Search the archive.

Although the patent-plus-prize scheme is relatively simple administratively, and consistent with profit-making incentives, it is likely to encounter political opposition. If the government gives prizes equal to profit (or half of profit) from patents to large firms, eventually politically savvy actors would oppose the scheme. It would be attacked as “corporate welfare,” and the attacks would probably seem appealing to the median voter.12 To maintain the prize system in the face of such opposition, the government would have to continually remind voters that society gains more from the prize system than it loses. Political attacks on the prize system, by contrast, need only be successful once to put an end to the system. Eventually, the prize scheme would generate sufficient public opposition that it would be terminated.

What makes the patent-plus-prize scheme especially vulnerable to political attack is that it is an open transfer to patentees. If the transfer were in some sense disguised, it might be survivable. Many laws lead to disguised transfers from poor to rich. In Massachusetts, the Community Preservation Act subsidizes land conservation and public beautification projects in affluent suburbs while taxing residents in every community, affluent or not.13 The economically regressive transfer effected through the Massachusetts CPA, taxing residents of Dorchester to fund open space acquisition in Weston, goes largely unremarked because it is not open and obvious. But the patent prize would be an open and obvious transfer from the general public to the patentee, and, consequently, an easy path to political power through attacking the transfer as regressive.

The first argument rests squarely on the notion that the provision of technology transfer through investment by MNEs from advanced countries increases the pace by which the knowledge gap is closed, because of the otherwise limited absorptive capacity on the part of the developing country. According to the ‘absorptive capacity’ argument, stronger IPRs stimulate diffusion by providing a secure channel for multinational companies to share their know-how. In the absence of this, countries simply do not have the domestic capacity even to imitate these technologies. IPRs therefore act as essential midwives for technology diffusion. At the same time, it is assumed that with weak IPRs the country’s ability to absorb the technology is so high that the knowledge will be effectively stolen. But, putting aside the seeming contradictory positions on the country’s ability to absorb knowledge - it can only do so when the production occurs within the country - as a theoretical proposition this argument is dubious.

After all, IP will be protected in other countries even if a particular developing country does not have strong protection. This means that the only risk a potential investor faces from investing in a country with weak protections is the use of the knowledge in that country. This could be an important issue in some large countries with potentially lucrative internal markets, but it’s hard to see that as a great risk to potential investors in most developing countries.

Patent supported research also creates incentives for wasteful research in the form of duplicative drugs. There can be large rents associated with developing a second, third, or fourth drug for a specific condition when a breakthrough drug is earning large patent rents. As noted, these drugs will typically have some value, but in most cases research funding would be better spent on seeking cures for conditions where effective treatments do not currently exist.

Patent supported research also creates incentives for secrecy in the research process. A company in search of patents will disclose only the minimum information necessary to secure a patent and to gain approval for its drugs. It has no incentive to share information with potential competitors. In addition, patent support also has the effect of pushing research in the direction of patentable products. Companies have no incentive to pursue evidence suggesting that a particular condition could be best treated with diet or exercise or that environmental factors may be a cause of bad health. While they may make this information public for others to pursue, they have no direct incentive to do so.

Even in the United States and other advanced industrialised countries, the patent system is in a period of crisis. There is widespread concern over the proliferation of weak patents—those that are not real advances on existing knowledge but that are granted for a variety of reasons, including a structural bias towards granting patents in the patent offices of advanced industrialised economies. Weak patents 10 can provide an impediment to follow-on innovation, while providing at best weak incentives for innovative activities themselves.11 The myriad of patents has created a ’patent thicket‘, that in some sectors has not encouraged innovation, but on the contrary, has encouraged litigation. These problems are especially important in complex products (like a computer chip) where the production entails dozens of patents. The patent thicket has been exploited by patent trolls, i.e. law firms that buy up patents that look for possible infringement by important patents.

As discussed in Section 2, a key aspect of the patent system is the requirement that firms must disclose their invention, which in principal disseminates the scientific knowledge underlying the patented technology. However, a question remains of whether the patenting of a given technology nonetheless discourages cumulative innovation, in the sense of subsequent innovation building on the initial (patented) technology. Although the effects of IPR on subsequent innovation are ambiguous from a theoretical perspective, recent empirical evidence consistently suggests that on net IPR discourages subsequent innovation (Murray et al. 2009, Murray and Stern 2007, Williams 2010). This empirical evidence raises the idea that one useful context for prize mechanisms may be to reward innovations where IPR may be expected to substantively distort cumulative innovation.

It is worth first reviewing the empirical evidence suggesting that IPR can distort cumulative innovation, at least in some contexts. It is difficult to estimate the effects of intellectual property on subsequent innovation, largely because technologies that are held with IPR in most cases will be inherently different than technologies that are in the public domain. For example, Moser (2007) finds evidence that higher quality innovations are more likely to be patented. Such patterns of selection into IPR complicate simple comparisons of the levels of subsequent R&D on – say – patented and nonpatented technologies, since the levels of subsequent R&D may reflect both any effects of IPR on subsequent innovation, and the “selection effect” of which technologies are patented in the first place.

(2) How can rewards under prize mechanisms be calibrated to be roughly in line with the incremental

social benefits of the rewarded innovations, in the absence of a price mechanism? Here, a key

Despite the distinct benefits of the patent system, scholars have identified a number of problems with it. The principle concern--deadweight loss--results from one of its strengths, the right to exclusion. Exclusion creates artificial scarcity. 162 Deadweight loss results as competitors, who could drive down prices, are restricted by higher prices. 163 Such monopoly pricing opportunites create market distortions. 164 This renders the patent system inefficient because it results in reduced availability or production, resulting in artificially [*21] higher prices. 165 Economists typically consider this deadweight loss from monopoly pricing to exceed the costs of other incentive systems. 166 In some sectors--for example, pharmaceuticals--analysts have found that monopoly power spawns a number of detrimental effects, including high drug prices, inequitable allocation of medicines, and the creation of follow-on drugs with little additional value. 167

Several procedures are available to minimize deadweight loss. A form of price discrimination, two-part pricing, is

Unique pricing and efficiency issues arise with government prizes. Although a primary argument in favor of prizes

over patents is the avoidance of intellectual property's deadweight loss, the overall reduction of deadweight loss

One of the prize system’s fundamental drawbacks compared to intellectual property is that the government must estimate the social value of inventions to set their reward without any direct knowledge of consumers’ willingness to pay for those inventions.160 Social value is notoriously difficult to measure objectively in most circumstances, and measuring the social value of innovations—which are unique goods by definition—may be particularly difficult.161 The prize system requires the government to identify an appropriate measure of social value because the default measure of social value provided by patents—that is, consumers’ willingness to pay—is intentionally eliminated to avoid deadweight loss. Goods are usually valued by way of the market, in which individual consumers reveal their demand for goods through their purchasing decisions. This market-based process for valuing goods works only in the presence of scarcity, however, and since inventions are intangible ideas, they are not scarce goods.162 As discussed above, the patent system introduces artificial scarcity into the markets for inventions in order to force consumers to reveal their demand for them, but in doing so, it prevents consumers from using those inventions at the efficient level. The prize system eliminates the artificial scarcity created by patents and thus avoids the deadweight loss from higher consumer prices under intellectual property.163 However, in the absence of intellectual property, the government will always have limited information about consumer demand. Historically, this was considered by many economists to be the fatal flaw of the prize system.164

Prize advocates have proposed a number of solutions to the problem in the form of alternatives for measuring the social value of an invention. First and foremost, the government can link prize payouts to sales volume,165 which discloses the number of consumers who are enjoying the good and provides a data point for estimating demand.166 The government could then surmise an innovation’s social value by combining the sales-volume data with an estimate of the innovation’s utility to consumers167— perhaps based on evidence from consumer surveys about the nature and frequency of its use,168 declared consumer preferences through voting,169 objective evidence of its utility to the average consumer,170 or observational studies measuring the social value it created.171 An alternative strategy is to introduce a small amount of artificial scarcity into the market from which to estimate consumer demand—such as through an auction172 or by observing profits in a limited test market.173

With patents, the central authority need not attempt to calculate the economic value of an invention, because the market will aggregate everyone’s demand for said invention and award the inventor proportionally. Since patents don’t have to choose a goal to incentivize ahead of time, they also promote investment in a wide range of inventions, even those that almost no one has thought of or those that most people think are useless.

What Smith leaves out is that governments still must proportion the reward from patents to the merit of the invention by choosing how long they are protected for. If 14 year patents are good, would 15, 50, or 5 year patents be better? In the US, design patents still get 14 years but the most common type, utility patents, get 20. There are exceptions for pharmaceutical products and the majority of newly issued patents receive some sort of extension over the 20 year mark. Additionally, although patents are more flexible than some targeted prizes, like the Royal Society’s prize for a method of calculating longitude at sea, prize funds can easily be open to an unspecified range of entries like the Macarthur Genius Grants, which have rewarded select researchers from poetry to physics with a million dollars for over 30 years.

Indeed, there are multiple reasons to believe that patents and patent enforcement are of minimal value and interest in China, such that the patent system is not a substantial driver of growth in the country.

For one thing, Chinese patent applications are low in quality. Chinese law offers three types of patents: "invention" patents akin to standard utility patents for inventions in the United States, "design" patents for ornamental or decorative features on products and "utility model" patents for "technical solutions proposed for the shape and structure of a product."10 The latter two patent types are less rigorously examined and less powerful as enforcement tools." Multiple recent studies show that Chinese patent filings have been predominantly of the design and utility model types, which suggests that the incentives for filing patents are not encouraging serious inventive activity.12

As temporary monopolies that suppress competition, patents are an important part of innovation but must be used in appropriate measures. Failing to do so undermines the rate of American innovation for at least two reasons. First, increasing patent rights encourages companies to put resources into patent disputes rather than research and development. Patent licensing can be an incredibly lucrative business for lawyers but it does not engage scientists and engineers to innovate. Obviously some level of patent protection is necessary to preserve the value of R&D investments but scaling up protection too far can make rent-seeking more valuable than research.20 And second, U.S. patents are not solely owned by U.S. firms. A rapidly growing number of patents in the United States are held by Chinese companies.21 If patents become too powerful an enforcement tool, they could ultimately be turned into weapons against American companies, further stymieing domestic innovation and giving a leg up to foreign competitors.

If businesses are rational economic actors, we should assume they will maximize their opportunities to file for and obtain patents. When patents of dubious quality are granted, this distortion can become more pronounced and more harmful to the goal of innovation. Maximizing patents can mean investing in lawyers, rather than engineers, and filing applications for inventions and processes which the firm has no intent ever to bring to market. In such cases, innovation and competition suffer, for no discernable benefit.

Even when they work properly, patents limit competition by granting a 20-year legal monopoly.7 De jure legal monopolies are able to use the power of the law to extract excess rents from consumers and other firms. In practice, it is not unusual that multiple teams work simultaneously on similar concepts and make similar or iterative discoveries, but only the team that receives the patent enjoys the windfall. The others typically will be barred from bringing their independent invention to market, rendering the research and development invested in such projects sunk costs.

As one notable example: the Wright brothers made a modest improvement to existing flight technology, but their patent allowed them to monopolize the U.S. market and, in essence, to prevent innovation until World War I.8 Other pioneers in the field effectively were shut out from bringing similar, even superior, technologies to market. As Steven Johnson demonstrates with dozens of anecdotes in his book Where Good Ideas Come From, independent invention is the rule, not the exception.9 Outside of the pharmaceutical industry, more than 95 percent of patent lawsuits do not even claim willful infringement – essentially conceding that the accused infringers likely developed the technology independently.10

Indeed, there are some who suggest that the marginal cost of any patent protection exceeds the marginal benefit, at least in many industries. The earlier analysis which said that without patent protection firms would have no way of appropriating returns to innovative activity oversimplified the issue in many critical ways. The first mover - the inventor of a new product - has distinct advantages over successors. He can move down the learning curve, producing at a lower cost or refining the product in ways that make it more attractive to customers. Though there may be instances of ‘leapfrogging’, where a new entrant leapfrogs the first entrant, these are rare, and noteworthy because they happen so seldom. In some industries, the costs of patenting (including that associated with the disclosure requirements, which provides valuable information to rivals) exceed the benefits. These industries rely on trade secrets. (Dosi and Stiglitz, 201438 )

Some algae-based products might most effectively be incentivized by prizes. Prizes are especially appropriate for incentivizing high-risk research on technologies that are still at their earliest stages. 415 Scientists still need to conduct basic research regarding several potential algae applications--such as biofuels and bioplastics--to establish their viability at acceptable costs. 416 Technical challenges and limitations still preclude these avenues. 417While centralized decision making might not be advantageous, the government might be best positioned to fund this basic research until directions and products become more apparent. Thus, prizes--which encourage a wide range of participation, perspectives, and directions--would be particularly appropriate. 418 Furthermore, because of the uncertainty of the paths forward, prizes have several advantages. First, they are likely to encourage participation by additional persons than might otherwise conduct this research. 419 Second, and related to the first, prizes are more likely to engender a wide range of solutions, including some not contemplated by the prize organizers. 420Finally, algae uses are still at their initial stages, so prizes are particularly well-suited incentives. 421 Prizes would be superior to patents because of the latter's provision of exclusive rights, which tends to discourage follow-on inventions. 422 Indeed, organizers could even break the prizes into a series of smaller prizes to further encourage follow-on or cumulative inventions. 423

Analysts have identified a number of benefits that prizes have over other incentive systems, especially patents. A primary advantage is that prizes can encourage researching technologies that markets do not value sufficiently. 254 Markets fail to encourage the development of technologies whose market prices do not reflect their value. 255 Prizes (and grants) "reward innovations that 'are publicly valued but not privately marketable.'" 256 A government prize, for instance, is essentially a government intervention into the markets where they have failed to sufficiently incentivize a public good. 257 Prizes are also [*31] well suited to encourage high-risk research on technologies that are still at their earliest stages. 258 Similarly, they might also be well suited to encouraging research in circumstances where scientific opinion is divided concerning the appropriate path to direct technological development. 259In other words, prizes fit circumstances where goals are clear, but the best paths to achieve them are less certain. 260 A number of competitions have demonstrated this pattern. Specifically, the Longitude Bill, the Netflix Prize, and the Progressive Insurance Automotive X Prize all involved identifiable goals where the means to achieve them were uncertain. 261 By establishing criteria that encourage research in particular areas, prizes can offer ex ante incentives to pursue a targeted objective. 262 Finally, by setting criteria that suggest a particular result, organizers can signal the importance of a particular issue. 263

Prizes also avoid the deadweight loss of patents. 264 Unlike the X Prize Foundation's provisions, organizers of other prizes usually require winners of traditional prizes to place their intellectual property into the public domain. 265 Consequently, if the proceeds from prizes are comparable to the returns inventors would receive from patent rights, then inventors receive fair compensation while the public gains ready access to their inventions without incurring the deadweight loss of monopoly patent rights. 266 In programs like those of the X Prize Foundation, which allow innovators to retain their patent rights, the prizes augment the rewards of the patent system. 267 This may be especially helpful where markets do not price in the social value of innovations because the prizes can help to close the gap between investment cost and market compensation. 268

A third method to encourage innovation is the use of structured prizes. Under the prize model, government agencies, private organizations or a mix of the two, typically host a competition to achieve some specific breakthrough, with the winner promised a set reward. The prize model is notable for its ability to produce significant multiplier effects, as a relatively small prize can spark major investment by the private sector.

In practice, the prize model offers a uniquely level playing field. Newer teams frequently bring novel solutions that outpace participants with nominally more impressive credentials. While prizes are not as common as other incentives to innovations, the historical basis for the model is at least as old as that as for patents. Prizes sponsored both by the private sector and by the public sector each have proven effective in encouraging research and development. A 2009 McKinsey report found that philanthropic and private-sector investment in prizes has increased significantly in recent years, including $250 million in new prize money brought to bear between 2000 and 2007.17 The Wall Street Journal concluded that “prizes have proliferated because they actually work.”18

Do prizes successfully incentivize innovation? Clearly they need not in all cases: for example, in

some cases the reward may be too low to successfully encourage R&D, or firms may not perceive the

In addition to the historical review done so far, another approach to understanding the relationship among patents, competition, and national security is to consider the role of cybersecurity. There is little doubt that computer system vulnerabilities that enable hacking and spread of computer exploits are a threat to the nation's defenses, so better cybersecurity is a key part of national security strategy. 155

Strong competition can thus complement national security by enhancing domestic cybersecurity, and patent assertion that unduly weakens competition [*395] detracts from cybersecurity. 156 Competition promotes better cybersecurity in at least two ways. First, multiple studies show that competition encourages firms to improve their products on multiple vectors including cybersecurity. Second, competition avoids a situation that security experts call a "monoculture," which increases vulnerability to severe cyberattacks. As former Secretary of Homeland Security Michael Chertoff wrote recently, "We need competition and multiple providers, not a potentially vulnerable technological monoculture," to guarantee national security. 157 Thus, cybersecurity provides a useful lens for understanding how unfettered patent assertion and licensing can detract from national security.