Ex post rewards overcome the possible informational advantage of patents – info will be better and more widely distributed

The most serious problem for government contracts is likewise the most serious problem for prizes: The government must determine what to pay for and how much to pay.57 Too small a reward relative to social value will lead to too little invention; too large a reward, in turn, will lead to wasted inventive effort. On the other hand, patents only clearly have benefits over the other two systems if innovators have important information about the value of the desired invention or creation.58 This advantage may be substantial if we assume that governments often will be less likely than private investors to know of the existence of possible creations or inventions, much less of their value.

Recent work on prize design, however, shows that the informational advantage of patents may be less substantial than once thought. The key insight is that the size of a prize need not be established ex ante. It can also be determined ex post—when there is better and more widely distributed information about value. For example, Michael Kremer has suggested an ex post patent buyout mechanism that uses an auction to elicit private information about the value of the invention.59 Steven Shavell and Tanguy Van Ypersele subsequently brought attention to the possibility that prize amounts could be set on the basis of market sales.60 The latter model has been the subject of important recent proposals for innovative incentive mechanisms, most prominently in the areas of pharmaceutical research and music. These incentive mechanisms would reward creators according to a measure of the uptake of their creations, and at the same time, would address deadweight loss by suspending price in lieu of a prize.61 While these models would require funding, presumably through taxation (which also generates deadweight loss), price is equivalent to a tax on a single market, “which is generally thought to impose greater deadweight loss than the broad-based taxation that generates general revenue.”