Benefits and costs of patents

WITH THE end of the Uruguay Round and the establishment of the World Trade Organisation (WTO), there has been an acrimonious controversy over the relative merits of product and process patents. In the bargain, an overall benefit-cost analysis of patents, per se, product and process, has not been the target of analytical focus. It is this lacuna we aim to fill.

What are the social benefits and costs of awarding patents for inventions? Many economists and patent lawyers seem to think that the answer to this question is simple and settled, at least theoretically. In this article we discover that the answer certainly is not simple and not well settled. There are a number of theories that give different answers and only limited knowledge of where these apply.

The most familiar theory - we will call it the invention motivation theory - is that the granting of patents increases the supply of useful inventions, and that the cost of patents is the restriction on access to completed inventions that a patent creates. An implication is that, if possible, one should not award patents in contexts where invention would proceed without them.

The existence of several theories is not an indication of intellectual troubles. The empirical work on the effects of patents suggests that the kinds of benefits and costs associated with patents differ across economic sectors and across kinds of inventions. Thus, we well may need to have several theories that apply in various combinations in different contexts.

There are at least four broad theories about the principal purposes patents serve:

1. The anticipation of patents provides motivation for useful invention: we call this the ``invention motivation'' theory.

2. Patents induce inventors to ``disclose'' their inventions when otherwise they would rely on secrecy, and in this and other ways facilitate wide knowledge about and use of inventions: we call this the ``invention dissemination'' theory.

3. Patents on inventions induce the needed investments to develop and commercialise them: this we call the ``induce commercialisation'' theory.

4. Patents enable the orderly exploration of broad prospects: this is the ``exploration control'' theory.

Of course, these purposes are not necessarily mutually exclusive. To wit, the anticipation of a patent may stimulate the original invention, and the holding of a patent may prompt its subsequent commercialisation.

The different theories about the benefits and costs of patents make different assumptions - although sometimes implicit - about several of the following context conditions:

1. The nature and effectiveness of means other than patents to induce invention and related activities. These ``other means'' may be as diverse as government grants and contracts or strong first mover advantages.

2. Whether the group of potential inventors is likely to work on diverse and non-competing ideas, or whether the group is likely to be focused on a single alternative or a set of closely connected ones. Basically the issue here is whether or not more inventing input yields more useful inventing output or mainly duplication of effort and waste.

3. The deterrent effect of the presence of patents on unauthorised use of a technology and on the transaction costs involved in licensing an invention.

4. Whether the multiple steps in the invention, development, and commercialisation of a new technology tend to proceed efficiently within a single organisation, or whether efficiency is enhanced if different organisations are involved at different stages of the process.

5. What we will call the topography of technological advance, by which we mean the manner in which inventions are linked to each other temporally, and as systems in use.

Motivation theory

Theory-I - that patents motivate useful invention - is the most familiar one. Indeed, much discussion about the benefits of patents proceeds as if motivating useful invention were the only social purpose served by patents, and that patents always serve this purpose productively. In many cases, neither presumption may be valid.

All versions presume either that if there were no patent protection, there would be no invention, or, more generally, that without a patent system, incentives for invention would be too weak to reflect the public interest and that the prospect of a patent enhances invention incentives. Also, generally they assume that the stronger the patent protection, the more the inventing.

Under what might be called the canonical version associated with the models of K. J. Arrow, W. D. Nordhaus, and F. M. Scherer, it is assumed that the group of inventors is diverse and working on different and generally non-competing things.

Thus, a stronger patent protection results in a greater number of useful inventions or in better inventions.

In most versions, it is assumed, generally implicitly, that the social benefits of a particular invention are strictly its final value. The social benefits of patent protection stem from the additional invention induced by the prospect of a patent. And the social costs of a patent are the restriction on use associated with the monopoly power conferred by a patent.

The theory take on a different look if, instead, competition in R&D is allowed. When firms are presumed to be focused on a common research strategy or a common inventive goal, this gives rise to ``invention race model''. If the presumed common focus is on a broader but still limited ``pool'' of invention prospects, one has the ``overfishing'' models.

Such models point to a number of reasons why the increase in total inventive effort induced by the lure of a patent no longer is an unambiguous plus. If inventors perceive that other inventors are in the game (that is, if there is free entry/ competition in R&D), they will see that their returns are dependent not simply on whether they achieve an invention, but on whether they achieve it first. Relative to the social optimum, patent protection will result in competitive R&D market equilibria where firms invest their resources at a faster rate and too many firms race toward the same invention goal.

It would seem that a consequence of these kinds of invention inefficiencies induced by strong patents would be to shift the tradeoff between the benefits and costs of stronger patents so as to increase the latter. Thus, other things being equal, society ought to opt for stronger patents in fields where stronger intellectual property protection yields a larger flow of valuable inventions than in fields where the stronger patents lead largely to more hounds barking up the same tree.

Patent claims in general extend well beyond the particular specification described in detail. Thus, the awarding of a broad patent to one party inventing in a field can cause other inventors to stop or divert their efforts, even if their inventions would have been somewhat different. J. Lerner has found exactly this effect in the field of biotechnology. In particular, the holding of patents by large firms tends to deter small firms from trying to invent in the same areas.

The issue of the consequences of greater patent length or scope becomes even more complicated if today's inventions not only have direct use value, but also set the basis for subsequent inventive efforts. Arrow especially called attention to the possibility that the principal use of some inventions may be as inputs to further invention. T.W. van Dijk considers what he calls the ``height'' of a patent, by which he means the extent to which the patent controls subsequent improvements and variegations in the initial invention. S. Scotchmer, J. Green and others have dealt in some detail with the issue that, if the original inventor is able to capture only a small portion of the benefits from follow on inventions, profit incentives do not adequately reflect the social interest in a ``prospect opening'' invention. On the other hand, the long-term effect of granting a broad, strong patent on the initial invention will depend on how the presence of that patent affects subsequent inventing.

A number of empirical surveys in the U.S. and OECD have come to the conclusion that patents are an important inducement to invest in only a few industries.

And this conclusion holds for most industries where firms do a lot of R&D. In pharmaceuticals, patents do seem to be an important part of the inducement for R&D. However, in industries like semiconductors and computers, the advantages that came with a heard start, including setting up production, sales and service structures and moving down the learning curve, were judged much more effective than patents. In some of these industries, the respondents said that imitation was innately time consuming and costly, even if there was no patent protection. In others, it was said technology was moving so fast that patents were pointless.

Dissemination benefit

The conventional version of Theory 2 assumes that an inventor can appropriate some returns from a new process or product simply by using or producing it while keeping the relevant information secret to prevent rapid imitation. The possibility of patenting the invention, however, lures the inventor into making public the relevant information. In earlier years, the argument was often couched in terms of society's access to the technology after the inventor had died. However, in the modern world where companies, rather than individuals, are largely the custodians of invention- specific technological knowledge, the issue clearly must be posed more generally in terms of the speed, breadth and completeness of information disclosure or leakage.

In our view, Theory 2 becomes interesting when it is assumed that the inventor, by himself or herself, cannot exploit all possible uses of the invention. Then, to the extent that holding of a patent facilitates licensing, this not only increases the rewards to inventing, but also facilitates wider use.

This argument would seem potentially important in contexts where secrecy can be effective in enabling an inventor to reap at least some returns. In certain industries firms customarily engage in general cross licensing of process technology, a sharing of technology that would be much more difficult if patents were not available on process technology.

While secrecy in general is less effective as a means of appropriating returns from product inventions in many industries firms can profit from their product inventions without a patient. However, possession of a patent, rather than simple reliance on non-patent measures to reap returns, may make a firm more willing to advertise its inventions and to give technological information and assistance to a non-competing firm to help it adapt the invention to its own uses.

Under Theory, 3, a company is unlikely to engage in development of invention unless it has proprietary rights. If the universities hold strong patent rights, they will be in a position to sell such licences. In contrast, if there are no patents, or if the government holds them with a commitment to non-exclusive licensing, companies are unlikely to invest in the necessary development work.

Recently, an Indian university sold two inventions to a company for development into full proprietary rights.

In many areas, patents do in fact emanate from development. Further, studies indicate that in many industries patents are not needed to induce development. A simple head start on commercialisation can yield large profits on a new product, and secrecy often can protect effectively new process technology used by the developer.

Firms, in many instances, will have ample incentive to work with and ``develop'' what comes out of university research. They usually can patent the developments or gain the advantage of a head start of the market, or both. No ex ante grant of an exclusive licence is needed to motivate this work, and the presence of a patent and the requirement to get a licence to do further work on the original idea may restrict the number of parties who will do that work.

The provisions of the Indian Patent Act of 1999 on Exclusive Marketing rights (EMRS) and compulsory licensing in the context of WTO regulations have to be viewed against this backdrop.

`Exploration control'

Theory 4 suggests that an important issue on which the analysis of the and costs of granting patents on broad prospects turns is now one understands the market for patent licences. If one assumes that, in general, potential licencees and patent holders have little difficulty in reaching a licence agreement (that is, the transaction costs of patent licensing are small), then one may take a relatively relaxed view of the costs of granting a large prospect controlling patent, even when one believes that potential explorers of the prospect are diverse in terms of what they will do. One the other hand, if one believes that transaction costs often are high, and patent holders are prone to litigation, one is less sanguine about this.

Regulation issues

We now survey briefly some contentious issues in the application of patent regulations. In traditional societies, knowledge was the collective property of communities. The rigid application of WTO rules on Intellectual Property (IPRs) to the bio-diversity of indigenous peoples who subsist on ancient herbal remedies of forests, is a matter of vehement controversy. Much has been written on the patents granted to derivatives of neem, turmeric and bitter gourd and the CSIR's countermoves in the U.S. There was also a lot of noise on the Basmati rice versus `Texmati' rice issue.

TRIPS: The following alterations have to be carefully considered:

1. Agreements between MNCs, local pharmaceutical companies and the Government on the lines of the now famous Costa Rica-E-Merck agreement on the controlled exploitation of the nation's bio- diversity. A proportion of the profits can be returned to the indigenous peoples exclusively for their welfare. Companies plucking plants will be responsible for replanting the species to avoid depletion.

2. In Australia, the entire bio-diversity has been declared a protected area. Should we proceed on similar lines?

3. An inventory, at least of the salient plants used by pharmaceutical manufacturers, should be prepared.

4. Persons who apply for biological patents will have to specify the country of origin.

Since information technology is a rapidly growing sector in India, the arguments of IPRs for software need mention.

Some of the large companies advocating patent or patent-like protection on software pose their cases in terms of a simple Theory 1 argument. However, smaller companies and university researchers argue that there is little need for stronger intellectual property rights protection in order to induce software development and that patenting key elements of ``software systems'' will significantly cut down on the number of parties who will find it worthwhile to develop new software that is connected into those systems. That is, the issue is a Theory 4 one at least as much as a Theory 1 one. The case of those who argued against patents on software is that strong and wide intellectual property rights will hinder technical advance in this field.

In what areas of technology are technical advances so strongly inter connected either temporally or in a system of use, that effective inventing to-day requires access to prior inventions? Second, what are the fields of inventing where progress generally requires the effective interaction of a number of different organisations? And third, do patents in fact contribute to, or hinder, the access and cooperation needed for technical advance in such contexts?

There currently is very little empirical research aimed at answering this cluster of questions. Our lack of knowledge here clearly limits our ability to analyse intelligently the current pressing issues of patent reform.

S. Venu

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