Abolish Patents, Federal Reserve Economists Argue

Abolish Patents, Federal Reserve Economists Argue

The patent system has a negative net effect on innovation and productivity, two economists conclude in a study. They propose to abolish the system and find alternative legislative means to encourage innovation.

Michele Boldrin and David K. Levine, both research fellows with Federal Reserve Bank of St. Louis, Missouri and economics professors at Washington University in St. Louis, published their proposal in the paper The Case Against Patents.

The main drivers of innovation are a competitive environment and first-mover advantage, Boldrin and Levine argue. In the current system patents function as government-granted monopolies defensively used to prevent others from competing, as such they stifle innovation rather than promote it.

Framing patents as monopolies is not undisputed amongst economists. Proponents of the system often define patents and copyright as ‘intellectual property’. ‘Hence, strengthening them is ideologically and politically consistent with the general principle that “private property is good for growth.” But as we and many others elsewhere have argued, patents are just a monopoly, not property’, the authors write.

The economists acknowledge that the promise of a monopoly provides an incentive to innovate. But in a later stage these patents are used to prevent newcomers from entering the market through litigation and licensing fees. Patents granted in the past have a downstream blocking effect on current incentives to innovate. The negative effects of patents on innovation outweigh the positive effects.

Innovate, litigate.
To illustrate their point the authors describe the typical lifecycle of an industry. In the first stage of a new industry every player competes to bring their product to the market first. There is a high price elasticity of demand which means if the price goes down the demand goes up. The goal is not to dominate the market but to get products out fast and cheap. Consequently, innovation goes toward bringing down the cost of production processes. At this stage all players benefit from cost-reducing solutions, they imitate each other and compete on the market.

Only at a later stage when the industry is more mature, patents come into play. The market stabilizes, price elasticity goes down and there are no more great leaps in reducing production costs. At this point incumbent firms play their patent card to keep their market share. Newcomers are ‘subjected to legal action and licensing demands’ to prevent entry. Insiders no longer have an incentive to innovate because there is no competition.

This mechanism has only gained strength over the last decades because most of today’s products are made up of many components. For instance, to produce a smart phone a manufacturer has to deal with ‘thousands of patented ideas’.

Rewarding failed products
Another negative effect is that patents tend to level out profits amongst the incumbent firms. An example is the mobile device industry where Microsoft has been largely unable to create a marketable product. But with its huge patent portfolio the software giant forces Google to share the profits of its success through patent litigation. The absence of a viable product line on the Microsoft side prevents Google from countersuing or mutually canceling out licensing fees. Instead of promoting innovation the patent system rewards failure.

The political dimension of patents
Patents as government-granted monopolies carry with them ‘the many ill consequences we associate with monopoly power’, Boldrin and Levine say. Not the least of which is the tendency of the monopolist to engage in politics to ‘preserve and expand its monopoly’. Over time the systems works increasingly in favor of the patent holder, gravitating toward stronger protection for a longer duration.

The authors conclude that the patent system harms innovation and effects social welfare negatively. The best thing to do is to abolish the system and look for alternative policies to foster innovation.

However, the economists realize that ‘policy proposals are often better digested and metabolized in small bites’ therefore they have provided a list of incremental policy changes to phase out the system. The list includes reducing the duration of patents, reducing the set of what can be patented and disallowing patent grants for innovations coming out of from government-funded research.

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    avatar Tessel Renzenbrink is the editor of TechTheFuture. I focus on disruptive trends in technology.