Supercharging Innovation
Supercharging Innovation
Rethinking how we approach intellectual property
Intellectual Property is a subject of profound importance. The search for the proper balance between incentivizing innovation and the dispersion of new ideas has vexed many. How we design our innovation infrastructure is crucial to expanding and enriching human advancement, with implications for technological progress, economic development, and human well-being. But existing IP law is inflexible and flawed. New ways of managing IP may be on the horizon.
Why Do We Have IP?
A patent or copyright is a temporary government-sanctioned monopoly on an idea or product. For patents, this monopoly is typically 20 years, providing an inventor a temporary exclusive right of profit, after which the idea is placed into the public domain for anyone to use and improve upon. The intent is to allow the inventor to capture the positive externalities of their work and internalize them, for a time.
Patents exist because, it is thought, markets fail to properly incentivize innovation on their own. Typically, the cost of developing a new idea or product is high, while the cost of copying it is comparatively small. In a world without IP, copycats can reproduce an idea near marginal cost, leaving the inventor unable to recoup their initial expense. Absent patents, most will rationally choose not to innovate.
The same phenomenon plays out with copyrights. Imagine that you are writing a book in a world without IP enforcement. You put in hundreds of hours toiling over your piece, editing, revising, and researching for your manuscript. But the moment that it is published, another publisher copies the book, selling it at near marginal cost. To compete, you must lower the price of your book to match, but in doing so you are left unable to recoup your initial time and investment. Rationally, you will not write a book ever again.
This is especially a problem with pharmaceuticals. Again, the cost to develop a new drug is extremely high, often over $1 Billion, but the marginal cost to produce it is usually rather low. Absent patent protection, the smart entrepreneur will rationally wait for the competition to develop a new drug and copy it, undercutting the inventor. Copying, not invention, is rewarded.
Patents and copyright protections attempt to solve this by using the legal system to temporarily protect an idea from being copied.
The Failures of Patents
The problem is that patents create almost as many problems as they solve. They incentivize innovation but then prevent humanity from fully reaping the benefits of new ideas. As one example, patent pricing of AZT, a drug used to treat AIDS, prices many people of modest means out of treatment and leaves millions of children with preventable illnesses.
Patents can also perversely incentivize duplicative research, as competitors attempt to “patent around” existing patents to avoid paying royalties. This creates immense waste in research and development dollars. Worse still, patent “trolls” hold patents, not in the name of innovation, but by exploiting ambiguity and the high cost of litigation to extract money from the innovators themselves.
Additionally, patents largely lockout follow-on innovation. With monopoly pricing, the cost to buy or license a patent is such that most cannot afford to do so. As a consequence, would-be innovators, ready to improve upon an idea, remain on the sidelines for years, if not decades, until the idea enters the public domain.
What are the Alternatives?
There are alternatives to patents that have some success. Direct Investment, for example, as I discussed here, could be targeted at the bridge between basic and applied research through a DARPA-like organization, avoiding direct competition with the private sector. Instead, direct investment can focus on a complementary role by investing in areas that are deemed too risky, and/or returns too distant.
Prizes, where the government or private entities offer a cash prize for inventors to demonstrate new technology, also have a history of success. Cash prizes could be offered for socially beneficial innovations like life-extension medications or reusable rocketry.
The problem with Direct Investment and Prizes is that they require the government to foresee what society needs and accurately determine a compensation value. As history illustrates, it’s not clear that the government can do this reliably. In late 1970s America, for example, hobbyists invented the first desktop computers, kickstarting the PC era and an entirely new industry.
Around that time, the Soviet Union also had garage tinkerers, but in the command economy, were unable to tap VC funding or start a business; they had to seek bureaucratic support instead. Like many at the time, bureaucrats could not see the value in a personal computer and predictably refused to provide funding. As a consequence, the computing industry took off in America and stagnated in the USSR.
Such is a cautionary tale for those assuming that the government can successfully pick and choose which innovations to nurture. Thus, Prizes and Direct Investment would likely still leave significant gaps in the innovation infrastructure. These gaps require us to explore creative means of improving intellectual property.
Patent Buyout Auctions
The most popular proposal for the patent problem was suggested by Michael Kremer in 1997: Patent Buyouts. In his proposed system, an auction is used to determine the value of a patent, whereupon the government buys and open-sources it. As opposed to Direct Investment, the government purchases the output of research, rather than directing money at the input.
This has historical precedent with Daguerreotype photography (the first means of taking photographs), invented in 1837. The government of France recognized the monumental importance of this new technology and made the decision to purchase the patent and place it in the public domain.
Now free to use and improve by anyone, the technology rapidly spread across Europe. Within months, the process for taking photographs was translated into dozens of languages. Chemists all across Europe quickly improved upon the technology, far faster than they would have had the patent not been in the public domain.
Kremer’s proposal works like this: Anytime a patent is filed, it would automatically go into a public auction. The auction would be a Sealed Bid Second Price Auction (SBSPA). In an SBSPA, bids are submitted in written form without knowing the other bids in the auction. The highest bid wins, but only pays the second highest bidder’s price.
Unlike traditional first-price auctions where bidders are trying to guess what other parties are offering, the SBSPA incentivizes participants to bid the patent’s true value only. An honest and true valuation is crucial to the smooth functioning of the system. The key is that the government would also submit a bid, but the government’s bid would take the private value of the patent, determined by the auction, and add a multiplier.
Why? New ideas create positive externalities that cannot be fully captured privately. If they could, inventors would be better incentivized to innovate even more. The data suggests that the social return on R&D is at least twice the private return. Thus, Kremer suggests a multiplier of 2x should roughly account for the positive externalities that the private sector cannot capture.
By default, the government’s bid would win the auction. The patent holder could elect to sell or retain the patent. If sold to the government, the patent will be placed into the public domain for the benefit of humankind. The beauty of patent buyouts is that inventors will be rewarded for their work, while society simultaneously gets to immediately enjoy the fruits of new ideas.
The problem with Kremer’s system, however, is that it may be vulnerable to manipulation. Since the government is buying patents at a significant markup, there is an immense risk that bidders and inventors will collude, either explicitly or implicitly, driving up patent valuations and forcing the government into excessive and wasteful spending.
Kremer recognizes this and suggests that to keep bidders honest, the government steps aside on random auctions, forcing the highest bidder to take on the patent at the price they had bid, creating risk for colluders. As an additional measure to prevent collusion, the government might occasionally base its valuation on the third-highest bid rather than the second, forcing the cooperation of three parties rather than two, making manipulation more difficult and risky.
Kremer’s System is Impractical
With that said, even with safeguards, it is simply too easy for three CEOs to meet on a golf course and arrange a “patent pumping” scheme that would net billions in profit, even if they occasionally would take losses. There is simply too much upside to manipulation and collusion, and little corresponding downside.
Additionally, there is an open question as to whether such a system could ever be affordable. In 2019, the United States spent $667 billion on R&D, both privately and publically funded. Even if we assume, as is highly unlikely, that the output of this R&D is only valuable at face value, a 2x buyout markup brings total spending to ~$1.3 Trillion annually. But in a world with patent buyouts, we should expect more patent generation. Even assuming no collusion, a patent buyout system could cost trillions every year.
The Harberger Tax
Another alternative is to place a Harberger Tax on patents. Patents are legal monopolies and the monopoly protection enjoyed by the inventor is a pure creation of the sovereign state. As such, it may be socially optimal to reframe patents as partially publically owned. The private owner has the right to profit from his idea but must pay a portion to the sovereign authority that made this possible.
A small annual tax can transform patents from a monopoly into partially publicly owned property. As in Kremer’s system, the challenge lies in accurately assessing the value of the IP. That’s where Harberger taxes come in. To determine that valuation, we turn to the IP owners themselves. They self-assess the value, and the government charges the annual tax based on that valuation.
Now, won’t IP owners asses the value low so as to reduce their tax burden? They certainly will, which is why anyone can buy the IP at the self-assessed value at any time. The combined constraints of self-assessment and a recurring tax force a broadly honest valuation.
A patent holder for a widget, as a hypothetical example, might want to value their patent at $10 billion to prevent anyone from buying it. But with a 0.25 percent annual tax, for example, they would have to pay $250 million a year to keep their monopoly protection. Instead, they will rationally choose a realistic $100 million valuation, incurring a reasonable $250 thousand annual levy that is worth paying for patent protection.
Crucially, this recurring tax would discourage rent-seeking behavior, including patent-trolling, by imposing a cost on sitting and holding patents unproductively. It would also shake up the IP market, making it more liquid. If a company needs a patent, it can buy it at a reasonable price, no longer having to wait until the idea enters the public domain.
Modifying Kremer’s Proposal
For all of its flaws, Kremer has identified that, if one can accurately value a patent, copyright, or idea, we have a basis upon which to either open-source it or make it liquid and tradeable. The question becomes 1) How best to value the IP and 2) Which IP should be open-sourced? Can we refine his concept and make it practical?
Working his system backward, is it truly necessary for the government to pay a 2x markup on a patent? I question the value of striving to permit IP owners to fully capture the positive externalities of their work. As illustrated in Stanford Lawyers magazine, we do not permit the full internalization of social benefits in any other property realm. Thus, it is somewhat disingenuous to place such an extreme demand on IP.
Take the example of planting a flower on your front lawn. As the landowner, existing property law does not permit you to hunt down a passerby and charge them for the beautification that the flowers provided. The market need not provide an absolutely perfect capture of social benefits, only enough to cover the fixed and marginal costs of producing IP is required to incentivize output.
Realizing this, we may tweak Kremer’s buyouts and lower the markup to 20 percent above market value instead of 100. Doing this has two effects. First, it significantly lowers the cost of the system. Second, it reduces the upside incentive for participants to manipulate that system, further lowering the financial cost.
Working backward further, a second reform might be to invert the proportion of patents/IP that the government purchases. That is, instead of purchasing >80 percent of patents, as Kremer advocated, a minority of around 20 percent are purchased and placed into the public domain. This eliminates concerns about manipulation as colluders are more likely to lose than win, and further reduces the financial cost.
As a third tweak, we might also consider enacting a waiting period on the auction. Many patents have little, or questionable value upon filing. It takes time for the market to fully develop and utilize an idea. For this reason, it may be wise to install a delay period before the valuation is held. This gives the inventor time to prove an idea in the marketplace, potentially increasing the value of their IP at auction. This may be accompanied by extending patent and copyright terms to a hard 50-year limit.
Forth, for inventors that refuse the sale of their IP, they pay a Harberger tax on the value as determined by the offers of purchase made or self-valuation. From that point on, the IP remains available for purchase by parties who feel that they can make better use of it. If it is purchased by another party, the new owner pays the Harberger Levy instead.
A Practical Alternative
So how would such a system work in practice? Once a patent is filed, the valuation clock begins. Inventors can self-assess their IP or register for auction immediately if they chose but can do so no later than five years from the patent approval.
When the time for valuation arrives, they can choose to participate either in a patent auction or self-assess the value in the vein of a Harberger system. Either way, the moment that the IP is valued, it is open for purchase by the government or the private sector.
If the government chooses to purchase the IP, it will pay the markup value above the valuation, and open source it for all to use. This combines the best of Kremer’s Patent Auctions, without fear of manipulation and at an affordable cost. Because the government’s purchase engenders a markup, inventors will strive to create socially beneficial inventions that are more likely to be purchased.
Of course, private entities and non-profits can also bid for IP. This gives private players, who may be able to make more productive use of that IP, a chance at acquiring it. In other words, the IP market will become somewhat liquid, improving the allocative efficiency that is quite limited under the current regime with monopoly pricing.
One might imagine that private players could also band together into Associations to purchase IP that is beneficial for its members. For example, airlines might partner with aircraft manufacturers to purchase a new patent for a fuel-saving jet engine turbine blade. By spreading the cost across multiple firms, all parties benefit financially from a relatively small investment.
In the end, as in Kremer’s system, the IP owner has the right to refuse the sale. The caveat is that refusing the sale of the IP now engenders a Harbeger levy of 0.25 percent on the higher of the self-assessed value or the auction value. This levy generates some revenue to fund patent buyouts, charging inventors proportionally to the cost of the maintenance of their IP.
At any point thereafter, the IP remains available for purchase but the valuation can always change. Should a higher bid be received, for instance, and the again owner refuses the sale, the new bid value becomes the baseline of the Harberger levy. The higher the valuation, the higher the Harberger Levy will become.
IP inventors and new owners can avoid paying the Harberger levy at any time, all they need to do is open-source the patent or copyright for all to use.
This Solves IPs Challenges
This system would address most of the issues facing patents and IP. Because IP would be subject to valuation and taxation within five years, it would not be rational for orphaned works to exist. Conceivably, most would immediately be put into the public domain. Similarly, the existence of a recurring tax on IP would discourage patent trolls as they would now face potential losses.
Additionally, it would also greatly simplify and reduce the cost of IP litigation. In infringement cases, courts’ roles would be limited only to adjudicating whether or not an infringement took place. They would be freed from the arbitrary task of determining the damages suffered, as this number would be publically available.
Finally, it would make the IP market more liquid, giving the government and private players the ability to purchase and/or open-source key innovations much more quickly and easily than that can under the current system, greatly accelerating the diffusion of new ideas and technology into society for improved social welfare.