Patents and innovation – a difficult case for economists!

Economists are sometimes disappointing; they struggle to take sides. It’s the famous story of President Truman’s chief economist who couldn’t give a fixed opinion on most subjects of economic policy. It was always “on the one hand… on the other hand“ to the point that one day, exasperated, Truman exclaimed – “Someone please bring me a one-handed economist!“.

This is rather the problem we have regarding the role of patents in the innovation domain. On the one hand, patents have a positive effect as they enable the innovator to benefit from a certain exclusivity, which allows him to obtain a surplus of revenue (or economic rent) that represents encouragement and security for those, who invest in innovation. But on the other hand, this patent delays or even blocks subsequent innovators, who cannot freely recombine the patented knowledge to produce new solutions. The patent would thus form an obstacle to cumulative innovation.

Likewise, on the one hand, the patent tends to favour competition by offering new firms an intangible asset thanks to which they can obtain external financing and enter the targeted market. But on the other hand, the patent creates a form of monopoly that is obviously unfavourable to competition. The practically automatic result is an increase in prices of innovative products (drugs for example) and concomitant reduction of consumer surplus.

The great twentieth century economist Fritz Machlup had taken this “on the one hand – on the other hand“ even further when he wrote: it was madness to invent the patent system but now that it exists, it would be even madder to want to abolish it.

We may think that Machlup was right, even if at the time he wrote that (around the sixties), many of the system’s abuses and flaws were not clearly perceived, plus of course new facts have emerged since. These flaws and abuses are now well known – first of all there is the intrinsic problem that the patent represents an imperfect property law – that often fails to define the precise contours of the intellectual property – which is going to open the door to a lot of legal uncertainties and risks and therefore numerous and costly conflicts concerning intellectual property. Then there’s the problem of patent quality – which is very vulnerable to the operational modes of patent offices and the broad margins left for the interpretation of patentability criteria. And finally there’s the use of the patent as strategic weapon, which allows large companies to accumulate gigantic patent portfolios that are less a reflection of their innovation performance than their wish to block their rivals or even protect themselves against possible attacks in a sort of fearful balancing act. As for new facts, it’s clear that in many cases – innovation by users and within the context of communities of practice – patents can very well be dispensed with without innovation (or creativity anyway) suffering as a result. In many situations of collective creation, the patent that – in order for it to work – must individualise contributions, seems obsolete.

So why save the system? Firstly, the increase of tax levels in Europe and the United States represents a healthy development as higher fees better reflect the social cost generated by the privatisation of a public good (knowledge) and can only serve to slow the inflation of patents and improve their quality.

Secondly, we observe that the patent represents an essential tool of open innovation and markets for technology. There is no paradox between open innovation and intellectual property. We realise that careful and clever intellectual property management by companies is a critical instrument of open innovation regarding both horizontal relationships (with competitors for example) and vertical relationships (with research partners for example). The rise of open innovation has thus coincided with the growth of market for technology.

Finally, between the opinions of two “one-handed economists” – one calling for the abolition of intellectual property for fundamentally theoretical reasons and one who pragmatically considers that it’s still an essential instrument of innovation policies, we will choose the pragmatic view (in other words, the view of Machlup). The patent remains an important instrument because its economic function is not just to reward invention (there are other mechanisms to do that) but also to provide a secure economic environment for the investment that converts ideas into reality. In other words patents are probably more important for investors than for inventors: the “D“ part of R&D is expensive, and is often carried out most effectively in the private sector. Patents are particularly important for start-ups dependent on external finance and for inventions that must be transferred or licensed from one firm to another in order to make the transition to the commercialisation phase. To summarize, patents are important in the economy when they can help to protect the investors (not necessarily the inventors). Lastly, we will note that this argument about the securing of the economic environment of investors does not justify in any way the extension of patentability to scientific discoveries and fundamental knowledge.

A shorter version of this text was published in Horizon – the journal of the SNSF and the academies (June issue 2018)