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.
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