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The concept of the market for innovative control is also helpful in understanding the many types of firms that buy or sell patents. Different types of firms are needed for different types of technologies and for different tasks involved in invention, commercialization, and innovation. Christopher A. Cotropia, Jay P. Kesan, and David L. Schwartz point out that many types of companies engage in patent transactions, including universities, individual inventors, mass patent aggregators, failed startups and operating companies, patent holding companies, operating companies, IP holding companies owned by operating companies, and technology development companies.98

Different business models are an important aspect of the market for innovative control. Because the market for innovative control helps to allocate patents to the highest-value users, the types of firms that acquire patents will be those that provide the greatest market value. In a well-functioning market for innovative control, the business model of the acquiring firm acquiring IP will be the best suited to efficient management of that IP, all other things being equal. Restricting IP rights on the basis of the business model of the firm that owns the patent would create inefficiencies in the market for innovative control.

PAE = Patent Assertion Entities, commonly called patent trolls because they buy patents and then sue to assert rights, NPEs = Non Practicing Entities, another word for trolls

Moreover, the recent development of the markets for technology has been associated with an increase of patent litigation,148 frequently attributed to a category of NPEs, the so-called PAEs accused of acquiring patents to pursue nuisance litigation and strategic patent monetization.149 However, empirical research provides a more nuanced picture of this phenomenon: while patents acquired by PAEs are of similar quality compared to litigated patents owned by operating companies,150 the business models of PAEs vary significantly.151 In fact, under this umbrella term, there is a wide array of entities with different approaches to patent licensing and implications for technology diffusion.152

First, I show that key features of the patent system — exclusion, transferability, disclosure, certification, standardization, and divisibility — increase transaction efficiencies and stimulate competition in the market for inventions. These properties of patents reduce transaction costs associated with transferring, licensing, cross-licensing, combining, implementing, and developing inventions. Patents give owners rights to exclude others from making, using, or selling their inventions.19 Patents help convert inventions into transferable assets, so that inventors and adopters can transact more efficiently in the market for inventions. Patents promote disclosure of inventions, which reduces costs of search and bargaining in the market for inventions. Patents provide certification of technologies, which decreases information asymmetry in the market for inventions. Patents provide standardization in IP, which reduces the costs of contracting in the market for inventions. Finally, patents allow greater divisibility of technology, which promotes modularity and increases gains from trade in the market for inventions. Patents thus generate economic benefits that are based on more efficient transactions and greater competition in the market for inventions.

There is no empirical evidence for the assertion that patent owners systematically earn “excessive” rewards. In any case, there is no intrinsic value of an invention that departs from its market value. Economic analysis has long identified the value of goods and services as being given by market prices. Competition in the market for inventions strongly suggests that patent owners earn market rewards. A patent does not confer an economic monopoly because access to the market for inventions, markets for products, or financial markets remains unimpeded.

The standard Nordhaus argument is incorrect because it assumes that a patent confers an economic monopoly on their owners.168 This now standard assumption in the economics and law literature is inconsistent with reality. Competition in the market for inventions and in the product market that applies inventions means that a patent owner does not receive monopoly rents. This invalidates the standard analysis of patent policy that is based on the economic monopoly assumption.

Nonetheless—despite its numerous fallacies—the narrative of the first mover advantage has been echoed by popular, although exceptional, business success stories. For example, Sony gained first-mover status in 1979 with its personal stereo, the Walkman. Similarly, in 1995, eBay built the first online auction website, and the company today continues to be a popular shopping site worldwide. In the same year, Amazon created the first online bookstore and leveraged on its first-mover advantage to market a range of additional products. In the early 2000s, Apple released the iPod, which marked the end of Sony’s primacy in the portable music devices market, and the iPhone, disrupting the mobile phone landscape. At first glance, these remarkable stories seem to justify the idea that underpins the first mover advantage theory: in order to succeed, companies need to take risks and go to the market first.

On this basis, some have argued that achieving a first mover advantage—even in the absolute absence of patent protection—is sufficient to dominate the market and preserve monopoly over a technology.37 On this premise, policy interventions aimed at diluting the strength of patent rights have emerged.38 Scaling back both the scope and the duration of patent protection is an example of a frequently suggested policy, justified by means of the first mover advantage theory, especially for the information and communications technology (ICT) sector.39 Furthermore, some have even suggested the elimination of all means of IP protection.40 However, upon closer inspection, one can easily recognize how IP protection not only plays a vital role in the appropriation of the returns on R&D investments, but also in the survival of the successful first movers mentioned earlier. For instance, it is common knowledge that the success of Sony’s Walkman cannot be entirely attributed to its first mover status alone.41 In fact, before launching its iconic product, Sony developed a comprehensive strategy founded on: (i) a recombination of existing in-house IP, and (ii) an accurate mix of brand name and marketing skills, supported by substantial financial resources. Similarly, Amazon dominated its market by obtaining a patent for its ‘one-click’ system for processing customer orders. The ‘one-click’ patent gave Amazon a key advantage by putting pressure on competitors, such as Barnes & Nobles, who eventually left the market.42 Finally, the success of the iPhone was built upon strong IP protection of its iOS operating system.43

Another problem with the first mover advantage theory is that the high costs associated with being the first mover are largely ignored.28 More specifically, it is often overlooked that being the first to the market implies significant costs, for example in R&D and market intelligence. Other costs that are likely to arise when attempting to defend the first mover status from emerging competitors include: marketing campaigns, infrastructure building and maintenance and securing suppliers. In addition, later entrants can prepare for market entry by imitating the dominant technology, which can, in specific scenarios, provide them with a significant advantage over the first mover."9

The overemphasis on the timing of market entry is another misconception that can be defined as a form of reverse causation. In this context, reverse causation occurs when the company mistakenly assumes that being the first mover is the cause of its success, when in reality it is the result of other factors. In other words, the first mover advantage theory neglects several other factors that are likely to have contributed to obtaining first mover status.30

The market foundation role of patents implies that antitrust policy should support rather than weaken IP protections. When there is a market for inventions, competitive pressures, both among inventors and among producers who apply inventions, increase incentives to invent and to innovate.26 On the supply side of the market for inventions, competitive pressures increase incentives to invent and decrease royalties for inventions. On the demand side of the market for inventions, competition drives adopters’ incentives to purchase or license discoveries, introduce economic innovations based on those discoveries, and invest in complementary activities. Weakening of patents reduces incentives to participate in the market for inventions, leading inventors to protect their IP through other means such as trade secrets, R&D alliances, and vertical integration. In the absence of a market for inventions, competitive pressures tend to reduce incentives to invent and to innovate.

A patented invention is an intangible real asset with potentially valuable control rights. The market value of patents is subject to random shocks due to randomness in the outcomes of the development process, in the costs of the development process, and in market valuations of the outcomes of innovation. The market value of the asset can also depend on the extent of the claims in the patent.93 The patent owner can invest in development and commercialization, so that the probability distribution of the market value of the patent depends on the level of investment. The patent owner can choose among various investment projects with random outcomes, so that the probability distribution of the value of the patent also depends on the choice of projects.

The market for innovative control provides guidance to inventors regarding investment in R&D and the choice of R&D projects. Because market values of individual inventions differ, the returns to producing inventions through R&D depend on how the resulting inventions will be valued in the market. The expected returns to different directions in R&D will depend on scientific and technical opportunities and the potential market value of successful outcomes. Efficient levels of investment in R&D will be targeted to particular areas on the basis of expected returns to different types of inventions.

F. Scott Kieff’s valuable discussion of patents finds that “the treatment of patents as property rights is necessary to facilitate investment in the complex, costly, and risky commercialization activities required to turn nascent inventions into new goods and services.32 Furthermore, property treatment is equally necessary to help society decide which inventive activities are worth protecting in the first instance.”33 Kieff critiques the “rewards” view of patents, pointing out that reward systems do not account for innovative activities after inventions have been made.34 He highlights both coordination and investment in commercialization: “The patent right to exclude competitors who have not shared in bearing these initial costs provides incentives for the holder of the invention and the other players in this market to come together and incur all costs necessary to facilitate commercialization of the patented invention.”35 The analysis of the market for inventions presented here encompasses the coordination and commercialization aspects of patents discussed by Kieff.

The concept of the market for innovative control helps to explain why there are patent transfers. Firms have incentives to acquire patents as a means of adding value to the patent. Firms add to the market value of patents when they can improve on the invention, commercialize the invention more effectively, or better develop innovations based on the patent. Firms also have incentives to acquire patents when they can realize economies of scale and scope in the management of IP. Firms also have additional incentives to acquire patents when they can offer greater capabilities in the management of IP than existing owners. Producers acquire patents that they can apply in developing innovations in products, production processes, or transaction methods.

Some recent data reveals a negative impact on innovators by the weakening of the U.S. patent system and by the Alice-Mayo inquiry. First, a recent survey study by Professor David Taylor of investors and representatives from companies in the innovation industries reported as its “first principal finding [that] investors who responded to the survey overwhelmingly believe patent eligibility is an important consideration when their firms decide whether to invest in companies developing technology.”66 More specifically, Professor Taylor found that “overall 62% of the investors agreed that their firms were less likely to invest in a company developing technology if patent eligibility makes patents unavailable.”67 Similar to other empirical studies,68 Professor Taylor found that the significance of the availability of and reliance on patents varied between different sectors of the U.S. innovation economy, such as between biotechnology (higher reliance) and software/Internet services (lower reliance).69 In fact, Professor Taylor found the most significant “negative impact of the Supreme Court’s eligibility cases generally on investment . . . in terms of its impact on public health: the biotechnology, medical device, and pharmaceutical industries.”70 Still, Professor Taylor’s survey finds that “the results show the Court’s decisions [on patent eligibility doctrine] have negatively impacted each and every area of technological development studied” in his survey, including even in software technologies.71 The negative relationship identified by Professor Taylor between the ill effects of the Alice-Mayo inquiry and investment decisions is in accord with the many studies summarized earlier that consistently find a positive relationship between reliable and effective patent rights and economic growth.72

Other studies have provided additional data that the U.S. patent system is in distress, and that the U.S. innovation economy is faltering in important respects. The World Intellectual Property Organization (WIPO) reported a 1.6% drop in U.S. patent filings in 2018—the first decline since 2009 when the U.S. was in the midst of the Great Recession.73 In fact, the decline in U.S. patent applications in 2018 was not associated with either an economic recession or war, the two factors that have historically correlated with declines in patent applications in the U.S. Although patent applications increased again in 2019, they decreased in the ensuing years and only began to reverse this trend in 2022 with a moderate 0.5% increase over 2022.74 While it may be tempting to attribute the continued decline in U.S. patent filings in both 2020 and 2021 to the COVID-19 pandemic, the European Patent Office, South Korea, and China all experienced an increase in patent filings in 2021 while the U.S. experienced another decrease in patent filings that same year.75 Another revealing chart in the WIPO 2023 report on intellectual property data shows a flattening in the trend in U.S. patent filings since shortly after 2010, compared to varying positive growth trends in patent filings in the European Patent Office, South Korea, and China:76

The key contribution of the current paper is that it considers the effect of patenting uncertainty on innovations.2 This is important because patenting uncertainty may have detrimental effects on innovation and turn the actual purpose of the patenting system—protecting and stimulating innovation—into its opposite. If it turns out that patenting uncertainty diminishes inventive activity, that would undermine the intent of the patent system in fostering innovation over time. Yet, due diligence in the patent award process is important to reward true inventors and to adequately determine the scope of a patent (Goel, 2002).

Not all patent applications are ultimately granted patents, with reasons for denials varying from a lack of originality, technical issues with filing paperwork (or the transaction cost of patenting), multiple, simultaneous filers of the same invention, etc. Consequently, some new inventors (nascent entrepreneurs or first-time inventors) might be dissuaded from filing patents or inventing by looking at the low success rate in patent grants (Goel & GöktepeHultén, 2013). This possible effect has the potential to undermine the success of the patent process—whereas the intent of the patent process is to reward and encourage innovation by protecting the property rights of the inventors, the very process of due diligence to identify the true inventors and identify original contributions might have the opposite effect of dissuading innovation by some due to the uncertainty associated with patent grants.

Before addressing a specific legal or policy debate in the patent system, it is necessary to first review the legal and economic evidence that sets the framework for evaluating the current legal disputes and data. This is important, if only because there is widespread confusion today about the key role of a patent system in promoting innovation and driving economic growth. The patent system has been a key driver of the U.S. innovation economy for over 200 years, as economists, historians, and legal scholars have repeatedly demonstrated.16 The patent system was central to the successes of the Industrial Revolution in the nineteenth century, the pharmaceutical and computer revolutions in the twentieth century, and the biotech and mobile revolutions in the early twenty-first century. Studies have consistently shown that patent systems that secure reliable and effective property rights to inventors strongly correlate with successful innovation economies.17

Dr. Zorina Khan, an award-winning economist, has demonstrated that reliable and effective property rights in innovation—patents—were a key factor in thriving markets for technology in the United States in the nineteenth century.18 Other economists have also identified features of these robust nineteenth-century markets in new technologies—such as an increase in “venture capital” investment in patent owners, the rise of a secondary market in the sale of patents as assets, and the embrace of specialization via licensing business models—as indicators of value-maximizing economic activity that were made possible by reliable and effective patents.19 All of this remains true today: a twenty-first-century startup with a patent more than doubles its chances of securing venture capital financing compared to a startup without a patent, and this patent-based startup has statistically-significant increased chances of success in the marketplace as well.20 These are the academic and scholarly analysis that confirm the everyday experience of what most people have seen in Shark Tank, in which the venture capitalists always ask the entrepreneurs if they have patents for their inventions as a precondition to investing in their new products or services.

On the other hand, academic research offers evidence of the rewarding function provided by the patent system and confirms the centrality of patents in the innovation policy toolbox. A recent empirical study suggests that not

only are patents an effective tool against competition, but also that the temporary monopoly they confer generates a measurable monetary gain to innovators. In fact, there is evidence that patents provide a tangible mark-up on a broad range of consumer products across all industrial sectors.47 There is also large evidence that for smaller players—such as start-ups and SMEs—patents are a valuable resource, as they bring value through three crucial channels: (i) patents can be used to reduce information asymmetry between the company and the potential investors, (ii) they provide a licensing stream of revenues that helps mitigate the financial constraints associated with R&D investments and finally (iii) patents can be used as collateral to secure financing.48

The OECD's bold assertion that China's I.P. theft tallied up to a whopping $200 billion to $600 billion annually throughout the 2010s hinges on a dubious concoction known as the General Trade-Related Index of Counterfeiting (GTRIC) for products. This algorithm supposedly crunches customs data to gauge the global counterfeit trade, attributing a significant chunk of it to China.

Delve into the mechanics of the GTRIC and you'll find it operates on a blend of educated guesses and less educated assumptions. Modelers assign two "propensities": the propensity of a given country to export counterfeits, and the propensity for certain product types—like sneakers or watches—to be counterfeited. Comparing these figures with data on all international trade, the model generates estimates of the total volume of counterfeit goods from various source nations.

The final piece in the "we wuz robbed" argument is the claim that Chinese companies "steal" the I.P. of their American partners in joint ventures. China's prowess at the negotiation table is undeniable, and it wields its bargaining power aggressively to trade access to Chinese markets for learning. Yet the American companies that claim to be victims enter into these agreements freely and rarely come out net losers. These U.S. businesses have raked in trillions in sales and pocketed hefty profits—a testament to their ability to navigate the competitive landscape.

Even with all of this guesswork at play in the OECD reports, the 2011 USITC report makes them look like high scholarship. Focusing on I.P.-intensive U.S. firms operating in China in 2009, the report claims these firms "reported losses of approximately $48.2 billion in sales, royalties, or license fees" due to I.P. infringement. Yet a closer look reveals the range of estimated losses, stretching from $14.2 billion to $90.5 billion, was based not on direct reports from companies but on third-party guesstimates from industry associations. Essentially, these firms were parroting back guesses fed to them by industry groups with a vested interest in painting the grimmest picture possible to grab government attention. The claim that the oft-cited USITC report was based on accounts by victim companies is a fraud.

Diving deeper into the quagmire, a collaboration between PricewaterhouseCoopers and the Center for Responsible Enterprise and Trade used "several proxy measures" to conclude "that trade secret theft could be estimated to be between 1% and 3% of [U.S.] GDP"—yet another exercise in creative estimation.

These audacious leaps in logic are how we came to believe that China stole its way to becoming an economic and technological powerhouse.

CHRISTOPHER COONS: We appreciate the input of everybody who's come to the table, participated, testified. Mr. Kappos, my last question, some stakeholders have said that PERA doesn't define key term substantially, practically, and that depending on the meaning courts apply to these words, it may unreasonably be expanded or contracted.

Do you share those concerns? How do you think courts will handle um, language like practically or substantially?

RESPONSE TO QUESTION 5: Once Congress finalizes the contours of PERA and passes it into law, it will bring an immediate amount of certainty to Section 101. It will do this by eliminating the judicial exceptions, which have proven to be unworkable over the past decade, and replacing them with a clear articulation of what is a patent-eligible invention and what is not. This structure of defined matter that is not an invention, such as “mathematical formulas,” is much more amenable to judicial interpretation than amorphous terms like “abstract idea.” While there will always be litigation at the outer edge of any term’s meaning, the language of PERA starts off by being much more concrete. Importantly, this will not only help examiners and judges, but it will help inventors who do not have law degrees or experience in case law research understand whether they are operating within a patent-eligible field just by reading the statute. Any lay person now just reading the statute would probably not even realize that significant judicial exception exists to the plain text of Section 101.