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Invention – A Financial Analysis

Jacob Schmookler, an economist and author of Invention and Economic Growth, developed a financial analysis of the invention process.[1] The main point of this mathematical modeling of the invention process was to show that the probability of any invention being created is related to the size of the market for the invention.  I intend to present a model of the cost of inventing compared to creating me-too products.  I am not a fan of mathematical models for explaining most economic effects, because the terms in the equation are either unmeasurable or vary in an unpredictable manner.  As a result, I think these mathematical models give the impression of the accuracy of a physical science, which they clearly do not provide.  This can lead to logical errors.[2]

Despite this, I believe a simple mathematical model of the invention process will illustrate some important points.  In addition, some people understand concepts better when presented in a mathematical model.  Here is my model for the costs associated with introducing a new product based on an invention and me-too product:

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.

The reason I add the probability that the invention (P) will succeed is that not all inventions are successful.  An economist who wants to capture all the costs associated with introducing a product based on a new invention has to include this probability to determine the true cost of inventing.  This probability will vary based on the type of invention.  For instance, line extension inventions are much more likely to succeed than inventions that create whole new markets.  An example of an invention that created a new market was Webcrawler, which was the first full text web indexing search engine introduced in 1994.  On the other hand adding image or video searching to Google is a line extension.

The cost for marketing and selling a product based on an invention (Mi) is separate from the cost of marketing and selling a me-too product.  It takes significantly more money, time, and effort to sell a product based on an invention that is creating a whole new market than a me-too product.  Any sales person who has tried to sell a truly unique product knows that it is much easier to sell an existing product or a me-too product because you do not have to explain the value of the product, how the product works, and why the customer would want the product.  A true me-too product can be sold mainly on price.  A line extension product takes less marketing and sales effort than a revolution product.  Large companies tend to focus on line extension inventions because it reduces the risk that the product will not succeed and reduces the cost of marketing and selling.  Many start-ups sell through marketing channels in order to reduce this cost.

I include the cost of selling, advertising, and marketing of me-too product in overhead.  Once a product based on an invention is well known, then it will incur the same cost as a me-too product of selling, advertising, and marketing.  I believe this is an accurate characterization.  Non-recurring engineering (NRE) is the same for both the me-too product company and the inventor company.  The reason for this is that me-too products will incur approximately the same cost of setting up production as the owner of the invention.

The values of these variables will vary based on the type of invention involved, the type of market in which the invention is sold, and the point in time the product is introduced.  This model is not exact.  For instance, overhead (OH), production costs (PC), and marketing cost of the invention (Mi) should all be functions of the number of products sold (n).  Production costs usually decrease with the number of products sold.  Marketing costs of the invention (Mi) should be spread out of the first X number of products sold.  In addition, the total marketing cost of the invention (Mi) should not be included for failed products based on an invention, since the owner is likely to kill the project earlier and not spend as much as on a successful product launch.  There are probably other shortcomings of these equations.  However, certain facts are clear even with any flaws in these equations.  The cost of inventing increases the cost to the inventing firm over the me-too firm.  As a result, inventing is a market disadvantage without intellectual property.

Invention Law:  The cost of inventing increasing the expenses of the inventing firm compared to the expenses of the me-too firm.

There are only two common ways to compensate or incentivize inventors.  One is to provide the inventor with a property right (patent) in their invention.  The other is to have the government pay for the cost of inventing.  The first is consistent with a free market economy and has proven to be extremely successful.  The second is consistent with a command and control economy (statism) and has proven to be inefficient and political.

Intellectual Property Law: Inventing is a market disadvantage without intellectual property.

Now I will look at some specific scenarios to provide some insight to these laws.

Pessimistic Scenario

Scenario 1:

Consumer good sold through retail outlet

Inventing = New Market

Target Retail Price $10.00

Cost of inventing (Inv) = $100,000.00

Cost of Marketing Invention (Mi) = $900,000.00

Probability of Success (Pi) = 0.1

Nonrecurring Engineering (NRE) = $30,000.00

Production Costs per Unit (PC) = $2.00

Overhead Costs per Unit (OH) = $1.20

Unit Inventor’s cost per unit Copier’s cost per unit
1 10030003 30003.2
10 1003003 3003.2
100 100303.2 303.2
1000 10033.2 33.2
10000 1006.2 6.2
100000 103.5 3.5
1000000 13.23 3.23
10000000 4.203 3.203
100,000,000 3.3003 3.2003

It is assumed the manufacturers are selling their products $4.00, which is a standard double over manufacturing costs.  The 1/5th of retail price is a minimum necessary for the manufacturer to obtain a return that justifies manufacturing the product and selling it through a standard retail channel.  As you can see the inventor has to sell 100 million units ($1B in revenue) in order to get within 10 cents of the same manufacturing cost as the me-too manufacturer.  The copier’s break even[3] point is somewhere between 10 thousand units and 100 thousand units while the inventor’s break even is point is over 100 times as many units.

It is likely that this scenario overstates the difference between the costs of the inventor and the copier.  For instance, the inventor is unlikely to spend the full cost of marketing the invention (Mi) for the other nine failed product.  In addition, the percentage of successfully launched products is based on the stated success rate of venture capitalists.  Most VCs state that they have one highly successful company for every ten investments.  They also usually have 2-3 other companies in the portfolio that produce moderate returns or losses.  Not all of the other companies are in their portfolio are a complete loss.

Optimistic Scenario

Let’s look at a much more optimistic scenario.  Let assume the probability of success (P) includes these moderately successful investments and lets also include the idea that the probability includes some line extensions which have a 70% probability of success or higher.  We will also move up the probability of success to compensate for the fact that the inventor is unlikely to spend the full cost of marketing the invention (Mi) on failed inventions.  I will make the wild guess that setting the probability to 45% will compensate these differences.  I will also assume that instead of taking $1M to launch a new invention that it takes only $100 thousand.  Part of the justification for this difference is that the inventor and other founders are likely to not take a salary until the company has significant revenues.  I will also lower the overhead significantly, because this is one of the big advantages of a start-up.  My optimist scenario is:

Scenario 2:

Consumer good sold through retail outlet

Inventing = New Market

Target Retail Price $10.00

Cost of inventing (Inv) = $10,000.00

Cost of Marketing Invention (Mi) = $90,000.00

Probability of Success (Pi) = 0.45

Nonrecurring Engineering (NRE) = $30,000.00

Production Costs per Unit (PC) = $2.00

Overhead Costs per Unit (OH) = $0.50

Unit Inventor’s cost per unit Copier’s cost per unit
1 252224.7 30002.5
10 25224.72 3002.5
100 2524.722 302.5
1000 254.7222 32.5
10000 27.72222 5.5
100000 5.022222 2.8
1000000 2.752222 2.53
10000000 2.525222 2.50

In this scenario, the break even point for the copier is between 1000 and 10,000 units, while the break even point for the inventor just over 100,000 units.  The inventor is still at a significant disadvantage to the copier.  Some of this disadvantage may be offset by the first mover advantage.  However, if the inventor company is a start-up its first mover advantage is likely to be significantly offset by the established relationships of an established copier company.  In addition, the inventing company may sell more of their initial units directly (not through a retail channel) and their margins will be significantly higher for these units.

It is clear that inventing without intellectual property is a competitive disadvantage.  Large companies that invent can offset some of this disadvantage by using other competitive barriers to entry.  For instance, an established company can use its network of relationships to create a barrier to entry from start-up copier companies and may be able to use its relationships to provide some barrier to entry from other large established companies.  The empirical evidence is that established companies mainly produce incremental inventions.  This is because the invention process is risky and as an established company they often have less risky methods of providing incremental revenue or profit gains.

Start-up companies produce all the net jobs in America according to the Kauffman Foundation.   They are also the biggest producer of emerging technologies – see Do Individual Inventors and Start-ups Invent Anything Important?.  Advances in technology are the only way to increase our real per capita income.  We need to encourage investments in inventions, if we want to leave our children a better world than the one we live in.  Technology start-ups need the incentive of property rights in their inventions (patents) in order to justify the investment in these companies.


[1] Schmookler, Jacob, Invention and Economic Growth, Harvard University Press, Cambridge Massachusetts, 1966, pp 113-115.

[2] For instance, the measurement of GDP is said to be consumer spending plus investment plus government spending plus exports minus imports.  This equation leads to the logical error of assuming that consumer spending and government spending results in an increase in the output of a nation.  The reason this is a logical error is that people confuse the cause with the effect.  Consumption does not create goods and services.  Production creates goods and services, which is related to the consumption of good and services.  An engineering analogy is that temperature is often measured by determining a change in the resistance of a resistor.  If I change the resistance being measured by adding resistor in series with the thermistor this does not change the temperature of the environment being measured.  This is what economists are arguing when they suggest that increased government spending will cause the economy to grow.  Government spending does not create any new goods and services; it just either consumes production or transfers the return for production from one person to another.  Similarly, consumer spending is a way of measuring production.  Artificially increasing consumer spending does not increase production.  For instance, giving people income tax rebates when they never paid any income tax does not increase production, it just steals the productive effort of those who do pay taxes.

[3] The break even point is when the cost per unit is equal to the sales price per unit.

 
The Rational Optimist: Excellent Book, Disfigured by Open Source Utopianism

The author, Matt Ridley, has written an excellent book that is epic in the scope of issues he tackles.  The book covers why homo sapiens thrived while other members of the homo genus fail.  He shows that on average the human condition has gotten consistently better and this increase in wealth has been especially true in the last 200 years.  He destroys the noble savage myth.  He shows the intellectual failings of Marxism, environmentalism, self sufficiency, and renewable energy.  His two main themes underlying these vast topics are: 1) trade leads to division of labor, which leads to invention and 2) the inexorable march of human progress.

Despite Mr. Ridley’s incredible breadth of knowledge, there is a logical gap in his first thesis when he attempts to explain the industrial revolution and why it took off in England.  This logical gap is the result of his misunderstanding of intellectual property.

This misunderstanding of intellectual property is most likely due to his open source utopianism.  This utopianism leads the book to conclude “Thanks to the internet, each is giving according to his ability to each according to his needs, to a degree that never happen in Marxism.” P. 356.  Even with this imperfection, this is an incredible book that I highly recommend to anyone.

Population Density – Good or Bad for Wealth Creation?

The book argues that population density is necessary for trade and division of labor, which is the route to economic prosperity.  It also argues that the division of labor leads to inventions, which leads to further specialization.  Specialization requires a large enough market to support it and as a result population density is the friend of economic progress.  However, later in the book it argues that increasing population caused a decline in the living standards of Japan and Denmark.  This decline supposedly occurred because the increasing population decreased the value of labor and therefore the market for specialization and inventions.  England escapes this fate because of coal and phantom land in the colonies.  This contradiction between the need for human density for specialization and economic progress and the idea that increased population density reduced the value of labor destroying the market for inventions is not adequately resolved.

The book argues, starting on page 52, that trade is what allowed homo sapiens to succeed where other apes failed and even other humans failed such as Neanderthals.  It provides numerous examples of how various groups of humans regressed technologically because of inadequate population densities to support specialization, such as Tanzania.  The book summarizes the lessons by quoting economist Julian Simon “population leading to diminishing returns is fiction: the induced increase in productivity is scientific fact.”  P. 83.

In a chapter entitled “Escaping Malthus Trap,” Ridley discusses how Japan after a period of prosperity gives up its technology.  He states “that sometime between 1700 and 1800, the Japanese collectively gave up the plough in favour of the hoe because people were cheaper to hire than draught animals.”  P. 198.  The reason for this according to Ridley was rapid population expansion due to paddy rice technology.  This population boom made labor cheap and killed the market for technology.  Denmark follows the same path as Japan and by the 1800s becomes “trapped by its own self sufficiency.”  P. 200.  Britain escapes the Malthusian trap that Japan, Denmark, and Ireland suffer, according to Ridely, because of selective breeding (maybe p. 200), ghost acres provided by the colonies (p. 202), release valve emigration to the colonies (p. 202), and coal (sustained industrial revolution p. 216.)

There is a logical inconsistency between the conclusion early in the book that population density is necessary for prosperity, but later in the book arguing that prosperity stalled after a burst in population in various countries.  The explanation of selective breeding, does not explain why the US or Australia prospered.  These countries were heavily populated by British rejects.  Similarly, the ghost acres provided by the colonies were eventually used up.  It might be argued that there was some tipping point that could only be achieved with ghost acres.  I think this fails also, because it flies in the face of the book’s earlier argument that increased population densities allow more specialization and invention to increase everyone’s standard of living.  The release valve emigration fails for the same reasons as the ghost acres.  The emergence of coal is also unsatisfying.  Coal mining was known before the birth of Christ and trade in coal occurred in England as far back as the 1300s, according to Wikipedia.  The book also argues that many surges of economic growth were extinguished by parasitic political systems.  However, it never states this is why Japan’s and Denmark’s prosperity was reversed.

What was new in the industrial revolution was not coal, but the machines to use coal and numerous other inventions.  The book argues that these inventions were not in general due to new scientific discoveries, p. 255, and I agree.  So why at this particular point in time did we have a sudden increase in rate of technological advance, including machines that used coal?  The beginning of the industrial revolution coincides with the recognition of property right’s in inventions.  The US constitution states (Article 1, section 1, clause 8) that inventors have ‘RIGHTS” in their inventions.  Patents, which are legal title to an invention, are the only free market system for encouraging people to invent.  While Britain had a patent system at least back to the Statute of Monopolies, 1623, it did not recognize a right to property in one’s invention.  It was a royal grant, subject to the whims of the ruling monarch.  As a result, it was expensive and arbitrary.  However, when the United States recognizes that inventors have a property right to their invention, this provides a whole new incentive to inventors and their financial backers.  No doubt this attitude towards inventions also infected Britain.  For more on the correlation between real per capita increases in income and patent systems see Source of Economic Growth.

Mr. Ridley argues that patents at best have marginal effect on the rate of invention.  However, Mr. Ridley shows an appalling lack of knowledge about patents and intellectual property.  He also has a number of inconsistent statements about intellectual property.  For instance, on page 267, he states that copyrights have little effect on the creativity of musical composers.  However, on page 326 he states that Nashville was saved by music entrepreneurs using good local copyrights in the 1930s.  Not only are these two statements contradictory, there is no such thing as local copyrights in the United States.

Patents

The book has numerous other errors about intellectual property.  For instance, it states that intellectual property is not like other property, because it is useless if you keep it to yourself, p. 262.  This statement is nonsense.  The Coca Cola formula is not shared and this is the only reason it has any value.  A patent to an invention (legal title to an invention) only has value if there is some ability to exclude others from using it – as opposed to knowing about it.  If everyone can make a laser without pay royalties, then it may have value to the world but it has no differential value to the inventor.  Patents are derived from exactly the same philosophical basis as real property.  Namely,  Locke’s theory of Natural Rights.  For more information see Scarcity – Does it Prove Intellectual Property is Unjustified? Below are a list of some, but not all, of the book’s errors related to patents:

1) The book then states that people get rich by selling each other things and services not ideas, p. 263.  What are authors, professors, engineers, scientists, really selling?  Authors are not selling books, they are selling ideas that just happen to be embodied in books.  The Kindle proves this.  The Kindle does not allow the user to buy a book, but to buy the ideas in a book.  Professors are either selling the teaching of ideas or just an expensive way to bore students.  Engineers are selling a service, which encompasses ideas not the paper (digital ones and zeros) on which it is written.  Most companies do not make money manufacturing things, they make money with inventions (ideas) that are implemented in things.  When a company only sells things with no (new) ideas in these things, then their profit margins are extremely narrow.  One of the limitations on growth has been this Luddite refusal to allow inventors to specialize in inventing.  This book’s premise is built on the division of labor, but the author rejects this idea when it comes to inventing.

2) Mr. Ridley also seems to be confused between the spread of information related to inventions and the legal right to use that information to build an invention.  It is a major goal of modern patent systems to spread information about inventions so that they can be used by other people to build other inventions.  In the U.S. we built patent depository libraries to spread the wealth of information in patents (before the internet).  Patents encourage people to share the information associated with their inventions instead of keeping them a trade secret.  Countries without patent systems tend to invent mainly things that can be protected with a trade secret.  (See Switzerland before they adopt a patent system)  As a result, other inventors do not get learn from these inventions and the rate of technological progress is inhibited.

3) The book perpetuates the first mover advantage alternative to patents.  Xerox had the world’s greatest first mover advantage in plain paper copiers, when it agreed to settle an antitrust lawsuit in 1975 by giving away its patent portfolio.  Its market share went from almost 100% in plain paper copiers to 14% in just four years.  The first mover advantage is a fairy tale.

4) The book argues, p. 264, that there is no evidence that patents are what drive inventors to invent.  This statement is completely illogical.  Real property rights are not what drive farmers to farm or builders to build houses.  Nevertheless, there would be a lot less building and less efficient farming, if we did not have real property rights.  Just look at countries, where property rights in buildings and land are hard to impossible to obtain.

5) The book states that a number of inventions were never patented, p. 264, such as automatic transmission, Bakelite, ballpoint pens, cellophane, cyclotrons, gyrocompasses, jet engines, magnetic recording, power steering, safety razors and zippers.  While it is possible that the first version of some of these inventions were not patented, all of these inventions were subject to numerous patents.  This can be easily verified with a simple patent search.  For instance, there are at least 20 patents and probably hundreds of patents on automatic transmissions.  The same is true of ballpoint pens, gyrocompasses, jet engines, magnetic recording, power steering, safety razors and zippers.  A simple internet search shows that chemist Leo Hendrik Baekeland (1863-1944) invented and first patented the synthetic resin that we know as Bakelite in 1907.[1] Jacques E Brandenberger was granted patents to cover the machinery and the essential ideas of his manufacturing process of the new film (cellophane).[2] The assertions of no patents for the zipper is also easily shown to be incorrect.  Elias Howe, who invented the sewing machine received a patent in 1851 for an ‘Automatic, Continuous Clothing Closure’ (zipper).[3]

6) The book argues that the Wright brothers, enforcing their patent on airplane control surfaces, supposedly shut down the airplane industry in the US.  This is the typical propaganda of open source community.  First of all the Wright brothers were building airplanes, so the industry was not shut down by enforcement of the patents.  Second stealing other people’s property is not shutting down industry, it is shutting down theft.  We would not say that someone stopped the harvest of wheat, because they did not let someone else reap the wheat they planted on their land.

7) The patent thicket argument is repeated by Mr. Ridley to suggest that patents inhibit advances in technology.  A number of papers[4] have shown that there is no empirical evidence for the patent thicket argument and that the logical analogies on which it is based are flawed.  For more information see  Intellectual Property Socialism: Part IV USPTO Takes Aim at Inventors.
8) Mr. Ridley further demonstrates his ignorance of patents by repeating the concern that the US Patent Office was issuing patents for human genes in the 1990s, p. 265.  What the Patent Office did and does was issue patents on “isolated genes.”  This is similar to patents on things like isolated forms of vitamin B12, which was patented.  For more information see Gene Patenting Debate Continues.

9) The book also mistakenly calls a patent a “temporary monopoly.”  A patent is a property right, just like property rights in land, houses, cars, etc.  The logical basis for patents is exactly the same as other property rights.  Property rights are based on Natural Rights, which states that since you own yourself you own the product of your labor (physical and mental).  For more information see The Myth that Patents are Monopolies.

10) He also implies that patents are top down solution to encouraging invention.  Nothing could be further from the truth.  All a patent system does is provide property rights to inventors for their inventions.  This is similar to property rights for land, which is a bottom up way to increase the productivity of farming for instance.  Just giving pseudo property rights to peasants in the USSR and China caused enormous increases in farm production.  Property rights are a bottom up solution, not a top down solution.  In fact, the genius of the United States patent system (as opposed to Britain’s) is that it was accessible to all people, including women and slaves that had no property rights under their state laws.  This encouraged a torrent of inventive activity in the U.S. that propelled it from a backward farming country to an economic and technological powerhouse in the world in less than 60 years.  For more information see the excellent book by B. Zorina Kahn, The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920.

Open Source

I am convinced that Mr. Ridley’s poor research on patents and intellectual property is due to his infatuation with the open source movement.  On page 356 he opines that genetic research will soon go open source.  He is so excited about open source that he eventually suggests a Marxist’s open source utopia – “Thanks to the internet, each is giving according to his ability to each according to his needs, to a degree that never happen in Marxism.” P. 356

The open source movement has been a dismal failure.  Its biggest success has been to extend UNIX (LINUX) to personal computers, other platforms, and add new features.  Open source has mainly extended existing technologies, much like the incremental invention that can be expected from large companies.  The open source movement deludes itself into believing they are fighting some sort of David versus Goliath battle against large corporations and the patent system.  The reality is that open source developers are giving large corporations, such as IBM, their efforts for free and weakening the bargaining power of technical personnel.  The open source movement plays right into the hands of large corporations and other large institutions, by weakening the property rights of developers in their work.  It should be no surprise that open source has been an abysmal failure, since this exactly the situation most of the world lived under until 1800.  Before modern patent systems, new inventions were rare and the return for the invention was often controlled by a trade guild.  The members of the trade guild profited equally, meaning there was little incentive for the inventor to spend time creating.  Per capita income of the world before 1800 had been stagnant for millennia.  Where modern patent laws were adopted around 1800, incredible increases in per capita income occurred.  Mr. Ridley trumpets this progress throughout his book.  In areas without patent systems, we see stagnant growth in per capita income.  For instance, Japan’s per capita income does not take off until they copy the US patent system in the 1860s.

It is unfortunate that this excellent book is disfigured by the author’s irrational infatuation with the open source movement.  This infatuation causes the author to embrace the logical contradiction that increases in population density increase economic growth and also causes the Malthusian trap (decreases in economic growth).  It also causes him to reject the solution to the Malthusian trap, which is the recognition of property rights in inventions.


[1] http://bakelitecollector.com/bakelite-history 7/21/10

[2] http://inventors.about.com/od/cstartinventions/a/Cellophane.htm 7/12/10

[3] http://inventors.about.com/library/weekly/aa082497.htm

[4] Ted Buckley, Ph.D., The Myth of the Anticommons, Bio, www.bio.org (2007); Epstien, Richard A., Kuhlik, Bruce N., Is there a Biomedical Anticommons, Regulation, (Summer 2004), pp. 54-58

 
American Inventors for Patent Reform

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

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

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

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

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

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

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

OTHER RESOURCES

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

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

 
Innovation vs. Invention

I believe there is a lot of confusion regarding the difference between invention and innovation.  This confusion is the result of erroneous definitions and the purposeful intent of some to increase their importance by belittling the contributions of others.

I believe that most of this mischief started with the great economist Joseph Schumpter.  According to Wikipedia:

Following Schumpeter (1934), contributors to the scholarly literature on innovation typically distinguish between invention, an idea made manifest, and innovation, ideas applied successfully in practice

There is nothing inherently wrong with the distinction above, but the way it is applied blurs together a number of different skills.  Blurring skills together shows a  misunderstanding of the process of innovating.  Broadly speaking, innovation can be broken into two distinct sets of skills: creation and dissemination.  By creation I mean creating something new, not production – creating something old.

A subset of creation is invention.  An invention is a creation with an objective repeatable result.  A creation that is not an invention has a subjective result, such as the effect of a painting on a viewer, or the effect of a book on a reader.  Many activities combine both a subjective creation and an invention, such as architecture.  However, we can separate out the invention from the other creative elements and this helps our understanding of the process.

Dissemination may include a number of processes, such as education (marketing, sales), manufacturing, finance, and management.  This is not to say that marketing cannot be creative, it clearly often is very creative.  However, the creative part of marketing can be separated out from the dissemination or execution part of marketing.  The same is true of manufacturing, which can definitely include inventing.  But an invention related to manufacturing is part of the creation step not part of the dissemination step.

Finance can also have inventions.  For instance, the invention of a fractional reserve ratio bank is clearly an invention.  It has the objective result of securitizing assets and turning them into loans and currency.  A fractional reserve bank will securitize land and turn into a loan and currency.  Despite this, it is important to understand that the first person to develop the fractional reserve bank is inventing and the person operating the fractional reserve bank is disseminating.

All real per capita economic progress is the result of inventing.  This is not to say that it is unnecessary to disseminate inventions, but if there were no new inventions there would not be any economic progress. We would be stuck in static world once all the inventions had been completely disseminated.  Of course, if we stop all dissemination activities we will quickly starve to death.

It is my belief that business and economic professors have focused on “innovation” instead of “invention” because they have no idea how to invent or how the process of how inventing works.  They concentrate on what they know, i.e. business and economic practices.   As a result, the focus is dissemination,  under-appreciating the importance of inventing.  In addition, it results in misleading business theories, such as:

- Management teams are more important than the quality of the invention.

- Execution is everything; patents and other IP do not matter.

- Get Big Fast.

The truth-test of these theories is directly related to the strength of the patent laws at the time the company is created.  When patent laws are weak, these theories are more true and when patent laws are strong, these theories are less true.  Unfortunately, when patent laws are weak these theories do not overcome the disincentive to invest in risky new technologies.  Management teams do not build revolutionary or disruptive technologies, they just disseminate these technologies. These sorts of teams are like large companies and generally can produce a return with less risk by NOT developing high-risk technologies.  They tend to focus on incremental technologies or on stealing someone else’s technology.  While this may be good business advice in a period of weak patents, it is bad for our country’s competitiveness and our standard of living.

Technological progress (i.e., inventing), in the long run, is the only competitive business advantage.  The best management team in the world selling buggy whips at the turn of the century could not overcome the technological advance of the automobile and stay a buggy whip company.  The best management team in the world selling vacuum tubes in the 1940s, could not overcome the advance of transistors and semiconductors and stay a vacuum tube company.  This country is littered with companies that had great management teams that were overwhelmed by changes in technology.  For instance, Digital Computers had a great management team, but they could not overcome the advance of the personal computer.  Digital Computers failed to invent fast enough to overcome the onslaught of small inexpensive computers.  US steel was not able to overcome the onslaught of mini-mills, aluminum, and plastics.  This was not because they did not have a good management team, it was because the management team under- prioritized invention and over-prioritized execution or dissemination skills.  Ford & GM have not become walking zombies because they did not have strong management teams, but because they have not invented.  As a result, they have antiquated production systems and weak technology in their products.  86% of the companies in the Fortune 500 in 1959 are no longer there.  Some of these companies disappeared because of bad management, but most companies disappeared because they did not keep up with changing technology.  In other words, they did not invent.

Inventions or advances in technology are the ONLY WAY to increase real per capita incomes and the only long term business advantage.  Business school theories that do not prioritize invention, are bad business and bad for our country.

 
Death of Angel Capital
According to the Wall Street Journal:
Senator Chris Dodd’s 1,400-page financial reform bill contains many economic land mines, and here’s one of the worst: Provisions that would make it harder for business start-ups to raise seed capital. Currently, wealthy individuals who want to invest directly in a new business can do so with minimum interference from regulators. The law requires only that the investor be “accredited” by meeting thresholds for net worth ($1 million) or income ($250,000). Entrepreneurs depend on these “angel” investors, since many new businesses lack the collateral for bank loans and are too small to interest venture capitalists.
Mr. Dodd’s bill would change all this for the worse. Most preposterously, it would require that start-ups seeking angel investments file with the Securities and Exchange Commission and endure a 120-day review. Rare is the new company that doesn’t need immediate access to the capital it raises, and a four-month delay is the kind of rule popular in banana republics that create few new businesses.
The legislation also removes a federal pre-emption that prevents start-ups and investors from being subject to 50 different state regulators. The North American Securities Administrators Association, which represents state regulators, argues that federal pre-emption contributes to fraud. But angel investors don’t use broker-dealers and other middlemen linked to recent investment scandals. Nascent companies often seek financing from multiple investors in different states, and a state-by-state regulatory regime would mean higher compliance costs and more legal risks.
The Dodd bill also raises the net worth and income thresholds to $2.3 million and $450,000, respectively. The Angel Capital Association, a trade group, estimates that these provisions would disqualify about 77% of current accredited investors. Accreditation matters in luring other potential investors, such as venture capitalists who enter the picture once a company begins to mature.

Please see the full Article

 
Pikes Peak Economic Club May 4 Meeting

Local author, “The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulation are Killing Innovation”.

Dale B. Halling is a patent attorney located in Colorado Springs. His book, “The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulation are Killing Innovation“, explains that innovation is the key to getting out economy growing  again. Unfortunately, since 2000 we have passed a number of laws and regulations that are killing innovation in the US. The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital. All three of the pillars have been under attack since 2000. Our patent laws have been weakened reducing the value of intellectual capital. Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.

May 04, 2010
from 06:30 pm to 06:30 pm
The Vanguard School, 1605 D South Corona Ave., Colorado Springs, CO 80905

For more information click here

 
Blaming Greenspan and the Free Market

The Financial Crisis Inquiry Commission, being members of congress, are trying their best to pin the financial crisis on anyone but Congress.  It appears the favorite whipping boys are Alan Greenspan and unfettered capitalism.  Congress conveniently forgets that between Fannie, Freddie, FHA loans, Veterans Housing Administration, and the Community Reinvestment Act we don’t have unfettered capitalism.  Not to mention to the Federal Depository Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the National Credit Union Association, the Board of Governors of the Federal Reserve, the Department of Housing and Urban Development, the Federal Financial Institutions Examination Council, the Financial Crimes Enforcement Network, and state banking regulatory agencies.  The only way someone can call that unfettered capitalism is to propagate The Big Lie: that the US is a bastion of unfettered capitalism, which causes all our problems.  

As Alan Greenspan pointed out:

 the surge in demand was the heavy purchases of subprime securities by Fannie Mae and Freddie Mac, the major U.S. Government Sponsored Enterprises (GSE). Pressed by the Department of Housing and Urban Development and the Congress to expand “affordable housing commitments,” they chose to meet them by investing heavily in subprime securities. The firms accounted for an estimated 40% of all subprime mortgage securities (almost all adjustable rate), newly purchased, and retained on investors’ balance sheets during 2003 and 2004. That was an estimated five times their share of newly purchased and retained in 2002, implying that a significant proportion of the increased demand for subprime mortgage backed securities during the years 2003-2004 was effectively politically mandated, and hence driven by highly inelastic demand.

As Greenspan points out Congress had no interest in reining in the subprime mortgage party or the securitization of these mortgages (CMO).  In addition, Greenspan did warn about both the problems with Fannie and Freddie.  In 2002, he expressed concerns to the FOMC, noting that “…our extraordinary housing boom…financed by very large increases in mortgage debt – cannot continue indefinitely.” It did continue for longer than he would have forecast at the time, and it did so despite the extensive two-year -long tightening of monetary policy that began in mid-2004.  See Greenspan’s complete analysis at http://fcic.gov/hearings/pdfs/2010-0407-Greenspan.pdf.  

Greenspan then points out that there “was a pronounced fall from 2000 to 2005 in both global real long-term interest rates and nominal long-term rates, which indicated that global saving intentions, of necessity, had chronically exceeded global intentions to invest.  Yet the ex post global saving – investment rate in 2007, overall, was only modestly higher than in 1999, suggesting that the uptrend in the saving intentions of developing economies tempered declining investment intentions in the developed world.  This statement is the most interesting and important statement in all of Greenspan’s testimony.  Why had and has the developed world reduced its rate of investment?  Why has investment not grown since 1999?

Has the rate of investment in the developed world stagnated because we have run out of businesses and ideas?  No, since 2000 we have passed a number of laws and regulations that are killing innovation in the US. The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital. All three of the pillars have been under attack since 2000. Our patent laws have been weakened reducing the value of intellectual capital. Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups. If we want to create jobs, we need to have laws that encourage entrepreneurial start-ups. 

These issues are discussed in more detail in my book The Rise and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovationhttp://www.amazon.com/Decline-Fall-American-Entrepreneur-Regulations/dp/1439261369/ref=sr_1_1?ie=UTF8&s=books&qid=1262911287&sr=8-1

 
Aligning Unions with the Knowledge Economy

The importance and influence of unions has declined dramatically over the last thirty years.  While more than one-third of employed people belonged to unions in 1945, union membership fell to 24.1 percent of the U.S. work force in 1979 and to 13.9 percent in 1998.  Is there a way that unions, especially blue collar traditional unions, can increase their membership, align themselves with the knowledge economy, and help the U.S. become more competitive?

Unions are often perceived as lining their own pockets at the expense of non-union workers, the companies they work for, and the country’s interests.  Perhaps the greatest accomplishment of American unions was the AFL-CIO support for Poland’s Solidarity Union in the 1980s.  This support was a significant reason why the Iron Curtain fell.  This support for Solidarity shows that American unions are not Marxist.  I believe that it is possible for Unions to reorient their focus while still protecting their traditional role of protecting worker’s rights.  America’s shift to a corporatist society since 2000 is providing unions with a historic chance to revive their importance and help their country.

How can unions seize this opportunity?  They need to focus their efforts on the most important asset in a knowledge economy, intellectual property.  Unions have generally opposed the patent reform bills being proposed by Congress because they believe the bills will hurt America’s competitiveness and therefore the availability and quality of work for their members.  Now they need to become agents for inventors and refocus their lobbying efforts on strengthening our patent laws and demanding the other countries provide strong intellectual property laws.  Forcing other countries to respect our patent laws and strengthen their patent laws will keep quality jobs in the US and also help these countries to develop a culture of innovation rather than a culture of imitation and theft and long term poverty.

How can unions become agents for inventors and serve their traditional members?  Unions have the advantage of a large number of members with strong mechanical skills that have numerous potential inventions.  Unions should nurture the inventive interests of their members by providing education about patents and the invention process.  They should also provide funding for their member’s inventions and act as agents for these inventions.  In return, the unions would receive a portion of any royalties.  Unions have an inherent advantage over their members taking these projects on themselves.  One advantage they have is a large installed base for the inventions of their members.  They already have a mechanism for communicating with their members including training classes.  This significantly reduces the risk of bringing an invention to market that would be used by their members.  In addition, unions have a ready source of funds for development.  The retirement funds of unions need to be invested.  A very small slice of these retirement funds could be used to fund the invention program.  From start-up funding experiences we know that most of these inventions will fail or only be moderately profitable, however a few will be spectacularly successful.  By spreading the risk over numerous inventions, the union can obtain above average returns with less risk than their members attempting to commercialize their inventions directly.

Besides the direct financial return from any inventions the union decides to pursue, an invention development program would increase their membership.  If just one union member becomes moderately wealthy because of an invention their union decided to represent, the news would spread like wild fire and result in flood of new union members.  In addition, the union can use their member’s inventions as a bargaining chip in contract negotiations.  For instance, an invention on a better, cheaper, or faster way of installing electrical wiring could be used as a bargaining chip with the automakers or building contractors.  The union could provide a bid using or not using the invention.  If the company chose not to select the union’s bid with the invention, then the union could deny the company from using the invention.  If the union won the contract a portion of the payment would be for royalties for using the invention.

I would suggest that unions focus their initial inventing efforts on tools that their members are likely to use.  These tools could be branded and sold to the general public as well as to union members or the companies that they work for.  This would be the least risky inventions to pursue.  I would not suggest that union’s make the tools themselves as this would result in a conflict between representing their members and being a manufacturer.  However, they could use these invention to negotiate employment contracts in the companies that they select to make the licensed product.

If the unions adopt an invention agent model as part of their portfolio of services they provide for members it would:

* Increase their membership; provide a return on the knowledge of their members

* Increase the productivity and quality of the products made by the companies that work with the unions

* Improve the image of unions in the mind of the public

* Provide a counterbalance to the corporatism that is infecting the US

* Keep quality jobs in the US.

For more information on creating an invention company see The Next Big Thing http://hallingblog.com/2010/02/19/the-next-big-thing/ and Jump Starting a Secondary Market for Patents http://hallingblog.com/2009/11/16/jump-starting-a-secondary-market-for-patents/

 
Da Vinci Institute: Night with a Futurist

Dale Halling will be speaking at the Night with a Futurist event at the Da Vinci institute on April 5, 2010 at the Madcap theater.   As a patent attorney, Dale Halling deals with start-up entrepreneurs on a daily basis.  He began noticing a significant difference between the types of projects his clients were involved with in the 1990s and 2000s. Clients, in the 90s, would come into his office with plans to build businesses that were disruptive or revolutionary.  The technologies underlying these companies held the potential to completely redefine a market.  Some of the ideas would increase the available bandwidth by 10x for minimal costs or allow data searches that were 10-100x faster than existing technologies.  It was very exciting talking with these entrepreneurs.  Their energy was infectious and the potential implications of their work was mesmerizing.  However, the tech downturn of 2000-2001 changed all that.

After 2002, the start-up companies he came into contact with were all looking for narrow niche markets.  Instead of trying to make dramatic changes to technology and go public, these companies were looking to develop incremental changes and be bought out by an existing company.

He started wondering if other people in the tech world were seeing similar trends.

Recent innovations like the iPod, the tremendous amount of money Intel was spending to build their next microprocessor plant, and the social media industry are certainly innovative, but they are not capable of altering the entire economy like the Internet of the 90s.  The Internet in the 90s affected almost every business in the U.S.  It drove PC sales, retail, electronics, telecommunications, professional businesses, marketing, newspapers, and much more.  It also redefined whole areas of life, with email, online shopping, and online advertising. It was impossible to escape the effects of the Internet unless you crawled under a rock.

The personal computer revolution of the 80s had a similar effect.  The iPod has been cool, but hasn’t affected the whole economy.

So what’s behind all this? The changes have seemed subtle from the outside, but the ripple effects have been huge.

Join us as we take a hard look at how the face of innovation has changed, and what we can do to turn it around.

EVENT: Night with a Futurist
DATE: April 5, 2010 – Monday
TIME: 6:30pm-9:00pm
WEBSITE: http://www.davinciinstitute.com/events/433/night-with-a-futurist-monday-april–5-2010

LOCATION: MADCAP Theater, 10679 Westminster Blvd, Westminster, CO 80020
DIRECTIONS: Driving Directions

COST: $25, Members: Free, SuperMembers: Free
REGISTER: Register here

PHONE: 303-666-4133

TOPIC: “The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation”
SPEAKERS: Dale Halling, Allison Taylor, Catharine Merigold, Gene Branch, Mike Schmidt, Thomas Frey

 
Pat Choate: Technology Theft as a Business Strategy

Dr. Patent Choate has an excellent article in the Huffington Post, please read the full article, that shows that patent reform is really about patent theft by some of the largest technology companies.  As Dr. Choate explains:

America’s largest big tech corporations are now using a business technique called “efficient infringement,” which means that they calculate the benefits of stealing someone else’s patented technology against the possibility of getting caught, tried in court and being forced to pay damages and penalties. If the benefits exceed the costs, they steal.

The sad thing about the large technology companies cited in the article is that they all grew faster in the 90s when we had strong patent laws than in this decade.  Their desire to weaken the patent laws dooms them and the rest of the country to slow or nonexistent growth.  Ultimately, their actions will result in technological stagnation in the US.

Dr. Choate then give the specific example of how the large financial services companies conspired to steal a start-up’s, DataTeasury’s, patented technology.  Then they used their lobbyists to get a clause inserted into the so called “Patent Reform” bill that would have given all the defendants in the DataTreasury case immunity.  As the article explains:

Bank of America, Wells Fargo, and about a dozen other banks refuse to deal with the little company. Instead of paying up, those remaining banks have played dirty. In 2007, Washington lobbyists working for the banking industry had an amendment inserted into a pending patent-reform bill that would have granted legal immunity to all of DataTreasury’s defendants. The amendment died on the floor of the U.S. Senate after the press exposed the story.

As Dr. Chaote’s excellent book “Hot Property” vividly points out, lack of enforcement of intellectual property rights destroys innovation.  I particularly enjoyed his example of how Mexico’s failure to enforce copyrights has ensured that Mexico does not and will not have a recording industry – music or movies.  Theft always looks like a quick way to wealth, but it ultimately destroys the source of wealth creation.  These high tech companies would rather destroy America’s wealth than have to compete in the market on the basis of the technology they can develop.

 
Accounting Inhibits R&D

Accounting rules for R&D result in companies and nations under investing in research and development.   Since increases in real per capita income are the result of increases in our level of technology, this accounting error actually results in all of us being poorer.  The point of R&D is to create inventions, whether products or processes, that are useful.  R&D that does not result in inventions may be interesting intellectually, but does not increase our wealth- so the rest of the post will discuss investments in inventions as opposed to the more nebulous concept of R&D. 

 Creating an invention without obtaining legal title to the invention is like building an office building without obtaining title to the land and building.  Without legal title to the office building, you cannot finance the building, sell the building, or lease the building.  In other words, without legal title to the office building its economic value is significantly reduced.  The same is true of inventions.  Inventing something without obtaining legal title to the invention means that you cannot license (lease) the invention, cannot sell the invention, and cannot finance the invention. 

There are couple of ways to obtain title to an invention.  You can either obtain a patent on the invention or you can keep the invention a trade secret.  Many inventions are not amenable to trade secret protection.  As a society, it is better if people obtain patents instead of keeping their inventions a trade secret, since a patent allows other people access to the knowledge associated with the patent, allowing them to use this knowledge to build other inventions.

 The present accounting rules for the costs in creating an invention and obtaining title to the invention result in an immediate expensing of these costs.  While this may be helpful from a tax point of view, it causes these costs to appear superfluous.  Note that the rest of this post is concerned with accounting as an accurate measurement tool for the operations of a business and is not concerned with tax law, which has caused so many perversions to accounting and business generally.  Our present accounting systems never show  internally funded inventions produce any value. 

 

 
Study Shows Strong IP Key to VC Back Company Success

An article in IAM (Intellectual Asset Management), reports (please read the full article) on a study on the relationship between the success of venture backed companies and their intellectual property portfolio.  The study states

Success in the venture capital industry is an exit: an acquisition of, or an initial public offering (IPO) by, a portfolio company. Analysis shows that across all sectors a significantly higher percentage of venture capital backed winners (companies that have been acquired or have gone public) have patent portfolios as opposed to losers (companies that are out of business).

Winners are many times more likely to hold intellectual property than losers. Although the presence of intellectual property portfolios is not perfectly correlated to success or failure, this indication alone should support executive and investor focus on the role of intellectual property in their decisions and actions.

While having intellectual property increases the probability of success, those who manage intellectual property will have an even higher probability of success. In certain sectors, such as healthcare, data demonstrates the value of higher quality portfolios. In other sectors, such as telecommunications or information technology, the effect is less prominent – although still clearly and demonstrably present.

IAM summarizes it this way:

In fact, according to the metrics applied by IP Vision, 86% of the VC-backed winners (ie, companies that are acquired or go to an IPO) they identified had strong as opposed to typical intellectual property assessments. In other words, while a healthy IP position may not guarantee that a start-up technology company is going to be successful, it is going to find it a whole lot harder to succeed if it does not have one. And ,crucially, it is not just ownership of IP that is important, it is understanding the IP that is key.

The article also explains

[A] healthy IP position may not guarantee that a start-up technology company is going to be successful, it is going to find it a whole lot harder to succeed if it does not have one. And,crucially, it is not just ownership of IP that is important, it is understanding the IP that is key.

If you want to learn how to create strong intellectual property portfolio see my post IP Strategy Document That Amazes Investors .

 
Worldwide Patent Backlog

According to Intellectual Property Watch, the worldwide patent backlog “could impose £7.6 billion (about USD$11.3 billion) in annual expenses on the global economy within the next five years if nothing is done to fix it, according to a new economics study from the United Kingdom released this morning before directors of several top global intellectual property offices.”  Personally, I know this significantly underestimates the damage done by dysfunctional patent systems around the world.

The article suggests that patent harmonization is necessary to reduce the backlog.  However, harmonization has done nothing to reduce the backlog of unexamined patent applications to date.  In addition, all harmonization programs have been attempts to weaken the US patent system and give away our technology.  The article suggests that hiring additional examiners has not worked to reduce the patent backlog.  Of course, if the US government took its constitutional duties seriously they would prioritize the patent system instead of trying to take over health care, or spending billions on green projects or social engineering projects.

What is needed to reduce the backlog of unexamined patents is a reciprocity system.  Under reciprocity if an inventor received a patent in Canada they would obtain some patent rights in the US and vice versa.  This does not require harmonization, so it does not hurt the rights of US inventors.  “About 50 percent of patent applications seen in the US come from overseas,” according to David Kappos, Director of the US Patent and Trademark Office.  The US Patent Office is just repeating the work done in other patent offices of other countries.  While not all of these countries can be counted on to perform a thorough examination, many can.  It makes no sense that your patent is only valid in one country but can be invalidated by prior art anywhere in the world.  It’s as if you lost the rights to your car when you drove it into Canada.  Reciprocity would also encourage more investment in technology, which is the only way to increase real per capita income.

 
Hot Property

Hot Property by Pat Choate

This excellent book by Pat Choate will both frighten and upset you.  For instance, Dr. Choate relates the shocking tale of a woman from Alabama who received a counterfeit antibiotic for a routine infected ingrown toenail and almost died.  Counterfeit medicines kill and injure people every year.  The U.S. is not immune to counterfeit medicines entering our market as the story of the woman from Alabama shows.  Counterfeiting medicines has become a major criminal enterprise.  The reason for this, according to Choate,  is  the risk of getting caught counterfeiting legitimate medicines is significantly less than distributing and selling illegal drugs.  In addition, the margin for counterfeit medicines is often higher than the profits obtained selling illegal drugs (and less dangerous).

The pharmaceutical industry is not unique in dealing with counterfeits.   According to a FAA report,  176 aircraft accidents were the result of counterfeit parts between 1973-1996.  Almost every industry in the U.S. is under attack by pirates making counterfeit products.  The tales of counterfeit music, software, and movies are well known, but there isn’t a personal harm component.  It is past time that we deal with piracy issues effecting our citizens’ security.

A number of these pirates operate with the tacit or even explicit support of their governments.  Dr. Choate documents the long history of state supported industrial espionage.  Often foreign governments target certain technologies that both increase their commercial and military might.  Our government has not prioritized stopping commercial pirates or industrial spies and the United States citizens are all poorer for their negligence.  In some cases, there is even domestic industry that profits from the pirates’ activities at the expense of our long term future.  These domestic industries lobby hard for inaction on the part of our government.  For instance, the retail industry often turns a blind eye to trademark and copyright violations and other forms of counterfeit products.

Perhaps most maddening though,  is our government’s policy of giving away our technology.  For instance, Dr. Choate shows that during the Clinton administration and continued in the Bush II administration,  we failed to protect the technologies of our domestic inventors.  Our government gave away many of the most important safeguards in our patent system to the Japan and  Europe and received almost no concessions from them.  For instance, we now publish our patent applications at 18 months for the whole world to see and providing the opportunity to steal our technology.  We fought hard in the GATT trade negotiations to require other countries to strengthen their intellectual property laws and enforcement.  In return, we significantly reduced our tariffs on textiles and apparel.  This has decimated our textile and apparel industries; but these countries have not come into compliance with the requirements for strengthening their intellectual property systems.  We could bring suit against these countries in the WTO (World Trade Organization) and force compliance, but for some reason we seem uninterested or unwilling to require these nations to uphold their part of the bargain.  I am a strong believer in free trade, but stealing intellectual property is not free trade-  it is just theft, pure and simple.   Theft of real property results  in underinvestment in real property.  It follows that  theft of intellectual property results in underinvestment in technology,  making  us poorer in the US, which in turn makes the whole world poorer.

An interesting point that becomes clear in Hot Property,  is  the Reagan Administration took intellectual property rights, particularly patent rights, more seriously than any subsequent administration.  Reagan understood that our technological innovation has always been the key to our wealth.

 
Keynesian Economics

I received the following question:

So is Keynes right or wrong?

You can make up for lack of private sector spending after a panic, thus maintaining demand.

OR

You can’t make up for lack of private sector spending after a panic, because the money is just borrowed, which causes inflation, or is taken from the private sector and just redistributed, not increasing demand in the aggregate.

My answer is:

If you actual follow what Keynes states, which is run a budget surplus during good times and spend the surplus during bad times you can moderate the economic cycle.  Note the moderation will include dampening the upside.  In addition, this substitutes government decision making for private decision making, which always results in less growth over time.

The way Keynesian economics works in practice is that it is an excuse to spur demand by deficit spending, usually by programs like cash for clunkers or tax rebates to people who do not pay taxes.  In these cases they are stimulating consumption (mainly).  No one ever got rich by consumption or stimulating the economy by consumption.  Think of a farmer eating his seed corn, this stimulated demand but he is likely to starve to death.  The other common example is to suggest that we break everyone’s car window.  This increases demand and consumption, but are we any wealthier?  No, all we have done is transfer money from the rest of the country to the auto glass industry.  When Keynesian policies result in the country having to borrow money to spur demand, then it does lead to either inflation, higher borrowing costs, or higher taxes or a combination of all three.  This reduces future economic activity and usually the amount of economic activity is not conserved but subject to entropy.  I think you can sum up Keynesian economics in practice as consumption creates wealth, which is clearly nonsense, no matter how many PhD trained ivy-league economist professors repeat it.

I think of my chart on page 11(reproduced here) as showing the boundary layer condition for wealth.  In engineering and physics we look for boundary layer conditions to check and setup our answers to problems.  The income per capita chart clearly shows that the only way to grow income per capita is by changing our level of technology.  Look at the major suggestions on how to spur our economy.  Keynes: consumption equals wealth creation.  This is clearly complete nonsense.  Supply side economics: this normally focuses on reducing taxes and regulatory burdens.  When an economy is running at less than its optimum point this will cause economic growth, but without inventions we will eventually stagant.  Now regulations and taxes can reduce the incentive to invent, so there is overlap.  Monetarists: If we just manage the money supply appropriately we will create economic growth.  Money is just a medium of exchange and a medium of measurement.  While screwing with the money supply messes up the functioning of the economy, even if the money supply is stable it will not create anything that makes us wealthy.  Invention-side economics is the only way to increase our wealth over time – it is the boundary layer condition.  An interesting example from the book is Eli Whitney’s invention of the cotton gin.  The US was producing just 4000 bales of cotton per year before the Whitney’s invention.  Ten years later in 1801 we were producing over 100,000 bales of cotton per year, more than a 50x increase.  “But for” (as lawyers like to say) Whitney’s invention the output of cotton would have hardly changed.  Inventions are game changers in the economy.  The other approaches are just tinkering around the edges at best.


 

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