IP Rights and Their Effect on Innovation

David Weder

According to the Oxford English Dictionary (OED), innovation is:

1. The action of innovating; the introduction of novelties; the alteration of what is established by the introduction of new elements or forms; or, in terms of commerce,

2. The action of introducing a new product into the market; a product newly brought onto the market. (1)

Each of these definitions implies elements of originality and creation which in turn imply some creator. While this may seem obvious, I feel it worthwhile to point out that innovation does not occur spontaneously. It requires conscious effort on the part of some creative individual or group willing to devote time, effort and resources to produce something new. Put simply, it is the innovator�s work which yields the innovation.

Why is innovation important? Once again this may seem straightforward, but it is often under-appreciated. Without innovation there would never be any change; we would be living in a static world with a stagnating economy. Things would be done as they had always been done. Nothing would ever change. Life would be very predictable, that is for sure. How enjoyable it would be is another question altogether.

Innovation is of vital importance. It drives economic growth. Innovation helps us all to be better off than we would be without it. It helps us extract as much value as possible from our resources, our time and our effort. Nathan Rosenberg, Professor Emeritus of Economics at Stanford, gives a very good explanation of just how important innovation is in his paper simply titled �Innovation and Economic Growth.� In it, he argues that there are only two ways of increasing the output of the economy:

1. You can increase the number of inputs that go into the productive process, or

2. (if you are clever) you can think of new ways in which you can get more output from the same number of inputs.(2)

Prof. Rosenberg mentions a study done by a colleague of his at Stanford, a Prof. Abramovitz, in the mid-1950�s. In the study, Prof. Abramovitz measured the growth in the output of the American economy between 1870 and 1950. As it turned out, when he measured the growth of the inputs (i.e. in capital and labor) he could only account for around 15% of the actual growth of the economy.(2) At first, you might think he had made some gross error in his calculations. However, it is that �unaccounted for� residual of 85% that was so interesting.

Several other prominent economists performed very similar studies subsequent to the one by Abramovitz, most notably, Robert Solow, who would later win the Nobel Prize in Economics. Solow and the others all used their own methodologies to analyze various sectors of the economy. Shockingly, virtually all of them arrived at nearly identical results. They were all left with very large residuals of near or exactly 85%. The consensus was and still is that technological innovation is a major force behind the growth of output in highly industrialized nations, which explains the enormous 85% residual common to all of the studies of the time. As Prof. Rosenberg said:

[These findings] served as a kind of �wake-up� call to the economics profession because most economists for the previous 200 years had been building models in which economic growth was treated as if it was primarily a matter of adding more inputs into the productive process, especially inputs of capital. The large residual told economists that they had to look elsewhere in order to account for economic growth.(2)

What Abramovitz, Solow and their colleagues were all observing was a shift to the right in the production possibilities curves of the economic sectors in their studies. That is to say, they were able to show that through technological innovation the economy was able to get much more output per unit of input than previously. This concept is illustrated in the graph below. Line A represents the Production Possibilities curve at the beginning of the study period. Line B which lies to the right of Line A represents the Production Possibilities curve at the end of the study period.

B

A

Production Possibilities Economy Q

Units of

Units of X

As we clearly can see, total units of production (output) have increased significantly. Abramovitz and the others would all argue that around 85% of that increase in productivity is a direct result of technological innovation.

Intellectual Property (IP)

Intellectual property is defined as �. . . property (such as patents, trademarks and copyright material) which is the product of invention or creativity, and which does not exist in a tangible, physical form.(1) Posner and Landes take a considerably broader view. They define intellectual property as:

. . . ideas, inventions, discoveries, symbols, images, expressive works (verbal, visual, musical, theatrical), or in short any potentially valuable human product (broadly, �information�) that has an existence separable from a unique physical embodiment, whether or not the product has actually been �propertized,� that is, brought under a legal regime of property rights.(3)

From their perspective, the concept of propertizing ideas is an ancient one. They trace its origins back at least as far as ancient Rome. The notion of formal legal recognition of ownership in ideas, so they tell us, is an old idea, as well. As proof, the authors cite the Venetian Patent Act of 1474, the English Statute of Monopolies of 1624, the petition of the English Stationers� Company to Parliament in 1643, the Statute of Anne (the English Copyright Act of 1710), the U.S. Constitution of 1787, the U.S. patent and copyright statutes of 1790, and the French Patent Act of 1791.

Principal Reasons Given for the Establishment of IP Rights (and Systems to Protect Those Rights)

Historical Background

On April 10, 1790 when President George Washington signed the bill which became known as the United States Patent Act of 1790 a monumental step was taken. (This act was later repealed and replaced by another, longer act, the U.S. Patent Act of 1793.)(4) The Lockean sentiment of the Acts is unmistakable. To say the new U.S. patent system was unique would be a gross understatement. For the first time in history the intrinsic right of an inventor to profit from his invention was recognized by law. Previously, privileges granted to an inventor were dependent upon the prerogative of a monarch or upon a special act of a legislature. The Constitutional basis for the federal patent and copyright systems can be found in Article 1, Section 8, clause 8 which states:

Congress shall have power. . . to promote the progress of science and useful arts by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.(5)

It seems as though the framers recognized the vital role innovation plays in driving economic growth over 175 years before Solow�s theory of endogenous growth. Equal measures of Locke�s labor theory of value and the Scriptural principles which tell us �[t]hou shalt not muzzle the ox that treadeth out the corn. . . the workmen is worthy of his hire� (I Tim 5:18)(6) and �[t]he husbandman that laboureth must be the first partaker of the fruits� (II Tim 2:6)(6) can be seen in the writings of those involved in the establishment of the U.S. PTO. Somewhat later, in an 1824 speech to Congress, Daniel Webster, in his ever-eloquent style, explained the value of invention to the nation�s economic well being. He told the assembly, �invention is the fruit of a man�s brain, that industries grow in direct proportion to invention, and that therefore the government must aid in progress by fostering the inventive genius of its citizens.�(4)

Theories of Property

2. Labor Theory of Value

Classical theories of physical property are often applied to intellectual property. It should be abundantly clear from the quotations above that such theories were in the minds of those behind the establishment and continued administration of our United States Patent and Trademark Office. Most notable and identifiable among these theories, as mentioned earlier, is the labor theory of property developed by John Locke. So strong was the belief in that view that it became embodied in the Law of the Land, our Constitution, and ingrained in the hearts and minds of our leaders. Very simply put, Locke�s theory says that it is the labor which we invest in something that makes it ours.(7) Locke would argue that a piece of land belongs to someone because that person has labored to improve and maintain it. The owner built fences, cleared brush, and maybe planted crops. Being his land, the owner is entitled to enjoy the use of it and all its �fruits.� Ideas, it has been argued, are no different. My idea is my idea only because I am the one who worked to develop it. Since it was the sweat of my brow that produced the thought, I should be the one to reap its benefits. This view is still widely held. In an October 2004 article in The Washington Times Tom Giovanetti wrote:

Our lives have been made healthier, more pleasant and more productive because of the property-rights model of innovation, where those who invest their time, money creativity and effort in developing new products and services get to direct their own efforts, own the results and profit from their inventions.(8)

The Little Red Hen herself would be hard pressed to state the labor theory of property more succinctly.

2. �First in Time�

Another property theory which can be seen in our IP system is the notion of �first in time, first in right.� From this view, possession counts for quite a lot, not necessarily the amount of �labor� invested. Like the fox in Pierson v Post (9), a single innovation is often chased after and hunted by competing inventors. Sometimes, rightly or wrongly, they take advantage of one another�s hard work and discoveries along the way. Who owns the idea in the end? Most often, ownership goes to the first one to file for the patent, copyright, trademark or what have you. Unless someone else can clearly demonstrate they conceived of the idea earlier, the first person to apply for official recognition will be granted ownership.

3. Rose�s Communication Theory

Often, �first in time� doctrine seems to be at odds with the labor theory of ownership. Perhaps in an effort to reconcile the two, Professor Carol M. Rose suggests that both views have merit and are not mutually exclusive. She argues that communication is the real key to establishing ownership of something. Professor Rose says that whoever is first to communicate an effective claim on property is the rightful owner. Rose considers this communication to be a form of Lockean labor. Also, she would point out, notice that you are the owner must be continually given. If the communication stops or becomes ineffective, then the owner is liable to lose his property to an adverse possessor.(10) A similar situation exists in the realm of intellectual property, the trade secret. If the owner of a trade secret fails to communicate continually, both verbally and through his actions, that the information is indeed his and is a secret, then it can be legally appropriated from him.(3)

4. Property as a Product of Law

Especially interesting to me is the theory of property developed by Jeremy Bentham. He explains that there is no such thing as natural property. Instead, Bentham argues that property is completely a creation of the law. He says:

Law does not say to man, Labour, and I will reward you; but it says; Labour, and I will assure to you the enjoyment of the fruits of your labour�that natural and sufficient recompense which without me you cannot preserve; I will insure it by arresting the hand which may seek to ravish it from you. If industry creates, it is law which preserves; if at the first moment we owe all to labour, at the second moment, and at every other, we are indebted for everything to law.(11)

This view seems particularly applicable to intellectual property. It is the government that turns ideas into property and assigns ownership to individuals. Modern-day practice of issuing patents, copyrights and trademarks is an exact illustration of what Bentham meant when he said, �industry creates . . . law preserves.�

Unlike physical property which can be protected by physical means, intellectual property requires intellectual safeguards. Of course, an idea could be protected very reliably by purely physical means. However, such protection would tend to limit its use so severely as to render it worthless. For example, if I have an innovative idea that I want to keep as my own, I can write it down and deposit it in a safe. Unfortunately, to maintain control over it, I must never take it out and use it. As soon as I do, some would-be imitator may notice and appropriate my idea.

IP Rights and Their Effect on Innovation

Arguments in Favor of IP Rights

In its most simple form, the argument in favor of intellectual property rights is that such rights provide reward mechanisms to compensate those who invest in innovation. As Abraham Lincoln said, �[t]he Patent System added the fuel of interest to the fire of genius.�(4)

Intellectual property laws encourage innovation by allowing individuals and firms to stake out IP rights thereby protecting their investments in research and development.(12) An example often used to justify this position comes from the pharmaceutical industry. Researching and developing new drugs is a lengthy and incredibly costly process. Without the protection of patents, it is unlikely that pharmaceutical companies would be willing to invest in much R&D. Absent patent protection, there would be nothing to prevent a competitor from reverse engineering a new drug in order to produce a generic version. Obviously, this would greatly reduce the price for which the drug would sell. Innovation would thus be discouraged and, as a direct consequence, economic growth would be restricted.

Following this line of reasoning, Kenneth Arrow, Karl Shell and William Nordhaus concluded that optimal levels of innovation may not be achieved in a free market. In his 1962 article, �Economic Welfare and the Allocation of Resources for Invention,� Kenneth Arrow explained why perfect competition might fail to �allocate resources optimally in the case of invention.�

We expect a free enterprise economy to underinvest in invention and research (as compared with an ideal), because the product can be appropriated only to a limited extent, and because of increasing returns in use.(13)

Arrow recognized that the likelihood that the innovating firm will be able to capture any profits that might be generated by its innovation has a direct bearing on that firm�s willingness to engage in the development of new ideas. Essentially, he is saying there exists a sort of �free-rider� problem. If an invention is not patentable, then it will likely be imitated by competing firms that have spent none of their own money in developing the product. In addition to inappropriability and increasing returns, Arrow also suggested that the risk inherent in innovation would discourage investment in R&D. He argues that IP rights help address all of these concerns.

Arguments against IP Rights

Opponents of strong intellectual property rights argue that such rights do far more to discourage innovation than they do to promote it. Recent criticism has focused primarily on patents, but the same arguments have been applied to all types of government-recognized intellectual property (i.e. copyrights, trademark and trade secrets)(3). In their paper, Perfectly Competitive Innovation, Michele Boldrin and David K. Levine provide what is widely considered to be the most comprehensive critique of the conventional wisdom that intellectual property rights foster innovation.

Boldrin and Levine contend that government-granted monopolies arising from patents and copyrights induces rent seeking. � . . . [W]hile awarding a monopoly to an innovator increases the payoff to the original innovator by giving her control over subsequent uses of the innovation, it reduces the incentive for future innovation.� (14) They admit that indivisibility may exist. That is to say, that there are significant upfront costs associated with developing an innovation. Once the first new product is produced, the cost of copying it is usually very small. Boldrin and Levine acknowledge that increasing returns to scale presents serious problems in a perfectly competitive market. In free markets, products are priced at their marginal cost, the cost of the latest copy. Often, such a price is just insufficient to cover the huge initial outlay.(15) The authors do not deny this fact. In their own words, �[i]ndivisibility may result in some useful ideas not being produced, but government-grants of intellectual monopoly may lead to even less innovation than under competition.

Many in the anti-IP lobby claim that the U.S. PTO has become increasingly lax in screening patent applications and that this has lead to spurious claims being approved. The critics say that too many newly issued patents are for products that are neither novel nor innovative. To quote one such critic, �[s]ince it [the U.S. PTO] first emerged in modern form in the 18^th century, it has just �growed and growed,� like Alice in Wonderland.�(16) The diminished quality of patents, it is argued, has an extremely negative effect on innovation (and hence economic growth), because too many individuals and firms are seeking what are called �blocking� patents. That is, they seek patent coverage not to allow them to produce some new product but to preclude someone else from producing it. Most often, this is done to protect some existing product or technology. With the huge backlog of applications and short staffing in the U.S. PTO, patent examiners haven�t the time to give each application a thorough review. Therefore, it is argued, many patents are being allowed for technologies which are already in the public domain. Until found invalid in a federal court (after lengthy and costly litigation), these specious patents place an unnecessary drag on the economy as they prevent firms from using technology which really should be available to them.

Conclusion

That innovation is a primary driver of economic growth is well-proven fact. What remains hotly contested is how best to encourage such innovation. From the reading I have done and from my own experience, I conclude that innovation would suffer without meaningful, credible and enforceable intellectual property rights. Such rights provide incentives to those who would be creative. The protection afforded by patent, trademark, copyright and trade secret laws allows someone with a novel idea to reap the fruits of his labor. Were there no such protection or were the protection less than adequate, few creative individuals would be willing to invest their effort, time and other resources to develop new technologies. What would be the point? Why should anyone devote years of his life to developing his idea only to have it taken away from him once its potential is recognized. Even Milton Friedman, that outspoken champion of free markets and free speech, recognizes that we must provide some protection of intellectual property.

The question of intellectual property rights is very complicated. Freedom of speech is the opposite of copyright, which means that you can�t get copyright rights. And, intellectual property is different from physical property: in both cases, you have a monopoly but the monopoly on intellectual property is wholly different because duplicating the property comes generally at a very low or zero marginal cost. You are enforcing monopoly pricing, as it were, that limits output to lower than the optimum social level. You cannot be in favor of infinite copyright. Essentially, it�s a problem of practical compromise, whether you have 17 years, 25 years, 10 years, 50 years.(17)

Works Cited

1) Oxford English Dictionary Online (as accessed through McKendree�s Holman Library website) http://lance.mckendree.edu:2081

2) Rosenberg, Nathan. �Innovation and Economic Growth.� OECD, 2004.

3) Posner, Richard A.; Landes, William M. The Economic Structure of Intellectual Property Law. Belknap Press of Harvard University Press. Cambridge, MA, 2003.

4) Inventing Trivia: http://tenonline.org/art/usa/9902.html

5) �The Constitution of the United States,� Article 1, Section 8, Clause 8.

6) The Bible, King James Version. Cambridge University Press (January 12, 1995)

7) Locke, John. THE SECOND TREATISE OF CIVIL GOVERNMENT 77-78 (For the Classics Club by Walter J. Black, Inc. 1947)(1690) [This is from Dr. Frank Spreng�s unpublished Law and Economics handout, �II. The Origin of Property.�]

9) Epstein, Richard A. �Possession as the Root of Title,� 13 Georgia L.R. 1221, 1221 (1985). [This is from Dr. Frank Spreng�s unpublished Law and Economics handout, �II. The Origin of Property.�]

10) Rose, Carol M. �Possession as the Origin of Property,� 52 University of Chicago L. R. 73, 74 (1985) [This is from Dr. Frank Spreng�s unpublished Law and Economics handout, �II. The Origin of Property.�]

11) Bentham, Jeremy, THE THEORY OF LEGISLATION 111 (Routledge & Kegal Paul, Ltd. 1802) (1950) [This is from Dr. Frank Spreng�s unpublished Law and Economics handout, �II. The Origin of Property.�]

13) Arrow, Kenneth J. �Economic Welfare and the Allocation of Resources for Invention,� in Richard Nelson (ed.), The Rate and Direction of Inventive Activity, Princeton, NJ: Princeton University Press.

14) Boldrin, Michele; Levine, David K. �Perfectly Competitive Innovation.� Minneapolis Federal Reserve, 17 Jan 2003.

15) Clement, Douglas, �Creation Myths,� The Region. Federal Reserve Bank of Minneapolis. Sept 2002

16) Howkins, John, �The Creative Economy,� Thomson Scientific: http://scientific.thomson.com/knowtrend/ipmatters/acctecon/8199580/

17) Friedman, Milton. �Economic Freedom of the World: Report 2001.� Published 2002.