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Fundamentals of Economic Science: An Objectivist Approach

Ayn Rand stated in, Capitalism: The Unknown Ideal, that

Political economy was, in effect, a science starting in midstream‘

 

Economics has ignored the unique features of its principle resource – Man.[1] We are going to avoid that problem, by first examining the unique nature of homo sapiens.  But before we look into the unique nature of man, let’s examine what it means to be a science.  It is my premise that economics is objective and therefore can be a hard science[2], based on empirical observation, logic, and reason.  There are some who would say that economics cannot be a hard science because we cannot setup isolated experiments to test hypotheses.  However, the same can be said of geology and astronomy, both of which are considered hard sciences.

All science is based on certain fundamental empirical observations.  One of these fundamental observations is that reality is objective.  This means that reality exists independent of any person’s belief, hope, faith, or desire.  The evidence for this proposition is overwhelming and includes all the incredible advances in physics, chemistry, biology, geology and the applied sciences (engineering).

 

Fundamental Observation: Reality is Objective[3]

Ayn Rand would state this fundamental observation as:

 

Reality exists as an objective absolute—facts are facts, independent of man’s feelings, wishes, hopes or fears.[4]

 

The second fundamental observation of science is that reality is understandable or discoverable using observation, logic, and reason.  In science, we follow logic and reason even if it seems counterintuitive.  For instance, the implications of special and general relativity predict that clocks on GPS (Global Position Satellites) satellites will run at a different rate than clocks on earth.[5] This appears counterintuitive, but empirical evidence shows that this is true and failure to account for this difference will result in meaningful navigational errors.

 

Fundamental Observation: Reality is understandable or discoverable using observation, logic, and reason

 

Ayn Rand would state this fundamental observation as:

 

Reason (the faculty which identifies and integrates the material provided by man’s senses) is man’s only means of perceiving reality, his only source of knowledge, his only guide to action, and his basic means of survival.[6]

 

If economics is going to be a science, it must be based on these two fundamental observations/assumptions.  Some people may object that science is based on observations.  All logical systems are based on either observations or assumptions.  For instance, Euclidean geometry is based on the assumption that a line goes on forever and two parallel lines never intersect.  Spherical geometry is not based on these assumptions.  It assumes that a line will wrap around on itself.  In science we do not arbitrarily pick the starting point, we use observations.

 

Definition: Economics is the study of how man transforms things to meet their needs.

 

Keeping Rand’s admonishment about the state of economics in mind, we now turn our attention the unique nature of man.  Aristotle and Rand define man as a rational animal.  The genus is animal.  The unique nature of animals and all life is that it thrives on negative entropy.[7] The species in the definition of man is that he is rational.  In the context of economics, the important part of being rational is that man invents.  No other animal invents.  In Atlas Shrugged invention plays a major role in the story.  The major character John Galt is an inventor as is Hank Reardon.

 

Man’s unique reward, however, is that while animals survive by adjusting themselves to their background, man survives by adjusting his background to himself.[8]

 

The first need of every person is to stay alive.  This means that life is a fight against entropy, the second law of thermodynamics.  Entropy is normally defined as the measure of the disorder of a system.  Entropy was discovered as part of thermodynamics and it explains that a perpetual motion machine is impossible.  Entropy always increases in a closed system.  Luckily for us, the Earth is not a closed system.  For instance, we receive energy from the Sun.  The only way to increase order is by the input of energy.  Life represents increasing order and therefore just to sustain life at its present level requires energy.  Edwin Schrödinger, Nobel Prize winning physicists, proposed this idea in his 1944 book, What is Life.[9]

 

Fundamental Observation: Life is a fight against entropy

 

Plants create this energy by photosynthesis.  They convert carbon dioxide into sugars (energy) using light.  They use this energy to create order.  Animals eat plants or other animals and use the energy to create order.  Note that when animals eat plants or other animals, they are increasing the disorder of the plants and animals they eat.  Thus, there are two general mechanisms that increase the entropy of life forms, 1) internal and 2) external.  Internal mechanisms are those that result from the failure to consume enough calories (energy) and aging.  Animals require oxygen, water, and food in that order to survive.[10] Without oxygen, the animal cannot oxidize enough sugar (fat, protein) to survive – overcome entropy.  Without water, the animal’s cells are unable to absorb energy and expel wastes.[11] As a result, the animal does not receive sufficient energy to overcome entropy.  Aging is a process of increasing disorder – entropy.  This disorder is caused at least in part by disorder in genetic information.[12] External mechanisms include being eaten or attacked by other living organisms, diseases, accidents (for animals), and the elements.

In general, living organisms use energy to overcome entropy first and then to increase their size.  However, some animals also create simple shelters or seek shelter to ward off the entropy increasing effects of the elements and predators.  Rain, sun, hail, snow, heat, and cold all contribute to the increase in entropy of living organisms (disorder).  A living organism dies when its entropy increases above a certain level.  Life has two main methods of overcoming the effects of the second law of thermodynamics: 1) food (energy) consumption and 2) shelter creation (inhabitation).

A species of life becomes extinct when the species as a whole reaches a certain level of entropy either because it cannot consume enough energy or because external mechanisms increase its entropy to the extinction level.  A species reaches the Malthusian Trap when increases in population of the species results in the total required energy (food) to support the population is greater than supply of food.  Or stated in the laws of physics, the total available energy is less than the energy required to overcome the total entropy of the species’ population.  Most life forms exist in the Malthusian Trap, including humans until the Industrial Revolution.  Evolution is life’s way of determining which species is best at overcoming entropy.

Homo sapiens also consume food and create shelter to overcome the effects of entropy.  Unlike other living organisms, homo sapiens organize their environment to minimize the effects of entropy.  For instance, humans have invented agriculture to increase their supply of food (energy) and therefore order.  Humans also harnessed the physical strength of animals, created internal combustion machines, electric lights, electricity, washing machines, tractors, computers, the internet, email, lasers, fiber optics, etc.  All of these are inventions.  Humans alter their environment by creating inventions.  This is different from every other animal.  This should not be surprising, since the distinguishing characteristic of homo sapiens is their ability to reason.  Man is a rational animal according to Aristotle’s classical definition.[13] Being rational is the distinguishing characteristic of humans.  Man uses his reason to alter his environment (invent) and increase order for himself.  Invention is the unique way in which man is able to create order – this is the fundamental observation of economics.

 

Fundamental Observation of Economics: Man’s unique ability to increase order (wealth) is his ability to invent.

 

Ayn Rand’s way of explaining this is:

 

Nothing can raise a country’s productivity except technology[14]

 

Inventing first results in the increased success of the species.  Homo sapiens populated most of the world in less than 500,000 years because of this unique ability.  As long as the rate of technological progress is slower than the growth in population, man is stuck in the Malthusian Trap.  Sometime around 1800 in Europe and the United States, the rate of invention exceeded the rate of growth in population and man escaped the Malthusian Trap at least in the West.[15] When man escapes, he is no longer subject to biological evolution.  As far as we know, homo sapiens are the only species to ever escape the Malthusian Trap.

Trade enhances man’s ability to invent.  By trading the products of each others’ inventions both trading partners can specialize and end up wealthier.  David Ricardo explained how both parties are better off because of trade using the example of England trading cloth for Portuguese wine:

 

England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time.  England would therefore find it in her interest to import wine, and to purchase it by the exportation of cloth.  To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time.  It would therefore be advantageous for her to export wine in exchange for cloth.  This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced with less labour than in England.[16]

 

Using the example above, if England produces twice as much cloth as it needs, it has invested 200 man hours.  If Portugal produces twice as much wine as it needs it has invested 160 man hours.  Now if England and Portugal trade their excess cloth for the excess wine, England has invested 200 man hours for all its cloth and wine, while Portugal has invested 160 man hours for all its cloth and wine.[17] If England had produced both all its cloth and all its wine locally, then it would have invested 220 man hours for the same goods.  This means that England requires 10% more man hours if it does not trade.  If Portugal had produced both all its cloth and all its wine locally, then it would have invested 170 man hours for the same goods.  This means that Portugal requires 6.25% more man hours if it does not trade.

Trade is a rational activity and humans are the only animals to engage in trade of non-like items and trade between non-related individuals.[18] Classical economics has focused on trade and the related supply and demand curves instead of the role of invention in economics.  This might have occurred because the beginning of classical economics was in reaction to the Mercantile system and its limitations on trade.  Adam Smith’s book, The Wealth of Nations, is often seen as a refutation of the Mercantile system.  Matt Ridley, in his book, The Rational Optimist, has suggested that trade is the key to creating wealth.  This emphasis on trade has been misplaced.  Invention proceeds trade.  If everyone produces the same thing, then there is no reason to trade.  It is only because someone has invented a new product that trade becomes a rational choice.  For instance, one group of people may have invented a process for skinning animals and using them as clothing.  They may have traded this with people who had access to flint and invented a system for making simple axes.  Invention has to proceed production, which has to proceed trade logically.  Of course, without trade the value of invention is severely diminished.

In summary, life is a fight against entropy.  Economics is the study of how man transforms things to meet their needs.  The unique way in which humans meet their needs is to invent.  Only by inventing can humans increase their level of wealth.

 


[1] Rand, Ayn, Capitalism: The Unknown Ideal, Kindle Edition, location 126-128, 2011.

[2] Hard sciences include physics, chemistry, and biology, as opposed to “soft science”, such as psychology, sociology, and political science.

[3] Even the bizarre results of quantum mechanics are repeatable and independent of the observer’s hopes, desires, faith, opinion.

[4] The Ayn Rand Institute, Introducing Objectivism, http://www.aynrand.org/site/PageServer?pagename=objectivism_intro, 2/0/11.

[5] Real-World Relativity: The GPS Navigation System, http://www.astronomy.ohio-state.edu/~pogge/Ast162/Unit5/gps.html, October 3, 2010.

[6] The Ayn Rand Institute, Introducing Objectivism, http://www.aynrand.org/site/PageServer?pagename=objectivism_intro, 2/0/11.

[7] Wikipedia, What is Life?, http://en.wikipedia.org/wiki/What_is_Life%3F_(Schrödinger), Edwin Schrödinger, 10/6/10

[8] Rand, Ayn, For the New Intellectual, p. 15.

[10] There are few exotic life forms that do not need oxygen, but all require energy to overcome entropy.

[11] BNET, Physiological Effects of Dehydration: Cure Pain and Prevent Cancer, http://findarticles.com/p/articles/mi_m0ISW/is_2001_August/ai_78177228/, 10/6/10.

[12] Hayflick, Leonard, Entropy Explains Aging, Genetic Determinism Explains Longevity, and Undefined Terminology Explains Misunderstanding Both, PLoS Genetics, http://www.plosgenetics.org/article/info:doi/10.1371/journal.pgen.0030220, 10/7/10.

[13] The Philosophy of Aristotle, Adventures in Philosophy  http://radicalacademy.com/philaristotle4.htm, 10/7/10.

[14] “The Moratorium on Brains” The Ayn Rand Letter, I, 3, 5.

[15] This should more accurately be stated that the rate of growth in productivity due to the introduction of new technologies exceeded the rate of growth in population.

[16] Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Harper Collins, New York, 2010, p. 75.

[17] This example ignores the cost of transport the wine and cloth, but it illustrates the general concept.

[18] Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Harper Collins, New York, 2010, p. 56.

 

 
Toward a Hard Science Approach to Economics – 1

It is the premise of this post that economics is objective and therefore can be a hard science[1], based on empirical observation, logic, and reason.  Some clear objective results in economics include that failure of a person to produce (consume) enough food results in starvation and death.  It does not matter how much someone feels or believes (or has faith) that they should not have to produce (consume) enough calories, they will starve to death.  There is overwhelming empirical evidence for this proposition, including the purposeful starvation of numerous people by totalitarian governments in the last century.  Another example is that if the government raises the cost (or reduces the return) of performing an activity, you will have less of this activity than would have occurred without the government interference, as long as you have statistically large enough group.  For instance, if a government raises the cost of food or reduces the return for producing food enough people starve.  The empirical evidence includes numerous African countries that have held the cost of food below the cost of production and this inevitably results in mass starvation.  This is true no matter how much faith the government has that it should not occur, or how much they feel it will not occur, or how much they believe it should not occur.  Similarly, a person can deny the existence of gravity, but gravity will act on the person no matter what they believe about gravity.  Gravity is not a matter of belief, it is a matter of understanding.  It is clear that at least some of the laws of economics are as immutable as the laws of gravity.

All science is based on certain fundamental empirical observations.  One of these fundamental observations is that reality is objective.  This means that reality exists independent of any persons’ belief, hope, faith, or desire.  The evidence for this proposition is overwhelming and includes all the incredible advances in physics, chemistry, biology, geology and the applied sciences (engineering).

 

Fundamental Observation: Reality is Objective[2]


The second fundamental observation of science is that reality is understandable or discoverable using observation, logic, and reason.  In science, we follow logic and reason even if it seems counterintuitive.  For instance, the implications of special and general relativity predict that clocks on GPS (Global Position Satellites) will run at a different rate than clocks on earth.[3] This appears counterintuitive, but empirical evidence shows that this is true and that failure to account for this difference will result in meaningful navigational errors.

 

Fundamental Observation: reality is understandable or discoverable using observation, logic, and reason

 

If economics is going to be a science, it must be based on these two fundamental observations/assumptions.  Some people may object that science is based on observations.  It has been shown that all logical systems are based on either an observation or an assumption, in the case of mathematics.  For instance, Euclidean geometry is based on the assumption that a line goes on forever and two parallel lines never intersect.  Spherical geometry is not based on these assumptions.  It assumes that a line will wrap around on itself.  In science we do not arbitrarily pick the starting point, we base them on observations.  Unfortunately, the science of economics is in the same state as physics before Newton.

Life is a fight against entropy, the second law of thermodynamics.  Entropy is normally defined as the measure of the disorder of a system.  Entropy was discovered as part of thermodynamics (statistical mechanics) and it explains that a perpetual motion machine is impossible.  Entropy always increases in a closed system.  Luckily for us, the Earth is not a closed system.  For instance, we receive energy from the Sun.  The only way to increase order is by the input of energy.  Life represents increasing order and therefore just to sustain life at its present level requires energy to overcome entropy.  Edwin Schrödinger, Nobel Prize winning physicist, proposed this in his 1944 book, What is Life.[4]

 

Fundamental Observation: Life is a fight against entropy

 

Plants create this energy by photosynthesis.  They convert carbon dioxide into sugars (energy) using light.  They use this energy to create order.  Animals eat plants or other animals and use the energy to create order.  Note that when animals eat plants or other animals, they are increasing the disorder of the plants and animals they eat.  Thus, there are two general mechanisms which increase the entropy of life forms: 1) internal and 2) external.  Internal mechanisms are those that result from the failure to consume enough calories (energy) and aging.  Animals require oxygen, water, and food in that order to survive.  Without oxygen, the animal cannot oxidize enough sugar (fat, protein) to survive – overcome entropy.  Without water, the animal’s cells are unable to absorb energy and expel wastes.[5] As a result, the animal does not receive sufficient energy to overcome entropy.  Aging is a process of increasing disorder – entropy.  This disorder is caused at least in part by disorder in genetic information.[6] External mechanisms include being eaten or attacked by other living organisms, diseases, accidents (for animals), and the elements.

In general, living organisms use energy to overcome entropy first and then to increase their size.  However, some animals also create simple shelters or seek shelter to ward off the entropy increasing effects of the elements and predators.  Rain, sun, hail, snow, heat, or cold all contribute to the increase in entropy of living organisms (disorder).  A living organism dies when its entropy increases above a certain level.  Life has two main methods of overcoming the effects of the second law of thermodynamics: 1) food consumption and 2) shelter creation (inhabitation).

A species of life becomes extinct when the species as a whole reaches a certain level of entropy either because it cannot consume enough energy or because external mechanisms increase its entropy to the extinction level.  A species reaches the Malthusian Trap when increases in population of the species results in the total required energy (food) to support the population is greater than supply of food.  Total available energy is less than the energy required to overcome the total entropy of the species population.  Most life forms exist in the Malthusian Trap, including humans until the Industrial Revolution.

Homo sapiens also consume food and create shelter to overcome the effects of entropy.  Unlike other living organisms, homo sapiens also organize their environment to minimize the effects of entropy.  For instance, humans have invented agriculture to increase their supply of food (energy) and therefore order.  Humans also harnessed the physical strength of animals, created internal combustion machines, electric lights, electricity, washing machines, tractors, computers, the internet, email, lasers, fiber optics, etc.  All of these are inventions.  Humans alter their environment by creating inventions.  This is different from every other animal.  This should not surprising, since the distinguishing characteristic of homo sapiens is their ability to reason.  Man is a rational animal according to Aristotle’s classical definition.[7] Being rational is the distinguishing characteristic of humans.  Man uses his reason to alter his environment (invent) and increase order for himself.  Invention is the unique way in which man is able to create order – this is the fundamental observation of economics.

 

Fundamental Observation of Economics: Man’s unique ability to increases order (wealth) is his                                              ability to invent.

 

Inventing first results in the increased success of the species.  Homo sapiens populated most of the world in less than 500,000 years because of this unique ability.  As long as the rate of technological progress is slower than the growth in population, man is stuck in the Malthusian Trap.  Sometime around 1800 in Europe and the United States, the rate of invention exceeds the rate of growth in population and man escapes the Malthusian Trap at least in the West.  When man escapes, he is no longer subject to biological evolution.  As far as we know, homo sapiens are the only species to ever escape the Malthusian Trap.

Trade enhances man’s ability to invent.  By trading the products of each others’ inventions both trading partners can specialize in the inventions and both end up wealthier.  David Ridardo explained how both parties are better off because of trade using the example of England trading cloth for Portuguese wine:

England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time.  England would therefore find it in her interest to import wine, and to purchase it by the exportation of cloth.  To produce the win in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time.  It would therefore be advantageous for her to export wine in exchange for cloth.  This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced with less labour than in England.[8]

Using the example above if England produces twice as much cloth as it needs, it has invested 200 man hours.  If Portugal produces twice as much wine as it needs it has invested 160 man hours.  Now if England and Portugal trade their excess cloth for the excess wine, England has invested 200 man hours for all its cloth and wine, while Portugal has invested 160 man hours for all its cloth and wine.  If England had produced both all its cloth and all its wine locally, then it would have invested 220 man hours for the same goods.  This means that England requires 10% more man hours if it does not trade.  If Portugal had produced both all its cloth and all it wine locally, then it would have invested 170 man hours for the same goods.  This means that Portugal requires 6.25% more man hours if it does not trade.

Trade is a rational activity and humans are the only animals to engage in trade of non-like items and trade between non-related individuals.[9] Classical economics has focused on trade and the related supply and demand curves instead of the role of invention in economics.  This might have occurred because the beginning of classical economics was in reaction to the Mercantile system and its limitations on trade.  Adam Smith’s book, The Wealth of Nations, is often seen as a refutation of the Mercantile system.  Matt Ridley, in his book, The Rational Optimist, has suggested that trade is the key to creating wealth.  This emphasis on trade has been misplaced.  Invention proceeds trade.  If everyone produces the same thing, then there is no reason to trade.  It is only because someone has invented a new product that trade becomes a rational choice.  For instance, one group of people may have invented a process for skinning animals and using them as clothing.  They may have traded this with people who had access to flint and invented a system for making simple axes.  Invention has to proceed production, which has to proceed trade logically.  Of course, without trade the value of invention is severely diminished.


[1] Hard science, such as physics, chemistry, and biology, as opposed to “soft science”, such as psychology, sociology, and political science.  In general, soft sciences are not science at all.  For instance, Freud’s formulation of the id, ego, and super ego is not science.  This formulation is not testable and is not based on objective empirical evidence.  In fairness, psychology to the extent it is based on neurobiological processes is real science.  The first step in any science is categorization and psychology has attempted to categorize various behaviors.  Unfortunately, many of these categorizations are too vague to be testable or objective.  As we have gained more information some formally vague definitions have become objective.  Political science is not a science it is a study of politics.  Sociology also has no basis in science.  This is not to say that there is no value to studying politics or the interaction of groups.  History and literature do not call themselves a science, but there is great value in the study of history and literature.  History even uses science to discover new facts about history, but it is not a science.  The soft sciences use the nomenclature of science to aggrandize themselves.  This propaganda has undermined the value of science in the eyes of the general public.

[2] Even the bizarre results of quantum mechanics are repeatable and independent of the observer’s hopes, desires, faith, opinion.

[3] Real-World Relativity: The GPS Navigation System, http://www.astronomy.ohio-state.edu/~pogge/Ast162/Unit5/gps.html, October 3, 2010.

[5] BNET, Physiological Effects of Dehydration: Cure Pain and Prevent Cancer, http://findarticles.com/p/articles/mi_m0ISW/is_2001_August/ai_78177228/, 10/6/10.

[6] Hayflick, Leonard, Entropy Explains Aging, Genetic Determinism Explains Longevity, and Undefined Terminology Explains Misunderstanding Both, PLoS Genetics, http://www.plosgenetics.org/article/info:doi/10.1371/journal.pgen.0030220, 10/7/10.

[7] The Philosophy of Aristotle, Adventures in Philosophy  http://radicalacademy.com/philaristotle4.htm, 10/7/10.

[8] Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Haper Collins, New York, 2010, p. 75.

[9] Ridley, Matt, The Rational Optimist: How Prosperity Evolves, Haper Collins, New York, 2010, p. 56.

 

 
American Inventors for Patent Reform

AIPR has provided an excellent analysis of the numerous problems with the present “Patent Reform” bill.  There analysis is reproduced below:

S.515 and HR.1260, the Patent Reform Act: the weak grace period harms startups, small businesses  and university spin-offs, and will strangle millions of jobs

The Patent Reform Act weakens the one-year grace period, in  way that sharply tips the patent system in favor of large companies and companies with substantial offshore business, and against small companies, startups, university and other research spin-offs, and companies requiring FDA approval, and U.S. employees of international companies.  Small companies’ patents will be invalidated.   The costs of the patent system for small entities will increase, and venture capital investments in startups will decrease, by about $1 billion per year.  Because of multiplier effects, within a few years, the reduction in business formation that starts immediately will, within a few years, destroy about $100 billion per year of economic activity.

Current law gives an inventor one year to communicate outside a single firm, to openly raise capital, to assemble strategic partners, and to field test.  Under current law, the grace period allows a year to sort good inventions from bad, before significant resources must be committed to the patent process.  The current grace period lets companies gather information for a year so they can make good business, patenting, and investment decisions during the most difficult part of an invention’s lifetime, the early stage transition from the lab to commercialization.

The proposed amendment to the grace period is unworkable and unusable in practice.  The bill proposes that all disclosures of the invention within a year before the filing date bar will bar a patent, unless the true inventor can show “the subject matter was obtained directly or indirectly from the inventor.”  While this sounds facially reasonable, given the methods of proof available, this grace period is useless as a practical matter, because the bill provides no access to discovery of the facts that inventors will need to prove their cases.  Inventors will be forced into premature “use it or lose it” decisions, to file a patent application today or run a high risk of losing the option forever.

Further, the bill is ambiguous.  One key term, “disclosure,” is undefined.  Because the PTO must interpret statutes as adversely as possible in order to force issues to the Federal Circuit, the PTO will be required to interpret the new law to excuse only printed publications prepared with the care and expense of a full patent application.  ALL testing, offers for sale, public demonstrations, etc. will be patentability bars, with NO grace period, until the courts straighten this out.  That will take at least seven years.  It might be never, if the courts read the new law the way some big companies have advocated.

  • The situations that destroy patent rights arise suddenly, with no opportunity for a small company to recover.  The bill reflects the way large companies do business, but penalizes small companies:
  • The bill sharply favors companies that can do all of their financing, R&D, pre-launch marketing, etc. in house—but creates unacceptable risks for companies that must disclose their inventions or business plans in order to get investors or partners
  • Other countries that converted to a patent system like S.515 have lost their startup and small companies – the Patent Office admits it has never considered Canada, which made almost the same change, and had experienced no net benefit, only a shift from small companies to large
  • Because patent rights become so fragile, small company inventors must operate as if there were no grace period at all.  That raises huge costs:
  • Businesses have to conduct their affairs based on the information available today.  The bill assumes that businesses have perfect foresight knowledge, and can make good decisions without the information that accumulates over the grace period year of current law.
  • Under existing law, patent rights are largely determined by ordinary business activities.  A business doesn’t have to spend extra money just to speculatively protect patent rights.  Under the new weak grace period law, a business has “use it or lose it,” at great expense and risk of error.
  • The statute forces companies to spend money on patent attorneys far earlier, when most startups have the least money available, even on inventions that turn out to be worthless over the year.
  • Best estimates from other countries, whose laws are similar to S.515, are that inventors will have to file 100,000 to 200,000 more patent applications per year, a cost of about $ 500 million to $1 billion per year.
  • Venture capital investments will fall significantly if small companies are forced to spend money on patent applications for inventions that turn out to be worthless, and that are not filed under current law, but must be filed under S.515’s “forced to file”
  • This surge of patent applications will overwhelm the Patent Office, worsening backlog.   Many of these applications will go abandoned after the Patent Office bears its highest cost, the cost of examining an application for the first time.   The Patent Office’s fee structure is backloaded toward issued patents, so that the Office will receive only 20% or so of its fee income for doing 70% of the work.
  • “Harmonization” and international patent protection (the main rationales given by the proponents) are relevant to only a tiny minority of small entities
  • Why would we want to “harmonize” toward economies that have less than half the U.S. rates of startup formation and R&D investment?
  • Startups succeed or fail depending on their U.S. markets.  International patents are irrelevant to most startups.
  • The House bill provides that this provision only goes into effect when other major countries change their laws to harmonize toward a middle ground.  S.515 removes this quid pro quo. S.515 can’t achieve any benefit if it doesn’t require other countries to move our direction.

OTHER RESOURCES

Letter of the Small Business Coalition on Patent Legislation to SBA Administrator Karen Mills, (December 15, 2009) at http://www.connect.org/news/pdf/Coalition-Letter-to-SBA-Dec-15-09.pdf, on behalf of National Small Business Ass’n, CONNECT (San Diego small businesses), American Innovators for Patent Reform (coalition of inventors, researchers, engineers, entrepreneurs, etc.), Professional Inventors Alliance (independent inventors), National Ass’n of Patent Practitioners (patent attorneys, a majority of whom represent small businesses), IP Advocate (university faculty inventors)

David Boundy and Matthew Marquardt, Patent Reform’s Weakend Grace Period: Its Effects on Startups, Small Companies, University Spin-Offs, and Medical Innovators, Medical Innovation & Business, Summer 2010, 2:2 pp 27-37, http://journals.lww.com/medinnovbusiness/Fulltext/2010/06010/ Patent_Reform_s_Weakened_Grace_Period__Its_Effects.6.aspx

 
John Clemens Show – USA Radio

Dale Halling is on the John Clemens show on USA Radio Network which is syndicated around the country.  The transcript of the show is provided below.

With a nine-point-seven percent unemployment rate, many Americans are asking, “where are the jobs?”  Business-policy expert, entrepreneur, patent attorney and author Dale Halling says politicians should begin to look at where the real jobs can be created.  John Clemens reports.

3:00 Standard close

Dale Halling is the author of the book, “The Decline and Fall of the American Entrepreneur.”  Halling writes if Washington wants to create real jobs, they should look at technology where 70 percent of  new jobs will be found.

:20   “advances in technology”

He says entrepreneurs have been stifled by legislation over the last two decades.

:11   “number of entrepreneurs”

Dale Halling says over the last decade foreign countries have made great advances in technology, while the number of American patents issued has been flat.

:26   “to their inventions”

Dale Halling has a four step plan to get America back on track.

:30  “stock options”

It has been both legal rulings as well as legislation that has placed  road blocks in front of many potential entrepreneurs and with that the loss of potential jobs for Americans

:26   “to grow”

Dale Hallings is doing his best to get the attention of not only politicians but those Americans witnessing the Decline and Fall of the American Entrepreneur.

:13    “Halling b l o g-dot-com”

This is John Clemens.

 
Is it Time to Start Celebrating?

The fourth quarter GDP growth was reported at 5.7% growth.  Most economists believe this growth was mainly due to inventory rebuilding and government spending.  Both are likely to fall off in this year.  It is not possible to continue government spending at its present rate and once inventories are rebuilt to more normal levels companies will slowtheir production.  The best news for the economy is the election of Scott Brown as Senator from Massachusetts.  This is likely to lead to gridlock in Washington, which will allow businesses to plan for the future without the uncertainty of radical changes in regulations or taxes.  If gridlock does prevail, then the economy will recover but growth will be moderate.  I expect that if the Federal Reserve does not raise interest rate substantially, we will see inflation start to pick up around the fourth quarter of 2010 but no later than sometime 2011.  This combination of moderate growth and increasing inflation will be similar to the stagflation of the 1970s and will not substantially reduce the unemployment rate.  If the Federal Reserve does raise interest rates enough to quell inflation, then we fall into another recession.

Threats

The 800 pound gorilla in the room of the US economy this decade is Medicare and Social Security.  Our nominal federal debt is $12.3 trillion.  This represents a debt to GDP ratio of about 86%.  While this number is large, it was higher after World War II, when it peaked at 120%.  However, at the end of World War II we did not have large unfunded liabilities associated with Medicare and Social Security.  If you include the approximately $60 trillion in unfunded liabilities into the debt to GDP ratio, the ratio is 505.6%.  This is clearly unsustainable.  The effects of the unfunded liabilities are likely to be felt before the end of this decade and will dwarf the financial crisis associated with housing market in 2007-2009.  This will lead either to massive inflation or default on our debt and unsustainable tax rates.

Solutions

If we want the economy to grow and create jobs, we first need to reverse those changes in our laws in regulations that are inhibiting innovation.  Since 2000, we have passed a number of laws and regulations that are killing innovation in the US.  The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital.  All three of the foundations have been under attack since 2000.  Our patent laws have been weakened reducing the value of intellectual capital.  Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.  The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, explains these problems in more detail.

Reinvigorating our economy by encouraging innovation will reduce the problems associated with Social Security and Medicare.  It will also make it less painful to restore fiscal discipline to our government.  If we do not do not resolve these issues of innovation, fiscal discipline, and entitlements, the US will suffer a severe economic downturn this decade and the US position as economic, military, and political leader of the world will end.

 
U.S. Falls to 8th in Economic Freedom

It is a sad day in U.S. history.  According the Heritage Foundation and Wall Street Journal’s 2010 Index of Economic Freedom the U.S. has fallen to eighth.  The U.S. is behind Canada, Ireland, Australia, Singapore, etc.  According to the report the U.S. fell further in the index than almost any other country.  Please read the full report. http://www.heritage.org/Index/ My only complaint with the report is that they do not rank countries according to their protection of intellectual property.  I think this would be a valuable addition.

 
96% of Americans Believe Innovation is Critical

According to the BBC article “Governments stifle hi-tech innovation, says trade group” , American believe innovation is critical to the US’s success as a world economic leader.  The article states:

The weakening financial markets meant that in 2009 America was overtaken as the most competitive economy by Switzerland.

As regular readers of this blog know, In my opinion since 2000 we have passed a number of laws and regulations that are killing innovation in the US.  The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital.  All three of the pillars have been under attack since 2000.  Our patent laws have been weakened reducing the value of intellectual capital.  Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.  The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, explains these problems in more detail.

 

Technology start-ups drive innovation.  According to the book, The Decline and Fall of the American Entrepreneur, a start-up needs almost a billion dollars in sales to justify going public because of the cost of complying with rules such as  Sarbanes Oxley, depriving our technology sector vital financial capital.

Decline and Fall clearly shows:

*Sarbox fails to achieve its goals;

*Thriving IPOs are critical to providing capital for technology companies, even if most of those companies never go public;

*The SEC estimates the cost of Sarbox compliance at $91,000/yr per company, the actual cost is closer to $4.0M/yr!!!

*Is the medicine worse than the disease!!

Percentage of World IPOs:

1996 – 60% in U.S.

2005 – 20% in U.S.

*Decline and Fall shows how we can turn this around- Make the US the world leader again in Innovation. Jobs. Capital.

Your copy of The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, by Dale B. Halling, is at Amazon.com.

 
Larry Kudlow is Wrong!

Larry Kudlow is predicting a strong V shaped economic recovery in 2010.  His reasons for this prediction are a steep positive yield curve and the rising stock market.  While Mr. Kudlow is a top notch economist and I appreciate his optimism, here is why I believe he is wrong.

Yield Curve

A steep positive yield curve is not necessarily a good predictor of the strength of the economy.  As seen in the chart below, the yield curve was positive and above the 80 year average throughout the 1930s and this did not portend strong economic growth.

(Source: http://seekingalpha.com/article/23870-an-80-year-yield-curve-history-and-its-implications (12/24/09), An 80-Year Yield Curve and its Implications, Shaw, Richard, “Seeking Alpha.”

In the 1970s, the yield curve was positive and above the 80 year average for much of the decade and this did not portend strong economic growth.  The 60s saw the yield curve below the 80 year average and negative twice, which did not signal weak economic growth. 

 

Some people suggest that Venture Capital is just in a normal cyclical downturn.  Not a single venture backed company went public in second quarter of 2008.  This has not happen since 1978.  This was followed up by no venture backed companies going public in second and third quarters of 2009.  This is clearly not just a cyclical downturn.

Venture Capital is built on technology start-up companies whose main assets are inventions.  The value of these inventions is determined not just by their technical merit, but the strength of title to the invention.  If legal title to the invention is weak, then a great technical invention provides a very limited opportunity for the start-up company or its investors.  This clearly reduces the value of the company and the chances of return for it investors.  Since 2000 the U.S. has significantly weakened inventors’ title to their inventions.

A thriving Venture Capital ecosystem requires a viable exit market for start-up companies.  This provides returns for the Venture Capital investors, founders, and key employees.  While mergers and acquisition are one exit market, a viable public market is critical for start-ups to obtain reasonable valuations in M&A market.  As discussed above, the public market is essentially closed to start-up companies.

The book, The Decline and Fall of the American Entrepreneur, by Dale B. Halling,  explains:

How we have weakened inventors’ and start-up companies’ rights to their inventions;

How the capital markets have been foreclosed to technology start-up companies;

How the accounting rules have changed to limit start-up companies access to human talent; and

How these changes to our laws are killing the Venture Capital market.

Get your copy of The Decline and Fall of the American Entrepreneur today.  Available on Amazon.com.

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PRlog

 

Here is another article , “The Case for Market Based Patent Reform” pushing patent reform.  This article repeats many of the myths of those people who want to weaken our patent system.  For instance, it repeats the myth that there is a patent quality problem.  All the studies that purport to scientifically show that there is a patent quality problem have flawed methodologies.  For more information see Patent Quality Myth .  What we have in this country is a small number of large companies that have made a business out of infringing (stealing) other peoples’ patents.

 

The book The Invisible Edge, in chapter 8, makes a compelling case that the recession of the 1970s was largely due to the Federal Trade Commission’s (FTC) antitrust policies that limited the value of patents owned by U.S. companies.  The book describes in detail the shameful abuse of government power by the FTC to force Xerox to license all its technology to all comers for a pittance.  Xerox spent millions of dollars and over a decade to perfect the plain paper copier.  They held numerous patents on the technology that made the plain paper copier possible.  In 1975 when Xerox agreed to the FTC consent decree to license their patents, they had almost a 100% market share in plain paper copiers.  Just four years later, their market share was down to 14% and most of the rest of the market was controlled by Japanese companies. 

 

            The U.S. has been the most innovative country in the history of world.  “Virtually every major development in technology in the twentieth century – which was far and away the most important century in the history of technology – originated in the United States or was principally industrialized and turned into consumer products here.”[1]  The economic success of the U.S. is due to its technological innovation.  The first colony was only possible because of two new technologies – the full-rigged sailing ship and the joint-stock company.  This inventive spirit has continued to the present with the Information Age, which was founded in the U.S. and based on the internet (ARPANET) invented in 1969. 

 

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