The case for buyouts

• Government pays A to patent holder.• Consumer surplus increases from C

to A + B + C, eliminating deadweight loss B.

Q uan tity

Price

C

M arginal revenue

Dem andB

A

M arginal cos t

Q m Q c

Pm

P c

Guell and Fischbaum

• Government should take patents by eminent domain.

• Patent holder should be allowed to take a “market appeal” from judicial determination, in which case the patented product is sold in a test market to assess demand for the product.

• Problems– What if judges pay too much for a

patent buyout?– How do we extrapolate profits

across space and time?

Shavell and van Ypersele

• Identify central problem as information asymmetry about demand between the government and the patent holder.

• Consider opt-in and mandatory regimes, deriving a formula for the optimal optional regime, implicitly taking into account the adverse selection problem.

• Problems– What if a patent is not identical to a

product?– What if the government officials

making decisions are not well-motivated?

Kremer

• Creates market process– Step 1: Private parties bid on

patent.– Step 2: If patent holder agrees,

government purchases patent for a price based on bids (including a markup to account for full social value of inventions) and executes a randomization function.

• With probability p (say, 90%), the patent is placed in the public domain.

• With probability 1-p (10%), the high bidder purchases the patent.

Kremer

• Problems– What if patent holder bribes

bidders?– What if two frequent players

implicitly collude?– What about complementary

products? Bidders on each will conclude that the other will probably be randomized to the public domain, so total amount spent will be too high.

Duffy

• Simpler market approach.

• Government group deliberates in secret about which patents to take. Immediately after taking a patent, the government observes the fall in the stock price of the corporation holding the patent.

• It then pays an equivalent amount to those who held stock immediately prior to the announcement.

Lichtman

• Urges coupon alternative to buyouts, eliminating deadweight loss if government has perfect information at 1/8th the cost.

Q uan tity

Price

M arginalrevenue

Dem and

Q m 2Q m

Pm /2

Q uan tity

Price

M arginalrevenue

Dem and

Q m 2Q m

Pm

• Therefore, Lichtman concludes, coupons will be more cost effective if government spends at least 1 in 8 dollars correctly.

Lichtman (cont’d)• Problem: Failing to give a coupon

where needed will lead patent holder to choose monopoly price. Giving too many coupons, however, may lead to price above original monopoly price.

Q uan tity

Price

M arginalrevenue

Dem and

Q m 2Q m

Pm

Price

Q uan tity

M arginalrevenue

Dem and

Q m 1 .2 5Q m

Pm /2

1 .2 5Pm

Coupons vs. buyouts:A simulation study

• Modified coupon approach: Government makes up for not providing coupons to all in last quartile by redeeming coupons to last eighth of consumers at more than face value.

• Result: Depending on quality of government information, coupons may or may not be superior to buyouts.

Table 1. Simulation of Coupon Program Effectiveness Based on Quality of Government Information

Variance of error term (in dollars)

Minimum producer’s bonus needed (in dollars)

Total cost to government as percentage of original deadweight loss

0 0.01 13% 0.01 0.35 24% 0.1 0.49 57% 0.4 0.62 102% 0.5 0.64 109% 1.0 0.67 128% 2.0 0.70 150%

Other problems with prize proposals

• May be little incentive to commercialize after buyout, if there are great second-mover advantages.

• Government relies on information of patent holders.

• Buyouts may lead to rent dissipation from excessive follow-on invention.

• No proposals address redundant research in patent races.

A simple alternative

• Give prize awarders complete discretion in awarding prizes.– Uncertainty may not increase risk in

undertaking R&D over present system, and any additional risk is not very costly.

– Different patent holders (and third parties) may choose different approaches to reducing the deadweight effect of patents, including buyouts, coupons, and lowering prices.

– Decisions only have to be correct on average to induce appropriate investment decisions!

• Delay decisions, perhaps by a decade.– Invest money for prizes in the interim, and

allow sale of right to prize.

– Allows for more information on the importance of the patent to develop.

– Prevents distortion in decisions due to idiosyncratic preferences of known decisionmakers.

Case for a fixed fund• Avoids problem of open-ended

governmental liability.• Encourages actions with greatest

ratio of social value to amount that could be obtained through private exploitation of patent.– Suppose social value from efforts of all

other applicants adds up to $2 billion, and fund is $1 billion.

– If I could exploit my patent monopolistically for $1 million, I will seek a prize instead if social value is at least $2 million (plus compensation for any increased uncertainty).

• Neutralizes systematic bias for or against prize applicants.

Design of the prize agency and process

• Prize decisionmakers appointed by courts to limit possibility of political rent-seeking.

• Each prize applicant is assigned an opponent. A simple system is that the opponent must pay the prize. The government selects whichever opponent is willing to serve as opponent for the least amount of money.

• Baseball (final-offer) arbitration– Encourages settlements.– Especially useful where fairness

concerns are relatively insignificant.– If amount requested is announced at

time of application, will help others estimate total social value of other projects.

Critique of H.R. 417

• Probably a step in the right direction, but maybe too many steps.

• Main change: Make opt in system, with right to give up patent for stake in a fixed fund.– As a practical matter, this can help

promote pharmaceutical industry support. H.R. 417 won’t get that.

– It also allows incremental change and a smooth transition – start with a billion dollars (or less), and grow it over time.

– It’s also normatively justified, because it ensures that if the government cuts the budget, the patent system remains.

Critique of H.R. 417

• Miscellaneous changes:– Eliminate ex ante commitments to

particular disease categories (such as orphan diseases).

• Congress isn’t in a good position to figure out which diseases need funding.

• If we wanted to just pick diseases to fund, we could just rely on NIH.

– Trustees’ independence should be increased.

• We don’t want massive shifts in research depending on political composition of board.

• Ideally, decisionmaking should be quite delayed to minimize political influence.

What’s wrong with existing system?

• Deadweight loss– My focus in this paper

• Insufficient levels of funding of research– Probably much greater problem– H.R. 417 could make this worse

• Excessive funding on application of existing medical tools, and insufficient funding on creating new tools.– Patent system is weak here.– Government is better, but has trouble

picking best approaches, for example in Human Genome Project.

– A prize system could encourage this.

Some applications• Prescription drugs for seniors

– Only prize approach that can work for group targeted on basis other than income.

• Genomics– A mandatory prize system could help

overcome holdup and anticommons problems.

• Business methods• Copyright• Anti-terrorism efforts• Social services

– Prize system potentially useful wherever expectation of average governmental decision may be better than actual governmental decision by a particular decisionmaker.