Patent buyouts generate greater innovation and increase social welfare

Mitigating patent rights as a way to improve welfare fits with current concern over the patent system. Concerns about the potentially deleterious effects of patents have been voiced in both academic and policy debates. In a prominent book, Jaffe and Lerner (2004) conclude that in the U.S. patents have become “sand rather than lubricants in the wheels of American progress.” Some have even gone so far as to recommend more draconian reductions in permissible patenting (Boldrin and Levine, 2008; Bessen and Maskin, 2009). The buyout system replaces some of the rents that are obtained through monopoly rights with a prize. If the planner cannot discern the quality of innovations, pure prizes are difficult to implement because the value of the prize cannot be tied to the surplus generated by the innovation as the demand is unknown by the policy maker. Even if the planner could get good information about the number of units sold at a given price, for instance by observing units sold under perfect competition, this is insufficient to construct the inframarginal values of consumers, which is essential to estimating the full value of an innovation. In our model, the hybrid mechanisms can generate greater innovation incentives and increase social welfare if the policy maker has less than perfect information about market demand.