrecy would be available as an alternative to the prize, but not all innovations can be protected through trade secrecy. The risk of confiscation is obvious under the mandatory prize. If the patentee must sell the patent to the government in exchange for the prize, then the government, as a rational actor, will eventually reduce the value of the prize. Foreseeing this outcome, the innovator’s incentive to innovate would be weakened, and less capital would be available to support innovation.

A second and closely related problem is that putting innovations into the public domain removes the design-around incentives that have improved many markets involving patented products. The patent creates a protected market that induces rivals to invest into designing around the patent. These design-around efforts generate substitutes to the patented good, diminishing the market power of the patentee and increasing the variety of products available to consumers. Indeed, often the second or third iteration of some product is the best. The iPhone, for example, is a far superior product in comparison to the Blackberry, and especially in comparison to the IBM Simon, the first smartphone to enter the market.

Patents provide incentives for efficient invention and innovation because ownership is transferable. Competition among potential adopters helps the market for innovative control allocate patented inventions to the highest-value users. Patent owners have incentives to transfer their IP when others can increase its market value.

The market for innovative control provides valuable guidance for investment in invention and innovation. The market for innovative control determines the returns to invention, commercialization, and innovation. What matters are innovations — that is, the outputs of development, commercialization, and application of inventions — rather than the level of inventive and innovative efforts — that is, the inputs of R&D and the innovative process. Simply subsidizing invention or rewarding inventive efforts could produce more efforts, but not necessarily better inventions and innovations. Government subsidies or rewards for invention in the absence of IP protections would not provide incentives for development, commercialization, or application of inventions, which are essential for diffusion of technology and innovation.

Third, I explain that government prizes cannot achieve dynamic economic efficiency because they do not provide guidance for investment in commercialization and innovation. Public ownership and distribution of the winning technology at a zero price does not provide incentives for innovation. In contrast, investment in developing patented inventions occurs both before and after the patent is granted because a patent often covers the initial invention, development of the invention, and innovative applications, as Edmund Kitch recognized.2 5 Prices in the market for inventions guide economic decisions of inventors, innovators, producers, investors, and consumers. Market prices for inventions convey signals about seller cost and buyer willingness to pay. Market prices for inventions thus promote innovation and competition and increase both static and dynamic efficiencies. Prices are state-contingent because they reflect technological change and the features of complementary and substitute inventions. Market forces change prices without the transaction costs of establishing contingent contracts. Prices for inventions therefore guide decision making under uncertainty. The market for inventions is a market for innovative control because ownership of patented inventions not only generates residual returns but allows owners to exercise residual control over the development and application of inventions.26

A government prize system would diminish private incentives for commercialization of inventions. Kieff emphasizes the importance of markets in stimulating commercialization of inventions. 10 7 Public ownership or common ownership of inventions would eliminate private incentives for the commercialization of inventions, as Kieff explains. 08 Common ownership of inventions also would diminish incentives for innovation to develop products, manufacturing processes, and transaction techniques based on those inventions. Additionally, common ownership would diminish marketing of products that embody inventions.

Some advocates of government contests view the discouragement of commercialization as an advantage of a prize system. For example, Love and Hubbard assert that marketing products is a "waste,"

Prize proposals offer the benefit of putting inventions into the public domain as soon as possible. However, there is little consideration in the prize literature to the costs of putting inventions into the public domain at an early date.

Prize proposals go directly against Kitch’s (1977) prospect thesis, that the patent enables the patentee to coordinate further development of the invention. Kitch argues that it is only after the patent has been granted that the patentee is able to work with others who have complementary skills in order to optimize the social surplus from the patent. The patent right serves as an enclosure of the public domain, which would otherwise be mismanaged. In the absence of such a right to control development, which would be observed if the patent right were interpreted narrowly, multiple individuals would enter and attempt to take control of the path of the innovation. Knowing that this splintering would likely occur, the initial inventor would have weak incentives to develop the idea and weaker incentives, relative to the patent regime, to innovate in the first place.

When the government calculates prize payouts based on sales volume, it faces an incentive to save money by imposing a sales tax on innovations, with the effect of reintroducing deadweight loss. Most proposals for prize systems rely on observing sales volume to calculate prizes.253 Given the close connection between the utilization of an innovation and its social value, it is hard to imagine a comprehensive prize system that does anything else.254 Unfortunately, basing rewards on sales volume gives the government a perverse incentive to suppress utilization as a way to reduce its own liabilities.255 The government could use a variety of means to limit the public’s access at marginal cost,256 but the most direct is to impose user fees on innovations to inflate their price, thereby suppressing sales volume while also raising money to help finance the prize system.257 From the public’s perspective, these user fees are harmful to the extent that they undermine some (or all) of the efficiency gains from the prize system. Nevertheless, so long as the government is operating under budget constraints and calculates prizes based on sales volume, it will have a strong incentive to suppress the utilization of innovations though a sales tax or similar user fee.

There are two prize levels to consider. One is the minimum necessary prize, which is the breakeven level of profit. The other is the optimal prize, which is equal to the entire surplus (Shavell and Ypersele). The optimal prize ensures that entry occurs whenever the cost of development is less than the benefit to society.

The minimum prize is sufficient to induce entry by the patentee. However, the original problem in the patent setting is that the patent authority does not know the development cost of the patentee; that is private information. Given this, if the patent authority were to choose a prize of a given amount, there would be some innovators who would refuse to enter. Because of the information problem, the minimum or break-even prize is not a workable solution to the entry problem.

Second, I emphasize that government prizes, in contrast to the market for inventions, cannot achieve an efficient allocation of technology. A public prize system with government diffusion of technology can do little to promote efficient commercialization and innovation. Public prizes require planners to choose the best technology in advance, and government diffusion of technology eliminates many of the benefits of competition. Government contests and the selection of winners reflect the specific priorities of public policy makers rather than economic benefits of invention and innovation. In contrast, prices in the market for inventions are generated by competition and coordination that selects the best inventions and innovations. Patents, along with copyrights, trademarks, trade secrets and other IP, support invention, commercialization, and innovation by providing the foundation of the market for inventions.22 Competitive pressures among inventors and among producers increase incentives to invent.23 Inventions and innovations are not exogenous forces but instead are the results of economic decisions and transactions among many participants in the market for inventions. As Friedrich Hayek points out, competition is a discovery procedure because it helps inventors and producers discover the best inventions and innovations. 24

A major—and as yet unresolved—problem with delinkage in general, and prizes in particular, is

governments find it very hard to determine accurately the true economic and social value of an invention.

The most pressing political economy concern with the prize system is the risk of inadequate prize payouts and expropriation. When innovators earn their profits through a government-funded prize system, they are competing against other interest groups over scarce taxpayer dollars. Innovators are likely to be at a disadvantage in these types of political battles for three reasons. First, by nature, innovators often threaten established interests and therefore create opposition from more powerful interest groups.286 Second, because innovators capture an unusually small portion of the social surplus generated by their activities,287 they have proportionally fewer resources to devote to rent seeking in support of their R & D investments. Third, and most importantly, innovators are particularly vulnerable to expropriation under a prize system because the government determines their prize payout after innovators have invested in R & D and disclosed their inventions to the government. Since innovators’ R & D investments are sunk at this stage, the government can take advantage of its position to grossly underpay innovators,288 who may have little choice but to accept the insufficient reward.289 Legislators could then redirect funds that would otherwise incentivize innovation toward lower taxes or other government spending programs, many of which would offer more immediate political gains than payments to innovators meant to encourage R & D spending.290 Eventually, the public would suffer from the reduced output of socially valuable innovation. However, this malfeasance would be largely hidden from voters, since it is nearly impossible to observe the relative absence of new innovations.291 Consequently, the risk of expropriation in a prize system could be a significant deterrent to private-sector investment in R & D unless there are political checks to prevent underpayment.

Opponents of the market-based system of drug development decry funds spent by the pharmaceutical

industry on lobbying governments to ensure a favorable policy regime, such as a reasonably strong patent

Prize advocates assume that central planners are fully informed about market demand and producer costs. Central planners would need to have sufficient knowledge about science and technology to design contests and to choose the best inventions. Central planners must be sufficiently informed to allocate inventions efficiently to producers. The complexities of invention and innovation create significant information challenges for market participants; such challenges are likely to be insurmountable for central planners. The dramatic differences in the historical performance of market economies and centrally-planned economies are even more pronounced in innovative industries.

Problems with central planning extend beyond asymmetry of knowledge. Prize advocates assume that governments maximize social welfare. Even if they could be fully informed, central planners need not act in the public interest. Central planners can be expected to suffer from corruption, abuse of power, discrimination, bureaucratic inefficiency, and other forms of government failure. Government agencies are likely to provide rewards to cronies of politicians, lobbying organizations, incumbent firms, political donors, voting blocs, or ideological allies. A government prize system would encourage rent seeking to obtain prizes, diverting resources away from invention and innovation and toward political influence. Government agencies also are likely to pursue objectives other than allocative efficiency, such as subsidies for groups of voters, increases in employment, income redistribution, regional economic growth, industrial policy, and support for political causes.

//DH

Advancing biotechnology is a stated goal of the U.S. Department of Defense as it provides opportunities for new methods of producing products in the military supply chain, as well as for creating new or improved products with enhanced capabilities. Biological systems can be used for biomanufacturing of products in the defense supply chain, for example in the critical chemicals that the Department of Defense uses to make lubricants, fuels, or energetics, on which it now relies on foreign or sole sources. Biological systems can also produce novel products, such as materials that trap and prevent toxic chemicals from affecting soldiers. Biomanufacturing on-demand could enable logistics in contested environments, for example through engineered microbes that can transform waste streams like plastics into critical supply chain components like fuels. Biotechnology can be used to generate novel materials, for example fabric resembling spider silk could make lighter, stronger, and more flexible body armor, allowing warfighters to operate under reduced physical strain. Biological sensors could