Patent buyouts support innovation – historical examples prove the capacity for follow on

In this paper we have examined the problem of a social planner aiming to maximize consumer welfare and innovation incentives while observing prices and quantities practiced by the innovator over time. We have shown that in our model information about market outcomes may allow the planner to generate more welfare than a traditional patent system through patent buyouts. There are a number of historical experiences in which governments bought patents out. The most famous example of patent buyout took place in July 1839 when the French government purchased the patent for the Daguerreotype photography process. The inventor, Luis Jacques Daguerre, was not able to find buyers for the process, but obtained the support of a politician that convinced the government to acquire the patent and put the rights in the public domain. Within a short period of time the process spread around the country to become the technology standard in photography (Kremer, 2001). In recent academic and policy debates pharmaceutical patent buyouts have been suggested as a strategy to improve health in low income countries. For example, Banerjee et al. (2010) propose that a Health Impact Fund compensate drug manufacturers that sell in low income countries at marginal cost. They suggest that the compensation to a given manufacturer would depend on use of the drug and evidence of realized health benefits.20 Our paper provides two main insights into the design and application of such buyout schemes. First, the planner may find it beneficial to collect market data before the buyout and use them to estimate the surplus generated by the innovation. In practice, surplus may be estimated through structural econometric models that allow policy makers to estimate the primitives of consumer preferences and to generate out of sample predictions (Cho and Rust, 2008). Such estimates can provide useful guidance in the determination the buyout compensation for the innovator. Second, the planner should consider the welfare cost associated with collecting price-quantity observations. As long as local variation in market outcomes can be exploited to learn about the global properties of the demand, prices close to marginal costs minimize the loss in consumer surplus.