By Joel Russell First Year, Joint First Prize

Transcription

1 Since the development of intellectual property rights in 17th century England, economists have argued whether patents encourage the pursuit of entrepreneurship or hinder creativity and development. Take a stance either for or against the continuation of patent protection. By Joel Russell First Year, Joint First Prize Intellectual property (or IP) refers to creative work which can be treated as an asset or physical property. IP rights fall principally into four main areas; copyright, trademarks, design rights and patents. For the purpose of this essay I will be concentrating solely on patent protection. A patent protects a key technological design mainframe and imposes its recipient to solely hold the right to manufacture products with such a design for 20 years. The patent allows the recipient to challenge organisations and individuals in a court of law if the patent is expected to have been breached. This essay will detail the economic and social implications of ineffective patent protection, concluding with suggested methods of improvement. Initially it is important to consider the semantics of modern patents and their ideology, starting with the misunderstanding around the conception of patents. The Government website itself phrases IP, and therefore patents, very ambiguously: Intellectual property is something unique that you physically create (Gov.uk, 2015). It is widely presumed that the original creator of an idea will be the same person that a patent is granted to, and this definition extends the theory of such. Unfortunately, as is often the case, this is not true. The term you in this statement does not refer to the inventor of the concept but more the person who manages to get the idea approved by the Intellectual Property Office first. A patent race is the term coined to signify the race in which various competitors of the same inherently homogenous design take to secure a patent before their counterparts. In effect, patents do not protect their creator, they protect the individual or firm who manage to secure the patent from the IP Office before other competitors. The benefit to consumers of this methodology is almost non-existent. The determination of the most efficient firm is not considered, nor the firm who may provide the most social welfare, nor the firm who is most likely to provide consistent and unrestricted innovation to the market. The patent race is simply run on a basis of first come first served which applies to all markets and all products universally. Often firms compete in the patent race not to secure a patent, but instead to prevent a rival firm from securing a patent (Harris and Vickers, 1985) suggesting an inefficiency in policy design. Regardless of whether or not the fairness of the patent system is questionable, the morality of the system can be briefly ignored for the potential economic gain that removing patents would have on most industries. If we consider patents to be restrictive to the economy, various allusions can be drawn.

2 In a recent journal, Boldrin and Levine use the analogy of international trade restrictions to exhibit the similar behaviour of patent restrictions It will not escape the careful reader that patents are very much akin to trade restrictions as they prevent the free entry of competitors in markets (Boldrin and Levine, 2015). Economists fought for decades to remove international trade restrictions. The prevention of free entry to domestic markets ultimately led to restricted economic growth as the productive capacity of the economy was not operating at the most efficient levels that international trade could have provided. We can consider patents to be similar in this regard. The patent system is fundamentally active to prevent the sharing of an idea, thus limiting the creative innovation that could be multiplicatively applied to specific products across a wide range of markets. For specific markets such as software and washing detergent, the factors of production will become more efficiently allocated through improved technology if patents are removed, allowing a shift in the productive possibility frontier from PPF1 to PPF2.

3 The removal of these boundaries across most markets however would allow free access to ideas, and much faster and more efficient innovation in the long-run would show positive output shifts in the economy from Y1 to Y2, illustrating economic growth. We would also see the price fall from P1 to P2 as the factors of production are made more efficient through technology improving faster than the current patent system allows, allowing firms to produce goods at a lower average cost. The main problem for consumers of patents is that the price that we pay for a patent protected product currently (P1) is a much higher price than we would have to pay for the same good produced by multiple competitors (P2), without a patent system in place. This price is often justified by many for the innovation that will only be provided when supernormal profits exist, allowing a product to stimulate financial capital for reinvestment in research and development, and to further develop the product to become more advanced in its design and purpose. Whilst it is true that some supernormal profits are required to have innovation, the chain of thought that high profits are the only incentive for innovation is however out-dated; we understand intuitively that strong competition increases the requirement of cost minimisation and aggressive cost effective and rapid innovation is then required to steal market share from competitors, i.e. competition and innovation formed through lead time. The predominantly patent-free market of smartphone apps for example concludes that returns to investment in the app industry are made by fast movement and adaptability, not through the use of patents (Kraaijenzank, 2013). Considering this, the reverse would be true that patents can create a culture of stagnation in innovation and that adaptability does not matter as patents legally prevent competition from entering the market regardless of how efficient and creative new competitors may be.

4 To model a concept of this idea, take for example the mobile phone company HTC. Despite being a relatively small player in the mobile phone oligopoly, they would hold a 100% market share of smartphones if they had an international patent which detailed them as the only producer of smartphones in the world. If we consider the supernormal profits of HTC in this situation, considering that 6 in 10 people have a smartphone in the UK alone (Stakeholders.ofcom.org.uk, 2015), the profitability figures for reinvesting in innovation would be absolutely colossal. But would this translate to increased innovation in smartphones considering that current major players such as Apple and Samsung would not exist? Absolutely not. In fact, despite the huge supernormal profits, we would see HTC implementing new technology into smartphones much slower than in other market structures as competition would be non-existent as a monopoly. There would be no desire to push for faster technological change as the inelastic demand for smartphones would ensure that HTC could move as slow it would like, whilst maintaining full market share of smartphones. Incremental updates to technology would see consumers updating their smartphones regardless, and there would be no incentive for HTC to offer immediate and mass influxes in technology as it would affect long term profit maximisation. Due to the actual market structure of oligopoly for the smartphone market, we see innovation continually grow at a speed much faster than monopoly, without the tendency to become static as multiple firms increase the need for efficiency and speed of innovation. The more firms in the market, the faster we will see innovation spike. Unfortunately due to the normal profits which monopolistic competition

5 derives in the long run, the rapid creativity of monopolistic industries expires over time as there is no longer an incentive to invest in research and development when too many firms saturate the market, and lead time of improvements is vastly reduced. I have therefore derived the following model showing the relationship between innovation and time between the three market structures, showing oligopolistic markets to be most innovative in the LR: Taking the idea of patents allowing access to large market power, it is clear that patents are currently more of a monopoly right than they are a property right. The patent scheme is merely an unspoken statement that decries other market structures and warrants the allowance of monopoly control. Basic economic theory confirms that this is a completely inefficient and inadequate system to be operating within. The ability to set prices as a monopoly not only restricts consumer surplus, but in the event of necessity goods which are heavily patented such as pharmaceuticals this can literally have the ability to determine life and death between a consumer who can afford treatment, and a consumer who cannot. Whilst an oligopolistic firm still produces dead weight loss and poor social welfare in comparison to perfect competition, it is a lesser of two evils to ensure that innovation is still prevalent in domestic and global markets through lower supernormal profits than a monopoly. The removal (or restriction in certain markets) of patents should be considered an important supply-side policy which will bolster fast moving innovation in all markets and prevent large incumbent firms from constraining competition and weakening creativity. Restricting patent effectiveness allows for more oligopolistic structures in the market, and price wars should see the cost of products reducing alongside innovation through lead time. This is especially true for fast markets such as software programming, in which bad patents are undoubtedly issued and empirical evidence linking patents and innovation is still inconclusive for all fields, let alone software (Evans and Layne-Farrar, 2015). A simple multiplier effect of acquiring patents can be applied to firms who have reached monopoly status. As previously brushed upon, if a start-up firm can acquire a new patent and have an idea original enough to create monopoly power in an industry, it is then within their best interests as economic agents to maximise their own utility by preventing other firms from entering the market. Multiple patents can be acquired easily by a monopoly with supernormal profits, adhering to the idea that a single patent can lead to the exploitation of a market. The ability to be awarded a patent is therefore the ability to become a formidable monopoly should the patented concept have enough demand traction to grow exponentially. This is an inherent barrier to entry preventing creativity and development formally known as DPA and OPA. Defensive Patent Aggregation (DPA) is a relatively new concept in which large influential firms begin to aggregate various patents which are similar to the original patent idea of the firm, in an effort to protect themselves from patent lawsuits carried out by competitors against them. Similarly Offensive Patent Aggregation (OPA) details aggregated patents which are applied for to prevent future businesses from using the associated technology. As an example of the extent to which OPA is practiced Delco Electronics Corporation filed a patent in 1996 to prevent

6 competitors from producing technology that would send signals at a speed faster than light (Google Books, 2015). Both DPA and OPA are deemed anti-competitive as there is no intention for the business to use such patents bar the ability to counteract lawsuits (DPA) or to charge royalties and licensing fees to start-up businesses (OPA). The very concept of this is perfect example of hindered creativity and development as established firms with saturated levels of innovation maintain their foothold in the market by aggressively driving out new competition. DPA portfolios in the mobile phone industry have been marketed at a staggering value of $12.5bn, with Google recently purchasing 17,000 patents previously secured by Motorola (BBC News, 2011). This graph illustrates the recent trend in patent applications, with causation of DPA and OPA being mainly responsible for the correlation in high spikes in applications for patents: Source: The implications of DPA and OPA include that new innovative businesses pre 1980 had a much higher chance of entering their respective markets. The 300% increase in patent applications in the EU since 1980 demonstrate how innovation has been restricted. These figures will continue to rise until reforms to the Patents Act are implemented. Whilst it is unfeasible to suggest the immediate removal of patents, it is very important to begin the process of revising the patent system. Cheap and fast moving industries should have patents cut completely in the long run. This would prevent larger firms from restricting innovation and would force productive and allocative efficiency into the market. The slow removal will allow a small time lag for all firms to adjust their practices to become better suited to improving their products, whilst inefficient firms are forced to become more efficient, or be driven out of the market. Expensive and time consuming industries should remain patented as the initial cost of money and time would not produce innovative products if patents were removed,

7 due to low incentives. The pharmaceutical market for example currently has the following costs: 1) Time lags before the products are certified, thus reducing the effective patent lifespan. 2) High sunk costs of human and clinical trials, insurance and research. The cost of an average pharmacy approved drug is currently in the region of $2.6bn (Mullins, 2015). Fortunately both of these issues are somewhat rectifiable in the long run. In the medium-run pushing for reduced certification times of drugs will also significantly lower the cost to pharmaceutical companies whilst lowering the amount of time a patent will be needed to protect them for. Reduced red tape in clinical and human testing should be a main government scheme in the pharmaceutical industry, and costs will be set to rapidly decline. It is clear the immediate removal of patents in such a market would be a mistake of unpredictable scale, with no real incentive to manufacture a drug due to the relative cheapness of copying an approved drug without undergoing both 1) and 2). The main consensus here is that there are ways to intervene with the incentives to create pharmaceutical drugs without the absolute need of 20 year patents, notably by reducing the costs of production and decreasing the time required to get a product onto the market. The abolition of the current patent system will be a hardy battle. Opposition will be strong from monopoly firms however the government should force incremental changes and begin immediately to prevent major shocks to the market. Should we observe innovation decrease in the markets where patent lifespan has decreased, for example a fall from the optimum innovation rate I* to I1 and from patent length

8 P* to P1, then the equilibrium level before innovation decreases should be realised and patent lifespan should be capped at this point (P*I*). The most important factor to consider with patents is the wider economy. Consumers do not desire to pay high prices for products and services offering restricted technology when there are alternative systems which offer lower prices, improved social welfare and improved innovation. It is universally understood that a monopoly structure is undesirable, and even an oligopoly structure would bring a reduced price and increased innovation to the table. If patents are removed or restricted worldwide then previously high mortality rates deriving from AIDS and Cancer can be effectively reduced, with enhanced incentives to create drugs that are pushed to the market faster which will be available at a cheaper price, leading to an improved standard of living which is a crucial indicator of economic growth. The ultimate removal of patents across most markets will prevent DPA and OPA from heavily affecting start-up businesses and will encourage faster technological advancements and improve the potential productive output of our economy. As pointed out in Sell your ideas with or without a patent, the authors of the book state that if an industry has the ability to be fast moving and efficient companies are not going to wait for the lengthy process of obtaining a patent (Key and Key, 2015), therefore creating the incentive for firms to push for swift development. For markets where patents must exist quota limits should be applied to prevent mass attainment of patents which are not going to be implemented for consumer benefit. It is likely the decreased supply of patents will increase the price of such and reduce demand, and disincentive firms to cumulate patents. These markets in which patents are to be awarded in the long-run, i.e. pharmaceutical, should be awarded patents by a government body with an independent regulator. Applications of firms should be assessed empirically with the award of the patent achieved by the most successful candidate, determined by the assessor. This will remove the patent race from legislative practice and offer a more fair and suitable system of patent allocation. With this criteria met the potential damages to creativity and development will be minimized and patents will be reformed to offer genuine innovation protection in the few industries which they are required.

9 Bibliography BBC News, (2011). Google to buy Motorola Mobility. [online] Available at: [Accessed 13 Mar. 2015]. BBC News, (2014). HTC flagship phone gets depth sensor. [online] Available at: [Accessed 11 Mar. 2015]. Boldrin, M. and Levine, D. (2015). The Case Against Patents. [online] Pubs.aeaweb.org. Available at: [Accessed 10 Mar. 2015]. Evans, D. and Layne-Farrar, A. (2015). Software Patents and Open Source: The Battle Over Intellectual Property Rights. Virginia Journal of Law & Technology. Google Books, (2015). Patent US Hyper-light-speed antenna. [online] Available at: [Accessed 11 Mar. 2015]. Gov.uk, (2015). Intellectual property and your work - GOV.UK. [online] Available at: [Accessed 10 Mar. 2015]. Harris, C. and Vickers, J. (1985). Patent Races and the Persistence of Monopoly. The Journal of Industrial Economics, 33(4), p.461. Key, S. and Key, J. (2015). Sell Your Ideas With or Without A Patent. CreateSpace Independent Publishing Platform, pp.5-6.

10 Kraaijenzank, S. (2013). Innovation without Patents? Evidence from the Smartphone App Markets. Mullins, R. (2015). Cost to Develop New Pharmaceutical Drug Now Exceeds $2.5B. [online] Scientificamerican.com. Available at: [Accessed 13 Mar. 2015]. Stakeholders.ofcom.org.uk, (2015). Ofcom Adults Media Use and Attitudes Report [online] Available at: [Accessed 13 Mar. 2015].