Patents and innovation (and competition) Bronwyn H. Hall UC Berkeley, U of Maastricht, NBER, and IFS London

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1 Patents and innovation (and competition) Bronwyn H. Hall UC Berkeley, U of Maastricht, NBER, and IFS London

2 Patent system as viewed by a two-handed economist Effects on Innovation Competition Positive creates an incentive for R&D and innovation investments facilitates entry of new or small firms with limited assets; enables vertical disintegration Negative impedes the combination of new ideas & inventions; raises transaction costs; inhibits cumulative invention creates short-term monopolies, which may become long-term in network industries

3 Traditional (simplistic) view of patents Trade off limited term right to exclude (monopoly) in return for incentive to innovate (and reveal) Good for innovation Bad for competition But

4 Patents may help competition Increase dynamic competition by facilitating entry Useful for securing financing in knowledge-intensive industries (where there are few tangible assets) Can lead to competition-enhancing vertical disintegration by facilitating trade in technology (specialization; interface standardization) Chemicals - Arora, Fosfuri, Gambardella Semiconductor design firms Hall & Ziedonis

5 Patents may inhibit innovation The patent thicket problem of contracting when many inputs are essential High transaction costs lead to breakdown (Heller-Eisenberg) Negotiations fail due to holdup (Scotchmer) Large numbers of patents in a given area, impossibility of adequate search Ex post holdup by patentholder after costs are sunk (many examples) Given litigation costs, even invalid patents can be enforced

6 When do patents encourage innovation? Theory One patent/one product/static yes One patent/one product/cumulative innovation yes, but licensing has some problems Many differentiated patents/products with cumulative innovation not if the distribution of value has a thick upper tail (Bessen and Maskin 2006)

7 When do patents encourage innovation? Evidence Historical investigations of changes in patent systems Recent look at software/business method patents in the US Firm surveys

8 Historical evidence 19 century (variation across Europe/US) Moser (2005) finds little effect on overall innovation, but change in focus Lerner (2001) finds increase in patenting by foreigners but no increase by firms within country or in Britain (that is, no increase in innovation) 20th century Park and Ginarte 60 countries, Strength of IPR (including coverage of pharma) positive for R&D in developed countries Branstetter & Sakakibara increasing patent scope in Japan (1988) did not increase R&D Baldwin et al Canadian innovation survey. Innovation causes patenting, but patenting does not seem to increase innovation

9 Software patents in the US 1994/1995 CAFC decisions led to USPTO guidelines in May 1995 Market value of software firms (esp. applications) initially falls However, software patents are more valuable than other patents to the firms that own them post-1995 In general, firms are less likely to enter product classes in which there are more software patents However, firms that hold software patents are more likely to enter these markets and less likely to exit

10 Survey evidence Industrial R&D managers in the US Yale survey (Levin, Klevorick, Nelson, and Winter 1983) Carnegie-Mellon survey (Cohen, Nelson, and Walsh 1994) EU innovation surveys 1993 CIS for Norway, Germany, Luxembourg, the Netherlands, Belgium, Denmark, and Ireland 2,849 R&D-performing firms (reported in Arundel 2001)

11 US surveys " #!$ %! & % '((%() %%*%%+,% (%-

12 US surveys & % '((%() %%*%%+,% (%- " #!$ %!

13 1993 CIS (Arundel 2001)

14 Where are patents effective? US - product: 1983: drugs, plastics, chemicals; steel, pumping equipment, auto parts, measuring devices, medical instruments 1994: medical instruments, drugs, special purpose machinery, auto parts US - process: 1983: drugs, oil, chemicals, plastics, steel, pumping equipment 1994: none, but drugs, oil, medical instruments highest Europe 2000: chemicals (40% rate them first), pharma not included

15 A useful taxonomy discrete product industries food, textiles, chemicals including oil and plastics, pharmaceuticals, metals, and metal products patents used to exclude, and sometimes for licensing; also to prevent litigation complex product technologies machinery, computers, electrical equipment, electronic components, instruments, and transportation equipment patents used in negotiations (cross licensing and other), and to prevent litigation In general, patents more important for appropriability in discrete product industries Strategic uses (cross licensing, negotiations) greater in complex product industries

16 Conclusions The role of patents in encouraging innovation is ambiguous Positive on balance in discrete product industries Neutral or negative in complex product industries BUT considerable heterogeneity within industry Patents may actually help competition if they facilitate entry or leapfrogging

17 Patent policy reforms Raise the bar higher inventive step, stricter non-obvious standard Helps quality, by reducing numbers Benefit/cost ratio likely to be larger for higher step Reduces size of thicket Assess damages on proportional basis (to contribution to product), especially if asserter is not working the patent Some specifically US reforms