TOWARDS DESIGNING AN IDEAL PATENT SYSTEM

© Institute of Economic Affairs 2004. Published by Blackwell Publishing, Oxford

Other articles

Blackwell Publishing Ltd

T O W A R D S D E S I G N I N G A N I D E A L P A T E N T S Y S T E M

Alexei G. Orlov

An ideal patent system balances the returns to inventors and the dissemination

of new technologies. This article examines legal policy instruments –

encompassing duration, scope and strength of patent protection, as well as

invention disclosure and novelty requirements – and R&D subsidies that help

sustain growth in GDP. The paper studies the issues associated with designing

an effective patent system, surveys the industrial property literature and

delineates the focal points of debate among researchers and policy-makers.

The unanimous agreement of the economics profession on the growth accounting methodology is that technological progress is one of the key determinants of growth in per capita GDP, and, as such, is an indispensable ingredient of economic prosperity. Economists have long noted that although some discoveries are serendipitous, most technological improvements reflect purposeful research and development (R&D) activity, which is financed by private institutions or government agencies.

1

The expected profits are the primary determinant of the level of inventive activity,

2

so that the incentive for such activity is the inventor’s

ex-post

monopoly power.

3

Since the degree of monopoly power is largely determined by legislative Acts that govern intellectual property, patent systems are crucial in determining the level of the technology frontier and bolstering incentives to innovate.

4

To uncover the potential role for government policies in stimulating inventive activity, it is impelling to study institutional arrangements in light of King and Levine’s hope that

‘research into the economic, institutional, and legal determinants underlying innovation, human-capital accumulation, and physical-capital investment will improve our ability to design policies that promote sustained economic growth’.

5

Furthermore, Grossman and Helpman note that ‘institutional, legal, and economic environments that determine profitability of . . . investments [in new technology] must surely affect the pace and direction of technological change’.

6

In a more general context, North stresses in his 1993 Nobel Prize lecture that ‘institutions form the incentive structure of a society, and the political and economic institutions, in consequence, are the underlying determinants of economic performance’.

7

The goal of this essay is to search for the combination of legal policy instruments – encompassing duration, scope and strength of patent protection, as well as invention disclosure and novelty requirements – and R&D subsidies that are most favourable for sustained growth in GDP. The paper studies the issues associated with designing an effective patent system, surveys the industrial property literature and delineates the focal points of debate among researchers and policy-makers.

Historical background

England’s famous Statute of Monopoly, enacted in 1623, is claimed to be the first real legislative Act of industrial property protection.

8

The statute declared that only true inventions can lead to a grant of monopoly rights. More than a century and a half later, the USA mimicked the English Act in its Constitution. At the end of the eighteenth century, France also adopted the principles of the English statute.

Since the enactment of the English Statute of Monopoly, however, the world has seen very diverse patent systems. Countries have defined a patentable invention in different ways, and very vaguely – if at all. Industrial property legislative Acts in Belgium, Bolivia, Chile, Germany and British colonies failed to define a patentable invention altogether. In contrast, patent Acts in Argentina, Austria-Hungary, Brazil, France, Italy and Spain stated what a patentable invention is, and which inventions cannot be granted patent protection. For instance, Bolivia and Spain granted a patent only if the use of the patent would lead to the emergence of a new branch of industry.

9

Countries also differed with respect to the rigour of novelty, patentability examination, patent length, as well as patent fees.


40 t o wa r d s d e s i g n i n g a n i d e a l p at e n t s y s t e m

Although patent law is not universal even to this day, the existing international framework after the International Convention for the Protection of Industrial Property of 1883 (or the Paris Union Treaty) ensures that the issuance of a patent in one country will have some legal consequences elsewhere. The Paris Union Treaty establishes the main international rules governing patents. Most important, the Treaty forbids discrimination against foreigners in a state’s intellectual property system. Additionally, under the terms of the Treaty, someone who files a patent in one of the Union countries has a year to register the invention in the other Union countries without losing priority.

Looking at nearly 200 years of data on patenting per capita, one notes that for most of the countries (e.g. Australia, Austria, Norway and the UK) patenting rates start to rapidly increase after the Paris Union Treaty in 1883.

10

Also, the introduction of patent laws in the UK in 1852, Denmark in 1894, and Finland in 1898 set off the increased levels of patenting.

Plotting the average number of patents per capita against the level of patent protection for a broad cross-section of countries supports the expectation that patenting activity is positively related to the degree of patent protection. One can also depict the relationship between patents per capita and the rule of law. Higher scores of rule of law indicate ‘sound political institutions, a strong court system, and provisions for an orderly succession of power’, while lower scores of this variable indicate ‘a tradition of depending on physical force or illegal means to settle claims’.

11

Again, the resulting picture confirms prior beliefs about the positive relationship.

Issues in designing a patent system

This brief historical diversion begs a question: what would a well-balanced patent system look like? Several important issues are the focal points of debate in both the law and economics literature.

12

At the most fundamental level, an ideal patent system should maximise the gap between the expected social value and the social cost of the creation of intellectual property. Social value is the benefits derived by both consumers and producers from the introduction of new products and processes; social cost includes direct R&D expenditures, private and government subsidies, and the costs of administering a patent system.

As has been mentioned above, it is imperative that an inventor is allowed to capture a fraction of the social value of his or her invention in the form of monopoly profits. What fraction of this value would be a sufficient incentive to produce this invention in the first place is the single most important question in this regard. On the social cost minimisation side, it is important that innovators are able to borrow from previous inventions without paying excessive licence

fees or fines, and that monopoly pricing and duplication of discoveries are avoided. Possible remedies include: reducing the breadth of protection, requiring a disclosure of innovations and establishing a frictionless market for licensing.

Thus there is a clear tension between

static

and

dynamic

analyses.

13

The dynamic analysis suggests that, for instance, longer duration of patent protection produces a growth-enhancing effect by raising the rate of return on R&D.

14

But there is also static inefficiency: extending the patent length increases the proportion of the monopolistic sector in the economy, which leads to higher prices and lower output and consumption.

Another important issue is the diffusion of innovations within an economy and among countries. According to an OECD report, technology diffusion is just as important as innovations themselves. In the context of an endogenous growth model calibrated to the data from the five leading research economies, Eaton and Kortum conclude that removing international barriers to the diffusion of technology would increase both research effort and productivity.

15

As a result, the world growth rate would rise by at least 1%.

An ideal patent system would, therefore, balance between providing returns to the inventor and encouraging the dissemination of new technologies. The instruments that should be adjusted in order to maintain this balance are strength, breadth and duration of protection. An increase in the value of any of these three instruments would lead to a higher reward for innovation but would slow down the diffusion of new technology. Broad patent protection might offer deficient incentives for second innovators and inflate incentives for the first innovation.

Advocates of weak protection of intellectual property argue that, first, a high degree of protection leads to socially inefficient monopoly pricing. Second, if the protection is so strong that the patent’s value exceeds the cost of producing it, firms may ‘overinvest’ in research due to their involvement in a patent race. Finally, as discussed above, strong patent protection reduces spillovers and hence diffusion.

16

It therefore appears that the patent law should be strong enough so that an invention is not chosen to be protected by a trade secret law instead of a patent law. Secrecy is inimical to diffusion, even as compared with strong patent protection.

Government funding could be justified in cases when patent protection and licence fees are inadequate for the inventor to capture the required fraction of the social value of an invention. The private optimum of R&D is unlikely to be the same as the social optimum due to knowledge spillovers.

17

The government has to maintain the optimal balance between stimulating innovation and allowing dissemination of new technology. The government can correct the positive externality in two ways:


iea

e c o n o m i c a f f a i r s m a r c h 2 0 0 4 41

through enforcing intellectual property laws and by subsidising R&D investment.

What’s in it for developing nations?

It is important to investigate what motivates a developing country in its decision as to whether to establish and enforce intellectual property rights. Most developing countries have enacted intellectual property laws, but the scepticism regarding the virtues of paying royalties to foreign inventors runs deep. Correspondingly, multinational corporations and their home governments tend to view intellectual property protection in the developing world as inadequate, while many host governments consider the existing laws to be benefiting the industrialised nations at the expense of the poor countries. The result? Many developing nations provide weak or no protection of intellectual property; for instance, poor economies typically have much shorter patent duration compared with industrialised nations.

Should countries in the early stage of development seek to pirate the technological achievements of the more developed world? Under what conditions might a developing country enact and enforce strong intellectual property laws to attract foreign investment? The debate centres around the question of whether strong intellectual property protection is an effective means of encouraging the dissemination of technological advances within developing nations. Both sides generally agree that most innovations that are eligible for patent protection occur in the developed world and generate royalty incomes for residents of richer countries. With foreign inventors being primary – if not sole – potential beneficiaries of patent protection, countries that lack a domestic research base should be reluctant to provide protection of intellectual property.

18

Usually – and not surprisingly – imitation is cheaper than invention.

19

As a result, the developing country with weak protection of intellectual property may lower the cost of acquiring new technology and avoid an outflow of hard currency payments.

The main offsetting consideration is that foreign firms will refrain from using protected technologies in countries that encourage pirating, and otherwise will try to prevent residents of non-protecting countries from learning about their creations.

20

Reputational issues and potential retaliation of technology leaders towards the countries with weak enforcement of property rights might, therefore, induce developing countries to effectively protect intellectual property rights. Benefits of pirating seem tangible and immediate, while the costs are not apparent – at least in the short run. Without strong intellectual property protection the technological frontier of a nation is likely to be below the one of a country that enforces property rights. A sensible research goal might be to

find a threshold value of the developing country’s GDP above which it is optimal to enforce intellectual property rights.

The role of the WTO

The issues outlined in the preceding section make one wonder whether it is possible to achieve harmonisation of patent policies across countries and, in particular, to find the degree of patent protection that would be deemed acceptable by both industrialised and developing nations. Realising that the long-term costs of weak protection of intellectual property are likely to more than offset any immediate benefits – and not without pressure from the developed countries – several developing economies, indeed, unilaterally moved to strengthen their patent systems. However, international patent harmonisation requires a collective action on the part of all nations.

Since over the past several decades intellectual property has become intimately related to international trade, the World Trade Organization (WTO) endeavoured to resolve the tensions arising from the cross-border differences in patent laws. In an effort to ensure a uniform patent protection, the WTO launched the international agreement on Trade-related Aspects of Intellectual Property Rights ( TRIPs) at the Uruguay round of negotiations. The multilateral agreement, which came into effect in January 1995, sets and enforces minimum standards for national protection of intellectual property in all of the 148 WTO member nations.

In accordance with the TRIPs agreement, ‘patents shall be available and patent rights enjoyable without discrimination as to the place of invention, the field of technology and whether products are imported or locally produced’.

21

Under the provisions of the agreement, WTO members are obliged to grant and enforce patent protection for a minimum of 20 years. Developed economies are expected to comply with this stipulation within a year, developing and transition economies have five years to comply, while poorest nations have a grace period of 11 years.

22

A controversial South African law (passed in 1997) that authorised parallel importing, as well as production of generic versions of patented drugs, exemplifies the discontent of less developed countries with having to enforce strict patent protection. It is clear that the law was an attempt to avoid paying high prices on patented products, especially anti-AIDS treatments. In response to such controversies, it is expected that at the current Doha round of trade negotiations additional rules governing TRIPs will be developed. The new rules would allow low-income countries to override patent protection in the interest of public health.

The TRIPs agreement also addresses the issue of technology transfer by requiring governments to provide incentives to domestic companies to transfer


42 t o wa r d s d e s i g n i n g a n i d e a l p at e n t s y s t e m

technology to Third World countries. Predictably, poor nations are not satisfied with the current technology transfer requirements and are pushing for more effective incentives for multinational corporations.

Distributional consequences of uniform patent protection across borders are at the heart of the debate surrounding the TRIPs agreement. Many studies confirm that patent harmonisation will result in substantial income transfers between nations.

23

Clearly, most developed economies that own the largest numbers of patents stand to gain at the expense of the Third World nations. Since the TRIPs agreement entails burdensome obligations for developing economies, it is difficult for the WTO member nations to reach a consensus on the appropriate level of patent protection.

WTO members now abide by common standards of intellectual property protection. It should be noted that developing nations increasingly understand that adhering to the TRIPs agreement would help them reap the long-term benefits of more rapid economic growth. However, in the light of the discussion in this and the previous sections, it comes as no surprise that developing economies insist that the universal standards established by the TRIPs agreement are unreasonably high, while developed countries strongly believe that TRIPs’ requirements stop short of achieving an adequate level of patent protection. It remains to be seen how further WTO negotiations will play out.

Industrial property literature

In the extant literature on intellectual property protection, various theoretical models produce results that are sometimes polar opposites. For instance, Gilbert and Shapiro argue in favour of infinitely-lived patents, while Klemperer finds the conditions under which very short-lived patents are optimal.

24

Gould and Gruben examine empirically the role of intellectual property rights in economic growth by adding the proxy for patent enforcement to the standard growth regressions.

25

Their conclusion is that stronger intellectual property rights protection corresponds to higher economic growth.

Cozzi extends the classical Schumpeterian endogenous growth model to study the incentives to spy.

26

The author shows that the larger the skilled population (and, consequently, the inventive activity), the larger the incentive to undertake industrial espionage activities: with a large number of pure innovators, the probability of a new invention increases, which encourages espionage. Spying, in turn, discourages true inventive activities, which leads to fewer innovations and ultimately slower economic growth. Thus, Cozzi’s model produces a negative growth effect of having too many R&D workers – a concern relevant for more mature, industrialised economies.

Kwan and Lai study the transitional dynamics of an R&D-based endogenous growth model with expanding variety of goods.

27

In their model, strengthening patent protection results in the loss in current consumption and gain in future consumption due to higher growth. Kwan and Lai find that under-protection of intellectual property rights is much more likely than over-protection, and that the welfare losses in the cases of over-protection are negligible. The result implies that policy-makers should view under-protection of intellectual property rights as being of great concern, thus providing a strong case for government R&D subsidies.

Very recently the following question received due attention: should different sectors of a national economy enjoy different degrees of patent protection? Goh and Olivier study a general equilibrium model of an economy with two vertically linked sectors.

28

The authors conclude that more stringent patent protection in the final output sector accelerates economic growth, while stronger protection in the intermediate inputs sector has a negative growth effect. Stronger protection in the downstream sector leads to lower production of the final good and, consequently, lower demand for the intermediate goods. As a result, the profits of the innovators in the upstream sector decline, providing less of an incentive to innovate.

Final remarks

Highlighted above are the important developments in the industrial property literature. One weakness of the extant literature remains: the issues of optimal R&D subsidies, breadth, duration and strength of protection are not addressed in a single framework. Improving our understanding of the optimal policy mix for boosting inventive activity will simultaneously improve our understanding of technological progress and economic development. By studying the interplay of various policy instruments, we can begin to reconcile the discordant policy prescriptions that are advanced in the literature on industrial property protection and furnish guidance on improving social welfare.

The objective of this article was to examine the appropriate government policies for inducing the optimal degree of inventive activity and facilitating technology transfer. The paper began a search for the combination of legal policy instruments – encompassing duration, scope and strength of patent protection, as well as invention disclosure and novelty requirements – and R&D subsidies that sustain growth in GDP. The above discussion suggests that none of the instruments should be set at either high or low extremes.

1. Robert J. Barro and Xavier Sala-i-Martin (1995)

Economic Growth

, New York: McGraw-Hill.2. Jacob Schmookler (1966)

Invention and Economic Growth

, Cambridge, MA: Harvard University Press.


iea

e c o n o m i c a f f a i r s m a r c h 2 0 0 4 43

3. Paul M. Romer (1987) ‘Growth Based on Increasing Returns Due to Specialization’,

American Economic Review

, 77, 2, 56

−

62; Gene M. Grossman and Elhanan Helpman (1991)

Innovation and Growth in the Global Economy

, Cambridge, MA: MIT Press.

4. Of all intellectual property laws, only patent law is directly associated with technological innovation since it concerns the production of an industrial product or machine.

5. Robert G. King and Ross Levine (1994) ‘Capital Fundamentalism, Economic Development, and Economic Growth’,

Carnegie-Rochester Conference Series on Public Policy

, 40, 287.6. Gene M. Grossman and Elhanan Helpman (1994)

‘Endogenous Innovations in the Theory of Growth’,

Journal of Economic Perspectives

, 8, 1, 27.7. Douglass C. North (1994) ‘Economic Performance

Through Time’,

American Economic Review

, 84, 3, 359.

8. For a thorough account of the pre-legislative period in the development of intellectual property rights see Susan Sell and Christopher May (2001) ‘Moments in Law: Contestation and Settlement in the History of Intellectual Property’,

Review of International Political Economy

, 8, 3, 467

−

500.9. Stephen P. Ladas (1930)

The International Protection of Industrial Property

, Cambridge, MA: Harvard University Press.

10. The data on patents come from the World Intellectual Property Organization’s

100 Years of Industrial Property Statistics

, Geneva, and

Journal of the Patent Office Society

(1964) ‘Historical Patents Statistics, 1791

−

1961’, 46, 2, 89

−

171; the data on population are taken from Angus Maddison (1991)

Dynamic Forces in Capitalist Development

, Oxford: Oxford University Press.11.

International Country Risk Guide

.12. Some of these ideas are discussed in Stanley M.

Besen and Leo J. Raskind (1991) ‘An Introduction to the Law and Economics of Intellectual Property’,


, 5, 1, 3

−

27; and Suzanne Scotchmer (1991) ‘Standing on the Shoulders of Giants: Cumulative Research and Patent Law’,


, 5, 1, 29

−

41.13. Mark Rogers (1999) ‘Monopoly Power, Innovation and

Economic Growth’,

Australian Economic Review

, 32, 1, 9

6−

104.14. Tatsuro Iwaisako and Koichi Futagami (2003) ‘Patent

Policy in an Endogenous Growth Model’,

Journal of Economics

(

Zeitschrift für Nationalökonomie

), 78, 3, 239

−

258.

15. Jonathan Eaton and Samuel Kortum (1999) ‘International Technology Diffusion: Theory and Measurement’,

International Economic Review

, 40, 3, 537

−

570.16. International R&D spillovers are very important when it

comes to dissemination of new technology. For an in-depth discussion of the subject, see Marieke Rensman and Gerard H. Kuper (2000) ‘Do Technology Spillovers Matter for Growth?’, in Bart van Ark, Simon K. Kuipers and Gerard H. Kuper (eds.)

Productivity, Technology and Economic Growth

, London: Kluwer Academic, pp. 361

−

389.17. Paul M. Romer (1986) ‘Increasing Returns and Long-run

Growth’,

Journal of Political Economy

, 94, 5, 1002

−

1037.18. Walter G. Park and Juan Carlos Ginarte (1997) ‘Intellectual

Property Rights and Economic Growth’,

Contemporary Economic Policy

, 15, 3, 51

−

61.19. Robert J. Barro and Xavier Sala-i-Martin (1997)

‘Technological Diffusion, Convergence, and Growth’,

Journal of Economic Growth

, 2, 1, 1

−

26.20. An argument along these lines is advanced by Sunil

Kanwar and Robert Evenson (2001) ‘Does Intellectual Property Protection Spur Technological Change?’, Yale Economic Growth Center Discussion Paper 831.

21. Article 27 of the TRIPs agreement.22. The grace period for pharmaceutical patents was

extended to 21 years.23. See Phillip McCalman (2001) ‘Reaping What You Sow: An

Empirical Analysis of International Patent Harmonization’,

Journal of International Economics

, 55, 1, 161

−

186, and references therein contained.

24. Richard Gilbert and Carl Shapiro (1990) ‘Optimal Patent Length and Breadth’,

RAND Journal of Economics

, 21, 1, 106

−

112; Paul Klemperer (1990) ‘How Broad Should the Scope of Patent Protection Be?’,

RAND Journal of Economics

, 21, 1, 113

−

130.25. David M. Gould and William C. Gruben (1996) ‘The Role

of Intellectual Property Rights in Economic Growth’,

Journal of Development Economics

, 48, 2, 323

−

350.26. Guido Cozzi (2001) ‘Inventing or Spying? Implications for

Growth’,

Journal of Economic Growth

, 6, 1, 5

5−

77.27. Yum K. Kwan and Edwin L.-C. Lai (2003) ‘Intellectual

Property Rights Protection and Endogenous Economic Growth’,

Journal of Economic Dynamics and Control

, 27, 5, 853

−

873.28. Ai-Ting Goh and Jacques Olivier (2002) ‘Optimal Patent

Protection in a Two-sector Economy’,

International Economic Review

, 43, 4, 1191

−

1214.

Alexei G. Orlov

is an Assistant Professor of Economics at Radford University, USA.

Documents

TOWARDS DESIGNING AN IDEAL PATENT SYSTEM