Patents: Prompting or Restricting Innovation?

By Marc Baudry and Béatrice Dumont

The patent system is criticized today by some practitioners and economists. In fact, there is a partial disconnection between patent demographics and productivity gains, but also the development of actors who do not innovate and who develop business models that their detractors equate with a capture of annuities or a dangerous commodification of patents.

This book provides a less Manichaean view of the position of patents in the system of contemporary innovation. It first recalls that these criticisms are not new, before arguing that if these criticisms have been revived, it is because of a partial shift from an integrated innovation system to a much more fragmented and open system. This shift accompanied the promotion of a more competitive economy. The authors show that this movement is coherent with a more intensive use of patents, but also one that is more focused on their signal function than on their function of direct monetary incentive to innovation.

• Language: English
• Publisher: Wiley
• Release date: Oct 30, 2017
• ISBN: 9781119473732

Book preview

Introduction

It is tempting to see the debate about the relevance of patents for supporting innovation as a contemporary, updated version of the tongue anecdote from Aesop, the famous ancient Greek fabulist who was also a slave. When his master asked him to go to market to buy the choicest dainties to honor some special guests, Aesop only bought tongues, which he served with different sauces. When his master questioned his choice, Aesop responded, There is nothing better than the tongue, the connection to civil life, the key to science, the organ of truth, reason and prayer. Through it, we build cities and govern them, we teach, we persuade, we hold assemblies, and we carry out the most important of all work, which is to praise the gods. Offended by this answer, Xanthos, Aesop’s master, asked him to choose the worst meal for the same guests to try the next night. Again, Aesop bought only tongues, and served them with different sauces. To his puzzled master, he responded: There is nothing worse than the tongue, the mother of all disputes, the source of all conflict and wars, the organ of error and slander, blasphemy and impiety. Through it, we destroy cities, we convince people of evil things, and we utter blasphemy about the power of the gods¹.

Patents are at least as ambivalent as Aesop characterizes the tongue. This ambivalence has long been recognized. When concluding his report for the U.S. Senate about patents, Machlup [MAC 58, pp. 79–80] wrote: No economist, on the basis of present knowledge, could possible state with certainty that the patent system, as it now operates, confers a net benefit or a net loss upon society. The best he can do is state assumptions and make guesses about the extent to which reality corresponds to these assumptions. […] If one does not know whether a system as a whole is good or bad, the safest policy conclusion is to muddle through either with it, if one has long lived with it or without it, if one has long lived without it. If we did not have a patent system, it would be irresponsible, on the basis of our present knowledge of its economic consequences, to recommend instituting one. But since we have had a patent system for a long time, it would be irresponsible, on the basis of our present knowledge, to recommend abolishing it. After emerging in England, as a system of exceptions in the context of laws to counter monopoly rents, patents were conversely consecrated as a natural right of all men over what they produced following the French Revolution in 1789. Over the course of the 19th Century, calls to put an end to the patent system increased. In Great Britain, the news magazine The Economist openly took a position in favor of abandoning them in an article published in 1851². In France, the Saint-Simonian economist Michel Chevalier wrote as early as 1862 that the legislation of invention patents is harmful to industry today (Chevalier [CHE 62]). Some countries, such as Switzerland, refused all protection by patents, a system judged in principle to be pernicious and indefensible in itself³. The Netherlands abandoned the legal protection of inventions between 1869 and 1912 (Schiff [SCH 71]). The movement in support of abolishing the patent system – its reform as it was called – nearly carried the day between 1850 and 1875, but those in favor of maintaining the system were victorious in the end owing to the protectionist reaction at the turn of the century (Machlup and Penrose [MAC 50]).

The inability, for more than a century and a half now, of industrialized or industrializing countries to develop a sustainable mechanism that encourages innovation that could substitute for patents and displace them may be seen as default proof that patents are the best system. Even though the academic literature has considered, and continues to actively consider, the question of the best support mechanism for innovation, it must be said that no alternative solution seems able to fully eclipse patents. So, we can justify maintaining the patent system in light of Oliver Williamson’s criterion of remediableness [WIL 96], which is to say that an existing practice for which there exists no feasible better alternative, which can be described and implemented with a reduced net gain, is presumed to be efficient. This does not mean that the patent system does not have a certain number of flaws and quirks, only that the alternative solutions are not exempt from those either. Because of this, several economists defend the system as being the lesser evil, somewhat in the manner of Winston Churchill, who said that democracy was the least objectionable of the political systems. Therefore, according to a law and economics logic, strong patents are indicative of a system of intellectual property, just like property on tangible assets, that is indispensable for the good working of the economy (Kitch [KIT 77], Posner [POS 05]).

The demography of patents, however, compels us to be somewhat alarmist. In the last four decades, the increase in the number of patents requested and granted around the world seems out of control. Just as a population living in too great a concentration in a given space generates stress, illness, aggressiveness, and conflicts, the system seems to be becoming ill. Some people see evidence of this in the overlap of rights conferred by patents, generating patent thickets, which would lead to a prolific rise in litigation or blocking the dissemination of innovations by a stacking in license fees. Similarly, some authors indicate the weakness of empirical evidence regarding the link between the demography of patents and productivity growth, and only see an unhealthy outgrowth of the system, almost like a cancerous tumor, in the increase of this demography. The typical agent, according to this perspective, would be the patent troll who hides behind patents that are superficial in substance, only to capture rents at the expense of real innovators. For instance, Boldrin and Levine [BOL 08], who are at the forefront of the contemporary movement of patent contestation, criticize the idea that patents would lead to a higher rate of innovations. Based on the number of innovations presented at international trade fairs, they argue that in the 19th Century, countries that did not have a patent system were no less innovative than the countries that did have one. According to economists who support this slightly Manichean approach to patents (and they are no less numerous than their opponents), the staggering growth of patents is negative. For them, we must, at the very least, practice a technological Malthusianism by drastically narrowing the qualifying conditions for patents, or even abolish the patent system itself.

What can we contribute to such a polarized debate about the relevance of patents? First of all, we can trace the events and reasoning that led to this polarization. We can also re-situate it in a larger context. The last three decades of the 20th Century were marked by a number of economic changes. At the end of the 30 glorious years, the economic system characterized by a kind of capitalism that was tightly regulated by the State, has been replaced by a new economic system where the prevalence of markets is affirmed. It consists of goods markets based on the development of international trade and the advent of globalization. It also involves financial markets with unprecedented mobility for capital. It is not at all surprising that the model for innovation also changed in such a context. Confronted by markets for goods and services where competition is stimulated by new actors struggling to gain entry, the model of innovation necessarily led to change in the 21st Century. More actors also means that smaller actors cannot exist without specializing, including in the production of innovative solutions intended for others. However, smaller actors are also more subject to financial constraints. In order to bypass these constraints, what is more logical than to turn to the financial actors for whom obstacles were removed regarding the possibility of involvement? More actors can also mean more interactions among them. What we see emerging in this systemic logic is a shift away from a vertically integrated model of innovation à la Schumpeter where large firms create inventions internally, fund R&D themselves, and attempt to produce and commercialize innovations by themselves, toward a fragmented and intermediated model where a large number of actors interact with each other. These interactions require guarding against imitation as best as possible, but also sharing inventions while still being able to protect them. Patents can respond to these requirements. They ensure what economists call the appropriability of returns from inventions, and thereby encourage innovation. Aside from this traditional perspective on their role, patents also make it possible to demonstrate inventive capacities and reduce information asymmetry in transactions concerning new technologies, in partnerships forged to design these technologies, or in the access to external funding for R&D to support these technologies. This does not mean that the new system guarantees more innovations. It is only said that, while the vertically integrated system of innovation could more easily do without patents, the new fragmented system of innovation is much more constructed with, and even around, patents. That is what this book will attempt to demonstrate.

To understand this logic, it is important to start by recalling the purpose of patents. This is the goal of Chapter 1, which begins by reiterating the incentivizing role of patents. As the right to forbid others from exploiting an invention, in cases of successful inventions, it provides a rent that compensates ex post the inventor for having taken ex ante a risk and dedicated the means to develop the invention. The patent is therefore basically a sequential compromise for according a return ex post by creating an incentive ex ante. However, this right of intellectual property must not only be enacted by public authorities, it must also be defined. This delimitation is much more complex than for other property rights, especially land-related ones. It relies on the choice of multiple parameters and because of this, it can give rise to the best or the worst results, as the devil is often in the details. Aside from the incentivizing role of patents, which is traditionally emphasized, patents also have a transactional role. Chapter 1 discusses this as extensively as the incentivizing role. It shows how patents are intimately connected to the move by certain actors to specialize in the design of inventions, and then their transfer to other actors. The transactional role of patents is not limited to the transfer of innovative technical solutions. It also concerns access to external funding for R&D, as soon as it is subject to information asymmetry. In the sense of the economy of information, the patent becomes a credible signal of the capacity for innovation by young companies that are not yet well known. It facilitates the introduction of start-ups to venture capitalists. This shift is significant because it is no longer what the patent protects that is the most important, but the signal that it sends, whether or not the patented invention is developed.

The different facets of the delimitation of patents presented in Chapter 1 all offer room for a patent office to maneuver. Chapter 2 focuses on demonstrating how legal and institutional adjustments can have serious consequences on patent demography. This chapter begins with a factual analysis of the evolution of this demography and its connection with the evolution of productivity increases. It not only confirms a certain disconnect between the two evolutions but also indicates that the idea of an uncontrolled demography without the tangible benefits of patents is to be nuanced depending on the patent office under consideration. The problem is not only first and foremost an American issue, but also increasingly a Chinese issue, that is recent but whose scale will multiply several fold. Chapter 2 then focuses on a comparative study of American and European cases and their recent developments to highlight how different approaches and problems hide behind apparent procedural similarities. Today, it is well known that the European Patent Office does not easily grant its imprimatur. In this sense, it is representative of what we can characterize as top of the line in terms of requirements on the part of a patent office. In contrast, the US Patent and Trademark Office is known for its principle of rational ignorance, which consists of relying heavily on the legal system to regulate the question of patent delimitation and assertion.

From the principle of rational ignorance employed by the patent office, there logically follows a phenomenon of litigiousness around patents. The full extent of this phenomenon is detailed in Chapter 3. Often perceived negatively, this litigiousness is addressed by presenting the so-called hold-up problem concerning, on the one hand, the development of patent assertion entities (including the infamous patent trolls) and, on the other hand, the case of patents that are essential for a standard. The position taken in Chapter 3 is to consider that patent trolls are to patents what arbitrageurs are to finance: they play the maligned role of exploiting the flaws in the system, but in doing so, they prevent these flaws from developing. They are therefore all the more useful when patents are delimited vaguely and have a considerable risk of overlapping, which also explains why they prosper primarily in the new world, not the old one. The case of patents that are essential for a standard illustrates how the road to hell is paved with good intentions. Standards are a common reference point on which potentially competing companies can rely to develop a technology while guaranteeing compatibility for users, regardless of the technology provider. However, when standards are constructed around patents, the market power of the patent holder can be increased or even amplified by supposedly anticompetitive conduct. So-called FRAND (Fair Reasonable And Non-Discriminatory) licenses are supposed to remedy this. Even if, in reality, they can prove complex to implement because they are too imprecise, they demonstrate the ability of the system to adapt to problems it encounters.

To paraphrase a famous quote in American jurisprudence, everything under the sun that is made by man can be patented⁴. Chapter 4 addresses the emergence of a new place in the sun for patents in the context of a system of innovation that is not vertically integrated but fragmented between multiple actors. To this end, it supports the idea that there are other tools to support innovation besides patents. More specifically, it addresses prizes in innovation competitions that are often presented as alternatives to patents while still constituting, like patents, a tool to compensate inventors. It demonstrates that these competition prizes do not represent more of an alternative to patents than financial support tools for R&D. Rather, Chapter 4 argues that these tools are complementary to patents. Chapter 4 then goes further, supporting the idea that patents are paradoxically useful in a system of innovation that is not only fragmented and intermediated, but also open. Indeed, the notion of open innovation is often presented as contradictory to the proprietary approach generally illustrated by patents. A significant part of the academic literature tends, on the other hand, to show that an open innovation approach often requires spreading information about inventions while protecting them, and that patents allow for this better than other protection strategies, such as the secret. A more systematic use of patents could thus support the development of open innovation.

Throughout these chapters, this book seeks to inform the reader about a middle ground regarding patents. It moves away from a traditionalist conception which, by insisting on the incentivizing role of patents, tends to neglect their informational role, especially as a signal. Without contesting the relative disconnect between the upward demography of patents and the significantly more moderate productivity gains, this book proposes an alternative interpretation to that of the abolitionists. It suggests that the position of patents within the system of innovation is renewing itself, with the shift toward a more fragmented, more intermediated innovation that is also more open and which guides the contemporary evolution of the most developed economies.

1 See Mayvis [MAY 06], Chapter 8.

2 See http://economist.com/news/business-and-finance/21660769-second-leader-1851-about-patents-amendment-patent-laws.

3 Patent protection dates from 1888 in Switzerland, with an extension of the breadth of the protection in 1912.

4 See Case Diamond v. Chakrabarty 447 US. 30 (1980) and the opinion of Chief Justice W. E. Burger declaring Congress had intended patentable subject matter to include anything under the sun that is made by man. For a discussion of the origin of this expression, see also Kauble [KAU 11].

1

The Purpose of Patents

1.1. Introduction

Proponents of a patent system for inventions often present it as indispensable for supporting innovation, in the sense that innovation would not be fully realized without patents. From the outset, this perspective relies on the assumption that innovation cannot emerge from a "laissez faire" situation, or at least not in a complete and satisfactory way. Even before questioning the relevance of the patent system, it is important to consider the necessity, or lack thereof, of promoting innovation. This does not mean questioning the social utility of innovation, although technology divagations can sometimes lead us to consider some innovations to be more harmful than beneficial to society and call for a kind of precautionary principle. Without denying this problem, it is not the focus of our reflection here. Rather, we intend to discuss why public intervention would be necessary and, more particularly, if patents are in fine a more or less appropriate mode of regulation.

The discussion has two stages. In a first stage (section 1.2), the traditional approach to the role of patents to incentivize innovation is presented. By articulating the non-rivalry and non-excludability properties of patents in the use of ideas and inventions that result from them, it is shown that a lack of private incentives for innovation affects the economy. The emergence of the patent as an intellectual property right in response to this lack is discussed. The specificities of this type of property right are emphasized in order to provide a first glimpse into the debate about the relevance of patents. In a second stage (section 1.3), patents as intangible assets are addressed. Their importance as intangible assets is twofold. Not only are they assignable and make it possible for companies to specialize in the production of innovations, but they also play a facilitative role in the access to external funding for innovating companies. Reflecting a relatively recent development in the literature, the role of patents as a signal for innovativeness appears just as important as their role as an incentive. Above all, the recognition of this role leads us to consider the debate about the relevance of patents differently, even if it means shifting to other questions inherent to this movement of financialization.

1.2. Patents as an incentive mechanism

The main idea that is generally put forward to justify public intervention in matters of innovation is that innovation results from flashes of genius which are not subject to rivalry in use. This means that once an individual has developed an idea in the form of an invention, that invention can be used almost without cost by others. This is a simplistic view of things, because an effort to understand the ideas that led to the invention is generally required to mobilize it, but the main principle is that the cost of understanding with the view of reproducing the invention is minimal, compared to the cost of the rediscovery ex nihilo of the invention. It is therefore collectively desirable to spread the idea and its realization in the form of an invention to everyone. This prevents wasting resources, even if only time, in the economy¹.

Nevertheless, non-rivalry in the use of ideas has economic consequences that are quite different if it intersects with another property: the possibility of precluding use (or not). The impossibility of preventing use can result in a potentially strong disconnect between the private valuation that the economic agent who came up with the idea can expect from the invention he or she created and what the invention contributes to the community. Pushed to an extreme, such a disconnect eliminates all monetary incentives that endeavor to support innovation. It therefore greatly slows the rate at which innovations appear, limiting them to innovations that occur by chance or through motivations other than the pursuit of private interest. Long recognized by public authorities, this problem is at the root of the patent system, which is supposed to respond to it by establishing a right of intellectual property over inventions that result from flashes of genius. It is this incentivizing role of the patent that has long prevailed, and still largely prevails, over the debate about the relevance of the patent system. If there is a debate, it is because patents do not establish a property right like any other. This is what the first section intends to demonstrate.

1.2.1. The key question of appropriability of returns for innovation

What economists call club goods are the result of the combination between non-rivalry and the possibility to preclude usage. The economic model of club goods consists of requiring payment in exchange for access to the good. It is therefore possible for the individual or company who produces a club good to receive a part of their return from the use by each individual to whom access to the good has been granted. The compensation for the producer of this kind of good is therefore proportionate to the number of individuals who are willing to pay the asking price, and when applicable, the number of units that each individual wants. A live performance is generally a club good. Provided that the number of spectators does not damage the perception that each individual has of the performance, there is a non-rivalry. It is also possible to exclude individuals from accessing the location where the performance is occurring. On the other hand, when it is not possible to exclude usage, the individual or company who produces the good finds themself unable to derive returns from individual beneficiaries through an appropriate price structure. It is therefore not a viable economic model in the context of private production. An air show is an example of this. Even if, like the live performance, there is indeed non-rivalry as long as the number of spectators remains limited so that no one interferes with one another while watching the air show, it is generally impossible to prevent individuals outside of the airfield from watching the show. In the absence of market incentives to produce them, goods that have both properties of non-rivalry and non-excludability are produced either directly by public authorities or indirectly by public commission of private actors. What about innovations? To answer this, it is necessary to distinguish different steps in the process of creating innovations and, at the same time, clarify the term innovation.

Innovations are a link in a larger process of knowledge creation in which we can identify three major steps:

– the domain in which they are implemented;

– the primary activity that characterizes them;

– the result that they produce.

The first step falls under the domain of science and is characterized by research that can be either purely speculative or oriented toward a concrete goal but its result is always a kind of scientific discovery. The application perspectives are generally too distant in time to be correctly predicted or even suspected. Their production therefore cannot rely on a market process. As scientific discoveries are a base for the following steps, it is nonetheless necessary to ensure their production with adequate incentives. The economics of science tends to highlight the role of peer evaluation in the careers of scientists, even simply the personal satisfaction derived from moral recognition by others or from the very fact of having solved a problem². The absence of rivalry in the use of scientific knowledge is obvious. There is a possibility of direct excludability, for instance by controlling access to conferences or to publications that present discoveries. In contrast, there is generally an impossibility for indirect excludability, in the sense that we cannot often prevent a person who has had access to the discovery from passing on the discovery to others. Consequently, scientific production is essentially supported by public funds.

The second step falls under the domain of technology and is characterized by the production of inventions that make it possible to solve a practical problem. The concrete character of the problem solved makes it possible to consider a more or less short-term application for the invention and therefore a potential market value. There is no rivalry in the use, as one application can be developed without preventing other applications. The possibility to exclude is, however, subject to discussion. It can be imposed by force³. It also partly depends on the technological field under consideration and the possibility for reverse engineering in that field. This consists of finding the concept for the invention by examining what is produced thanks to the invention. This is a common practice in the engineering industries. It is more difficult in the tire industry, which relies on tacit knowledge, appropriable with difficulty, as opposed to explicit knowledge. Where the possibility of excludability is not imposed by the very nature of the inventions, notably by the difficulty to proceed with reverse engineering, it can be imposed by law. This can happen through prohibitions. Over time, the law has moved more toward the attribution of rights. This is how the issue of patents, the subject of this book, emerged. Before discussing this issue in more detail, we will present the third step of the process.

The third step falls under the domain of the economy, and is characterized by the creation of value within a society. The creation of value can be achieved in a marketable form, such as through the successful commercialization of a new product, or a non-marketable form, through the dissemination of best practices regarding how to produce a good. It is only when the creation of value becomes effective that we are talking about innovation. It then becomes important to distinguish innovations, which are inventions that have created value, from inventions in general that have not, or not yet, led to the creation of value. In addition, innovations are not exclusively technological. A typology by object, directly inspired by the definition given by Schumpeter [SCH 11], led to the present distinction between four types of innovations (Oslo Manual [OEC 05]):

– Process innovation (implementation of a new production technique). Thanks to this kind of innovation, a company can produce an existing good for a lower cost than its competitors. This type of innovation follows a logic of vertical differentiation in production tools. A classic example is the process invented and patented by the English engineer and inventor Henry Bessemer in 1855 to manufacture steel in a more efficient way.

– Product innovation (commercialization of a product that offers new features or responds to needs that were hitherto not satisfied or poorly satisfied). Thanks to this kind of innovation, a company can be the only one to supply the new good on the market. This type of innovation follows a logic of differentiation that is at least as much horizontal as vertical. A relatively recent example is the development of mobile phones in the 1990s and then smartphones in the 2000s. The iPhone from Apple Inc., commercialized as of June 2007 in the United States, was the first smartphone with a touch screen interface available at that time.

– Organizational innovation (rethinking the organization of tasks, human resources, decision procedures, and client and supplier relations). Thanks to this kind of innovation, a company can reduce its production inefficiencies or informational inefficiencies. This type of innovation is the responsibility of management and can be paired with an engineering logic. One widely documented example is the Taylor system adopted for the assembly-line production of the Model T by the Ford Motor Company from 1908 to 1927.

– Marketing innovation (modification to the design of a product or the way of selling it). Thanks to this kind of innovation, a company can succeed in attracting new customers. This type of innovation follows a marketing logic. The site Amazon.com introduced the idea of an online library in 1994.

The different types of innovation are not incompatible. It is possible to combine a product or process innovation, an organizational or marketing innovation. For instance, it is with the batteries developed by its subsidiary Batscap that the Bolloré group produces the Blue Car, the iconic model of the car-sharing service known as Autolib’ implemented by the city of Paris. In this example, there is a product innovation based on batteries. However, to create value from this product, rather than selling the batteries to automobile manufacturers, the group decided to offer a turnkey solution to the city of Paris that included a network of charging stations and the supply and maintenance of the vehicles for that network. This is an organizational innovation that makes it possible to circumvent the issue of the critical mass of users beyond which a network becomes profitable. This organization breaks with the strategy of automobile manufacturers who are often content to offer electric car models without getting involved in setting up charging stations networks, with the noticeable exception of Tesla Motors. The organizational innovation led to a marketing innovation because the firm generates its income not through vehicle sales but through automated, short-term rentals to customers.

The problem of the impossibility of excludability raised by the second step of the development of applications takes on its full meaning when inventions are likely to result in innovations, meaning the creation of value. However, it should be emphasized that the impossibility of excluding is contingent on the application; for instance, it is stronger where reverse engineering is simple. When this impossibility prevails, it is very difficult for inventors to get financial compensation through the commercialization of their invention even if it has a high value for the community. This difficulty, referred to as the problem of appropriability of returns from the innovation, comes from the early entrance of competitors copying the invention at low cost, so that the rent of the inventor is very quickly eroded⁴. The competition forces the selling price down to a level that covers the production or reproduction costs of the invention, but does not often allow the inventor to cover her own costs for research and development. Since the inventor is the only one to be subjected to the cost of R&D, she can find herself in a paradoxical situation where imitators earn profits, even small ones, while she is losing money. If this problem is anticipated by the inventor, she may refrain from engaging in the activity of R&D. The community will then suffer from a lack of incentive because innovations whose social value exceeds the cost of R&D will not be created. The problem of the appropriability of returns from the innovation by the inventor is at the heart of the economic analysis of patents⁵. In order to best understand the importance of patents to respond to this, it is important to highlight two points. The first point is, as noted by Schankerman and Schuett [SCH 16], that a good patent system is able to only target innovations that are appropriable with difficulty, and which would not be created without this system. Innovations that are not subject to this difficulty not only do not need a patent system, but also should not solicit one in