38E00100Economics and Management of Intellectual Property
Part IV
“Breadth and Duration of Intellectual Property and Their Optimal Design”
Tuomas Takalo, 24.1.2007 www.takalo.net
Week 1. Välimäki
1. Basic IP Law; 2. Use of IPRs
Week 2. Takalo
3. Basic Economics of IP and Innovation
4. Breadth and Duration of IP and Their Optimal Design
Week 3. Takalo + Guest Lecture
5. Optimal Design cont + IP Policy and Management: Cumulative Innovation
6. Cumulative Innovation cont + Guest Lecture
Outline of Lectures
1) Knowledge is a public good. Non-rival and to various extent non-excludable
There is a fundamental tradeoff between the creation of the incentive to innovate and using innovations once made
• Ex ante, before investments in knowledge production, there is an appropriability problem
• Ex post, once knowledge exists, it does not wear out and there is no point to restricts its use
• Intellectual property makes knowledge (more) excludable and hence stimulates the incentive to innovate ex ante but restricts its use ex post
Recapping Part III
calls for a balance:
inventors/creators users/public
inverted U-shape relation between strength of IP and welfare
• This fundamental tradeoff/need for a balance/inverted U-shape is underlying the most debate concerning IPRs!
cf. Gowers’ Review/ Economist’s article 9 of Dec
2) IP is not the only mechanism to encourage innovation.
- the other include prizes, public production and procurement, and subsidies.
- IP is roughly speaking worse in solving the ex post problem but better in solving the ex ante problem
- Its virtues: decentralization, only users’ pay, creates correlation of private and social value of innovation
-Its defects: restriction of use (DWL(+hold-up)), allocation of R&D effort
• DWL could be reduced or even eliminated, if the IP holder would be able to discriminate on price
• Some form of price discrimination is possible even with information goods (see Shapiro and Varian)
Is it possible to design IP better?
- Designing IP so that it does not restrict use (minimizes DWL) while providing the incentive to innovate
A Digression on Methodology
(Cf. “Arm-chair economist” by Landsburg or “Hidden order” by Friedman or Economics crime novels by Marsall&Jevons):
• TMP/IO-economics uses models not because they are realistic but because they offer a consistent way to understand firms’ & policy-makers’ behavior
• Models are like maps
– One-to-one map pretty useless in orienteering
– The real-world aspects left out depends on the purpose of the map
• Models build on assumptions:
– Some of them are plainly false but the literate truth of assumptions is never a prerequisite for scientific inquiry
– Assumptions are tested not by their literal truth but by the quality of their implications
• Good models and their predictions often generalize
• How to model innovation process?
Production function vs. ideas model
Breadth and Duration of IP and Their Optimal Design
(Scothmer, Chapters 3-4)
Production function
W = the social (gross) value of innovation
E.g.,with zero MC and a linear inverse demand P=a-Q, W=a2/2
= success probability of making an innovation
Cost of innovation C(). C’>0, C’’<0
• Net welfare from innovation S()=W-C()
• Society should choose the level of R&D to maximize S()
• I.e., innovation is just matter of investing resources.
• If W were known ex ante, why not just to post a prize equal to it?
• Or produce publicly?
Ideas model:
• Ideas are generated first and then decision to invest in developing an idea is made
• W is not known at least prior to some one thinking the idea.
• Ideas are scarce in the sense that an idea also identifies an economic need (W).
• In the ideas model the IP system has its virtues:
- potential inventors are the one who come up with ideas
- they and not some government agency decide whether to invest in the idea or not
- if the idea turns out to be valuable for market/society, IP system guarantees that the inventors get rewarded
• Ideas view applies in particular to the patent system as it o perates as the level of ideas/inventions
• Copyright in traditional context: the choice is about a career rather than which idea to pursue
Critique of ideas approach:
- Where do ideas come from?
- Would pouring more money to the production of ideas yield more ideas? Back in the production function model
• In what follows we for brevity use production function approach
- Keep in mind that presumption is that ideas, or their values (W) are non-observable or at least non-verifiable by an outside party (government agency)
• Focus on the basic trade-off between ex ante and ex post considerations
• Generic view on IP in case of stand-alone inventions/creative works
- Copyright- Patents (e.g. in pharmaceutical industry)- Trade secret
• Many insights apply more widely
• But leaves important issues out (as we will see next week)
Policy levers: duration and breadth
Duration: rather clear-cut, measures the time-period the IP is in force
• after IP no longer in force, information (invention, works etc) in public domain
• Patent: 20 years (from application, conditional renewal fees)
• Copyright: often authors’ life + 70 years (works for hire, 95 yrs after publication or 120 yrs from creation)
• Trade secret: forever (until becomes public)
• Statutory life usually differs from economic life
• E.g.• secret leaks out
• patented invention becomes obsolete renewal fees are not paid
•less than 10% patents are kept force full period
“patents as real options”
• Invalidity: Typically a firm that is sued for infringement claims that the patent is invalid
• copyrighted material becomes obsolete
Breadth of protection
• An elusive concept
• Not a legal concept but essential in practice and economics
• A loose definition: determines how different a competing product must be to avoid infringement/violation
• Breadth vs. inventive step (patents, EU) / non-obviousness (patents, US)
• Breadth vs. novelty (patens) / originality (copyright)
• Breadth vs. subject matter
Patent breadth• exclusive right to use invention commercially
• if a patent were restricted to the original invention exactly, protection would be trivial to circumvent (invent around)
• independent invention is not a defense!
• Doctrine of equivalents: “patent covers any product that does the same work substantially the same way to obtain the same result”
• E.g., if you patent a bottle that is closed by a screw cork the invention covers a bottle closed by an oak cork
• E.g., change of color not sufficient to escape infringement
• Infringement must be established with respect to patent claims
• Patent protects what is claimed for
• Claims chosen by the applicant and checked by the PO (patent examiners)
• All claims should be related to one invention
Writing claims carefully/strategically very important
• Patent breadth is endogenous
- The applicant and the PO determine the range of applications covered by claims
- the applicant claims as much as she can
- the PO checks out what claims allowable
• Constrained by disclosure: Patents granted for inventions that are disclosed in the patent application that will be put in the public domain
can facilitate imitation/inventing around the patent
failure to disclose can imply invalidity
• Constrained by user rights (experimental use, prior user rights (Europe), private use)
Copyright breadth
• protects exact expression, against direct copying
- ideas vs. expressions
• constrained by user rights (fair use, right to make private copies, citation, parody etc)
• constrained by independent invention
Trade secret breadth
• protects commercially valuable information, against misappropriation
- theft, bribery, unauthorized disclosure
• constrained by independent invention, accidental disclosure
• departure of personnel?
• contracting a crucial determinant
Notes:
• Breadth affects economic duration
• Breadth is endogenous (claim writing, DRM, IP management, contracting etc)
• Ultimately determined in the court
• Even patents do not necessary leverage a strong market power (not to mention a monopoly) on output market
• Breadth is nonetheless limited and patents can be invented-around
• Patents and protected innovations are usually inputs,
• Substitute inputs/patents are available
• New products need increasingly many inputs
fragmentation of IPRs (cf. Rahnasto 03)
Designing Optimal Duration of an IPR
• Assume an IP is so broad that it is not possible to make an non-infringing substitute
• If innovation is successful, an IPR is awarded for years
• T=discounted duration of the IPR
• Clearly dT/d>0 so we can focus on T.
∞ T1/r
01 1
11
tt
rrt
rr
edteT
• Consider an inventor with an idea
• Cost of innovation C
• If C is invested, probability of making an invention =
• When the IPR is in force, a profit flow p
• Eg with a zero MC and a linear inverse demand P=a-Q, p=a2/4
• When the IPR expires, entry by rivals drive the profits down to c[0, p]
• If imitation/entry costless, c=0
• Innovator’s ex post profits as a function of the discounted IPR duration, P(T):
• Assume c=0 P(T)= T p
• The effect of IPR duration on the ex post profits:dP/dT=p >0, i.e. the longer duration boosts incentives
to innovate
The innovator invests only if P(T)C
The innovator invests only if T> C/p
So T must be at least C/p
)()(0
cpc
crtprt Tr
dtedteTP
• Social return flow on innovation
• When the IPR is in force Wp=p+CSp
• After the IPR expires Wc=c+CSc=CSc
• In general, Wp<Wc, i.e., Wc-Wp=DWL
• E.g., with MC=0 and P=a-Q we have DWL=a2/2-3a2/8=a2/8
• We see a virtue of IP:
• The discounted social value of innovation = a2/2r
• The inventor with an idea knows to get Ta2/4, i.e. the investments will be made in relation to social value
• The more valuable is the invention to society, the more is the inventor willing to put resources in innovation
• Ex post social welfare as a function of the duration of an IPR:
i.e, the full social value minus DWL over the duration
• so the IPR is like a tax on users
• The effect of the IPR duration on ex post social welfare: dS/dT=-DWL<0.
pcc
crtprt WWTr
WdtWedtWeTS
0)(
• Seek the optimal patent life T*
• Assume that the government can commit to T*
a two-stage principal-agent game where the policy- makers choose first T* and then the firm chooses whether to invest
better to proceed backwards (look for a subgame perfect equilibrium)
The second stage
• The firm’s problem has been solved:- Invest if TC/p, do not invest otherwise
• In this kind of a principal-agent problem this rule is often called the agent’s incentive constraint (IC)
The first stage
• The policy-makers choose T to maximize S(T)-C subject to the firm’s optimal decision/incentive constraint TC/p
• Solution: Since S’<0, choose T as small as possible subject to the firm’s incentive constraint
T*=C/p
- Optimal duration of an IPR optimally balances the ex ante and ex post problems in the creation of knowledge.
- It minimizes the ex post DWL but provides enough protection to justify the investment
Notes:
1) Requires commitment to the optimal policy T* . Ex post the government has an incentive to cheat and put T=0: this is optimal ex post. However, if this were possible, the inventor would realize it, and would not invest
- e.g. Apple ITunes vs France (and other countries)
2) One size does not fit all.
• If T is the same for all inventions, there are
• inventions where the incentive constraint is not satisfied (T<C/p)
• or where the incentive constraint is slack (T- C/p>0) and hence DWL is higher than necessary.
Optimal rule suggests that T should be invention specific. With linear inverse demand P=a-Q, the optimal rule is given by T*=4C/a2
The larger is C or the smaller is or a, the longer should be optimal patent life (T*)
Recent debates on the duration of IPRs
• The US ‘Mickey Mouse’ Copyright Act of 1998
• Under the former law, Mickey would have been free stuff 2003 (Pluto 05, Goofy 07, Donald Duck 09) because he appeared first time in the 1928 cartoon “Steamboat Willie”.
• Huge lobby by Walt Disney and others the US copyright law was extended to the level of EU (an extension of 20 years)
• The US patent term extension of 1995 the US patent duration was extended to the level of EU (an extension from 17 to 20 years)
• The harmonization of patent term extensions
• in pharmaceutical industry marketing and sales of new drugs are delayed due to regulatory reviews required for commercialization
patentees unable to exploit full term US, Japan, Europe allow for patent extensions
• extensions (ex post) bad news for consumers and generic drug industry but stimulate the innovation of new drugs
• e.g., the US Patent Term Restoriation Act of 1984 explicitly designed to balance the opposing interests!