Patents and Innovation

Introduction

It is a well-established truth that innovation, whether technological or not, is a key determinant of economic growth and general welfare of the society. Broadly speaking innovation means developing a new idea or concept or a new association between existing ideas or concepts. It is a commonly perceived notion that intellectual property rights play a vital role in promoting innovation and growth. Technological advancement, a major force in propelling a country’s economic prosperity, is particularly argued to be best protected and promoted through a strict patent regime. There are two primary theories underlying this conception. The Public Interest Theory suggests that the public benefits from disclosure of the invention, which would have otherwise remained a secret. Such disclosure enables circulation and ready availability of the technical information which, in turn, stimulates further innovation. The Incentive Theory, meanwhile, asserts that the grant of patent provides an incentive for the production of new inventions and thereby encourages improvements and innovations.

A substantial amount of scholarly work has been devoted towards establishing the causal link between patents and innovation. Public disclosure and incentive arguments, however, continue to remain central to the justifications for grant of patent on ground of innovation. Further much of these justifications rely on the economic theory of intellectual property and employ economic arguments in asserting the positive correlation between patents and innovation. The economic theory asserts that intellectual property rights are necessary to promote inventions and creations, just as property rights are necessary to encourage the efficient use of the conventional types of properties. This approach treats information as a “public good” which is non-rivalrous and non-exclusive. In the absence of clearly defined rights in favour of the inventor such public goods are liable to freeriding, thereby preventing the inventor from benefitting from his/her own invention. This causes disutility to the inventor and leads to underinvestment and, therefore, an undersupply of information goods. In this way the lack of patent protection stifles further innovation. Patents address this situation by granting a temporary monopoly to the inventor. This allows the inventor to charge a higher price than the marginal cost of producing such information goods and thereby recover the innovation costs and make a return on the investment. This economic reasoning lies at the crux of the argument that patents encourage companies to invest in research and development (R&D) which in turn stimulates innovation and dissemination of information.

Despite extensive theoretical justifications suggesting the beneficial impact of patents on innovation, empirical evidence on the role of patents in promoting innovation and growth in general remains limited and inconclusive. Market research suggests that strengthening of the patent regime the world over has resulted in a surge in the number of patent applications as well as an increase in R&D expenditures of the companies. This, however, is only indicative of a few countries and of a few sectors of the economy and in no way embodies the general trend. This provides the backdrop for the discussion in this paper. The paper argues that neither public disclosure nor monopoly incentive argument is sufficient to indicate any positive correlation between patents and innovation. This is done by attempting to debunk the economic theory of intellectual property and the economic justification for the grant of patent rights. The first part of the paper will critique the extension of the “Tragedy of the Commons” model to explain the “undersupply” of information goods as well as the public benefit of disclosure proposition. The second part will highlight the inherent defect in the economic argument that patents encourage innovation by using the classic “Monopoly v. Competition” debate. The argument here is that competitive forces of the market are fully capable of encouraging innovation and that innovation is not stifled in the absence of a clearly defined intellectual property right regime.

Tragedy Of The Commons: Challenging The Premise

The economic approach to law understands intellectual property as merely another form of conventional property. Accordingly, it extends the economic rationale for definition of ownership rights to intellectual property as well. One of the most powerful arguments employed in justifying the existence of private property rights is a theory called the “Tragedy of the Commons”. The theory takes the example of a “common” property to explain the inefficiency and social loss caused in the absence of property rights. The example in the theory concerns the use of a village pasture land that is open to use by all herdsmen. It is argued that when property rights are undefined, herdsmen will have an incentive to keep on using the common land beyond its optimal use from the society’s point of view. Since the private incentives of individual herdsmen are not in line with the best social outcome, the collective behaviour of all herdsmen will cause overgrazing. Consequently it is argued that private property rights need to be defined in order to ensure efficient utilization of the property. The economic analysis of intellectual property rights draws a strong analogy between the overgrazing of the pasture with underinvestment and under-production of knowledge. It, therefore, makes a strong pitch for the conversion of the public good nature of knowledge into a private good in the form of a patent to encourage optimal generation of knowledge i.e. innovation.

The line of reasoning adopted in the above approach suffers from several defects. The primary difficulty in applying the “commons” theory to intellectual property is the nature of knowledge itself. The basic assumption of the theory concerns the use of a property resource which is unique and does not have any close substitutes. This cannot be said true of knowledge or, to be more specific, innovation. There are no objective criteria for assessing the substitutability or uniqueness of different forms of innovation. As a result the “commons” argument does not fully hold true as far as knowledge/innovation is concerned. Scholars have argued that, at best, the lack of property rights would result in underinvestment in knowledge generation. However there is never any real danger of over-exploitation since knowledge is neither a limited resource nor capable of depletion. So, even if there is any such ‘over-exploitation of knowledge’ it will be a positive dissemination of information. The increased availability of information and knowledge diffusion would actually provide increased returns in the form of greater innovation. It can, therefore, be argued that the patent right does not necessarily generate efficiency in the domain of knowledge but merely produces an artificial scarcity of a good which could be freely allocated to everybody under non-scarcity conditions.

There is yet another difficulty in extending the “tragedy of the commons” theory to the domain of knowledge and innovation. The example used in the theory presupposes the existence of a socially desirable use of resource which is economically efficient. When applied to the knowledge domain it would simply mean that there is a socially desirable level of knowledge generation and that there are set levels of innovation that are economically efficient and socially optimal. While the implications are clearly absurd, the assumptions themselves suffer from two flaws. Firstly, the existence of an efficiency standard entails the creation/existence of a theoretical benchmark against which the policy and institutional interventions should be compared. However setting such an efficient benchmark for knowledge generation and innovation is not just empirically difficult but descriptively improbable. Secondly, the efficiency assumptions relate to a strict notion of static efficiency which completely ignores the inherent dynamism in knowledge and innovation. In this context it may be pointed out that it has been adequately established that innovations which are sequential and complementary flourish even in the absence of patent protection on account of their dynamic nature.

The discussion in this part clearly indicates that the “undersupply” argument does not hold good as far as knowledge is concerned. The argument for creation of private rights over intellectual property thus falters at a fundamental level since it fails to account for the nature of knowledge and the dynamism of innovation. This brings us to the “disclosure” justification for patents. It is, contended, that patent protection provides adequate inducement to the inventor to make available technical information regarding the invention to the public, which would have otherwise remained a trade secret. This ensures that there is knowledge diffusion which in turn stimulates further innovation and other creative means to meet similar and expanded demands in the marketplace. This argument, when looked at closely, is again partially defective. It is argued by some scholars that patents merely add to the choice already available to an inventor. The inventor, before choosing, the nature of protection would assess his/her ability to keep the innovation a secret. He/she would thus choose secrecy in those cases where it is possible to keep the secret longer than the protection afforded by the patent system and would choose patent protection in cases where the secret can be kept for the lesser time.

Further there are also questions over the exact nature of the information that is actually revealed by this incentive. It is a long-standing observation that patent applications merely provide information in the form of vague “workable” descriptions that neither reveal the useful ideas nor enable others to easily imitate without reinvention from scratch. It is also pointed out that the modern patent regime rather than spreading information creates a pervasive atmosphere of secrecy resulting in wasteful duplication of efforts and fostering inefficient monopolies. The effectiveness of the “disclosure” argument is, therefore, highly debatable. It can very well be said that, in direct contradiction to the “tragedy of commons” problem, the existence of patent creates a situation which is aptly described as the “tragedy of the anticommons” i.e. a situation where existence of multiple exclusive rights makes difficult the creation of several products which involve use of multiple patented products/processes on account of high costs.

Part II: Innovation and the Competition/Monopoly Debate

The second major argument employed by the economic analysis of intellectual property law in justifying patents for spurring innovation is the Incentive Theory. It states that every inventor incurs certain ‘innovation costs’ in producing an invention or generating the desired knowledge for it. Non-excludability of this public good means that any such knowledge with potential economic value will be immediately and freely available to everyone. This disables the inventor from profiting off the knowledge so produced. Similarly, the non-exclusive character of the public good implies that the marginal cost of production for every subsequent unit by every subsequent user is effectively zero. However, in a perfectly competitive market the price always reflects the marginal cost. The market, in such a case, would prevent the inventor from charging a higher price to recover the ‘innovation costs’. The inability of the inventor to either recover the sunk cost of innovation as well as the disability to profit from his own creation provides a disincentive to innovate further. This problem is described as the problem of appropriating returns from innovative efforts.

The basic notion underlying the incentive theory is that competition inhibits innovation. This seems clearly paradoxical when we consider the economic analysis of market structures which describe a perfectly competitive market as the most efficient mechanism that drives competitors to innovate. There are two observations that need to be elucidated in this context. Firstly, although the creation of short-term monopolies through patents may enable the innovator to earn sufficient returns on investment, it does not necessarily incentivize innovation. Secondly, the economic models of market structure do not correctly describe the nature of competition in the real world. So, one can find many examples of successful and continuous innovation in markets which have little or no patent protection. It, therefore, makes the economic justification for the causal connection between patent protection and innovation redundant.

The grant of patent corresponds to the grant of a monopoly in favour of the inventor, albeit for a short duration. This enables the inventor to charge a higher-than-competitive price for the invention so produced. This enables the inventor to recover the sunk costs of production in generating the knowledge for the said invention. The return on investment is argued to spur further innovation. It may be pointed out that this conception is based on an incorrect understanding of innovation as corresponding to an invention. Invention, simply put, is a technical solution to a technical problem which can either be an innovative idea or maybe in the form of a working model or prototype. The grant of patent is on invention which has to satisfy the criteria of inventive step, novelty and industrial application. Innovation, on the other hand, is a much broader concept which does not necessarily require the association of commercialization.

The firm-centric approach of the economic theory would, therefore, successfully describe the positive correlation between patent protection and the increase in the number of patent applications by industries or for that matter an increase in the investment by firms on R&D activities. However, the fundamental difference between invention and innovation means neither an increase in patent applications nor increased investment in R&D necessarily translates into innovation. The existing patent regime ensures that firms invest in R&D aimed at developing products that can be commercially exploited. However, as pointed out before, commercialization is not a necessary feature of innovation. So much of the investment is not aimed at innovation as such but at specific commercial goals. It is also worth noting that the patent regime, at present, does not fully recognize or protect incremental or complementary innovations. The economic theory justifies this position by arguing that patents of excessive width or little novelty allow the holder to extract undue rents from other inventors and customers. This implies that any innovation which improves the functional aspect of any existing invention does not qualify for intellectual property right protection. This stance reeks of double-standards and fails to account for a majority of innovation that take place in small and medium scale industries as well by local artisans/craftsmen and other skilled individuals at a local level in many of the developing countries the world over.

This argument is further augmented by the fact that there are several examples of industries which are able to flourish, earn profit and innovate despite the absence of a definite exclusionary right such as a patent. A good amount of literature also exists that refer to several cases of successful innovations over a period of time in history and across industrial sectors despite the absence of the strict intellectual property regime that is in place today. It has also been established, through economic analysis nonetheless, that in certain dynamic industries such as software, semiconductors and computers the nature of innovation where the nature of innovation is sequential and complementary, competition actually increases the firm’s profits thus offsetting short-term dissipation of rents. Patent protection in such industries, thus, tends to reduce overall innovation and social welfare. This increasingly strengthens the argument that competitive forces in the market ensure that firms will innovate despite the absence of a defined patent protection.

On the face of it the conclusion that both monopoly and competition spur innovation in the market seems to present a contradiction. However this inconsistency can be easily reconciled when we take the market realities into consideration. The economic models discussed herein are merely the theoretical models underlined with several assumptions. In reality, the market operates between the two extremes of monopoly and perfect competition. So, it is not implausible to suggest that certain markets encourage innovation when there is competition while others depend upon grant of temporary monopolies for the same. It would thus be highly ineffectual if the economic justifications are blindly accepted to impose a patenting regime in a particular industry without assessing the attributes unique to that particular sector and the innovations therein.

Conclusion

The simple objective of the project was to highlight the fundamental flaws in using economic justifications for granting patent rights to encourage innovation. The models and justifications are merely theoretical and fail to account for the realities of the market and the nature of innovation that is unique to it. There is no empirical evidence to suggest any positive correlation between patents and innovation and it would be very difficult to establish so. It is a fact that innovation is a function of a number of factors and not just the intellectual property rights regime. Therefore, looking at the success of patents on innovation in one sector or the lack of it in another does not seem to be a viable approach. If the attempt is to encourage innovation there is a need to look into the specific characteristics of the market and the economy in general and provide policy interventions accordingly, which includes making necessary changes to the patent regime. The utility-based model to cover incremental/complementary innovation is one such way of doing so.

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