A reward system avoids high costs from patent-created monopolies --- information difficulties can be overcome

TWO basic means of stimulating innovative activity are compared in this paper. One is a system of rewards paid by the government to innovators. According to this system, innovations would pass immediately into the public domain, becoming freely available to all. The other approach is the familiar system of intellectual property rights that we employ, notably, patent and copyright protection, under which the government confers to innovators exclusive rights to market the goods and services that embody their intellectual works.

Our main conclusion is that the intellectual property rights system does not enjoy any fundamental advantage over the reward system. Indeed, an optional reward system--under which an innovator can choose between a [*526] reward and intellectual property rights--is superior to the intellectual property rights system in the model we examine. These findings derive from the primary virtues of reward systems: that incentives to innovate are provided without granting innovators monopoly power over price and that the magnitude of research incentives may be selected by the government. A principal difficulty with reward systems, however, concerns the government's need for information to calculate rewards (although the government might be able to base rewards on sales and other ex post data).

To motivate our analysis, we first mention a significant historical episode about the patent system and rewards. Although a fairly well articulated patent system had emerged as early as the 1400s in Venice and had spread through much of Europe and the New World by the end of the eighteenth century, the system came under strong attack in the next century, especially during the period 1850-75. 1 Criticism of the patent system reflected dislike of monopoly power, both because it harms consumers who have to pay high prices and because it can hinder improvements and subsequent innovations if patent holders disallow that. 2 Many economists disapproved of the patent system, and in some countries, such as Germany, the economics profession was virtually unanimous in its opposition to patent. 3

Reward systems were widely discussed as an alternative method of spurring innovation (and they had been used to a not inconsiderable extent). 4 For [*527] example, Robert Macfie, a member of Parliament in England and an influential champion of rewards, set out a proposal for a government-financed reward system to replace patent; the London Economist pressed for adoption of a reward system; and economists examined rewards in professional journals, books, pamphlets, and conferences. 5 Opinion was, however, divided on the virtues of rewards (criticism of patents did not imply endorsement of rewards). The chief argument against rewards concerned difficulties in their administration; it was typically expressed by John Stuart Mill, who maintained that patent is preferable "because it [patent] leaves nothing to anyone's discretion; because the reward conferred by it depends upon the invention's being found useful, and the greater the usefulness, the greater the reward." 6

As a consequence of the criticism of patent and also of the possible utility of rewards as an alternative, many countries in Europe prepared to reform or abolish patent, and some actually did so: England established a series of royal commissions from the 1850s to the 1870s to investigate the patent system; Chancellor Bismarck recommended abolition of patent in Prussia in 1868; Holland repealed its patent system in 1869; and Switzerland, which had no patent law, rejected legislation to adopt it in 1863. Nevertheless, Europe ultimately embraced patent, but for reasons that may perhaps be regarded as more politically accidental than indicative of a substantive policy judgment favoring that system. 7

In any case, today, intellectual property rights provide the principal legal financial stimulus for innovation. 8 Rewards are little employed; their payment appears to be limited to inventions in the area of atomic energy and to certain other exceptional cases, although they were provided to inventors in the former Soviet Union. 9

[*528] Modern economic literature reflects our reality and takes the general optimality of intellectual property rights largely as a given; the possibility of rewards is paid relatively little attention, despite the history we have summarized and despite the seeming appeal of the topic to the intellect of the economist. 10 There have been few papers written in economics journals in the past century on reward. 11 Two exceptions are those by Michael Polanvyi and Brian Wright. 12 Polanvyi recommends, in a sustained and insightful but informal argument, that rewards be adopted to foster innovation and to avoid the social losses associated with patent monopoly power; he offers reasons why informational difficulties facing the government in determining awards should not prove insurmountable. Wright is the first to consider a formal model of innovation in which innovators possess superior information to the government, and he finds that rewards are better than patents if the government's information is sufficiently good. Also, Michael Kremer, in an interesting, related paper, suggests that the government could avoid social losses associated with patents by purchasing them at a price that it obtains from an auction process. 13 (Governments have in fact occasionally purchased patents, and proposals for this to be done programmatically have sometimes been advanced.) 14 Another paper of significance is by Suzanne Scotchmer; although she does not emphasize rewards, she characterizes the optimal form of patent system under the assumption that innovators possess superior information to the government. 15

[*529] In this paper, we examine a model in which a single potential innovator knows the demand curve for the product innovation he might produce before he invests in research, whereas the government knows only the probability distribution of demand curves. 16 We first compare the patent system (for concreteness, we refer to patent rather than to copyright or to intellectual property rights in general) to the reward system, and then we investigate optional reward systems. 17 The chief contributions of the paper are that it clarifies the comparison between patent and reward systems through the use of a simple and natural model of innovation and that it considers the optional reward system and shows it to be superior to patent. 18