Data fully disproves patent holdup theory – innovation in SEP-intensive industry is higher than the rest of the economy

Like the theory of the peaceful Maya, patent-holdup theory had its own set of facts—stelae, as it were—that contradicted the theory. Patent-holdup theorists asserted that innovation in SEP-intensive IT products was under threat: excessive royalties were discouraging new firm entry and reinvestment by existing firms. They called particular attention to the threat to innovation in mobile telephones and personal computers, as well as in extensions of those products in the IoT.15

Economists measure rates of innovation by examining relative rates of change of quality-adjusted prices,16 and one can download the publicly available, product-by-product, quality-adjusted price data compiled by the Bureau of Labor Statistics in order to carry out an analysis of innovation rates across products and within products over time.17 An analysis of that data shows that from 1997 to 2013, rates of innovation in phone equipment (which includes low-tech items such as fax machines and landline phones, as well as wireless phones) was 10 percent per annum faster than the economy-wide average. The data show that the rate of innovation in portable and laptop computers was faster still—31 percent per annum faster than the economy-wide average. Similar rates of innovation are observed in other SEP-intensive IT products such as video equipment, audio equipment, desktop computers, and televisions. Furthermore, rates of innovation in SEP-intensive IT products have not slowed over time relative to the rates of innovation in similar, non-SEP-intensive IT products.18 For example, the rate of innovation in SEP-intensive laptop computers compared with non-SEP-intensive mainframe computers shows that SEP intensity was associated with faster innovation.19

There are other hallmarks of innovation beyond falling quality-adjusted relative prices: one would expect to see rapidly increasing output even in the face of falling prices; and, because innovation is typically characterized by Schumpeterian creative destruction, one would also expect to see high levels of firm entry and exit. This is precisely what researchers do see when they examine data on the canonical case of the mobile phone industry. Between 1994 and 2013, the number of SEP holders increased from 2 to 128. Patent-holdup theory would predict that this increase should have dramatically slowed the rate of innovation. That prediction did not obtain in reality, however. Prices of mobile devices dropped very fast, while output grew sixty-two-fold. During this same period, there was rapid entry of new firms into the manufacture of phones and tablets—so much so that industrial concentration, measured with the number of devices sold, actually fell in this industry over time.20