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Posts Tagged ‘innovation policy’


My Book: The Decline and Fall of the American Entrepreneur Now Available on Kindle

The The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation , is now available in Kindle format for only $7.99.

Book Highlights:

*New US laws since 2000 are killing US Innovation

*Explains why the venture capital model is dying.

*Innovation is key to creating high quality jobs

*Innovation is key to increasing real per capita incomes of Americans

*How to make the US the innovation leader of the world again

 

What others are saying about the book

Mr. Halling combines two topics — the impediments to entrepreneurship that have been created by the U.S. government as an unintended consequence of its pursuit of other goals and the systemic weakening of the U.S. patent system by the U.S. Supreme Court and the Congress.

The resulting technological stagnation is a major reason the U.S. has gone from producing 25 percent of the World’s Gross Product in the mid 1990s to about 20 percent today. The loss is significant – about $3 trillion of U.S. GDP in 2009 alone.

He demonstrates in clear terms the linkages between economic growth, productivity, and income. And he lays out how technological advancement has always been the American advantage in global competition, an advantage that the U.S. is squandering.

Dr. Pat Choate, economist, former Vice Presidential running mate of Ross Perot 1996, Director of the Manufacturing Policy Institute, Phd. Economics University of Oklahoma

 

“Dale Halling’s Decline and Fall of the American Entrepreneur makes a compelling case for the need to reform regulatory and other policies that hamstring entrepreneurial innovation in our country. Everyone concerned about the decline in American innovation should read this book.”

David Kline, Coauthor of “Rembrandts in the Attic” and “Burning the Ships”

The Decline and Fall of the American Entrepreneur presents the issues facing technology start-up companies in today’s environment.  The book sheds light on the underpinnings of these issues and is enthralling.  Halling’s tight, accessible and personal style make this a fast and compelling read.  His book is a political clarion call that should be heard now.

Greg Jones, Former President Ramtron International (RMTR) and CEO Symetrix Corporation.  Both companies founded on IP.

This book conclusively establishes the link between innovation and per capita income, and shows that we have recently entered into a time in which innovation is under assault.  This assault has resulted in a predictable loss of income and contributed significantly to the economic woes we are experiencing right now.  The book’s sound policy recommendations suggest a way to turn the economic ship around to set a course for a return to prosperity.

Peter Meza,Patent Attorney – Counsel Hogan & Hartson, Attorney for Alappat –  In re Alappat

 

 

The Myth of the Sole Inventor, By Mark A. Lemley, Stanford Law School http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1856610

Professor Mark A Lemley has written a paper suggesting that sole inventors and individual genius does not exist.  Mr. Lemley teaches patent law and intellectual property law at Stanford University.  However, Mr. Lemley is not a patent attorney, does not have a technical background and as his paper proves does not understand of technology.  Mr. Lemley’s idea of collectivist invention ignores three basic facts:

1) Groups of people are made up of individuals.

2) Every individual has to think for themselves – you cannot think for someone else, which is a source of frustration for every parent (child).

3) Throughout history the rate of invention was very slow until we introduced property rights for inventions (patents).

Lemley purposely downplays Edison’s achievement.  The fact is that Edison created the first high resistance, long lasting, incandescent light bulb.  This was a huge achievement that made electrical lighting commercially feasible.  Many “experts” with Ph.D.s from the most prestigious universities at the time said electrical lighting was impossible commercially.  Lemley also has his history wrong.  Swan was the most important inventor of the light bulb, before Edison.  He mentions Man and Sawyer, who I find no reference to in any history of the incandescent light bulb.  Lemley appears to have no regard for facts.  His analysis of the Wright brother’s achievements is similarly sloppy and just plain wrong.

Lemley’s argument that great inventions are created by multiple people simultaneously has been examined by numerous scholars and found to be incorrect.  For instance, see Jacob Schmookler and his ground breaking book, Invention and Economic Growth, which examined this issue.  People like Lemley attempt to smear together multiple inventions as being the same invention.  For instance, they see Swan’s light bulb and Edison’s light bulb as simultaneous inventions of the light bulb.  Lemley may have made this mistake because he does not have the technical background necessary to understand the issues surrounding the invention of the light bulb.  However, I suspect that Lemley is not interested in the truth, he is interested in pushing a political theory of collectivist invention.  If Lemley’s ideas held any water at all, then you would expect either: 1) the USSR/North Korea should have been one of the greatest sources of inventions in the history of the World, and/or 2) the greatest population centers would be the biggest creators of new technology.  The facts are that neither are true.  The first is self evident.  The second appears to be true until the creation of property rights for inventions.  When England and the U.S. create an effective property rights system for inventors almost all significant inventions for the Industrial Revolution are invented in the U.S. and England, even though their populations are much smaller than France, China, India, etc.

Lemley is pushing an old worn out socialist idea that individuals do not matter only the collective.  This paper is not novel and its thesis has been proven false over and over again.  But socialists do not believe in an objective reality.

The paper is an example of the intellectual and moral bankruptcy of many of our academic institutions.

The Myth of the Sole Inventor, By Mark A. Lemley, Stanford Law School http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1856610

 

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.

 
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.

 
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.

 

 
Net Neutrality: Requiem for the Internet

It is a sad day for innovation and freedom.  For more information on why see Does Net Neutrality Inhibit Innovation.  The FCC decided to enact a set of rules called Net Neutrality, which gives the FCC broad regulatory powers over the internet.  These rules are really an assault on property rights and a clear violation of the Fifth Amendment, which states “nor shall private property be taken for public use, without just compensation.”  Regulating the use of private property is a taking of some part of the owner’s property rights.  Property rights are a bundle of rights that define a relationship between something and the owner.  When the government takes, limits or modifies one of these rights it is a taking.

An ironic result about these rules is that the liberal left that pushed these socialist rules is unhappy with them.  They feel that the rules did not go far enough and that the regulatory process was captured by large companies.  Gee, that’s surprising.  Just look at how large Wall Street banks have used financial regulation to get rid of competition.  The large railroads did the same thing years ago.

Another ironic angle of these rules is that no consumer has come forward to complain about the way the internet works today.  A couple of very large technology companies have complained about issues of access.  They are part of the socialist groups that want to take someone else’s property without paying for it.  This is ultimately a fight between large companies that want to use the government to game the system in their favor.

A sad result of these rules is the useful idiots who believed that by supporting Net Neutrality they were supporting freedom and instead were supporting repression.  The FCC is out of control.  This is another assault by the FCC on free speech.  The FCC should be abolished.

 

 
Failing of Free Market Theory

I went to an excellent talk by Professor Gary Wolfram, of Hillsdale College, at the Pikes Peak Economic Club last night.  He explained that free market capitalism is associated with the wealthiest nations in the world and centrally planned economies are associated with the poorest nations of the world.  Free markets are based on property rights and the rule of law, not the rule of man.  The freest nations economically have the longest life spans.  The poorest ten percent of the population in the freest countries have a greater share of the total wealth than in non-free countries.  A poor person in the wealthiest/freest countries is likely to live in a house they own, the house is generally a three bedroom house, and most likely has air conditioning.

Professor Wolfram explained that the way you get rich in a free society is to provide goods and services that large numbers of people want.  He stated that we should celebrate people and companies that make large profits, because they have made a large number of people happy.  A big reason why free market countries are so wealth is because they provide an incentive to innovate.  He pointed out how many products that we use today did not exist 30 or 50 years ago.

In the question period of the talk, I pointed out to Professor Wolfram that there is a strong relationship between economically free countries and those that have strong property rights for inventions or patents.  The most innovative countries in the world are those with the strongest patent systems.  Those countries that first escaped the Malthusian Trap were those with strong patent systems.  Vice versa those countries with weak patent systems or non-existent patent systems are poor, not innovative, and are often still mired in the Malthusian Trap.  I then asked why so many “free market” proponents want to weaken or eliminate property rights for inventions (patents).

He rejected my premise that many free market proponents were anti-patent.  He went on to explain that some inventions deserve patent protection that had shorter periods of time and that other inventions deserved longer periods of protection according to a perfect theoretical model of economics.  For instance, inventions that would have been discovered by someone else shortly thereafter should receive shorter terms than “truly novel” inventions.  He also suggested that patents inhibit the diffusion of new technologies.  Finally, he implied that the way we increase our wealth is by driving down the profits associated with products and services.  Reducing the profit margin in goods and services increases the availability of these goods and services.  It is common for free market proponents to see the market process of reducing the profit and cost of goods and services as the major way free markets increase wealth.

Several people pointed out that his proposal for different lengths of patent protection seemed to contradict his idea that capitalism is based on the rule of law, not the rule of man.  The implication was that someone would have to decide which inventions would receive which term length.  As a result, this would be an arbitrary rule of man decision.  In fairness, Professor Wolfram pointed out that this was not true as long as the standard was objective.  While I disagree that we should have different terms for different inventions, Professor Wolfram is clearly correct that this is not necessarily subjective.

The empirical evidence does not support the suggestion by the Professor that patents inhibit the diffusion of inventions and technology.  Those countries with the strongest patent rights also have the greatest technology diffusion.  A major goal of modern patent systems is to spread the information associated with inventions, so that other inventors can build on the work of previous inventors.  There is also no empirical evidence for the idea that inventions would occur without property rights for inventions.  Those countries without strong patent systems do not produce inventions.  The suggestion that, in a free market system, inventions will just occur is at best speculation and the evidence we have shows the opposite.  When the US has weakened its patent system, our innovation has suffered as well as our economy.  For instance, in the 1970s we weakened our patent system and the US started to technologically fall behind Japan.  For more information see Foreigners Receive More Patents Than US!

The most troubling part of Professor Wolfram’s response was the implication that wealth is created in a free market economy by driving down profits.  Professor Wolfram seemed to imply that there was a “correct” or “optimal” amount of return an inventor should receive for a patent.  Shouldn’t we celebrate inventors who create something that everyone wants?  If an inventor creates something very few people want, how does that hurt technological diffusion?  More importantly, is it really true that wealth is created in a free market by driving down the profit margins of manufacturers (or inventors)?

The idea that the real power of the free market to create wealth is in its ability to foster competition (for the same product) and therefore drive down profit margins is incorrect.  If we were able to obtain every product available in 1900 at its cost or even free, we would not be nearly as wealthy as we are today.  Wealth is mainly created, not by cost or profit reduction, but by the creation of new inventions, i.e., technology.  We do not want people/companies competing to produce me-too products, but competing based on inventions.  Shortening the length of patents will encourage competition on me-too products instead of creating new products.  While the optimal length for patents may be difficult to determine, shorter terms will discourage innovation.  There is no evidence that the present length of patents are inhibiting innovation or the economy.

The idea by free market economists that the power of free markets is there ability to reduce the cost of existing products also leads to fallacies about antitrust law (now rebranded as competition law).  This cost reduction theory suggests that we should aggressively apply antitrust law to create competition.  However, the empirical evidence shows that periods of aggressive antitrust enforcement result is low levels of invention and weak economic growth.  For more information see Foreigners Receive More Patents Than US!

Wealth in a free market is mainly created by the invention of new technologies.  It is a failing of economists to suggest that the power of a free market is its cost reduction of existing products.  This fallacy results in an anti-property right policy towards inventions and an aggressive application of antitrust laws.  The empirical evidence shows these policies do not create wealth.

 
More Evidence that Stealing Inventions is a Business Strategy

I was reading a post on the myth of the first mover advantage, which intrigued me because I have argued essentially this point in my post, Invention – A Financial Analysis .   One of the responses suggested the book, Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge.  The description of the book on Amazon states:

In the business world, imitation gets a bad rap. We see imitating firms as me too players, forced to copy because they have nothing original to offer. We pity their fate: a life of picking up crumbs discarded by innovators striding a path paved with fame and profit.

In Copycats, Oded Shenkar challenges this viewpoint. He reveals how imitation the exact or broad-brushed copying of an innovation is as critical to prosperity as innovation.

Shenkar shows how savvy imitators generate huge profits. They save not only on R&D costs but also on marketing and advertising investments made by first movers. And they avoid costly errors by observing and learning from others trials. (Emphasis Added)

I show in my post that without intellectual property rights that copycats will “save on R&D costs” and “marketing and advertising costs” compared to inventing firms.  This book clearly argues for stealing the inventions and marketing efforts of inventors.  There is nothing wrong with being a copycat firm, if you pay the inventor for their intellectual property.  However, this is not what the author is suggesting.  He is suggesting stealing the inventing and marketing efforts of innovators.  According to the description of the book, the author suggests that copying is as critical to prosperity as innovation.  Since you cannot copy an invention until it has been created, invention always proceeds copying.  It is impossible for the effect, copying, to be as important as the cause, invention.  This book may be providing good business advice in the present environment of weak patent rights, but it is dead wrong that imitation is as important invention for the economy.  The only way to increase real per capita income is by increases in our level of technology.  Only by properly protecting the rights of inventors can we encourage (private) invention and therefore increase our real per capita income.  This book is sad statement on the US economy and its willingness to protect property rights.

 

 
The High Cost of Marketing and Selling an Invention

Inventors and critics of the patent system often ignore or are ignorant of the high cost of marketing and selling a new product embodying an invention.   I discussed this cost in Invention- A Financial Analysis http://hallingblog.com/2010/08/13/invention-–-a-financial-analysis/.  This cost is the variable Mi in the equation I developed as part of the financial analysis.  Another paper that discusses this additional cost that inventor’s incur in marketing and selling their invention compared to a me-too produces, is The Nature and Function of the Patent System[1].  Kitch, the author, explains:

Even in the case of an innovation patented in fully commercial form – as is the case with many relatively trivial patents – the firm must make significant investments to simply distribute and market the invention.  But expenditures necessary to identify the market for the product and to persuade potential customers of its utility can easily be captured by competitive imitations.  Absent a patent on the product, the incentives to provide information to purchasers about their need for a product as opposed to information about the particular characteristics of the seller’s product are limited.  The trademark law protects only the names and symbols identifying the seller’s product; it confers no protection against imitators of the product itself.  Thus competitors can ride on the demand for the product created by the first seller without incurring the expenses necessary to inform buyers of the advantages of the product.  Only in the case of a patented product in a firm able to make the expenditures necessary to bring the advantages of the product to the attention of the customer without fear of competitive appropriation if the product proves successful.  This aspect of the cost of introducing innovations is stressed here both because managements find that marketing is a major cost in innovation and to illustrate that even in the case where nothing remains but to make and sell the patented invention, there are significant costs whose return could be appropriated by competitors.  Absent a patent, firms have less than the optimal incentive to invest in providing information about and techniques for using the new technology.[2]

Inventors need to take these additional costs into account when undertaking a new venture.  There are several strategies that can be used to reduce these costs.  For instance, teaming with an existing company that has a strong market presence (marketing channel partner) in your marketplace.  Another solution is to invent only line extensions to a company’s existing products.  This second solution is common for large companies and is why large companies are not known for inventing revolutionary or disruptive technologies.

Critics of the patent system have to answer why they believe inventors will develop new technologies when it puts them at a cost disadvantage compared to copiers.


[1] Kitch, Edmund W., The Nature and Function of the Patent System, Journal of Law and Economics, Vo. 20, No. 2 (Oct., 1977) pp. 265-290.

[2] Ibid. p. 277

 
The US Economy and the State of Innovation

About a year ago I finished my book The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation.  The book argues that the US economy was faltering long before the financial crises because changes to our laws were inhibiting investment in technological advances.  Intellectual, financial, and human capital are the three foundations necessary to develop new inventions and all three have been undermined since 2000.  In this post I will review how the policies affecting these foundations have changed in the last year.

Intellectual Capital: patents mainly represent this prong.  The good news is that David Kappos replaced the incompetent and traitorous Jon Dudas.  Kappos is a patent attorney and therefore also has a technical background.  Unfortunately, he spent his whole career working for large companies and does not understand the challenges of individual inventors and technology start-up companies.  The bad news is that Supreme Court again illustrated their utter incompetence in the Bilski decision.  None of the Justices understand the difference between the utility requirement under 35 USC 101, the novelty requirement 35 USC 102 and the obviousness requirement 35 USC 103.  The justices demonstrated that they do not understand the need for a working embodiment (35 USC 112) in order to even evaluate 101 and 102 issues.  They presented nonsense hypothetical’s in oral argument that were not enabled and then demanded to know whether these hypothetical’s meet the utility requirement.  They also made absurd statements that patents limit the flow of information.  Another low point in the year was the farcical ruling in the ACLU v. Myriad case.  The judge ignored the law and wrote 100 pages of nonsense to his cover up his crime.

Despite some progress in this area, overall the US continued to weaken the Intellectual Capital foundation necessary for economic growth, job creation, and investment in inventions.

Financial Capital: Sarbanes Oxley significantly undermined this foundation.  The only good news is that the financial reform bill raised the threshold for the application of SOX to $60 million in market capitalization.  However, SOX did incredible damage to our economy in only 60 pages.  The financial reform bill is 2700 pages and no one knows all the damage it will cause, but it certainly was not a step in the right direction.  The major issue financial reform should have addressed was Fannie and Freddie and it did not even address this issue.

There was no progress at all in this area.

Human Capital: this was undermined by the FASB rules requiring the expensing of stock options.  Despite the fact that accountants are unable to understand the simple fact that dividing a pie does not reduce the size of the pie, this idiotic policy continues unchallenged.

The US has made no progress in the last year in implementing policies that would encourage technological entrepreneurship.  The US is continuing its corny capitalism policies that reward political connections over true economic progress.

The US is also likely to increase the capital gains tax rate from 15% to 20% in 2011.  This will further damage the incentive to invest in new technologies.  The Obama administration is proving that it is even more incompetent than the Bush administration.

 
Rent Seeking and Patents

Patents are often analyzed as monopolies or rent seeking.  Patents are clearly not a monopoly.  A monopoly give the exclusive right to sell a product or service.  A patent does not give the holder this right.[1] For more information see The Myth that Patents are Monopoly.

The concept of economic rent is a more useful concept than monopoly for analyzing patent law. In the typical patent case production will either remain the same or increase compared to the pre-patent situation.  As a result of the invention, protected by the patent, the inventor has a cost advantage that allows him to make more money–economic rent–than his competitors.  In that sense there is no restriction of production and hence no monopoly.[2]

Economic rent is defined in Wikipedia as “excess returns” above “normal levels” and they are associated with a lack of competition in markets.[3] What is meant by “normal levels” of return?   Is it the same return that a person could make by putting their money in the bank?  Or is the same return a person could make by investing in the stock market?  Or is the same return that a person could make by investing in non-inventive manufacturing or service business?  The concept of “excess returns” suffers from the same flaws as all socialist concepts of fairness – who decides?  The concept of “excess returns” only makes any sense statistically.  We are not talking about the returns from a specific patented invention, but the average return from inventing versus other economic investments.  In addition, it only makes sense to compare the return on patented inventions to investments in private manufacturing or private service businesses.  Let’s assume that the people who suggest that patents are rent seeking mean, patent holders are on average (statistically) receiving a higher return (excess return) compared to other similar private investments.  For simplicity I will assume a private manufacturing business.  Based on these assumptions, would the fact that investors in patent inventions (hereinafter inventors) receive a higher return than other manufacturing business be bad for the economy or bad for consumers?  Let’s be clear that most commentators who state that patent holders are rent seekers, believe this would be damning evidence against patents.

There are several possible scenarios that meet the assumptions above: 1) inventors receive normal returns on manufacturing their invention, 2) inventors receive normal returns both on their manufacturing costs and their cost of inventing, 3) inventors receive normal returns both on their manufacturing costs and the risk adjusted costs of inventing and marketing a new invention, and 4) inventors receive excess returns both on their manufacturing costs and the risk adjusted costs of inventing and marketing a new invention.

My post Invention – A Financial Analysis , created the following mathematical model for the cost of inventing.

Ci(n) = (Inv + Mi)/P + NRE + PC*n + OH*n   (New Product based on invention)

Cmt(n) = NRE + PC*n + OH*n  (Me-too product)

Where Ci is the cost of creating a product for the owner of the invention, Inv is the cost of creating the invention, P is probability of that the invention will succeed in the market, Mi is the incremental marketing and sales cost of introducing a new invention, n is the number of products that have been produced, NRE is the nonrecurring engineering cost of setting up production, PC is the production cost of the making n products and OH is the cost of overhead for producing n products, Cmt is the cost of creating a me-too product. I will use this mathematical model to analyze the four scenarios discussed above.

Scenario 1 – Inventors Receive Normal Returns On Manufacturing Their Invention

In the above equation this means that the inventor can receive no compensation for cost of invention (Inv), the cost of marketing a new invention (Mi), or for the probability of success (P).  This means that the inventor will never be able to justify the cost of inventing (Inv, Mi, p), since it is a sunk cost that will always cause the inventor’s return to be less than they would receive by investing in other manufacturing businesses.  Why undertake the cost, risk, and hassle of inventing when you can obtain better returns by investing in any random manufacturing industry.  If this is patent critics’ idea of rent seeking, then they will essentially kill off all but accidental inventing and inventions that can be kept a trade secret.  It will also kill off all venture capital.

Scenario 2 – Inventors Receive Normal Returns on Both Their Manufacturing Costs And Their Cost Of Inventing

In this scenario inventors are allowed to receive normal returns on their inventing costs (Inv) and their manufacturing costs (NRE, PC, OH).  However, this does not compensate them for costs of marketing the invention (Mi) or their probability of success (P).  While this makes inventing slightly more favorable, it still does not justify investing in inventing instead of any random manufacturing industry.  If this is patent critics’ idea of rent seeking, then they will essentially kill off all but accidental inventing and inventions that can be kept a trade secret.  It will also kill off all venture capital.

Scenario 3 – Inventors Receive Normal Returns Both On Their Manufacturing Costs And The Risk Adjusted Costs Of Inventing And Marketing A New Invention

Now this scenario sounds fair.  Inventors (statistically) are compensated for all their true costs and risks.  Inventors are in exactly the same position as investors in any other (manufacturing) business.  In addition, inventors have the random chance of hitting the jackpot.  This supposedly fair mined solution to the problem of rent seeking by patent holders ignores the return received by the beneficiaries of the invention (hereinafter society).  Is this a fair solution if society receives an “excess return” when they buy (use) the invention?  Let’s look at a real world example to illustrate this point.  Because of the cotton gin, US cotton exports change from less than 500,000 pounds in 1793 to 93 million pounds by 1810.[4] A single cotton gin could generate up to 55 pounds[5] of cleaned cotton daily a 25 fold improvement over previous methods.[6] So Eli Whitney would receive a 10% or so return on his invention, while society (cotton farmers – owners of the cotton gin) would receive a 2500% return.  Why is it fair for Eli Whitney to receive a “normal return” of say 10% on his efforts while the purchasers of his cotton gin receive a 2500% return on their investment?  Who is the real rent seeker in this situation?

Is the Eli Whitney case an outlier case?  Real world purchasers in a B to B situation will only purchase an inventive product if they will receive more than an “normal return.”  If an invention only provides a “normal return” to the purchaser, then they will have a wide variety of known devices that will provide them average return.  There is no reason to select an inventive product that is going to require the purchaser to learn a new product and possibly alter their existing processes when they can get the same return from existing choices.  Similarly, no rational investor is going to invest in an invention if they can obtain the same return by investing in a number of other known projects.  This shows that in the real world both the inventor and the purchaser have to receive excess returns for an invention to be successful.

We know that neither the inventor nor the purchaser of the invention is expecting a normal return.  An invention will only be successful if both the buyers and the inventor receive an above normal return on their investment.  The inventor and the buyer are both rent seeking according to standard economic theory, which shows that the concept of “rent seeking” is seriously flawed.  I propose that real rent seeking is when one party to a transaction obtains above normal returns and while the other party obtains below normal returns.

It is clear that the real rent seekers are not patent holders but a society that wants to obtain the benefits of new technologies without paying the creators of these new technologies.

Scenario 4 – Inventors Receive Excess Returns Both on Their Manufacturing Costs and the Risk Adjusted Costs of Inventing and Marketing a New Invention

This is the only scenario under which inventing can be encouraged.  As explained above, both the inventor and the purchasers must receive above normal returns in order for the invention to successful in a free market economy.   This is the very definition of how economic progress occurs.  Economic progress (real increases in per capita GDP or per capita income) only occur because of increases in our level of technology.  Our patent system has to provide excess returns above normal levels for inventors if we want our economy and standard of living to increase.


[1] 35 USC 154 [2] Dam, Kenneth W., THE ECONOMIC UNDERPINNINGS OF PATENT LAW, JOHN M. OLIN LAW & ECONOMICS WORKING PAPER NO. 19 (2D SERIES), http://www.law.uchicago.edu/files/files/19.Dam_.Patent.pdf, p.4. [3] Wikipedia, Opportunity Costs, http://en.wikipedia.org/wiki/Opportunity_cost, 8/24/10. [4] Wikipedia, Eli Whitney, Jr., http://en.wikipedia.org/wiki/Eli_Whitney,_Jr., 8/24/10. [5] Wikipedia, Eli Whitney, Jr., http://en.wikipedia.org/wiki/Eli_Whitney,_Jr., 8/24/10. [6] Gordon, John Steele, An Empire of Wealth: The Epic History of American Economic Power, Harper Perennial, New York, 2004, p. 84.

 

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