Patents are key to innovation---any other incentive creates create low quality innovation.

Patents as discrete inventions are the building blocks for collections of inventions. Patents can be combined to form a patent portfolio. Firms can assemble a portfolio of patents with different technologies to meet their production needs. Buyers can license or purchase patents from different patent owners. Patent bundling offers transaction efficiencies by providing convenience to buyers and sellers. Because they represent discrete inventions, the particular needs of buyers and sellers can be satisfied by choosing the best combination of patents.

By offering divisibility, patents promote efficiency in the organization of firms and industries. A firm need not conduct R&D on all the technologies necessary to produce a product or service. Instead, firms can specialize in a particular type of R&D. Then, buyers can assemble the technologies they need through the market for inventions. In this way, patents help foster modularity of technologies, which allows the separation and combination of different parts of a technology platform.

Modularity of technologies generates efficiencies from specialization and division of labor. Different companies can focus on invention, innovation and manufacturing. Also, companies can focus on different types of R&D. For example, in the computer industry different firms can focus on R&D in software, microprocessors, memory, and screens. This type of specialization improves inventors’ knowledge and experience in comparison with what occur if firms would need to be proficient in all technologies needed to produce a particular product.

Because patents offer divisibility, as well as exclusivity and transferability, companies can engage in specialized R&D and exchange technologies in the market for inventions. This allows a division of labor in invention, innovation, and manufacturing. Specialization allows companies to take advantage of economies of scale and other types of efficiencies in invention, innovation, and manufacturing. Market exchange of technologies generates gains from trade by selection of the best inventions and wider usage of the best inventions (Spulber, 2008, 2010). Patents offer technological divisibility to the market for inventions that increases gains from trade.

II. The Market for Innovative Control

Because of patent protections for IP, the market for inventions is a market for innovative control. The residual returns from licensing, selling, or using patented inventions are only part of patent ownership. A patent owner can exercise residual rights of control because they can exclude others from making, using or selling the invention.35 The market for innovative control provides incentives for efficient investments in invention, innovation, and complementary assets. This is related to the way that ownership of corporate securities is the basis of a market for corporate control. Securities facilitate the separation of ownership and control and yield other transaction efficiencies (Manne, 1965, Spulber, 2009b).

A. Invention and Commercialization

The market for innovative control provides incentives for inventors to produce inventions that are desirable for consumers and producers. As a result of competition among inventions, the market for inventions helps to determine the best inventions for particular needs of consumers and firms. Competition among potential adopters also helps the market for inventions allocate inventions to the highest value users. The market for inventions determines the relative returns to invention, commercialization, and innovation.

The market for inventive control thus provides valuable information and guidance to inventors and adopters. What matters are inventions, which are the outputs of R&D, rather than inventive efforts, which are the inputs of R&D. The point is not simply to reward any and all inventive efforts, but rather to provide incentives that direct inventive efforts based on the anticipated market value of inventions and innovations. Simply subsidizing invention or rewarding inventive efforts could produce more inventive efforts but not necessarily better inventions. Government subsidies or rewards for invention in the absence of IP protections also would not provide incentives for commercialization of inventions, which is essential for diffusion of technology and innovation.