A primer on patent and innovation

In this paper, the patent system will be briefly reviewed and some particular problems in designing and using it will be considered within the broad framework of the relationships between patent and innovation. The bulk of the argument is that economists typically consider the patent system as a necessary evil: innovation will benefit from the incentive created by a patent but it may suffer if patents discourage the combining and recombining of inventions to make new products and processes. Thus the relationship between patents and innovation is guaranteed to be a complex one, and one that may vary over time and across industries. Part 1 deals with some simple economics of patents involving analysis of the basic problem to be solved (imperfect appropriability), the complexity of the design of solutions to that problem, since more than one thing have to be done at the same time, and the centrality of the topography of technical advances as an important factor determining the relation between patent and innovation. Part 2 reviews the costs and the benefits as well as the different classes of effects of patent on the creation, development and commercialization of new or improved products and processes. Part 3 emphasizes that the search for an “optimal design” of the patent system is difficult. There are strong variations across sectors in the conditions, procedures and impact of innovation, which means that a truly uniform system treats “unlike things” alike and this is not what should be done in a “perfect optimal world”. While this paper is focusing heavily on the relationships between patents and the economics of innovation, it must be clear that the patent system is only one option among others, as peculiar ways to solve the tension between the maximization of inventor’s private interests and the socially optimal use of knowledge. The theoretical option taken by most economists assumes the availability of different classes of institutions which have been designed to respond through various incentives and co-ordinations mechanisms to the generic problem of optimizing the production and use of knowledge. Economists and policy makers are interested not so much in one or the other particular mechanism but in the design of “superior” solutions to the knowledge trade off – given the social value of the knowledge (is it an essential or a cumulative knowledge) and the characteristics of the market (demand elasticity, size). The initial step in constructing a rationale in the domain of patent involves the classical source of market failures as analysed in Arrow (1962) and in the following literature. This approach focuses attention upon the special characteristics of knowledge as an economic commodity, which will be seen to affect its generation and distribution. As Rockett did in a very recent survey (2009), let do an intellectual experiment (which actually has some historical precedents): no intellectual property right exist. Further, as soon as an innovative product is sold or used, a variety of individuals become familiar with the invention, creating the seeds for imitation. If the innovation generates profits, potential imitators are attracted to the innovation to produce their own version of it. This process creates a variety of suppliers of the innovative product or process, driving down its price and so the profits of the original innovator. If the process is quick or very cheap, then very little surplus is captured by the initial innovator. Any innovator anticipating this process will not invest in the innovation in the first place. In essence, the innovator contributes to a common pool of knowledge when she creates and practices an innovation. This positive externality, if it is not captured …