Strengthening patent protections unlocks monopoly war-chests

In the long run, even the positive partial equilibrium effect of patents in providing an incentive for innovation may be more apparent than real: the existence of a large number of monopolies created by past patent grants reduces the incentives for current innovation because current innovators are subject to constant legal action and licensing demands from earlier patent holders. The downstream blocking effect of existing monopoly grants on incentives for future innovation has greatly increased in recent decades because modern products are made up of so many different components. The recent—and largely successful—efforts of Microsoft to impose a licensing fee on the large and expanding Android phone market is but one case in point. With the exception of Motorola Mobility, all the handset manufacturers have agreed to the fee, and Motorola lost its first battle against the fee in spring 2012—fought not in court but in the more receptive domain of the US International Trade Commission (Investigation Number 337-TA-744, May 18, 2012). Microsoft is attempting to charge a licensing fee solely over a patent involving the scheduling of meetings—a rarely used feature of modern smartphones. The meeting-schedule feature is but one of many thousands of patented "ideas" used in a modern smartphone, and each owner of each patent potentially can charge a licensing fee. Hence, the main dynamic general equilibrium effect of a patent system is to subject future inventions to a gigantic hold-up problem: with many licenses to be purchased and uncertainty about the ultimate value of the new innovation, each patent holder, in raising the price of his "component," imposes an externality on other patent holders and so charges a higher-than-efficient licensing fee. In Boldrin and Levine (2005) and Llanes and Trento (2009), we and others have explored the theory; and many case studies involving patents (and other fractionated ownership problems) can be found in Heller (2008).

To understand more about the actual effect of patents in the real world, consider the recent purchase by Google of Motorola Mobility, primarily for its patent portfolio—not for the ideas and innovations in that portfolio. Few, if any, changes or improvements to Google’s Android operating system will result from the ownership or study of these software patents. Google’s purpose in obtaining this patent portfolio is purely defensive: it can be used to countersue Apple and Microsoft and blunt their legal attack on Google. These remarks apply to the vast bulk of patents: they do not represent useful innovation at all and are just weapons in an arms race. This is not news: the same message emerged decades ago from the Levin, Klevorick, Nelson, and Winter (1987) and Cohen, Nelson, and Walsh (2000) surveys of research and development managers.

One could argue that the costs of building up a patent portfolio to engage in this sort of defensive patenting are not too large: after all, it can cost as little as $15,000 to file a successful patent application, and filing applications on a larger scale might be cheaper. However, the acquisition of large patent portfolios by incumbents creates huge barriers to entry. In the smartphone market, for example, Apple is the market leader and Microsoft is unable to produce a product that appeals to consumers. Each is an incumbent firm with a large patent portfolio. In this market, Google is the new entrant and innovator and, while wealthy, Google found itself lacking a large defensive patent portfolio. Hence, we see both Apple and Microsoft attacking Google with patent litigations, generating hundreds of millions in wasteful legal costs and no social benefit whatsoever.

Despite the fact that patents are mostly used for arms races and that these, in turn, are driven by patent trolls, there does not yet exist convincing formal models of the ways in which this interaction can inhibit innovation. In a pure arms race theory, if all firms get counterbalancing patent portfolios and all innovate, then they would all have innovated in the absence of patents---hence, patents do not encourage innovation. This follows because with counterbalancing patent portfolios, no firm can sue any other firm—exactly as would be the case in the absence of patents. Hence, in this setting, patents simply add a cost to innovation: if you wish to innovate, you must acquire an expensive patent portfolio to avoid trolls. On the other hand, if a patent holder does not produce a marketable product and hence cannot be countersued—like Microsoft in the phone market or other patent trolls in other markets—then patents become a mechanism for sharing the profits without doing the work. In this scenario, not only do patents discourage innovation, but they are also a pure waste from a social standpoint.