Patents key to innovation – financial incentive

Economists have repeatedly demonstrated that inventors are driven primarily by the expectation of profiting from owning the rights to their inventions. Zorina Khan of Bowdoin College, whose 2005 classic The Democratization of Invention: Patents and Copyrights in American Economic Development was awarded the prestigious Alice Hanson Jones Prize for outstanding work in economic history, observed that “Ordinary people [are] stimulated by higher perceived returns or demand-side incentives to make long-term commitments to inventive activity.” She also found that “their patterns of patenting were procyclical [and] responded to expected profit opportunities.”

Along with her colleague the late Kenneth Sokoloff of UCLA, Professor Khan then summarized the role of patents in helping U.S. startup businesses grow the economy from an agrarian backwater into the most powerful industrial economy on the face of the earth:

The U.S. patent system had a powerful impact on the patterns of inventive activity. Its provision of broad access to property rights on new inventions, coupled with the requirement of public disclosure, was extremely effective at stimulating the growth of a market for technology and promoting technological change [emphasis added].

Then, as now, the American formula for success was simple:

Startups + patents = jobs and economic growth!

Over the last 50 years, economists have found that patents continue to foster ex ante innovation — meaning, they induce people to invent because of the prospect of profiting from those inventions. The work of economists such as Arrow (1962), Griliches (1963), Schmookler (1966), Kitch (1977), Reinganum (1981), Klemperer (1990), Romer (1990), Giulbert and Shapiro (1990), Grossman and Helpman (1991), Scotchmer (1999), and Gallini (2002) on this issue is mostly available for free online at the Social Science Research Network.

One especially interesting 2007 study by Arora, Ceccagnoli, and Cowen entitled "R&D and the Patent Premium" found that "the patent premium for innovations that were patented is substantial. Firms earn on average a 50% premium over the no patenting case, ranging from 60% in the health related industries to about 40% in electronics.”

Sure, one should be cautious about academic research, especially given the old joke about how an economist opens a can of soup. (Answer: assume a can opener.) But real-world economics clearly confirms the research findings.

Consider, for example, that the biggest job-creating new industries of the last 60 years — semiconductors (consumer electronics), PCs, software, biotech, mobile telephony, and Internet e-commerce — were all launched and grew strong on the basis of patented inventions created by startup businesses. As the CEO of Juno Therapeutics, Hans Bishop, and ARCH Venture Partners co-founder Bob Nelson recently wrote in Forbes: “Let us be clear: investments in the biotech industry are based entirely on patents. Without strong patents, we cannot raise money to find cures for disease.”