A novel means of accelerating innovation
Whether civilization can survive the 21st Century remains an open question. The triple challenges of slowing economic growth, depopulation, and climate change, threaten humanity’s survival. The key to overcoming these obstacles requires unlocking technology at an accelerated pace. The problem is that the political institutions and policies designed to encourage innovation are woefully inefficient. The path forward requires a new approach.
Policymakers have long sought to incentivize technological progress through policy. Generally, these incentive structures fall into three basic categories: Direct Investment, Prizes, and Patents. All approaches are highly imperfect, but nonetheless useful means of encouraging innovation for societal benefit.
Direct Investment, which we delved into here, uses taxpayer funds to subsidize the development of new technology. Often, the fruits of this research are placed into the public domain, for anyone to use and improve upon. As with anything that is government run, however, Direct Investment spending can be politically influenced and inefficiently allocated.
Prizes have historically had much success in promoting breakthrough innovations. In a prize system, the government or a third party sets out a goal with a pre-prescribed monetary award. The first to achieve the goal receives the award.
The Longitude Act of 1714, for example, offered a £20,000 prize for a practical method to determine longitude to a half degree accuracy at sea1. The prize spurred innovation in timekeeping and ultimately made sea navigation much safer and cheaper.
Prizes have their drawbacks, however. Namely, they require the prize-issuing authority to be able to foresee what innovations society needs, and calculate a financial compensation figure that will be sufficiently motivating to the market. This requires information that a third party may not possess.
As a consequence, patents have become humanity’s preferred mechanism of innovation promotion. A patent is a temporary government-sanctioned monopoly on an idea, often up to 20 years. This monopoly gives an inventor a temporary, but exclusive right of profit, after which the idea is placed into the public domain for anyone to use and improve upon.
Patents, however, create as many barriers to innovation as they solve. For starters, the monopoly power bestowed on the patent holder is not socially optimal. For example, monopoly-pricing of AZT, a drug used to treat AIDS, prices many people in developing countries out of treatment, leaving millions of children with preventable illness worldwide.2
They also perversely incentivize duplicative research, as competitors attempt to “patent around” existing patents to avoid paying exorbitant royalties. This creates immense waste in research and development dollars. Meanwhile, “trolls” file and hold patents, not in the name of innovation, but as weapons in lawsuits designed to extract money from the innovators themselves.
Furthermore, patents largely lock out 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 and able to improve upon an idea, remain on the sidelines for years, if not decades, until the idea enters the public domain.
Even then, patents still fail to provide truly sufficient incentive for innovation. Even at monopoly pricing, they do not fully reward researchers for the positive externalities of their work. Indeed, studies suggest that the social return is around twice the private return. In other words, patents leave innovative capacity dormant.
A New Path Forward
Some have argued that it might be better to abolish patents entirely, but research suggests that this move would be counterproductive3. Typically, the cost of developing a new idea or product is large, while the cost of producing copies is comparatively small. In a world without patents, copycats will produce the idea essentially at marginal cost. The inventor will be unable to recoup their R&D expense, meaning they will rationally choose not to innovate.4
Instead of a blanket elimination of patents, we ought to employ a blend of Direct Investment, Prizes, and reframe patents as partially publically owned. With this balanced blend, we can leverage the strengths of each system for the benefit of society and accelerate technological progress.
First, Direct Investment would be targeted at the bridge between basic and applied research through a DARPA-like organization (named HARPA) outlined here. Government funds would avoid direct competition with the private sector, focusing on a complementary role by investing in areas too risky or returns too distant, for the private sector to stomach.
Second, HARPA could also employ the use of prizes to motivate the market. Cash prizes could be offered for socially beneficial innovations like life extension medications or reusable rocketry. Crucially, however, whether funded through prizes or Direct Investment, the fruits of this research should be placed immediately into the public domain, where others can further improve them.
Third, we need to rethink how we approach patents. One such path, which we explored here, is the use of patent buyouts. The concept of a patent buyout is simple. All patent filers are required to place their IP up for auction. The auction is used to determine its value. Using this valuation, the government buys the patent at a significant mark-up and then places the idea into the public domain.
The beauty of the buyout is that inventors will be approximately rewarded for the positive externalities of their work, while society simultaneously gets to enjoy those externalities as well. The problem with an auction system, however, is that it might be gamed and manipulated by its own participants.
Since the government is buying most patents at a mark-up, there is significant risk that companies and investors will collude, either explicitly or implicitly, driving up patent valuations. This would force the government into excessive spending, likely into the hundreds of billions per year at least.
A Harberger Tax
While most don’t think of it this way, private ownership is another form of monopoly. This monopoly can sometimes be detrimental to society. For example, an expanding airport may have difficulty buying land from nearby landowners who rationally “hold out” to extract as much money from the airport as possible. Often, far above and beyond actual value of their land.
Patents are ideas, and while the inventor deserves compensation, it is important to recognize that 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 share a portion of those fruits with the sovereign authority that made this possible.
The concept of partial public ownership is further bolstered by the fact that patents, unlike most private goods, are nonrivalrous. That is, one party's use of a patent does not deprive any others' ability to do so, save for the existence of a patent that creates artificial scarcity, scarcity that is the pure creation of the sovereign state.
This can come in the form of annual tax. The challenge lies with accurately assessing the value of the IP so as not to over-tax. That’s where Harberger taxes come in. To determine that valuation, we turn to those who have the best information: the IP owners and inventors themselves. They self-asses the value, and the government charges the annual tax based on that value, anywhere from 5 to 10 percent per year.
Now, you’re probably thinking, 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 so as to prevent anyone from buying it. But with a 5 percent tax, they would have to pay $500 million a year at this valuation. Instead, they will rationally choose a realistic $100 million valuation, incurring a reasonable $5 million annual tax that is worth paying because the patent still nets a profit.
In situations where the inventor may not be confident of their self-evaluation, they may elect to put their patent up for auction in the method described here. The stipulation, however, would be that the subsequent owner would still be required to pay the annual tax based on the valuation as determined by the auction.
This 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 liquid. If a company needs a patent, they can buy it as reasonable price. No longer will they have to wait until the idea enters the public domain or pay an exorbitant fee.
The self-assessment system would also greatly simplify the complexity, and reduce the cost of IP litigation. In alleged infringement cases, courts’ roles would be limited only to adjudicating whether or not infringement took place. They would be freed from the complex and arbitrary task of determining the damages suffered, as this number would be publically available.
What should we do with the tax revenue raised by this system? We should reinvest it, using the proceeds to fund HARPA and socially beneficial prizes. The government can also set up a panel of experts to review patents for buyout potential. This independent panel will selectively buy IP that would be uniquely beneficial to society, and put them into the public domain.
Unlike a patent buyout system where all nearly all patents are purchased at a markup, this system would only buy out a minority of crucial ideas while collecting tax on the rest. It would be largely budget neutral while still rewarding innovators, discouraging rent-seeking behavior, and unlocking select IP for the societal good. Patents would no longer exist in a dichotomous realm of private/public ownership. Instead, they would straddle both. Society and the economy would be all the better for it.
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