Subsidies fail – doesn’t effectively solve market failures and misallocates resources

[Christopher J. Jr., et al. "The Hidden Cost of University Patents." Berkeley Business Law Journal, vol. 21, no. 1, 2024, pp. 203-249. HeinOnline -tm]

Universities are engaged in a public-facing enterprise: the creation and dissemination of new knowledge. Clearly, they do this through their educational mission; they educate and credential students for success in the workforce-an example of a public good through human capital creation. And because of their organization as charitable corporations, universities rely on altruism, a nod to the fact that they produce a public good, in recognition of their educational mission. But they also, theoretically, create public good in pursuit of patents via disclosure. Yet, where universities rely on altruism as charitable corporations, their technology transfer model also relies on profits from their patent portfolio. This juxtaposition makes technology transfer offices the corporate beachhead embedded within the university, while also tangentially aligned with a university's mission of encouraging innovation.

And innovation, itself, is a public good.ss It is non-rival.s9 That is, the use of innovative ideas and products does not reduce their supply.9o And it is theoretically non-exclusionary, except when patent protections disallow profit­ seeking uses of disclosed innovative ideas.91 But, as with all public goods,market failures can occur, particularly when users of innovations do not pay the marginal costs of production of the innovation. n In these cases, the government may step in to correct market failures by providing direct subsidies for innovation via grants and other direct payments. 93

But direct government subsidies cannot always solve market failures in innovation, because information costs prevent the government from allocating direct subsidies efficiently. For example, the government does not always know which potential innovations to subsidize. It may under-subsidize valuable research and over-subsidize worthless endeavors. Politics also creates information costs. Political actors decide what to subsidize, and their decisions may be influenced by factors other than efficiency (including self-interest).

Accordingly, the government uses patents to solve these "government failures" by subsidizing innovation indirectly. At least in theory, innovators have better information about which potential innovations are likely to be valuable and which ones are not. Patents give innovators a financial incentive to invest in potential innovations they believe will be valuable by granting them certain exclusive rights in those innovations. Rather than paying for the innovation directly by issuing a research grant, the public pays for it indirectly by paying higher prices for innovative products and services protected by patents.