Patent system, only way to promote innovation?

Yogesh Pai, Assistant Professor of Law and Co-Director of the Centre for Innovation, Intellectual Property and Competition (CIIPC) at National Law University, Delhi counters the argument that the patent system is ‘broken’ by pointing out that although patents may not be necessary for innovation per se, they facilitate market-based transactions for converting useful ideas into products and help markets to value the entitlements by way of bargaining in the shadow of property rights

That intellectual property protection – specifically patents, are extremely relevant in the context of global innovation, although heavily contested, is a foregone conclusion. The global R&D-based pharmaceutical firms by continuing to innovate new and useful medicines have helped reduce human suffering and increase the average global life expectancy. Similarly, the hi-tech industry has been extremely innovative in ushering the digital-tech revolution that we are all witness to. While it may be argued that the patent system may raise input cost for rival firms engaging in different kinds of technical innovation or that it may raise barriers for static price competition in healthcare thereby hindering access to the needy, it is difficult to conclude that the so-called ‘broken’ patent system has actually ‘harmed’ innovation per se. At least, such claims are often made by scholars and pundits who have criticised the patent system for impeding innovation- much in contrast to the objectives it seeks to foster!

So much has this narrative been mainstreamed over a period of time that a popular news paper The Economist did a cover story in August 2015 focussing on how the patent system is a ‘rotten way’ of rewarding ideas! It can’t be anyone’s claim that the patent system is the only way to promote innovation. Also, to claim that patents are important to ex-ante incentivise innovation is overstated in some industries. However, the function of the patent system has been grossly misunderstood. Patents as property rights help markets allocate optimal innovation incentives since price is the only signalling mechanism to facilitate exchange in the marketplace of ideas. Certain inventions are valued more than others in this process. Although patents may not be necessary for innovation per se, there is an important ex-post rationale for the existence of patents as property rights. They facilitate market-based transactions for converting useful ideas into products. The existence of patents does help markets to value the entitlements by way of bargaining in the shadow of property rights. To replace property rules for valuing entitlements that currently forms the foundation of the patent system with any other system would require of us to make important choices of imposing forced coordination and non-market-based valuation of patented entitlements. As suggested by some scholars shifting pricing of assets from an informed marketplace to uniformed regulators and by disturbing the organisational choices made by firms to facilitate market exchange of assets (thereby pushing them to become vertically integrated) are only among few consequences. In other words, men- bureaucracy, regulators and judges- will play ‘God’ to generate a pre-determined outcome (by both overcompensating or under- compensating inventors) instead of a rule-based market allocated outcome!

And yet, some scholars seem fascinated with the idea to replace the current private property-based patent system with a ‘regulatory type’ patent system (and whatever that entails). The oft quoted criticisms against the patent system are that the high propensity to patent does not lead to correspondingly higher innovation and that many unclear parcels of property rights (patent thickets) operate to raise cost for rivals through litigious waste. Such patents are often enforced by Patent Assertion Entities (PAEs- pejoratively referred to as ‘trolls’) to generate monopoly rents as against ‘true’ innovators and manufacturers by engaging in opportunistic conduct such as patent hold-up (i.e. disproportionately claiming beyond the economic value of the actual contribution made by a patented technology) and royalty-staking (i.e. cumulative royalties for different patents leading to exorbitant prices for end products).

A constant concern in biotech has been the so-called phenomenon ‘anti-commons’, where it is claimed that innovation in the bio-drug industry could suffer due to coordination breakdown leading to socially sub-optimal innovation. Not that these claims could not be theoretically made. But there is little evidence to show that these issues are pervasive in the patent intensive industries. This is also because markets have shown resilience by engaging in private ordering and by relying on transactional solutions to help reduce such coordination breakdown. It is difficult to argue that such markets actually experienced any reduction in innovation or output notwithstanding the intensity of patenting activity. Of course, one may always claim that in a ‘but for patents’ world, there could be ‘x’ amount of innovation, much higher than the market-allocated outcome. But the question is how would that be economically efficient outcome?

This is not to suggest that some firms may not wish to engage in heavy patenting behaviour. Or even when they do, they would enforce patents defensively or strategically rather than offensively to generate royalties. The incentives for such firms may be generated purely through secrecy, first-mover advantage or network-effects-often seen in platform markets. In fact, some firms may choose to voluntarily forfeit their assets by pledging patents. In the now famous article titled ‘The Hosts Dilemma’ published in the Harvard Law Review (2011), Prof Jonathan M Barnett has articulated that firms engage in a trade-off between open and closed IP policies by being able to sustain revenues within the total consumption bundle of platforms and complementary goods and services. In his view, the markets reward generosity where ‘to win a platform race, the clever host must leave a substantial portion of total revenues to third parties that provide complementary goods. Conversely, the market punishes the selfish host that keeps too large a portion of market revenues for itself.’ Clearly, calibrating firm’s IP policies depending on the nature of the market to self-maximise is actually an efficient market-based outcome. How far these conclusions support the pitch for substantial ‘reforms’ in the patent system in an attempt to ‘fix it’ by analogising it with some imaginative ‘regulatory’ mechanism is anybody’s guess!

Of course, this is not to suggest that the patent system is perfect. In fact, it has miserably failed to facilitate R&D in neglected diseases that disproportionately affect the developing world. We do need government interventions on a massive scale to support R&D in such cases. Perhaps we shouldn’t stop trying non-market based alternatives to the patent system like prizes, subsidies etc… Again, whether the state-supported R&D will replicate the success of the market in innovation without recourse to patents and market exchange is a difficult question. However, it is important to note that these alternative measures can only be in addition to the patent system and not by undermining it!

(Views are personal)