Welfare, Innovation and Growth: The Patent Paradox

by Morgan Churma November 2 2012, 08:27

Increasing intellectual property rights (IPR) poses a risk to both consumers and economic growth. The United States scored 4.9 out of 5 in 2005, up from 3.8 in 1975, according to the Park index for evaluating the strength of patent protection.[1] This trend has continued to gain strength, as evidenced by the over one billion dollars awarded to Apple for its infringement case against Samsung. Economic considerations dominate the arguments favoring this trend towards strong IPR, namely the “incentive to invent” theory. This rationale, however, falls short in its justification for continuing to strengthen IPR. Firstly, the “incentive to innovate” theory fails to discuss the implications stringent IPR have on consumers. Secondly, the Endogenous Growth Model demonstrates the role imitation plays in fostering economic growth. Finally, this article will examine a policy solution to these conflicting social and economic standpoints.        

The “incentive to invent” rationale appears to satisfy capitalist ideals. This rationale relies upon the presumption that the propensity for a prospective inventor to invent would be increased by protection against imitators. This protection secures an inventor’s investment of time and capital with the prospect of market control, thereby gratifying Lockean notions of property and profiting from the fruits of one’s labor. This article will argue that, while IPR justification is valid, greater incentives for innovation and economic growth can be achieved by balancing IPR with appropriate levels of imitation; at the same time maximizing utility for society as a whole.

Effect on Consumers and Society Through Waste

Patent holders incorporate high levels of rent protection activities (RPA), to ensure rent is paid by imitators.[2] RPA discourage cumulative innovations, advancements on existing innovations, thereby forcing R & D towards horizontal innovations, essentially just differentiations of an existing patent.[3] For example, iPhone software and Android software are the result of horizontal innovations, they both achieve similar functionality but were developed independently (infringement suit aside) to avoid patent infringement. In contrast, vertical innovations, or cumulative innovations, resemble a step-by-step process of imitation followed by improvement (this process is discussed at length in Competition, Imitation and Growth with Step-by-Step Innovation[4]). This process is analogous to “standing on the shoulders of giants,” where previous ideas are seen as building blocks for future developments. To the degree that strong IPR allows only horizontal innovations among competitors, “incentive to invent” holds true, but how much do these innovations benefit society? Resources would be better spent advancing technology rather than simply developing similar technology a different way to avoid infringement.  Society is ultimately left advancing at a slower rate than the equilibrium between imitation and IPR protection.

A company’s goal is to reduce competition. IPR allow for horizontal innovations, so companies have been increasingly utilizing design patents as additional barriers to entry.[5][6] Design patents are the stylistic, in essence the fashion, components of a product that may be valuable to clothing companies, but do little to enhance the utility of a technology product. A company will invest in hoarding design patents, making it difficult for a competitor to avoid infringement, even after independent development. The adverse effects of incentivizing design patents in technology as quasi-RPA are twofold: 1) innovators will be discouraged from attempting enter the market due to an additional barrier and 2) societal advancements will be even further slowed. With the continuation of this trend, resources will be increasingly allocated away from utility enhancing R & D and placed towards fashionizing technology. Despite, its “incentive to invent” rationale, strong IPR create a number of disincentives for potential innovators.

Effect on Economic Growth

In contrast to strong IPR, the Endogenous Growth Model discourages disincentives towards imitation.[7] The Endogenous Growth Model relies on innovation to stimulate economic development,[8] so why are IPR an inefficient means for growth? When IPR are highly protected, monopolistic effects occur as a result of the high levels of RPA.[9] With strict IPR, patent holders will typically be the industry leaders, so by utilizing effective RPA they create barriers against competition giving them price control. This creates the monopolistic effect of unfair pricing with little incentive to innovate. Furthermore, it increases benefits for allocating funds into RPA instead of R & D. Aghion et. al. uses the Endogenous Growth Model to suggest some imitation will mitigate these monopolistic effects. The logic behind this idea is that through imitation competitors are placed on a more level playing field.

The ultimate result of the Aghion et. al. system is that the “top” will be in constant flux; terms as market leaders will be cyclical. In this competitive atmosphere resources would be better spent on vertical innovations instead of RPA. IPR protection will be sufficient to compensate investment through cyclical market leader profits. In fact, incentives for prospective inventors and start-ups will be increased by the greater prospect to be a market leader. In summary, economic growth depends on vertical innovation,[10] and the allowance of imitation improves the quality and rate of innovations.

Advocates for strict IPR protection argue that U.S. firms receive investments over firms abroad because of our strong protection and enforcement. If the U.S. were to reduce its IPR protection, the gap between domestic investments and investments abroad may shrink. However, more firms in close competition coupled with increased economic growth would mitigate investment risks. Consider the following relationships: 1) diversity reduces investment risk while lower IPR protection increases diversity among competitive firms; 2) economic growth reduces investment risk while lower IPR increases economic growth. These relationships would encourage a greater quantity of investments mitigating the potential loss to foreign innovators. Overall, the benefits from a policy encouraging some imitation with moderate IPR protection could greatly improve societal welfare.

Potential Policy Solution

After all this analysis, an important question still lingers, how can policy consolidate these issues? Ultimately the answer to this question rests with various taxes and subsidies regarding RPA, R & D, and imitation.[11] The strength of IPR in a country, the natural rate for imitation within a society, and the desirability of horizontal goods need to be balanced to determine the appropriate policy. RPA, being private solutions for patent holders, benefit social welfare when IPR protection is low.[12] However, U.S. protection is extraordinarily high. Hence, taxing RPA would be the most beneficial recourse to dissuade patent holders from obstructing potential innovations. Absent extremely high natural propensities to imitate, subsidizing vertical R & D would benefit the U.S. economy as well.[13] To a certain extent horizontal innovations also provide a benefit to consumers, so this benefit should be weighed against imitation subsidies.

Conclusion

Given the incredibly high, and increasing, IPR protection in the United States it is important to evaluate whether the “incentive to invent” is maximized through IPR protection. Consumers and society as a whole are adversely affected by strong IPR. Consumers may benefit from diversity of similar products through horizontal innovations, but this benefit is less than the benefit obtained from cumulative advancements. Strong IPR protection is supposed to create economic growth by incentivizing innovators. However, when the protection is overbearing, many vertical incentives are lost and monopolistic effects come into play obstructing economic growth, under the Endogenous Growth Model. U.S. policy has been to keep strengthening IPR, as evidenced by the large amount of damages awarded to infringement plaintiffs. A better policy would be to provide incentives for patent holders to forego RPA through close competition. Furthermore, actually providing some level of subsidies for imitation in R & D would vastly improve vertical innovation and further reduce monopolistic impacts of IPR. We are a long way from getting out of the “Great Recession,” but IPR reform could go a long way towards building consumer morale, sustaining economic growth from within, and bringing back the vertical innovations that have propelled the United States to the forefront of the world’s economies.

           



[1] Angus C. Chu et. al., Does intellectual monopoly stimulate or stifle innovation?, European Economic Review (2012) 56, 727–746

[2] Lewis S. Davis and Fuat Sener, Private patent protection in the theory of Schumpeterian growth, European Economic Review (2012) 56 1446–1460

[3] Chu et. al. (2012)

[4] Philippe Aghion et. al., Competition, Imitation and Growth with Step-by-Step Innovation, Review of Economic Studies (2001) 68, 467-492

[5] Bruce Kugler, A Fresh Perspective on Design Patents, 38-JUL Colo. Law. 71 (2009).

[6] U.S. Patent Statistics Chart Calendar Years 1963 – 2011, U.S. Patent and Trademark Office: Patent Technology Monitoring Team (May 21, 2012, 6:53 PM), http://www.uspto.gov/web/ offices/ac/ido/oeip/taf/us_stat.htm.

[7] Philippe Aghion et. al., Competition, Imitation and Growth with Step-by-Step Innovation, Review of Economic Studies (2001) 68, 467-492

[8] Philippe Aghion and Peter Howitt, A Model of Growth Through Creative Destruction, Econometrica (1992) 60 #2, 323-351

[9] Lewis S. Davis and Fuat Sener (2012)

[10] Chu et. al. (2012)

[11] Lewis S. Davis and Fuat Sener (2012)

[12] Lewis S. Davis and Fuat Sener (2012)

[13] Lewis S. Davis and Fuat Sener (2012)

 
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