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 Hannah McCartney Second Year, First Prize Introduction This essay will examine the view that patent protection should be abolished from an economic standpoint; the stance will be critically analysed throughout, though the essay will not attempt to cover all the arguments for and against the position, for to do so would be beyond its scope. Competition and Efficiency The World Trade Organisation defines intellectual property rights as “the rights given to persons over the creations of their minds. They usually give the creator an exclusive right over the use of his/her creation for a certain period of time.” (WTO, no date) These rights include patents, trademarks and copyrights as well as trade secrets and inside knowledge. The principle argument against intellectual property rights is, from an economic standpoint, the issue of limiting competition. In order to maximise consumer welfare, markets should be as close to perfectly competitive as possible; by granting one firm ownership of an idea, an “intellectual monopoly” is created. This results in lower quantities of a good being produced at a higher price to the consumer. Economic theory also shows that monopoly introduces a deadweight loss to society. A comparison between perfect competition and monopoly can be seen in Diagram 1 below. PM QM and PPC QPC represent the prices and quantities produced under monopoly and perfect competition respectively. The shaded portion shows the deadweight loss that monopoly inflicts on society. Boldrin and Levine (2008), who coined the term “intellectual monopoly”, argue that: “The government does not ordinarily enforce monopolies for producers of other goods. This is because it is widely recognized that monopoly creates many social costs. Intellectual monopoly is no different in this respect.” Diagram 1 £ MC PM PPC MR QPC QM AR Q Due to this reduced competition in markets where intellectual property rights are enforced, the topic of efficiency is also particularly significant. Intellectual property law attempts to strike a balance between two economic efficiency objectives: static efficiency and dynamic efficiency. To achieve static efficiency, an allocation of resources should maximize total surplus (consumer surplus + producer surplus). Dynamic efficiency refers to the improvement and renewal of production techniques and goods over time as a result of investment in research and development (R&D), design and creation (Leveque and Ménière, 2004). Diagram 2 shows the effect of intellectual property rights on surplus, and therefore static efficiency. Diagram 2 After protection expires During protection £ £ p0 1 c0 2 c1 D q0 Q p0 p1 1 2 c0 3 c1 D q0 q1 In this example an innovation reduces the costs of a manufacturing process from c 0 to c1. Before the innovation, the quantity of goods produced (q0) is sold at a price of p0 = c0: total surplus is therefore equal to the area labelled 1. During the lifetime of the patent, the quantity of goods produced is always q0 and the price p0 but the total surplus has increased by the area of rectangle 2. This producer surplus is gained by the inventor through license revenue (c0 - c1 per unit of output). When the patent expires and passes into the public domain, the price falls to p1 = c1 and the quantity produced rises to q1. The total surplus increases by the area labelled 3 as new consumers now have access to the good. This increase in surplus shows that society is better off if an innovation is produced, and even better off if its patent has expired. This suggests that it would be preferable (in terms of efficiency) to move straight from the innovation phase to the public domain and bypass the protection phase. Patents (and all intellectual property rights) cost businesses and individuals a lot of money, both to obtain and to enforce: for example, last year Viacom settled a $1bn copyright infringement suit with YouTube (Steel, 2014) in relation to which Google (the owners of YouTube) had already spent over $100m in legal fees alone by 2010. By firms competing with each other to try to obtain a patent, scarce resources are wasted when only one firm (the first firm to succeed) is granted the right to sell the product: all the research, investment and innovation undertaken by the losing firm(s) are effectively written off. The following model demonstrates how a patent Q race depletes the value of an innovation. Investment in R&D by a firm increases the probability that an innovation will be produced (p(n)) when n firms have undertaken investment. Every additional investment increases p(n), but less than the previous investment: therefore p(n) is increasing and concave. If n firms have taken part in the race and the innovation is realised, each firm has a one in n chance of obtaining the patent. The innovation has a value v and the cost of an R&D investment is c. This means a firm’s expected profit is given by: E(n)=p(n) (v-c) n Firms will enter the race as long as their expected profits are positive. Diagram 3 shows the welfare maximising number of firms in the patent race (n*), and the number of firms that actually participate (ne). p(n)v is the expected benefit (private and public) of the innovation and nc is the social cost of the investment effort. Diagram 3 p(n), v, c nc p(n)v n* ne Source: (Leveque and Ménière, 2004) n The socially optimal investment effort (n*) is the one that maximizes the difference between p(n)v and nc. However, firms have a positive expected profit until n=ne so they enter the race. Thus the number of firms participating in the race is always higher than the number that maximizes welfare. The excessive investments undertaken by firms waste the benefit that society derives from the innovation. This race by firms to the same goal is therefore inefficient and could be avoided if patents were abolished. Moreover, if firms were not competing for patents they would be forced to constantly innovate in order to compete with other firms and stay profitable, which would ultimately be beneficial for the consumer as output would be higher and price would be lower (closer to PPCQPC in Diagram 1). Boldrin and Levine’s example of James Watt, a steam train engineer who held a patent on engines from 1769-1800, shows such inefficiency: “Watt’s inventive skills were badly allocated: we find him spending more time engaged in legal action to establish and preserve his monopoly than he did in the actual improvement and production of his engine.” This point is re-enforced by the fact that, once his patent expired, not only did innovation across the industry increase (and steam power became “the driving force of the industrial revolution”), but Watt’s business “for many years afterwards kept up their price and had increased orders.” This shows that without intellectual property rights significant profit can still be made and competition, efficiency and innovation can increase. Innovation The fundamental motivation behind property rights is to give innovators a profit motive that calls forth desirable innovation that would not otherwise occur. However, Boldrin and Levine argue that “it is a long and dangerous jump from the assertion that innovators deserve compensation for their efforts to the conclusion that patents and copyrights, that is monopoly, are the best or the only way of providing that reward.” The US Constitution states that intellectual property rights are in place: “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.” Nevertheless there have been mixed findings of whether intellectual property rights actually do promote innovation: while Varsakelis (2001) and Kanwar and Evenson (2003) find strong positive correlations between the two variables, others have found no effect whatsoever (Qian, 2007 and Ku et al., 2009) and many have found significant differences in correlation related to a country’s development (Allred and Park, 2007 and Schneider, 2005). One way to examine the effect of intellectual property rights is to look at innovation and creativity before they came into effect: after all, there were many successful artists, writers and inventors before intellectual property rights existed who created as a result of their passion rather than purely for profit. Scherer (2004) analysed this situation by comparing data about music in Europe both before and after copyrights were introduced. Tables 1 and 2 below show the average number of composers born per million population per decade in pre- and post- copyright periods. Table 1 uses the UK’s pre-copyright period as 1700-1752 and post-copyright period as 1767-1849. As controls, Scherer compared the UK with Germany, Austria and Italy, in which there was no change in copyright from 1700-1849. Table 1 Nation Pre (1700-1752) Post (1767-1849) Ratio (Post/Pre Copyright) UK 0.348 0.140 0.40 Germany 0.493 0.361 0.73 Italy 0.527 0.186 0.35 Austria 0.713 0.678 0.95 As shown in Table 1, the number of composers per million declined in all four countries, but it declined considerably faster in the UK after the introduction of copyright. Therefore, there is no evidence here to suggest that copyright increased musical output. In opposition to this finding, Table 2 shows the same data compared to France. In this experiment, the pre-copyright period is 1700-1768, and the postcopyright period is 1783-1849. Table 2 Nation Pre (1700-1768) Post (1783-1849) Ratio (Post/Pre Copyright) France 0.126 0.194 1.54 Germany 0.527 0.340 0.65 Italy 0.587 0.153 0.31 Austria 0.847 0.740 0.86 Table 2 shows that, when copyright was introduced in France, the number of composers increased more than in other countries. It is worth noting however that this is the only data that Scherer could find in defence of copyrights during his research, leading him to ultimately conclude that: “the absence of effective copyright certainly did not cause creative musical output to be stalemated. There is reason to believe that copyright systems made a positive contribution to the economic success achieved by some composers, but copyright was by no means the only operative stimulus. The world would be full of glorious music even if copyright laws had not come into being.” Alternative research into the growth in patent grants also shows that intellectual property rights have had mixed results in terms of innovation. Table 3 below shows a comparison of the number of patents granted in four countries. Looking first at Mexico, it was expected that the number of patents (and therefore innovation) would increase after it joined NAFTA (The North American Free Trade Agreement) in 1994. Instead, the number of patents granted to residents actually decreased by 7 between 1995 and 2005, while the proportion of patents awarded to resident investors as a share of overall grants fell from 3.9% to 1.6%. Brazil has seen similar results: their resident investors’ share of overall grants fell from 19.7% in 1995 (when they joined the World Trade Organisation and accepted international intellectual property rules) to 10.2% in 2005. Table 3 Grants at domestic patent offices Country Brazil Mexico South Korea China 1995 Resident Non-resident 525 2134 138 3400 6575 5937 1530 1863 2000 Resident Non-resident 685 2904 113 5414 22943 12013 6177 6881 2005 Resident Non-resident 249 2190 131 7967 53419 20093 20705 32600 Source: WIPO, 2008 In contrast, the data from South Korea and China shows increases in resident innovation. However, this is exaggerated by the fact that South Korea and China both require that “domestic legal offices or affiliates be listed in patent applications, even where the knowledge comes from abroad” (Maskus, 2010). Despite this peculiarity, it can be seen clearly that the overall number of patents has increased over the years, particularly in non-residential grants. In 2006, the share of nonresident patent filings worldwide accounted for 43.6% of total filings, representing an 8.0 percentage point increase from the 1995 level. Concurrently, the share of resident patent filings decreased from 64.3% to 56.4% (WIPO, 2008). This shows that although intellectual property rights have been put in place to stimulate innovation, there is no conclusive evidence that they succeed in doing so: they may in fact hinder it, particularly in terms of foreign patents crowding out domestic innovators. The markets in which patents and copyrights are used can still function with many innovators, rather than just one, with the benefit that socially beneficial simultaneous innovation is possible. For example, James Watt’s 1775 patent meant that plentiful other improvements of great social and economic value could not be implemented until after the patent expired in 1800. Ironically, these subsequent improvements then lead to further innovation by Watt that had not been possible while he held the patent: “not only did Watt use the patent system as a legal cudgel with which to smash competition, but his own efforts at developing a superior steam engine were hindered by the very same patent system he used to keep competitors at bay.” (Boldrin and Levine, 2008) In the majority of cases, innovation builds on innovation; for example, Galileo made many great discoveries, most of which were an outcome of using a telescope. The telescope, however, was not invented by Galileo: its ancestry traces to the spy glass, which had been in use by ships for many years previously. The spy glass itself made little, if any, contribution to the study of the heavens (Demsetz, 2009). By implementing intellectual property rights, this progression of ideas seen throughout history is slowed significantly: most patents last for twenty years and copyrights last for the author’s lifetime plus an additional 70 years. Morality Many would argue that innovators have a moral right to the output of their efforts and although intellectual property rights impose substantial costs (pecuniary and otherwise), they are necessary as they prevent other people from benefitting from an innovator’s ideas. Maskus (2010) explains, “If everyone has the right to own a home, why shouldn’t everyone also own the exclusive rights to whatever inventions, music, books and commercial names they can come up with? People build and buy homes so they can benefit from them, whether by just living there or renting them out. Creators equally want to enjoy the fruits of their labour by offering their goods or technologies for sale or license under terms they decide.” However, intellectual and tangible property have different characteristics that make treating them equally very difficult. Firstly, tangible property is excludable: it can be locked away or secured in order to stop other people from accessing it. Intellectual property is inherently non-excludable without the laws and regulations we have in place which define the rights under which others may use it. Secondly, tangible property is rival, meaning only a finite number of people can use an object. Intellectual property on the other hand is non-rival; an idea can be enjoyed or used by many people without diminishing its quality or quantity. Thomas Jefferson compared an idea to “the flame of a candle, which could be used to light other candles without diminishing the original light.” (David, 1993). Using this analogy, it could be seen as detrimental to society to stop ideas from being used freely as the idea itself (the original light) would not be negatively affected in any way; the only thing intellectual property rights are achieving is the slowing of the dissemination of information and products, and some of these information and products may be incredibly beneficial to society. As already discussed, intellectual property rights have been put in place in order to give innovators a profit incentive by enabling them to charge higher prices for patented goods. Boldrin and Levine argue that: “there are many other ways in which innovators are rewarded, even substantially, and most of them are better for society than the monopoly power that patents and copyrights currently bestow.” For many goods, although this may be inefficient, it does not seem morally wrong. However, there is rising concern that granting patents to certain goods is immoral, particularly in the pharmaceutical industry. One example of this is the fifteen patents various firms in the US hold on different HIV/AIDS medications (Fisher & Rigamonti, 2005). Because the drugs are patented, and the firms that own the patents have legal monopolies over them, other firms cannot produce any generic alternatives. This means the prices of these drugs are significantly higher than they would be without the patents, so the countries with most need for the medication, for example South Africa, are unable to afford them in the necessary quantities. HIV drugs for one patient cost approximately $15,000 annually (Hink, 2001). In South Africa, UNAIDS (2013) estimates 6.1m people were HIV positive in 2012. Therefore, treating all 6.1m patients would cost $91.5bn - 26% of the nation's GDP. As a result of these prices, only 0.001% of South Africa's AIDS patients receive treatment each year (Hink, 2001). This raises a serious moral issue associated with intellectual property rights: pharmaceutical companies legally have the right to effectively withhold the treatment needed by millions of people, by maintaining high prices, just because they discovered how to make the drug first. Conclusion Taking into consideration the effects of intellectual property rights on competition, efficiency, innovation and morality, it is clear from an economic perspective that intellectual property rights should be abolished. Although they give innovators a profit incentive for innovation, there is no conclusive evidence that they actually succeed in stimulating innovation that wouldn’t occur in their absence. The moral implications associated with intellectual property rights also make a strong case for their abolition within certain industries such as pharmaceuticals, as the costs of intellectual property rights in such industries ultimately outweigh the benefits. References Allred, B.B. and Park, W.G. (2007) ‘Patent Rights and Innovative Activity: Evidence from National Firm-Level Data.’ Journal of International Management, 84(3): pp. 488-500 Boldrin, M. and Levine, D. (2008) ‘Against intellectual monopoly’. United Kingdom: Cambridge University Press. David, P. A. (1993) ‘Intellectual Property Institutions and the Panda’s Thumb: Patents, Copyrights, and Trade Secrets in Economic Theory and History’, in Wallerstein, M. B., Mogee, M. E., and Schoen, R. 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