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Book Review: Why America Has Stopped Inventing?

Darin Gibby, a patent attorney, has written the book Why America Has Stopped Inventing?.  Let me first say that I agree with Mr. Gibby’s premise that America has quit inventing and that it is hurting our economy.

The book has an excellent review of the history of how patent law developed in the US, with the 1836 Patent Act playing the hero of the book.  The Act was modeled on the patent statute in Venice in the 1400s, according to Gibby.  This leads to an explosion of invention in the United States and in the economy.  This story is told through the lens of the great inventors of the time, including Morse, Colt, and Goodyear.  These stories are well told and compelling.  The book is a fount of knowledge about the early history of inventing and patent law in the United States.

The book argues that the change in the patent laws resulted in a brain drain from England and that there was an explosion of invention in the US.  The book states:

The rate of innovation as determined from the number of patents increased six times from 1840 to 1850, nine times from 1850 to 1860, and 13 times from 1860-1870, as compared to the increase in population.

The book claims that our per capita rate of inventing is less than half of what it was in the 1860s.  The US rate of inventing has decreased over the last decade.

The conclusion of the book is that our patent system is broken and this is hurting innovation and the US economy.  While I generally agree with the conclusion, I believe the premise could have been better supported.  Also, I think it is impossible to talk about the lack of invention without also mentioning the restrictions on raising capital by inventors.  Perhaps the biggest impediment to raising capital has been Sarbanes Oxley.  This is not mentioned at all in the book.

The biggest downfall of the book is that the author calls a patent a monopoly.  A patent is not a monopoly.  35 U.S.C. 261 makes it clear that a patent is personal property.  Patents have all the attributes of property and none of the attributes of a government monopoly.  Property rights arise from of the act of creation – but for the creator the item would not exist, therefore they have a property right in the item.  Inventing is creating a new product, process, or service that did not exist before.  The fact that a patent attorney could make this mistake is hard to believe, but more importantly I believe this completely undermines the thesis of the book.

The book has a number of specific proposals for fixing the patent system.

Complex Patent System: The book states that the biggest reason for our inventive decline is the overly complex, over administered, and underfunded patent system.  I agree that our patent system has become overly complex, too expensive, and overly officious.  The author believes this is the result of a judicial reaction to the Wright brothers’ patent, which he believes was too broad.  Here I completely disagree with the author.  The Wright brothers’ patent broadly claimed the ability to control an airplane by “having lateral marginal portions capable of movement to different positions above and below the normal plane” of the wing.” (USPN 821393)  The author believes the Wrights only invented wing warping.  I disagree.  The Wright brothers clearly showed that any method of altering the flow of air over the wing could be used to control the airplane.  If the Wright brothers had been limited to the author’s interpretation, then Glenn Curtis and others would have been able to free load off of the Wright brothers’ invention.

The author also argues that the growth of the airplane industry was retarded by the Wright brothers attempting to enforce their patent.  This argument is also made by anti-patent forces and is without any logical basis.  We have no idea how long it would taken for someone else to have created a controllable airplane if the Wright brothers had not done so.  It is just as likely that, but for the Wright brothers it would have taken years for someone else to invent control surface for airplanes.  If there was any delay in the development of the airplane, it was the fault of Glenn Curtis and others who refused to pay the Wright brothers for their invention.

I think it is also inexcusable that the book does not mention the detrimental effects of antitrust law on patents.  The anti-patent backlash in the early 20th century was not a result to the Wright brothers patent, but to the rise of antitrust law.  The author’s lack of understanding that patents are a property right and not a monopoly has blinded him to this simple fact.

Require Models: The author wants us to return to a patent system that requires models.  He suggests that computer models would be acceptable, so we would not have the problem of storing these models.  The author’s main reason for this requirement is based in the belief that the Wright brothers, Seldon, Bell and others received overly broad patents or really were not the true inventors.  In the case of Bell, the author suggests that Bell’s attorney copied Elisha Grey’s patent application by hand into Bell’s application upon filing the Bell application.  I cannot comment directly on these assertions.  But the book does not even mention that there was an interference between Bell, Grey, and Edison (see Bell).  All of these inventors had top patent attorneys and I seriously doubt that hand copying part of another person’s application would have survived very long in an interference.

The author seems to want to use models to limit the scope of the claims.  This would allow inventors who improved another person’s invention not to have to pay royalties for using their underlying invention.  I don’t see any advantage to this system and I believe the author has fallen for the anti-Wright brother, and anti-Bell propaganda.

Abolish Obviousness Standard and Doctrine of Equivalents: The author makes a strong case for abolishing the obviousness standard, which I agree with.  He explains that the obviousness standard is subjective and unworkable.  He suggests that the doctrine of equivalents and the obviousness standard are opposing ideas used to overly broaden or overly narrow the rights of an inventor.  I did not initially agree with the author, but he made strong points in defense of his thesis.  Specifically, he argues that eliminating the obviousness standard would allow inventors to craft their claims to correctly define their invention.  As a result, he believes that it would be unfair for inventors to then be able to expand/change the scope of their invention in litigation.  The only problem with the author’s argument is the doctrine of equivalents has been dead for all practical purposes for at least twenty years.

The author also makes the excellent point that eliminating the obviousness standard would significantly reduce the backlog of unexamined patents.  His reasoning is that moving to an objective system of patentability would eliminate a lot of wasted effort on the part of the Patent Office and Applicants.

Cut the Current Twenty-Year Patent Term in Half: I disagree with the author and I think his point of view is based on the erroneous belief that patents are a monopoly.  Shortening the term for patents is likely to reduce the value of investing in new inventions.  This would decrease the rate of new technologies being created and introduced into the economy.  The result would be slower economic growth and lower per capita incomes.

Curtail the Continuation Practice: Continuations are critical for start-up companies to reduce their cost.  While I agree that eliminating the obviousness standard would reduce the cost of filing patent applications, this advantage is unlikely to be enough to protect our highly innovative start-up companies.

 

First to File System: The author buys into the absurd idea that eliminating interferences is going to free up resources at the Patent Office.  With less than 100 interferences a year, this is very unlikely to occur.  He also argues that this will be good for individual inventors and startups.  While he is correct that interferences are too expensive for individual inventors (start-ups), the solution is not to subvert the Constitution and award exclusive rights to the first person to file instead of the inventor.  The solution to this problem is to reduce the absurd cost of all federal litigation.

There have been several studies on the effectiveness of changing from a first to invent system to a first to file.  All these studies have shown a decrease in patenting by the most innovative groups in our country – namely individual inventors and start-ups.

Conclusion: Overall there are many important points in this book.  But the author’s incorrect labeling of a patent as a monopoly undermines many of the most important points he is trying to make.

 

Keynesians believe that you can create economic growth by spending government money.  The goal of government spending is to increase aggregate demand.  If just increasing demand was the way to increase economic growth, then stealing would also create economic growth.  Now you make object that government spending is not like theft.  The recipient of the government money did not break any laws when receiving government money, but from an economic point of view the recipient did not provide any economic value for the goods or services they received from the government money and the same is true of the thief.  The thief may have expended effort to obtain the money to buy various goods and services, but they did not exchange anything of economic value.  Thus, neither the thief nor the recipient of government money provide any economic value for the items they receive because of their theft/welfare.  As a result, theft should provide the same economic benefits as government stimulus programs.  Since increasing aggregate demand is the goal, thieves perform this function admirably.  Most thieves do not save their money and they do not invest, they spend their money – this is part of what makes them thieves.  This ensures that the stolen wealth is immediately converted into demand (spent), which is good according to Keynesians.  Money that is saved or invested does not immediately increase aggregate demand, which is the cause of economic slowdowns according to Keynesians.

Economic growth or wealth is not created by spending, but by increasing the technological level of the country.  If spending (consumption) created wealth, then a farmer could get rich by eating their seed corn.  This is complete non-sense.  Only by creating inventions or by investing in other people’s inventions can a country increase its per capita wealth.

There are three ways that the government can take money from productive people and give it to non-producers to spend.  The most straight forward is to (immediately) tax it from producers.  In this case, it is clear that the government is taking money (productive effort) from productive people and giving it to non-producers of the wealth.  This is exactly what a thief does.  We know that this is not a 100% efficient process, since there is the cost of collecting (stealing) the wealth of the productive people and giving it to non-producers.  This requires numerous government bureaucrats and effort on the part of honest taxpayers.  However, this is not the only loss in the transfer of wealth.  The government has substituted its judgment or worse the judgment of non-producers for producers in how to allocate wealth (productive energy).  This means we are substituting the judgment of people who have not proven the ability to create wealth for wealth producers.  We know that most of the recipients will not invest in creating new technologies or diffusing new technologies, as result we know that this money will not result in an increase in economic growth.  Note that government statistics will not show the whole result of this decrease of economic output, since government statistics of economic output measure consumption, not production.  The Gross Domestic Product is calculated as GDP = private consumption + gross investment + government spending + (exports − imports).  At first this formula would appear to balance out government spending and gross investment, but the government can only measure spending, even for gross investment.  As a result, when government steals from producers this does not show up as a decrease in gross investment if the producers do not believe that the present climate is not conducive to investment.  This is like the government forcing a farmer to eat or give away their seed corn, it does not show up as a net reduction in planting (investment) until later, but it does show up as private consumption.[1] As a result, government stimulus numbers inflate the GDP incorrectly during a stimulus program and under estimate the GDP in times of private sector growth.

The government may borrow or use inflation to fund its stimulus programs.  When the government borrows money or causes inflation the overall result is the same, but the mechanism is different.  If the government borrows in order to pay for its stimulus program, then this reduces the amount of investment capital available and reduces private sector investment by crowding out investment dollars.  It also increases the cost of labor, goods, and services by creating artificial demand.  In addition, it results in higher tax rates than would otherwise be necessary in order to pay back the money borrowed reducing long term growth.  Inflation is just a way of taxing (stealing) from everyone’s paycheck, savings, and investment.[2] The net result is to transfer money from productive people to unproductive people.  Since inflation does not immediately show up in the Consumer Price Index, it artificially inflates the GDP during stimulus programs at the expense of future economic growth.  Inflation does not immediately show up in the CPI because the government measures the CPI at distinct intervals and because the CPI does not distinguish between changes in demand and inflation (an increase in the amount of money).  Much like the way the government measures GDP, the CPI understates the inflation during times of economic contraction and overestimates the CPI in time of economic growth.  Increased demand for products and services during a time of economic growth shows up as inflation in the CPI numbers, while decreases in demand during recessionary periods shows up as deflation or low inflation in the CPI numbers.

Now some people may complain that the people being taxed are not (necessarily) producers.  For instance, the banks that were bailed out by TARP or the carry trades[3] created by the Federal Reserve, or other corporations (GM, Chrysler, GE, etc.) bailed out by the government.  However, the government cannot fund itself except by taking money (wealth, productive effort) from producers ultimately.  Taxing government leaches results in a circular system that is negative sum game that would collapse very quickly, but for producers.  Taxing non-productive entities does not change the basic analysis above.

Now other people may complain that Keynes actual theory was for the government to store reserves during times of economic prosperity and then spend the reserves during economic downturns.  While this may be preferable to a spendthrift government, such as the U.S. presently, it does not change the overall analysis.  It just means that during times of economic prosperity, government is overcharging, has a higher tax rate than necessary.  This results in underinvestment in technological, which means a lower rate of economic growth rate in the future.  In economic downturns, Keynes still advocated spending on things that created immediate demand, not on investing in inventions.  Such as paying people to dig holes and then filling them up.  Thus, this also lowers long term economic growth.  Finally, Keynes did not take into account the large overhead (entropy) necessary to take this money away from productive citizens.

Stimulus programs overinflate the GDP while the stimulus money is being spent, by ignoring the decrease in investment capital.  This decrease in investment capital results in lower long term economic growth, since it means there is less money (wealth) to invest in new technologies in the future.

Not surprisingly, this also results in higher unemployment rates.  There was a recent study by Timothy Conley from the University of Western Ontario, Canada Economics Department and Bill Dupor of Ohio State University which showed that the U.S.’s recent stimulus program killed two private sector jobs for every job saved or created.  This is just one of many examples that shows Keynesian economic theory is truly VODOO ECONOMICS

IF KEYNESIAN THEORY WORKED, THEN THEFT WOULD INCREASE GDP AND WEALTH.


[1] For those engineers and people with a mathematical background saving is like a capacitor (integrator), draining the capacitor increases the short term current, but reducing the current in the future.

[2] Even if the money is borrowed from foreign investors, it reduces the amount of investment capital.  It also reduces the willingness of foreign investors to invest inU.S. companies.

[3] A carry trade is when the Federal Reserve allows banks to borrow money at a lower interest rate than they can loan it out  at (risk free).  The most egregious example is when political powerful banks (corporations) can borrow from the Federal Reserve at a lower rate than short term Treasury Bills are yielding.  This takes absolutely no intelligence to make huge amounts of money, as long as the Federal Reserve will loan out money.  This is how the TARP banks have been able to pay back their TARP loans.  However, it is just a fraud and the cost of this fraud is being paid for by the American taxpayer/worker.

 
SOX: Shooting Ourselves in the Head

Hear is an excellent article, IT’S OFFICIAL: The IPO Market Is Crippled — And It’s Hurting Our Country  in the Business Insider, on the damage we have done to our capital markets.  The article starts out by showing that many of our biggest companies went public when they were very small.  At the time there were numerous underwriters and often the main inventors were individual investors.  For instance, the article explains:

As recently as 1986 Adobe had an IPO raising $6M.   None of these companies could have gone public in today’s environment even adjusting for inflation.  Virtually all the buyers at the time were individuals and there was a robust “over the counter” after market for young companies.

The article then explains that a company has to have a market valuation of $250M or more to be viable in today’s market.  My estimates are higher.  The article points out that a major reason for this change in the market is because of Sarbanes Oxley or SOX, which imposes onerous accounting requirements on companies.  The article then discusses some attempted solutions to this problem.  (I have suggested an alternative in my post Circumventing Sarbox and the IPO drought)

This has been a disaster for the venture capital industry.  As a result, VCs are looking for companies that can exit by M&A at earlier states.  VCs are also not investing in capital intensive companies.

Unfortunately, the article calls for half measures of curtailing but not eliminating SOX.  They suggest this course of action despite the fact that they do not single benefit provided by SOX.  The authors point out that:

The number of annualU.S.issuers listing IPOs onU.S.exchanges has declined since 1996 from 756 to a low of 36 in 2008 and 50 in 2009 and 120 last year according to Dealogic.  By contrast, there have been 346 Chinese issued IPOs listed onChinaexchanges in 2010 even though the U. S. GDP is 3x larger thanChina’s.

This is just one more example of how were are exporting our innovation and jobs overseas.

The insane thing about our securities laws is that in the U.S. you have to hire a lawyer to invest in a non-public company, but you can blow your money in Vegas, Atlantic City, etc freely.  One activity creates jobs and wealth and creates value.  The other is a less than zero sum that destroys wealth.

 

This intriguing question and its implications for US economic policy are tackled in the groundbreaking book Great Again, by Henry R. Nothhaft with David Kline.  They answer the above query with a series of questions:

Could a twenty-year-old college dropout, just back from six months in an ashram somewhere, attract funding for a capital-intensive venture based on the manufacture (yes, the manufacture) and sale of a $2,500 consumer product unlike any that had ever been bought by consumers before?  One whose potential uses were at best unknown, and possibly nonexistent?  And one for which the total current market size was exactly zero?

Not only could Apple not get funded today, it probably could not go public. Nor would Apple have received its first patent (USPN 4,136,359) in only 20 months.  The book asks “how many of today’s Apples are not getting a chance?”

The authors use the above example to make a broader point that theUSis failing economically and technologically because of the policies we are pursuing.  They show that all net new jobs created in theUSsince 1977 (and possibly longer) were created by startups like Apple.  All increases in real per capita income are due to new technologies and most revolutionary/disruptive technologies are created by startups and individual inventors.  So what are the policies that have undermined our economy, by undermining technology startups?

The book examines five areas:

1.Role of regulations.  The Authors show that our tax policies, Sarbanes Oxley and our indifferent (some might say arrogant) regulators’ application of well meaning regulations to startups is driving them either overseas or out of business.

2. Underfunding the patent office. This is costing theUS millions of jobs and billions in GDP.  According to the authors, each issued patent is worth 3-5 jobs on average, particularly patents issued to startups.

3. Manufacturing policies in the US.  Manufacturing is key, particularly in a world that does not respect property rights in inventions, to ensuring that theUS profits fromUS innovation and not other countries.  TheUS is also losing the global battle for human talent.

4. Battle for global talent. Our restrictive immigration policies are depriving theUS of talented entrepreneurs such as Andy Grove, founder of Intel.

5. Funding for research.  The book shows that our spending on basic science and engineering is not only declining as a percentage of GDP, but the system has become short-term oriented and bureaucratic.

While this book tackles complex issues, it is a quick easy read.  It is full of interviews from entrepreneurs, venture capitalists, and technologists who built America’s technology startups over the last three decades.  Great Again provides numerous real life examples to illustrate its points.

This pioneering book shows how the US can create jobs and increase per capita income.  The policy prescriptions are based on solid science.  Just cutting government spending (balancing the budget) will not cause theUSeconomy to grow vigorously, we need pro-growth policies.  The authors are some of the few people that understand what policies are needed for the US to be GREAT AGAIN.

Great Again: Revitalizing America’s Entrepreneurial Leadership, by Henry R. Nothhaft and David Kline

 
Are Transaction Costs for Patents Too High?

I was confronted with the statement that there are “Hugh transaction costs related to patents.”  This statement implies the assumption that these transaction costs are unjustified.  I disagree with the premise, but since all systems can be improved I will provide a number of specific proposals to reduce the transaction costs.

The alternative proposed by the author of this statement, was to shorten the length of patents and increase government funding of R&D.  The proposed system of government funding for research is not effective substitute for patents.  The history of government funding for research is mixed at best and much more expensive than patents.  The US patent system is completely funded by user fees (in fact Congress has been stealing user fees to pay for their pet projects).  The patent system has been significantly more effective at stimulating innovation than government funded projects – see Zorina Khan’s work including her book The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920 (NBER Series on Long-Term Factors in Economic Development) also see The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention, by William Rosen.

Assumptions

Litigation Costs:  There has been a very effective propaganda campaign to suggest that the patent litigation is out of control.  The implication is that there is an explosion in patent litigation.  This is just not true.

“The real facts of the so called litigation crisis are that for the past two decades the number of patent lawsuits commenced annually has been about 1.5 percent of all patents granted. In 2006, it was 1.47 percent. This is business as usual. Most patent lawsuits, moreover, settle before trial. In 1979, some 79 percent of patent cases settled before trial, while in 2004 almost 86 percent did. Matters are actually improving.

Also, the U.S. has few patent trials. For instance, in 2001 only 76 patent lawsuits were tried and only 102 went to trial in 2006. By no measure can 102 patent trials be considered a national litigation crisis. The annual report of Federal Judicial Caseload Statistics, which is on the Internet, provides the factual antidote to false claims of a litigation crisis (www.uscourts.gov/ caseload2006/contents.html).” see http://www.manufacturingnews.com/news/07/0629/art2.html

Even though this data is a little old nothing has changed in the last several years.  In a $14.4 trillion economy built on technology this is anything but a litigation crisis.

There is also a myth that there is a patent quality issue in the US.  This is not supported by the facts.

“As to the massive numbers of “unworthy patents” argument, the real-world test is how many patents are challenged and the outcome of those challenges. Between 1981 and 2006 the USPTO issued more than 3.1 million patents. In that period, 8,600 were challenged at the Patent Office through inter partes and ex parte reexaminations. The number challenged amounts to less than three-tenths of one percent. Of those challenged, about 74 percent resulted in claims narrowed or cancelled. In addition, almost 60 percent of the relatively few patents challenged in a court trial are sustained.

My point is that the USPTO’s work is certainly not perfect, but the Patent Office is also not pouring out a stream of bad patents.” http://www.manufacturingnews.com/news/07/0629/art2.html

By every objective measure: R&D per patent, GDP per patent, and number of citations per patent patent quality is increasing.  See http://hallingblog.com/2010/01/07/patent-quality-nonsense/ and http://hallingblog.com/2009/08/18/patent-quality-myth/.

Cost and Time to Obtain a Patent: When Edison applied for his light bulb, he received a patent in 3 months.  The reason it takes so long to obtain a patent today is because Congress has been stealing money from the Patent Office.

I have an angel investor friend who was a highly successful entrepreneur who complained that when he invested in a company he did not know about hidden prior art and this created a large amount of uncertainty.  He supported the idea of publication of patents.  However, the answer was not publication of patents, which breaks the social contract, but fully funding the patent office – as the Edison example above proves.

Disingenuousness of Libertarian Argument about Costs of Patents:  All property rights systems have some costs involved in them.  GE employs 600 attorneys to comply with tax laws, it probably employs another 600 to comply with SOX, discrimination laws, environmental laws, health and benefit laws.  However, it probably employs less 100 patent attorneys.  Their patent costs are a drop in the bucket compared to dealing with tax and other regulatory laws.  The Libertarian attack on patents in light of all the other burdens imposed on business is disingenuous.

Patents are property rights and companies’ purposeful infringement of other people’s property rights is not a regulatory burden, it is the result of purposeful belief that they can get away with the theft.  It is called efficient infringement.  See “Technology Theft as a Business Strategy”  http://hallingblog.com/2010/03/24/pat-choate-technology-theft-as-a-business-strategy/

Solutions

Patent Litigation: While patent litigation costs are similar to litigation costs generally, there are a number of things that can be done to make the system more efficient.  Some are changes to government and some are private sector initiatives.

Secondary Market/Title Insurance for patents.  Before the advent of title insurance it was very expensive to buy a piece of land.  You had to pay an attorney for a title report that did not come with any insurance.  Lawsuits over the boundaries of real property were epidemic before the advent of modern survey tools.  Patents are in the same position where no title insurance has been created.  Unfortunately, antitrust law undermined the first efforts to create a title insurance/secondary market for patents.  Patent pools were a way to determine the validity of patents, enforce patents, and widely license the patents in a cost efficient manner.  But the antitrust idiots said that they were illegal.  Today, Luddites are using the rallying cry of “patent troll” to kill off the beginning of a secondary market – see http://hallingblog.com/2009/09/18/in-defense-of-patent-trolls/ For more information see Jump Starting a Secondary Market for Patents http://hallingblog.com/2009/11/16/jump-starting-a-secondary-market-for-patents/.

Accelerated Patent Court:  A new court similar to the ITC that has expertise in patents and accelerates the patent litigation process is needed.  The court should be sufficiently funded and have procedures that allow patent cases to be resolved in under a year.  Perhaps the court would be limited to issuing injunctions as a remedy as opposed to economic damages.  The goal of this new court is to establish the US as the premier arbiter of patent rights.  The US is the best positioned country to protect patent rights, despite our recent history.  This would increase the US’s standing as a technological leader in the world and draw innovative companies and people to the US.

Judges:  Appoint judges with technical backgrounds and who have passed the patent bar to adjudicate patent cases.  Judges without these qualifications make silly mistakes, such as stating that any invention that is just a combination of known elements is suspect whether it should obtain a patent.  All inventions are combinations of known elements – it is called conservation of matter and energy.  You cannot create something from nothing.  (For more on the Supreme Court’s ignorance see http://hallingblog.com/2010/01/19/ksr-supreme-ignorance-by-supreme-court-2/ )

Patent Acquisition

Patent Reciprocity: One of the largest costs of obtaining patent protection is foreign filing.  Patent reciprocity would significantly reduce this cost.

If you drive your car across the border into Canada you do not lose title to your car.  If you take your manuscript across the border into Canada you do not lose the copyright to your manuscript.  But, if you take your invention across the border into Canada, you lose your patent protection and anyone can steal the invention – not the physical embodiment, but the underlying invention.

Patent reciprocity would automatically provide patent rights in a foreign country when you obtained a patent in the US and vice versa.  This idea was first proposed by the US in the mid 1800s according to B. Zorina Kahn’s book “The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920“. Unfortunately, the idea died and since then patent rights have been part of the convoluted process of trade negotiations.

Patent reciprocity would significantly increase the value of patents and increase the value of research and development.  As a result, it would spur investment in innovation.  Reciprocity would increase the valuation of technology start-up companies in all countries that participated.  It would also increase per capita income.

Eliminate Maintenance Fees: Maintenance fees are the major cost associated with a patents filed outside the US.

Maintenance fees are a backhanded way of introducing a “working requirement” to patents.  Working requirements for patents have always been rejected in the US.  These fees favor large entities and reduce the effective life of patents.

A strong patent system pays for itself several times over in increased tax revenues from increased economic activity.  The supply side returns from a strong patent system probably exceed the return resulting from lowering the capital gains tax.

Reduce Formalism in Patents:  A large part of the cost of obtaining and litigating a patent is overly formalistic requirements.  The Non-obviousness requirement should be repealed.  It is not logically a part of the definition of an invention and is the source of uncertainty, and increases the cost of both obtaining and enforcing/defending patent lawsuits.  For more information see Non-Obviousness a Case of Judicial Activism http://hallingblog.com/2010/06/18/non-obviousness-a-case-study-in-judicial-activism/.

Some of the other overly formalistic requirements include the rules on restrictions, the inequitable defense, and the silly requirements related to section 101.  Restrictions are required for trivial differences that are embodiments of the same inventive idea.  The doctrine of equivalents has been dead for over a decade.  Formalism over logic rules in the realm of inequitable conduct.  USC 101 issues related to software inventions also place form over function that require absurd recitations to computer hardware.  All of these formalistic requirements favor patent thieves at the expense of real innovators.

 
Monopoly/Rent Seeking vs. Property Rights/Intellectual Property

Here are three easy questions for Libertarians, Socialists, and Economists to determine if a right is a monopoly or a property right.

 

1) Does the right arise because the person created something?

Creation is the basis of all property rights.  The law is just recognizing the reality that the person is the creator and without that person the creation would not exist.  This is consistent with Locke’s Natural Rights and Ayn Rand’s Objectivism.

 

2) If someone else was the creator would they have received the right in the creation?

This ensures that the right does not arise from political favoritism.

 

3) Is the right freely alienable?

Freely alienable means that right can be sold, transferred, divided, leased, etc.  This is a key feature of property rights.

 

Let’s see how this applies to some common property rights, some monopolies, and rent seeking systems.

 

Land: 1-yes, 2-yes, 3-yes.

Some people may be confused about why question 1 is a yes with respect to land.  Clearly no one created land.  That is true, but the reason that the person owns the land is because they improved it.  This was the major criteria for receiving land under the Homestead Act.

Now some people may complain that most of us do not obtain title to land because we improved it.  This is true, but we had to create something and trade this for money.  This money was then used to buy the land.  Because property rights are freely alienable, they can be transferred for other property.  As a result, creation is still the reason we own the land.

Thus a right in land is a property right.

Note in the modern world land is usually not completely alienable because of various regulations.  However, this is an encroachment on property rights but does not change the underlying fact that rights in land are property rights.

 

Utility Grants: 1-yes, 2-no, 3-no

Utility grants includes electric utilities, water utilities, cable television, etc.  In all cases, the company that receives the right has to build something (electrical power system, water purification and distribution system, or cable system.  As a result, the answer to question one is yes.  However, if someone else created a utility system in the same geographic area they would not receive the same right.  Utilities receive their legal rights not because they created something, but because a political entity selected the particular organization.  The grant is generally not alienable.  If the present holder of the utility right wants to sell, lease or subdivide their utilities rights, they have to get permission from a political entity.

Thus utility grants are monopolies not property rights.

 

Patents: 1-yes, 2-yes, 3-yes

You obtain a patent because you created an invention.  If someone else had created the invention, they would have received the patent to the invention.  Patent rights can be sold, leased and subdivided.

Patents are property rights.

Note that you have to apply for a patent in order to obtain it.  The same was true for land under the Homestead Act.

 

Mineral Rights: 1-yes, 2-yes, 3-yes

You obtain mineral rights because you discovered minerals at a particular location.  Much like land in the modern world most mineral rights are purchased, but this is still the result of creation.  If someone else had discovered the minerals they would have received the right.  Mineral rights can be sold, leased, subdivided etc.

Mineral rights are property rights.

 

Professional licenses: 1-no, 2-yes, 3-no

Professional licenses include medical licenses, legal licenses, cosmetology licenses, etc.  You obtain a profession license because you proved a mastery of certain knowledge and fulfilled other bureaucratic requirements.  You do not obtain a professional license because you have created something.  If someone else proved mastery of the subject matter and fulfilled the other bureaucratic requirements they could also receive a license.  Professional licenses are not alienable at all – they cannot be transferred, sold, subdivided, etc.

Professional licenses are pseudo monopolies or rent seeking devices.  They clearly do not limit the market to one provider, but they do limit the number of providers in a market.

 

 

Antitrust Law

Modern antitrust law turned the law against monopolies on it head.  The Statute of Monopolies limited the power of the Crown (government) to interfere with private property rights.  The Statute of Monopolies excluded patents for inventions because they result from the creative act of the inventor and therefore are property rights.

On the other hand modern antitrust law increases the power of government to interfere with private property rights.  The underlying theory of antitrust law is the efficient market hypothesis.  The hypothesis postulates that wealth is created by falling prices for existing goods and services and this is result of competition to sell existing goods and services.  However, this is not true.  Increases in per capita income are the result of increases in technology – inventions.  Antitrust law undermines the incentive to create and invest in new technologies and therefore hurts our economic health.

 

 
The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention

This book has an extremely intriguing title.  The book’s goal is to explain why the Industrial Revolution happened and how it happened.  The book explains that there are over two hundred theories for why the Industrial Revolution occurred.  The author points out that most of these theories miss the most obvious point, “which is that the Industrial Revolution was, first and foremost, a revolution in invention.” (Italics in the original)  It further explains, “For a thousand centuries, the equation that represented humanity’s rate of invention could be plotted on an X-Y graph as a pretty straight line.  . . .  Then during a few decades of the eighteenth and nineteenth centuries, in an island nation with no special geographic resources” it changed.  Ultimately, the Industrial Revolution was a perpetual innovation machine.

The author explains that England’s patent laws democratized invention and this combined with the advent of limited liability companies and the new capital markets resulted in an explosion of new inventions that created unimaginable wealth.

“The best explanation for the preeminence of English speakers in lifting humanity out of its ten-thousand-year-long Malthusian trap is that the Anglophone world democratized the nature of invention.

In England, a unique combination of law and circumstances gave artisans the incentive to invent.  . . .  Human character (or at least behavior) was changed, and changed forever, by seventeenth-century Britain’s insistence that ideas were a kind of propertyThis notion is as consequential as any idea in history.” (emphasis added)

The United States went on to create the first modern (non-archaic) patent system that was considerably more democratic (this is small d democrat) than England’s.  This was a major reason why the U.S. became a world economic power in less than 100 years.  Unfortunately, the U.S. is presently considering legislation, the America Invents Act (aka Patent Reform), that will again make inventing undemocratic and the province of the wealthy.

The book explains the history of patent law, the history of the science of steam (thermodynamics) as well as the history of the technology and economics of steam engines.  The writing style is easy to read and very informative.  Despite the bold initial statements in the book, it really focuses on the story of the Industrial Revolution instead of supporting its thesis.

The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention, by William Rosen.

 
Forbes Jumps on the Anti-Patent Anti-Intellectual Bandwagon

Steve Forbes, publisher of Forbes Magazine, was a strong defender of the US patent system.  He followed in the footsteps of one of his hero’s, Ronald Reagan, who made strengthening the US patent system a major part of his economic reform.  For more information see Reagan’s 100th Birthday.

Now Forbes (the magazine) pushes an anti-intellectual, anti-free market, anti-patent point of view as evidenced in the opinion piece Google’s Conundrum: Buy The Patents Or Pay The Lawyers? The author belongs to that Luddite group that wants to categorize patents as monopolies.  Patents are property rights.  Property rights derive from the act of creation or more specifically invention in the case of patents.  Monopolies are the result of political calculations and have nothing to do with creation.

The author then goes on to state:

When Prime Minister Tony Blair and President Clinton suggested imposing restrictions on patents in the field of genetics, publicly traded bio-tech firms experienced a predictable mini-crash. The impact of their recommendation would not have been as violent if the patents had shorter lives than twenty years.

Of course if the property rights in one’s invention was weaker before you suggested making it even weaker, it would have less impact on the value of the companies owning these assets.  This is like saying the value of a company will decrease less when nationalization is proposed if the tax rate were higher.  For instance, if the tax rate were 100% then it would not affect the value of company at all if politicians proposed nationalizing the company.  The author Reuven Brenner, is an economics professor at McGill University according to Wikipedia.  You would think that a professor would not make these obvious logical errors – the sort of errors that would make even an undergraduate paper on the topic receive a C or lower.

As if this gaff were not enough the professor then asks:

What would happen if the life of patents was shortened?

Prices of patented goods would decline and there would be less piracy

Yes and the price of all goods would decline if we would just get rid of property rights.  Of course, no one would produce anything and the same is true of weakening patents.  Innovation will come to a virtual standstill.  History shows that without secure property rights in inventions, innovation grows so slow that humans are stuck in the Malthusian Trap.  See The Source of Economic Growth.

As for there being less piracy that is like saying there would be less car theft if we did not give people title to their cars.  This is not Alice in Wonderland Mr. Brenner.  Words have meaning and even if there is not a law against piracy, it is still piracy.

Mr. Brenner continues with his Socialist line of reasoning by arguing, “Phillips’ initial success in Holland and throughout Western Europe was due to copying Edison’s lamps without paying any royalties to the Edison interests.”  Stealing always enriches the thief, but it does not create wealth it redistributes it and destroys it.  How many invention was Edison or some other inventor unable to fund because Phillips stole Edison’s inventions?

Mr. Brenner should be aware that since Robert Solow’s famous paper on economic growth it is clear that all per capita growth is due to increases in technology.  Most new technologies are created by start-ups that require property rights in their inventions (patents) in order to secure capital.  (See SBA Study).  In addition, all net new jobs in the US are created by start-ups according to the Kauffman Foundation.  If the US wants to create high quality, high paying jobs it needs strong property rights for inventions.

 
America Invents Act Will Increase Patent Application Backlog  and Will Not Encourage Innovation or Job Creation!

This is a Press Release from American Innovators for Patent Reform and Eight Other Organizations Send Letter to Congress Stating Objections to House Version of America Invents Act:

 

New York, N.Y. − April 1, 2011American Innovators for Patent Reform (AIPR) joined eight other national organizations in a letter sent to all members of the House of Representatives and the staff of the House Judiciary Committee on March 29. The letter details the organizations’ objections to the House’s version of Senate bill S. 23, the America Invents Act, H.R. 1249. The letter explains why this proposed legislation will increase the cost of securing a patent, reduce access to the patent system for inventors and small businesses, increase the current 700,000 patent application backlog at the Patent Office, and decrease the ability of patent holders with limited resources to enforce their patents.

The organizations object to a weakening of the grace period as proposed by the Senate bill and the House’s version of the bill.  As stated in the letter, a weakening of the grace period granted to inventors under current law − during which they can refine and improve their inventions, build working prototypes, or secure financing or manufacturing for their inventions − would put inventors and small businesses at a distinct disadvantage as they might not be prepared to bear the costs of filing a patent application while large corporations can file their patent applications sooner and more frequently.

The letter recognizes that some of its signatories are opposed to the establishment of a post-grant review provision that creates yet a third process by which the infringer of a patent can challenge the validity of a patent and force patent owners to abandon their patents rather than enforce them.

The letter strongly recommends that Congress take a more targeted approach and shift its attention away from the broad and technically difficult America Invents Act, and instead pass a streamlined, targeted bill that focuses only on long-term funding for the Patent Office.

“We hope the House will seriously consider our objections to this legislation,” says Alexander Poltorak, founder and President of AIPR. “We need legislation that truly promotes innovation and investment in new technologies. Such a system will create new industries and new jobs. The America Invents Act, as now proposed, will likely have the opposite effect.”

Joining AIPR in co-signing of this letter were:

  • CONNECT, an organization entrepreneurs and investors dedicated to innovative technology and life sciences
  • IEEE-USA (Institute of Electrical and Electronic Engineers) in the U.S., the largest organization of technical professionals in the world
  • IP Advocate, a group that represents and assists the academic research community
  • NAPP (National Association of Patent Practitioners), the trade association for patent attorneys and patent agents
  • National Congress of Inventor Organizations representing independent inventors and entrepreneurs
  • National Small Business Association, an organization reaching 150,000 small businesses
  • Professional Inventors Alliance USA, a group that promotes the interests of inventors and entrepreneurs
  • U.S. Business and Industry Council, an association representing small to mid-size businesses

“The fact of the matter is the America Invents Act is an infringer’s dream-come-true,” claims Alec Schibanoff, Executive Director of AIPR. “It was pushed by lobbyists for the large corporations that are the most notorious infringers of patents. If enacted, this bill would tilt the U.S. patent system in favor of the large corporations and put inventors, small businesses and universities at a distinct disadvantage.”

 

About American Innovators for Patent Reform

American Innovators for Patent Reform (AIPR) represents a broad constituency of American innovators and innovation stakeholders, including inventors, engineers, researchers, entrepreneurs, patent owners, investors, small businesses, and intellectual property professionals such as patent attorneys, technology transfer managers and licensing executives.
AIPR opposes any patent reform that weakens the U.S. patent system, which is a driving force behind American innovation. AIPR advocates a multi-tier patent system, automation of the patent application process and synchronization of patent and copyright laws.

For more information about AIPR, please visit www.aminn.org.

 

 
Manzullo on American Invents Act

The America Invents Act is bad for the US economy and I will be posting principled statements explaining its flaws.  Rep. Don Manzullo has shown the courage to be an independent thinker and not to blindly follow the lead (money) from large corporations that want a system that makes it easier for them to steal other people’s technology.

U.S. Rep. Don Manzullo (R-IL) released the following statement expressing his concerns with patent reform legislation that was introduced today in the U.S. House of Representatives.

STATEMENT

“I am deeply concerned that ‘The America Invents Act,’ which was introduced today as H.R. 1249, will stall American innovation and send more of our jobs overseas. This legislation reflects an approach to patent reform that stalled previously, in 2007, in the face of massive opposition from American innovators.

“Like its Senate counterpart (S. 23), the House bill includes an unfortunate provision that would shift America’s current patent system – where the first person to conceive of an invention is granted a patent – to a ‘first to file’ system that would turn our system into a foot race to the Patent Office.

“The U.S. has always awarded a patent to the first inventor to come up with an idea, even if somebody else beat them to the Patent Office. The Constitution, in fact, mandates that inventors have exclusive right to their discoveries. This is a system that produced game-changing inventions from people like Samuel Morse, Alexander Graham Bell and Dr. Ray Damadian. Despite that track record, some people are now insisting that the U.S. should ‘harmonize’ with the rest of the world. With all due respect to our friends and allies abroad, I would not trade America’s record of innovation for that of any of those first-to-file countries.

“The bill would also devastate small inventors by effectively eliminating the one-year ‘grace period’ that U.S. inventors currently have. This grace period is critical to small inventors, who can use that year to develop their invention, seek investors and raise funds to begin the expensive patent application process.

“The House bill also fails to provide appropriate safeguards, like those included in S.23, for the controversial new administrative post-grant review process it proposes. Current law already provides two separate administrative tracks to challenge a patent within the PTO, and this bill proposes to add a third ‘post-grant review’ process. Any additional layers of administrative review must be accompanied by safeguards that will diminish the potential for abuse, particularly by infringers with deep pockets and other third parties.

“Moreover, the bill also establishes a transitional review proceeding at the PTO that would affect certain financial service business method patents. Subjecting patent holders who have proven the validity of their patents, both administratively within the PTO and at trial, to a new type of retroactive challenge seems like unnecessary harassment.

“Many of America’s inventors and innovators are alarmed over these fundamental changes to our patent system, and we must hear them out and address their concerns. I urge the House Judiciary Committee to listen to stakeholders of all sizes and perspectives and to find a truly consensus approach to modernizing our patent system.  I look forward to working with my colleagues on and off the Committee to craft legislation that will support and encourage all of our American innovators.”

 
Intellectual Property’s Great Fallacy: Another Rambling Diatribe for Open Source Marxist Utopia

Intellectual Property’s Great Fallacy,by Eric Johnson

This paper starts with a bold statement that the theoretical underpinning for intellectual property (patents & copyrights) “has been washed away.”  Shortly thereafter it states “it’s hard to imagine big-budget Hollywood movies being made without copyrights.  And many new pharmaceuticals would not have been brought to market without the inducement of the patent laws.”  The paper never attempts to resolve this contradiction.  But this is far from the only problems and errors with the paper.

Property Rights:  Mr. Johnson does not seem to understand the basis of property rights or the difference between property rights and monopolies.  He incorrectly states that patents and copyrights are monopolies.  Patents and Copyrights are property rights and any definition of monopoly that includes patents also includes all property rights.  This of course leads to the nonsense that all property rights are monopolies.  For more information see The Myth That Patent are Monopolies.

Mr. Johnson tries to denigrate patents and copyrights by showing that their origin is from arbitrary government grants.  In the case of patents this was reformed by the Statue of Monopolies.  The exact same thing can be said of all property rights.  All land was considered to be owned by the King and he arbitrarily gave monopolies over certain areas of land.  This usually included the right to profit from the peasants on the land.  If the noble who received this arbitrary grant of land crossed the King, the King could and did take back the grant.  This practice continued at least until the U.S. Revolutionary War.  For instance, most of the colonies were arbitrary grants of land and President Washington was given large tracts of land for his service in the French and Indian War.  It was not until Locke that the theoretical basis for property was established, which is productive effort.  Patents and copyrights are property rights given for the inventor’s or author’s productive effort.  This theory of property rights acknowledges the reality that but for the creator the property would not exist and therefore the creator is the owner.

Extrinsic vs. Intrinsic Rewards:  The main thesis of the paper is that creative activities do not need extrinsic rewards.  In fact, the author argues that extrinsic rewards actually reduce the amount of creativity.  His evidence appears to be survey data.  However, survey data tends to be subject to a number of bias errors.  The paper ignores the actual empirical evidence.  The industrial revolution was an outpouring of new inventions.  As explained in the book The Most Powerful Idea in the World “For a thousand centuries, the equation that represented humanity’s rate of invention could be plotted on an X-Y graph as a pretty straight line.”[1] “Then during a few decades of the eighteenth and nineteenth centuries” in England and the US that equation changed.[2] Michael Kremer published a study (Population Growth and Technological Change: One Million B.C. to 1990) that argued that inventive talent and motivation are randomly distributed throughout the population.  His model works well until the industrial revolution.  Then England and other common law countries significantly out invent the rest of the world and their GDP per capita also grows much faster than the other countries in the world.[3]

Mr. Johnson also repeats the myth of the First Mover Advantage.  Even the author of the seminal paper on the first mover advantage has admitted that he overstated the case.  There are numerous business books that have argued that it is better to be a copier, including In search of Excellence and more recently Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge.  For more information see More Evidence that Stealing Invention is a Business Strategy.  My post Invention – A Financial Analysis, show that an inventor is always disadvantaged compared to a copier without property rights in his invention.

The paper argues that R&D managers at large corporations believe there are plenty of incentives for companies to invent aside from patents.  First of all this survey data is selective.  There are plenty of studies that show patents are critical for the success of start-ups.  See Patent Signaling, Entrepreneurial Performance, and Venture Capital Financing .  Once again Mr. Johnson’s data is selective at best.  Large corporations are not highly inventive.  According the SBA most emerging technologies are created by individual inventors and startups.  See An Analysis of Small Business Patents by Industry and Firm Size.

Free Markets and Patents

Mr. Johnson makes a number of statements like “While intellectual property entitlements are conceded to be modes of interfering in a free market, they are nonetheless understood to be necessary to address a problem of “market failure.”  This statement is based on the “Efficient Market Hypothesis.”  This hypothesis has been an major excuse for interfering with markets and property rights by statists, while pretending to support free market capitalism.  For instance, it is used to justify government involvement in education, labor markets, and limiting property rights through antitrust laws.  Free market capitalism is not based on the efficient market hypothesis.  It is based on property rights and contracts and the right of individuals to exercise these rights without government interference.

Value of Patents

Mr. Johnson makes the outrageous and completely unsupported statement that, “Patents have turned to be largely worthless to own, and, even worse, costly to defend against.”  As shown above Patents (property rights for inventions) were essential for humans in escaping the Malthusian Trap.  Patents have been shown to be critical for startups, see Patent Signaling, Entrepreneurial Performance, and Venture Capital Financing.  IBM makes over $3B a year from licensing fees.  Once again Mr. Johnson’s assertion is selective at best and perhaps purposely misleading.

Open Source

Mr. Johnson argues that the low cost of inventing has opened up opportunities for most people to be inventive and they are doing so in increasingly large numbers.  Again his data is selective at best if not outright misleading.  Since the advent of the open source and anti-patent movement the U.S. has faded from the clear technological and innovation leader of the world to being a second tier country according to most observers.  People in the US are not talking about the explosion of innovation, but the implosion.  Mr. Johnson seems to live in an academic fantasyland.

Conclusion

This paper may pass for an academic paper in today’s world, but it is not science.  At best is a selective survey of existing research in this area.  It does not add any new data, informatio, or conclusions.  If it were a patent application, it would not pass the novelty test.  However, this appears to be the norm for most of what is considered academic research today.

 

Intellectual Property’s Great Fallacy, by Eric Johnson

 


[1] Rosen, William, The Most Powerful Idea in the World”: A Story of Steam: A Story of Steam, Industry, and Invention, Random House, Kindle Version, location 258-264,  2011.

[2] Rosen, William, The Most Powerful Idea in the World”: A Story of Steam: A Story of Steam, Industry, and Invention, Random House, Kindle Version, location s64-270,  2011

[3]Kremer, Michael, Population Growth and Technological Change: One Million B.C. to 1990, Quarterly Journal of Economics, Vol 103, p. 681-716, 1993.

 

 
Obama: Make Regulation Efficient

President Obama in a Wall Street Journal op-ed piece said that he has directed federal agencies to eliminate job killing regulations.  According to Obama the Executive order requires “a government-wide review of the rules already on the books to remove outdated regulations that stifle job creation and make our economy less competitive.”  As an example he points out:

For instance, the FDA has long considered saccharin, the artificial sweetener, safe for people to consume. Yet for years, the EPA made companies treat saccharin like other dangerous chemicals. Well, if it goes in your coffee, it is not hazardous waste. The EPA wisely eliminated this rule last month.

The fact that it has taken a severe economic recession and the lagging poll numbers of a president to make this changes shows how heavy handed our government has become and how Bzyantine our regulatory environment is.  I have suggested that the US needs a Regulatory Bill of Rights to provide citizens protections from excessive and contradictory regulations.  The Bill of Rights (first ten amendments) do not protect citizens from regulatory rules.  With just a few exceptions, if the governmental designates something a regulatory law or civil penalty then it can completely ignore the Bill of Rights.  I doubt that this is what the Founding Fathers intended when they passed the Bill of Rights.

 

If President Obama really wants to get rid of job killing regulations here is a list in order of importance:

1) Repeal Sarbanes Oxley

Sarbanes Oxley has effectively killed the IPO market and the better part of the equity market in the US.  See Sarbane Oxley Obstructing Innovation

2) Fully Fund the US Patent Office

Congress has stolen about $2B in user fees from the US Patent Office over the last two decades.  This has hurt innovation, job growth, and the economy.  See Restore Patent Funding to Create Jobs.

3) Repeal all Securities Laws

Every econometric study of our securities laws shows that they provide no benefit for investors.  See Liu, Tung, Santoni, Gary J., Stone, Courtenay C.,   Federal Securities Regulations and Stock Market Returns. This paper surveys several papers that have studied the effects of securities laws all of which show no meaningful change in investor outcomes.

4) Pass a Regulatory Bill of Rights

This would provide ordinary citizens the tools necessary to require the federal government to only implement regulations that achieve their purpose in a cost efficient manner.  See Regulatory Bill of Rights.

 

5) Eliminate the Income Tax

The income tax is not designed to generate revenue for the federal government.  It is designed to punish certain people who have committed no crime (violation of the due process clause of the 5th Amendment) and to allow Senators, Congressmen and the President to sell tax favors to the wealthy.  The income tax system should be replaced with a system with the sole goal of providing the federal government the revenue it needs.  A flat tax or a national sale tax would both work.

 

6) Repeal ObamaCare

This is a job killing piece of legislation that we cannot afford.

 

7) Reform Social Security and Medicare

The best reform is to make them defined contribution programs instead of defined benefit programs.

 

If President Obama were to implement these five simple changes, the U.S. would see above 7% growth for the next two decades.

 

 
Long Term Economic Predictions

Background

It has been a year since I published my book The Decline and Fall of the American Entrepreneur: How Little Know Laws and Regulations are Killing Innovation.   The book explains that the only way to increase real per capita income is by increasing our level of technology.  This can be accomplished by capital equipment purchases, which upgrade plant and equipment with newer technologies or by creation of inventions.  Since the United States is a leader in technology, we do not have the choice of just upgrading to new technologies produced in another country.  So we must create new technologies if we want our economy to grow.  There are two ways to encourage the creation of new technologies; government funding or private investment in inventions.  Government spending on research and development is not nearly as effective as private spending for all the same reasons that government spending is always wasteful.  A study by the Small Business Administration shows that most emerging technologies are invented by small entrepreneurial start-ups.  Unfortunately, since 2000 the U.S. has undermined the three foundations on which technology start-ups are based.  Those three foundations are intellectual capital, financial capital, and human capital.  We weakened the intellectual capital foundation by weakening our patent system, we weakened the financial capital foundation with the passage of Sarbanes Oxley, and the human capital foundation was weakened by the accounting rules that required the expensing of stock options.

Since my book was published the financial capital foundation has been further undermined by the passage of the financial reform bill.  There has been no change on the human capital front.  There is mixed news on the intellectual capital front.  The good news is that David Kappos replaced the incompetent and traitorous Jon Dudas as the head of the Patent Office.  The bad news is that Supreme Court again illustrated their utter incompetence in the Bilski decision.  For more information, see The US Economy and the State of Innovation.

These problems are being exacerbated by the budgetary issues associated with aging baby boomers.  The Obama and Bush administrations compounded these problems by expanding Medicare to prescription drugs and the passage of Obama Care.  Presently, Medicare/Medicaid and the Children’s Health Insurance Program (CHIP) represent 21 percent of the federal budget.  Social Security represents about 20 percent of the federal budget and interest payments represent about 8 percent of the federal budget.  It is estimated that about 10,000 baby boomers will go on Medicare per day for the next twenty years.  However, about 5000 seniors are dying per day.  Each Medicare recipient costs about $10,500, so Medicare costs will expand by $185 billion dollars (today’s dollars) or another 5% of the federal budget.  Roughly, the same calculation applies to social security.  So Medicare and Social Security will consume approximately 50% of the U.S. federal budget by 2020.  In addition, the interest payments are likely to consume around 30% of the U.S. federal budget.  This means that 80% of the federal budget will be spoken for.  This does not include any additional costs for Obama Care.  It is unlikely that the federal budget as a percentage of the economy can grow, since the U.S. had to borrow one third of the federal budget in 2010.

Here are my predictions for the next decade based on this background.  I provide an optimistic, most likely, and pessimistic scenarios.  Note these scenarios are based on what I believe is most likely to occur, not what I believe is the best that could be done or the worst that could be done to the U.S. economy.

Predictions Common to all Scenarios

Properties rights of all kinds will continue to be weakened.  It appears that you can get a PhD. in economics (or even win the Nobel Prize) without understanding even the most basic ideas of property rights and how they affect a free economy.  Even so called free market economists forget that Reagan not only cut tax rates, he strengthened property rights.  Particularly he strengthened patent rights – for more information click here.  He also strengthened property rights by weakening regulations and weakening the power of unions.  A number of so-called free market economists do not understand that property rights are based on productive activity.  As a result, they have joined in an all attack on property rights for inventions – patents.  For more information see Scarcity Does it Prove Intellectual Property is Unjustified.

There does not appear to be any meaningful ground swell against Sarbanes Oxley[1] and the Financial Reform Bill.  As a result, entrepreneurial companies will be starved for financial capital.  Because it appears very unlikely we will strengthen property rights for inventions or property rights generally or strengthen our capital markets so they work for start-up companies, the most optimist scenario is limited to subpar growth.

The growth of the Internet will result in a continued decline in commercial real estate values under all scenarios.  Commodity prices are likely to increase, inflation adjusted, under all circumstance.  Growth in China and inflation will drive this increase in commodity prices.

Optimistic Scenario

This scenario assumes that the U.S. faces up to its budgetary problems, repeals Obama Care, and rationalizes it tax structure.  This scenario assumes that Obama is not elected for a second term.  Government spending will grow slightly as a percentage of GDP.  Supply Side economists would probably consider this enough to create vigorous economic growth.  However, it does nothing to really encourage investment in new technologies.  As a result, real inflation adjusted GDP growth over the decade will probably be around 2%.  Median household family income after taxes will be stagnant.  This will be two decades during which median household income has not grown in the U.S.  I believe that will be the first time in the history of the U.S. this has occurred.

The housing market is likely to be stagnant since family incomes will be stagnant.  Inflation is likely to run 4-6%, but this will not be enough to cause appreciation in housing prices.  In fact, inflation adjusted housing prices will likely decline.

The best economic opportunities will be in government related jobs or businesses.  Commodity based business will also prosper.  Technology entrepreneurs will be few and far between.  Unemployment numbers will hover between 7-9% throughout the whole decade – this will be the new normal.  The U.S. will no longer be the largest economy in the world and based on per capita income among large countries the U.S. may fall below the top ten in the world.  The U.S. will also be one among many equals in technological and scientific leadership.  All social ills will increase slowly including crime, number of welfare dependents, and black market transactions.

Most Likely Scenario

This scenario assumes that the U.S. will not face up to its budgetary problems and Obama Care will not be repealed completely.  Under this scenario, the U.S. will go from financial crisis to financial crisis.  Each financial crisis will be meet with a short term band-aid solutions.  Federal government spending will grow to at least 30% of GDP and total government spending will be 50-60% of GDP.  Inflation will grow to 10-14% by the end of the decade.  Despite this, housing prices will not keep up with inflation.  Median household family income after taxes will decline by 2-7%.  Official GDP numbers will show slightly negative growth, but this will over state the actual growth rate.

The best economic opportunities will be in government related jobs or businesses.  Commodity based business will also prosper.  The financial differences between those who are in the government’s favor and those who are not will be huge.  Technology entrepreneurs will be almost nonexistent.  The brain drain from the U.S. will be apparent and a cause for anxiety.  Unemployment numbers will hover between 9-15% throughout the whole decade.  The U.S. will no longer be the largest economy in the world and based on per capita income among large countries the U.S. will fall well below the top ten in the world.  The U.S. will also be a declining power in technology and science.  All social ills will increase moderately including crime, number of welfare dependents, and black market transactions.  The chance of a major war in the world will be moderate.

Pessimistic Scenario

The U.S. will not face up to its budgetary issues even to get through a crisis.  The U.S. will either literally default on its debt or inflation will be over 20% or both.  Multiple states will go bankrupt and be bailed out by the federal government.  Tax burdens will skyrocket as will the black market.  Housing prices will decrease significantly except in extremely exclusively neighborhoods.  Social order will collapse.  The pretense that the U.S. is a nation of laws or that the Constitution has any meaning will be completely destroyed.  There is a possibility (15%) that there will be a military coup.  Alternatively or in combination there is a possibility that the U.S. will break up into a number of separate countries.  Many parts of the U.S. will decide that it no longer makes sense to support Washington, Wall Street and parts of California that have become use to crony capitalism and government handouts.  The brain drain from the U.S. will be well known and huge.  This may be the driver for politicians and voters to demand real reform.  China and India will dominate the world economy.  Unfortunately, neither will likely fill the U.S.’s shoes and become a technological and scientific leader.  Singapore will likely be the richest country in the world on a per capita basis by a large margin.  They will be the major center of technological and scientific research.  The chance of a major war in the world will be probably.

Caveats

The best reason to be more optimistic is that the U.S. has never had two bad decades in a row.  In the late 1930s and late 1970s there was no reason to suppose that the U.S. would right itself economically.  We pulled out the 1930s because Roosevelt realized that he had to adopt pro-business policies if the U.S. was to have any chance of winning World War II and so did the voters.  In the 70s, there was little hope that the U.S., let alone England, would pull out of the inflationary spiral, increase unionization, increased regulation, increasing government spending and entitlements.  However, there was the glimmer of Ronald Reagan and a surge of free market economists such as Milton Friedman, who still understood property rights.  Unfortunately, I do not see a Ronald Reagan on the horizon and many of today’s free market economists are overly focused on the detrimental effects of Federal Reserve and high marginal tax rates.  Very few seem to understand the importance of strengthening property rights, particularly for inventions or the need to free up our capital markets from regulation.  I hope I am wrong and there is a politician who understands property rights, particularly for inventions, and the need to free up our capital markets, while having the strength to stand up to government unions and special interests.

I cannot decide if we are seeing the collapse of Western Civilization under the weight of the welfare state (socialism) or if we are seeing the last hurrah of the welfare state.


[1] Ron Paul and Newt Gingrich have advocated eliminating SOX.

 
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.

 

 
$30 Billion for Small Business Lending

President Obama’s latest proposal to stimulate the economy is to subsidize community banks so that they lend to small businesses.  Gary Townsend has a great article on this at Seeking Alpha.  He suggests the program is flawed because of poor execution issues.  In his more cynical mood (honest mood), he suggests that it is payback to the banks for supporting financial reform.

More important than poor execution is that Obama’s proposal is fundamentally flawed.  It is another case of the government stealing money from one group to give it to another group.  It will not create jobs.  Banks lead to established businesses that have assets and cash flow.  The Kauffman Foundation has shown that all net new jobs over any decade are created by new businesses not small businesses.  High quality jobs are created by new business that are creating new technologies.  President Obama could get 300 times the impact with 1/30th the spending by fully funding the Patent Office and repealing Sarbanes Oxley and the new financial reform bill.  New companies (start-ups) that create high quality jobs are funded by equity investments.  These equity investments are backed by intellectual capital – patents.   The best return on these equity investments occurs when these companies go public.  Sarbanes Oxley has made this almost impossible.

This proposal by President Obama is not about creating jobs, but about political payback.

 

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