chapter 4 - innovation without patents

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Boldrin & Levine: Against Intellectual Monopoly, Chapter 4

Chapter 4: Innovation Without Patents

As a matter of theory, intellectual monopoly appears unnecessary.

As a matter of fact, e have seen numerous e!amples shoing the

frenetic pace of creation in the a"sence of copyright. As the theorysuggests, creations such as literature, music, movies, and nes

thrive in the a"sence of copyright. #o perhaps copyright is not such

a good idea. $oever, hile e may hope to live lives free of

"oredom in the a"sence of intellectual monopoly % hat a"out

invention, the driving force of economic groth and prosperity

'ould e "enefit from all of the marvelous machines, drugs and

ideas e are surrounded ith if not for the "eneficent force of patent

la Can e ris( the foundation of our prosperity and groth "y

eliminating patents )uess hat % e are going to argue that

ithout patents e ould have more, not less, marvelous machinesand inventions. 'e are going to o"serve that patent la is largely

the unelcome conse*uence of competitive innovation and poor

legislation, and not the source of innovation at all.

It may not come as a shoc( to anyone that computer softare

and financial securities are scarcely the only industries in hich

patents are less than essential to innovation. In fact, most successful

industries have folloed the same pattern: no intellectual property at

the pioneering stage hen innovations come pouring in and "etter

and cheaper goods are invented ith high fre*uency+ desperate

scram"ling for the por( that intellectual property provides hen thecreative reservoir runs dry. Because this is true in every ell

esta"lished sector, from cars to electricity, from chemical and

pharmaceutical to te!tiles and computers, e ill try to ma(e the

point "y loo(ing at some unusual, less o"vious e!periences. 'e ill

sho ho innovation thrives ithout patents in sectors here

imitation is cheap and here there are a lot of fiercely competing

companies.

World Without Patent

$istorically, very fe ideas and innovations have "eenrearded ith government protected monopolies. Although the

enetians introduced limited patent protection to -accutissimi

Ingegni, apti ad excogitar et trouar varij Ingegnosi artificij in

/404, fortunately this as an e!ceptional provision. It as the

1nglish in /234 ho really pioneered patent la ith the Statue of

Monopolies. otice that at that time the euphemism of intellectual

-property had not yet "een introduced % that it as a monopoly

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right and not a property right that as "eing granted as not in

*uestion. 5he Statue of Monopolies defined the "asic concept of

patents and alloed for the possi"ility of a fourteen years monopoly

provided that: -they "e not contrary to the la nor mischievous to

the state "y raising prices of commodities at home, or hurt of trade,

or generally inconvenient.5he Statute of Anne, in /0/6, e!tended,revised and improved the la, hile also introducing copyright.

7ntil these formal las ere introduced patents and copyright ere

either none!istent, used as a form of governmental e!tortion through

the sale of economic privileges, or ere a tool for harassing

scientists and philosophers, as )alileo and many other ere forced

to learn. Insofar as the British system of patent as helpful in

inducing the industrial revolution, it is li(ely that it as the

limitation placed "y these las on the ar"itrary poer of

government to "loc( and monopoli8e innovation that as important.

After the British legislative innovations of /234 and /0/6,imitation proceeded rather sloly in the rest of 1urope: for good or

ill the transmission of ideas does ta(e time. A patent la as

enacted in 9rance in /0/+ "ecause it as "ased on the principle that

no e!amination of any (ind as re*uired it amounted to no more

than a -registry of inventions, often ith very many duplicates,

variations, and so on. It as also *uite costly to get a patent, and the

latter as declared void if the inventor tried to patent the invention

also in another country. As a conse*uence of all this, the 9rench

system did not introduce much monopoly until it as reformed in

/;44.It is only "eteen the end of the nineteenth and the

"eginning of the tentieth century that countries such as 9rance,

)ermany, Italy and #pain came to adopt fairly comprehensive

intellectual property las. By this time, innovation, the rule of la,

and the onership of ideas in these countries as idespread, and

the introduction of intellectual property las served to create private

monopolies rather than to limit the ar"itrary poer of government.

)ermany enacted a comprehensive patent la, introducing for the

first time the principle of mandatory e!amination, only in /;00.

#till, )erman patent la as mostly restricted to processes, not products+ in particular, chemical products ere not patenta"le until

much later. A num"er of significant holdouts remained until even

after the #econd 'orld 'ar for e!ample, #it8erland and the

etherlands and to a lesser e!tent Italy.

As for the 7nited #tates, the adoption of intellectual

property las started ith the <atent Act of /06, and e!tended

progressively to more and more areas of "usiness. 5he first 7.#.

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patent as granted in /06 to #amuel $op(ins of <hiladelphia for

-ma(ing pot and pearl ashes, a cleaning formula used in soap

ma(ing.

=uring the last tenty>five or thirty years the -everything

should "e patented trend has set in, especially in the 7nited

#tate.1ven in the 7.#. "usiness practices and financial securitiesere not su"?ect to patent prior to /; and softare code as not

patenta"le until /;;. In most of the rest of orld they still cannot

"e patented.

5he list of industries that ere "orn and gre in the a"sence

of intellectual property protection is almost "oundless. In Italy,

pharmaceutical products and processes ere not covered "y patents

until /0;+ the same as true in #it8erland for processes until

/@4, and for products until /00. Agricultural seeds and plant

varieties could not "e patented in the 7nited #tates until /06, and

they still cannot "e in most of the orld. All (inds of -"asicscience from mathematics to physics and even economics, "ut no

longer finance cannot "e patented. #imultaneously, the copyright

on scientific articles enriches a handful of encroached and

inefficient pu"lishers instead of the scholars ho rote the articles.

'e are getting personal, so let us appeal to a less partial

authority. 'hile a minority among economists, e are not alone in

noticing these facts+ )eorge #tigler, riting in /@2, cites a num"er

of e!amples of thriving innovations under competition:

When the new industry did not have such barriers patentsand other contrived restrictions on entry!, there were an

eager host of new firms " even in the face of the greatest

uncertainties. #ne may cite automobiles, fro$en foods,

various electrical appliances and e%uipment, petroleum

refining, incandescent lamps, radio, and &it is said' uranium

mining .

$e provides further ela"oration in the case of the mail>order

"usiness:

(here can be rewards " and great ones " to the successful

competitive innovator. )or example, the mail*order business

was an innovation that had a vast effect upon retailing in

rural and small urban communities in the +nited States. (he

innovators, I suppose, were Aaron Montgomery Ward, who

opened the first general merchandise establishment in -/,

and 0ichard Sears, who entered the industry fourteen years




later. Sears soon lifted his company to a dominant position

by his magnificent merchandising talents, and he obtained a

modest fortune, and his partner 0osenwald an immodest

one. At no time were there any conventional monopolistic

practices, and at all times there were rivals within the

industry and other industries ma1ing near*perfect substitutes &e.g. department stores, local merchants', so the

price fixing*power of the large companies was very small.

#ince /@@ e can add to this list such modern innovations as Day

ErocFs fast>food franchise, the 34>hour convenience store, the

su"ur"an shopping mall, franchise>everything from coffee to

hairdressing, and online commerce.

$oever, these all seem rather o"vious if not stereotyped

e!amples. A less o"vious "ut nevertheless familiar form of

innovation is emigration. 5he first 1nglish, =utch, Irish, or #omaliimmigrant to the 7nited #tates as no less innovative than the

inventor of the airplane, and emigrants are constantly discovering

ne countries and "usiness opportunities ithout any need for

intellectual monopoly. Indeed, emigration and the formation of ne

communities is "oth a prototypical e!ample of the fundamental role

played "y competitive innovation in the development of human

civili8ation, and a reminder of the fact that the forces of monopoly

are alays and almost inescapa"ly at or( after every great

competitive leap forard.

5he first immigrant faces a large cost: he must cross theocean or desert, or mountain range and he faces a high ris( of

failure. 5he cost of imitation is much less % it is (non that the

nefound land is hospita"le and fertile % and the pioneers are

availa"le to inform necomers a"out ?o" opportunities and local

las and customs. Get the common association of -early settlers

ith -old money confirms that there is still a su"stantial advantage

to "eing first.

#adly, as in other industries, after years have gone "y and

the num"er of ne opportunities for immigrants diminishes pressure

from early entrants for monopoly protection emerges, and usuallysucceeds. #uch rent>see(ing legislation in the emigration industry

e call -immigration and naturali8ation restrictions or -*uotas.

5he history of emigration carries also some "roader

messages a"out innovation. It shos that free>entry and unrestricted

imitation characteri8e the most successful e!periences, hile

monopolistic restrictions on immigration are often associated ith

poor su"se*uent economic performances. Hne e!ample is the

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contrasting e!perience "eteen the <ortuguese#panish settlement

of Central#outh America, and that of the 1nglish settlement of

orth America. 5he first as limited to small "ands of politically

connected adventurers, the second as open even to politically

unpopular groups such as the <uritans. 5he economic conse*uences

spea( for themselves. In a similar ay, successful ne industriesare almost invaria"ly the product of innovation cum imitation cum

cut throat competition, hile many potential successes have "een

tharted from the start "y the adoption of monopolistic

arrangements.

It is also true that the more mature and economically

successful a country is, the stronger is the internal pressure for the

introduction of monopolistic restrictions to immigration. #o it is also

at the end of the industry life>cycle, that ealthy, mature, and

technologically stagnant firms are the "reeding ground of

monopolistic restrictions purchased through the constant lo""ying of politicians and regulators.

The Industrial Revolution and the Steam Engine

It is a idespread "elief that the Industrial Devolution too(

place hen it too( place allegedly, sometime "eteen /0@6 and

/;@6 and here it too( place 1ngland "ecause patents giving

inventors a prolonged period of monopoly poer ere first

introduced "y enlightened rulers at that time and in that place. 5he

e!emplary story of James 'att, the prototypical inventor>

entrepreneur of the time, is often told to confirm the magic role of patents in spurring invention and groth. As e pointed out in the

introduction, this is far from "eing the case.

5he pricing policy of the Boulton and 'att enterprise as a

classical e!ample of monopoly pricing: over and a"ove the cost of

the materials needed to "uild the steam engine, they ould charge

royalties e*ual to one>third of the fuel>costs savings attained "y their

engine in comparison to the ecomen engine. otice to

interesting properties of this scheme: it allos for price

discrimination, and it is founded on the hypothesis that, than(s to

the patent protection, no further technological improvement illta(e place. It allos for price discrimination "ecause, given the

transport technology of the time, the price of coal varied

su"stantially from one region to another. It assumes that

technological improvement ill "e stifled, "ecause it is "ased on the

idea that only the 'att engine could use less coal than the

ecomen engine. o surprise, then, that Boulton and 'att spent

most of their time fighting in court and "an(rupting any inventor,

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such as Jonathan $orn"loer, ho tried to introduce a machine

either superior to theirs or, at least, superior to the ecomen

engine. It ill also come as no surprise to our readers that, in the

Cornall region here copper and tin ere mined and coal as

e!pensive, a num"er of miners too( to -pirating the engine. 5his

naturally "rought a"out a legal dispute ith Boulton and 'att,hich ended only in /0 ith the, phyrric, victory of the to

monopolists. <hyrric, "ecause their patent e!pired a year later.

5he episode that interests us here, though, lies in the pace

and nature of innovation after the e!piration of the Boulton and 'att

patents. In /;// hen the Boulton and 'att patent had long e!pired

-K a group of mine K managers decided to "egin the pu"lication

of a monthly ?ournal reporting the salient technical characteristics,

the operating procedures and the performance of each engine. 5heir

declared aims ere to permit the rapid individuation and diffusion

of "est>practice techni*ues, and to introduce a climate of competition among the various minesF engineers. 5he pu"lication

enterprise continued until /64.

Hne year later, in /;/3, and in the same region the first high

pressure engine of the so>called -Cornish type as "uilt "y

Dichard 5revithic(. Interestingly enough, 5revithic( did not patent

his high>pressure pumping engine, and alloed any"ody ho

anted to copy it. It happened to "e as efficient as the 'attFs, "ut

much more amena"le to improvement. 5his triggered a long and

e!tremely successful period of -collective innovation in hich

different firms made small, incremental changes to the originaldesign of the Cornish engine. #uch changes ere neither patented

nor (ept secret, there"y spreading rapidly among other firms in the

Cornall area, alloing and at the same time forcing ne

improvements from competitors.

As a measure of the social value of competition versus

monopoly, consider the folloing facts. 5he duty of steam engines

a measure of their coal>efficiency that, during the tenty five

years of the Boulton and 'att monopoly /00@>/;66, had remained

practically constant, improved "y roughly a factor of five during the

/;/6>/;@ period.5his successful colla"orative effort to improve the Cornish

engine illustrates the genius of the competitive mar(et. Because of

uncertainty in coal mining, a modest num"er of investors engaged in

mutual insurance "y each oning shares in a "road cross>section of

mines. As is the case ith shareholders in pu"licly traded

companies, this means that each investor is a"le to capture the

"enefit of innovation, regardless of hich particular firm or

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engineer made the improvement. And indeed, the employment

contracts of engineers reflected these incentives. 1ngineers ere

employed on a contract "asis "y particular mines to improve

engines, ith the understanding that they ould pu"lish their

results. Investors captured the common gains to all mines from the

innovation, and engineers having signed aay the right tomonopoli8e their invention, instead profiting from their fees and "y

the advertising value of pu"lici8ing their innovations. Indeed in

many respects, this colla"orative, competitive mine engine

improvement is similar to modern day open source softare.

5he Industrial Devolution period is, indeed, a mine of

e!amples, "oth of patents hindering economic progress hile

seldom enriching their oners, and of great riches and even greater

economic progresses achieved ithout patents and than(s to open

competition. Hf many anecdotes, the story of 1li 'hitney is

particularly instructive. Born in 'est"oro, Massachussets, on =ec.;, /02@, 'hitney graduated from Gale College in /03. By April

/0, he had designed and constructed the cotton gin, a machine

that automated the separation of cottonseed from the short>staple

cotton fi"er. ery much li(e the 'attFs engine in the coal districts

of 1ngland, the cotton gin as enormously valua"le in the #outh of

the 7nited #tates, here it made southern cotton a profita"le crop

for the first time. Li(e James 'att, 1li 'hitney also had a "usiness

partner, <hineas Miller, and the to opted for a monopolistic pricing

scheme not dissimilar from the BoultonFs and 'attFs. 5hey ould

install their machines through )eorgia and the #outh, and chargefarmers a fee for doing the ginning for them. 5heir charge as to>

fifths of the profit, paid to them in cotton. ot surprisingly, farmers

did not li(e this pricing scheme very much, and started to -pirate

the machine. 'hitney and Miller asted a lot of time and money

trying to enforce their patent on the cotton gin, "ut ith little

success. Beteen /04 and /;60 they ent around the #outh

"ringing to court everyone in sight, and receiving little

compensation for their strenuous efforts.

Ironically 1li 'hitney did eventually "ecome a rich man %

not through his efforts at monopoli8ation, "ut through the ondersof competitive mar(ets. In /0;, he invented a ay to manufacture

mus(ets "y machine, developing the idea of interchangea"le parts

and standardi8ed production. $e did not "other to see( patent

protection this time, "ut instead set up a shop in 'hitneyville, near

e $aven. $ere he manufactured his mus(ets and sell them to the

7.#. Army. #o it as not as a monopolist of the cotton gin, "ut

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rather as the competitive manufacturer of mus(ets that 'hitney

finally "ecame rich.

Agriculture

Among economists the reaction to the idea that economic

progress is the fruit of competition is "imodal. 5hose "elonging tothe theoretical variety, interested in matters of pure economic theory

and logic, tend to *uic(ly agree and then yan aay the rest of the

seminar+ the conclusion seemed to follo straightforardly from

the assumptions. #pecialists or(ing in the areas of innovation,

economic groth, and industrial organi8ation long steeped in the

conventional isdom are certain that the idea cannot possi"ly "e

correct, although uncertain as to hy not. 5he e!ception are

specialists in agricultural economics, ho react ith neither

"oredom nor rage. It turns out that until the early /06s innovation

in agriculture has flourished ithout much in the ay of protectionfrom intellectual monopoly % and that agricultural economists are

ell aare of this. Breeders ould develop a ne plant variety, the

initial seeds of hich ere sold to farmers at relatively high prices.

9armers ere then free to reproduce and resell such seeds on the

mar(et and compete ith the initial "reeders, ithout the latter

"ringing them to court "ecause those "ushels of, say, 5ur(ey Ded

heat ere -illegal copies of the 5ur(ey Ded heat variety they

held a patent on.

Innovation in agriculture revolves around plants and

animals. either the /0 original nor the /@3 revised version of the 7.#. patent code mentioned the possi"ility of patenting different

forms of life, "e they animal or vegeta"le. 5he issue did not arise

during most of the nineteenth century, "ut a precedent against

patenting as esta"lished in /;;, hen the 7.#. Commissioner of

<atents re?ected an application for a patent to cover a fi"er identified

in the needles of a pine tree. 5he Commissioner isely pointed out

that patenting some nely found form of life ould "e tantamount

to attri"ute monopoly poer and de facto onership on all copies

of that form of life to "e su"se*uently found, hich struc( him, as it

stri(es us, as -unreasona"le and impossi"le.#hortly afterards, the discovery of MendelFs la % imagine

a orld in hich Mendel had managed to patent his la, a very

li(ely possi"ility these days % started a long series of attempts to

su"vert the /;; doctrine. 5he ational Committee on <lant <atents,

created and financed "y the countryFs "reeders, as the leader of an

intense lo""ying campaign arguing that no, contrary to "efore, a

-ne plantanimal could, in principle, "e e!actly identified and that

;




its -creation as e*uivalent therefore to the invention of a ne

mechanical tool. otice an important detail: during the many

decades it too( to "uy monopoly protection from Congress, the

"reeding industry as, literally, "lossoming and groing under

conditions of competition and ithout intellectual monopoly

protection. In fact, it had prospered so much that its economic poer and a"ility to influence congress and the pu"lic opinion increased to

the point that it as a"le to get the la changed.

5here is a "asic pattern here, that is u"i*uitous in the life

cycle of most ne industries. Innovative and dynamic industries

emerge either "ecause intellectual monopoly is not present or to

"ypass it. 5hey gro rapidly "ecause competition and imitation

allo and force their firms to innovate or perish. In fact, in the early

stages, agricultural innovators often ould provide their customers

ith incentives to copy and reproduce their seeds, as a tool for

spreading its usage. $oever, as the industry gro more poerfuland the opportunities for further innovation diminishes the value of

monopoly protection for the insiders increases, lo""ying efforts

multiply and, unfortunately, most often succeed.

In the case of the "reeding industry, a partial victory as

first achieved during the )reat =epression, ith the <lant <atent Act

of /6. 5he victory as only partial "ecause, due mostly to issues

of enforcea"ility, patents ere alloed only for plants that could

reproduce ase!ually. It e!plicitly e!cluded tu"er and se!ually

reproduced plants. 9or these crops the scientific (noledge of the

times made it impossi"le to satisfy the <atent La re*uisite that a patenta"le invention "e disclosed specifically enough to "e

identically reproduci"le.

As the reader may imagine, this limitation did not please the

American #eed 5rade Association, hich had greatly contri"uted to

the lo""ying effort. 'hile a useful precedent, the /6 Act as too

ea( and covered too fe plants, hence it did not really provide

"reeders ith the e!tensive monopoly poer they sought+ such

-ea(ness revealed itself in the fact that, hile agricultural

innovations continued at a su"stantial pace, only // plant patents

ere assigned in the period until the early /@6s. In the meanhilelo""ying "y potential monopolists did not go aay, instead it

intensified as ne and poerful interest groups ?oined the clan. 5he

discovery of the =A code, and the su"se*uent development of

"iological engineering, ould, eventually, come to rescue the

monopolistFs demand for full protection.




5o mar( the progress of innovation in agriculture, corn as a

common and important crop ma(es a useful case study. 'e sho in

the figure "elo crop yields for 7.#. corn, averaged "y decade.

7p until the /46s yields do not change much % this turns out to

have little to do ith lac( of innovation, and is due primarily to the

fact that as agriculture moved est into poorer climates and soil

continuous innovation as re*uired ?ust to maintain crop yields. As

the area under cultivation sta"ili8es, "eginning ith the /46s and

especially in the /@6s crop yields e!plode. 5he primary

innovations underlying this e!plosion are the introduction of

improved hy"rid varieties that are more responsive to heavy

fertili8ation.

5he (ey point to reali8e is that the "ul( of the groth in

yield too( place hen patents on plant life ere impossi"le or rare.

Indeed, as e have o"served patents on corn hy"rids "ecame

idespread only after =A "ased research "egan. <ioneer>$i>Bred

International recorded the first such patent on corn in /04. 5he

large surge in patenting of corn varieties occurred in the period/04>;4 % su"stantially after the revolution in crop yield as ell

under ay.

Spanish Hortalezas and Italian Maglioni

Introducing high>tech greenhouse fruits> and vegeta"les>

culture in Almeria, #pain, in the early /26s as as much an

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-economic innovation as the development of the 3;2

microprocessor in California, 7nited #tates, to decades later. It

too( place through the effort of a large num"er of completely

un(non farmers and in the a"sence of any patent protection of the

"usiness methods and production techni*ues they created or

adopted. In /2, Almeria as as poor and desert as anything can "e, so much so, that #ergio Leone ent there to shoot his -spaghetti

esterns: it loo(ed li(e the desert of Ari8ona and #outhern 7tah,

"ut it as a lot closer and cheaper. 5hen the first greenhouse, a

simple and lo>cost pergola>type structure, gave "irth to the

-Almerian miracle. 5he physical change rought in Almeria is

graphically illustrated in the A#A satellite images "elo, shoing

the landscape "efore and after.

'hoever the first fe innovators ere, they ere rapidly

and idely imitated "y many other small farmers, "ut this did not

apparently reduce their drive to get there first. In fact, the innovators

of Almeria ere, most certainly, imitators of the long esta"lished

tradition of family -huertas in the near"y region of Murcia. 5he

difference "eing that, in Almeria, "etter land as availa"le, agesere loer, and the sudden competitive drive that reciprocal

imitation spurned, led to gigantic efficiency gains. Hver a period of

forty years, this competition "rought /66,666 acres of land under

cultivation, and it "uilt todayFs most productive and successful

agricultural enclave in all of 1urope, and pro"a"ly of the orld.

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A similar revolution happened at a"out the same time in the

area around 5reviso, Italy, hen the mem"ers of the Benetton

family introduced the -ready>to>color seater production process

and adopted creative franchising techni*ues that in a couple of

decades transformed a large segment of the clothing sector. Both

their original production process and their mar(eting anddistri"ution methods ere rapidly imitated, and improved, first "y

competitors from the same area and then from all (inds of far aay

places. 5he megastores of 2ara and 34M , attracting hordes of

shoppers everyhere in the orld, are, until no, the last stage of

the innovation>cum>imitation process that 5enetton started forty

years ago.

1ach of these economic innovations as costly, too( place

ithout intellectual property and as *uic(ly imitated+ "ecause of

these facts, they not only "rought fortune to their original creators,

"ut also led to idespread economic changes in the geographicalareas and the economic sectors har"oring the initial innovation. In

the cases of Almeria and 5reviso the innovation>cum>imitation

process as so deep and so persistent that it spilled over to other

sectors, leading to a continued increase in productivity that, in a fe

decades, turned to relatively underdeveloped areas into some of

the richest provinces of #pain and Italy, respectively. Indeed, the

social value of an innovation is ma!imi8ed hen it spreads rapidly

and, "y spurring competition, it induces further aves of innovation.

Current legislation seems designed to prevent this from happening,

there"y greatly reducing the social value of innovative activity.

Financial Markets

'hen you hear the phrase -?udge>made la you pro"a"ly

thin( of controversial areas, such as a"ortion and privacy. But the

greatest changes in the legal system made "y ?udges, ithout

legislative revie or approval, have occurred in the area of patent

la. 5he e!tension of patent protection to computer softare is one

e!ample. Another is the patenting of financial securities. <rior to

/;, investment "an(ers and other firms selling financial securities

operated ithout the -"enefit of intellectual property. 5he rapid pace of innovation in financial securities prior to /; is ell

documented, for e!ample "y 5ufano. 5ufano estimates that roughly

36 of ne security issues involve an -innovative structure. $e

reports developing a list of some /;2 ne securities over a 36 year

period and remar(s that this

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severely underestimates! the amount of financial

innovation as it includes only corporate securities. It

excludes the tremendous innovation in exchange traded

derivatives, over*the*counter derivative stoc1s &such as the

credit derivatives, e%uity swaps, weather derivatives, and

exotic over*the*counter options', new insurance contracts&such as alternative ris1 transfer contracts or contingent

e%uity contracts', and new investment management products

&such as folio)6 or exchange traded funds.'

5hree features of this mar(et particularly deserve note. 5he

first is that innovating in the financial securities industry is very

costly, as those creating ne securities are highly paid individuals

ith <h=s in economics, mathematics and theoretical physics. 5he

second is that financial innovations are *uic(ly imitated "y

competitors. 5he third, is that there is a pronounced advantage of "eing first, ith the innovator retaining a @6>26 mar(et share even

in the long>run. Accounts in the popular press of investment "an(ing

in the /;6s, such as LeisFs vivid portrayal, also document that

innovation as idespread, despite the complete lac( of intellectual

monopoly.

5he story, sadly, is not over. Hn July 3, /;, in State

Street 5an1 4 (rust 7o. v. Signature )inancial 8roup, Inc., the

7.#. Court of Appeals for the 9ederal Circuit held patenta"le

#ignatureFs -=ata <rocessing #ystem for $u" and #po(e 9inancial

#ervices Configuration. <rior to this ruling, methods of doing "usiness and mathematical algorithms could not "e patented. After

this ruling, at least insofar as they are em"odied in computer code,

"usiness methods and algorithms are patenta"le, and in particular, it

is no possi"le to patent financial securities: there are no tens of

thousands of patented -financial inventions. By this remar(a"le act

of ?udicial activism the courts e!tended government granted

monopolies to thriving mar(ets, such as those for financial

securities, here innovation and competition had gone hand>in>hand

for decades. #hould this trend not "e reversed, e e!pect that ithin

a decade or so, economists studying the 7.#. financial securitiesindustry ill "e pondering a -productivity slodon, and

ondering hat on earth may have caused it.

esign

9or historical and practical reasons, neither fashion design

nor design at large achitecture, furniture, lighting, and so forth are

effectively protected "y patents and copyrights. 5o "e sure, design

/




patents e!ist, are carefully and scrupulously descri"ed in

voluminous manuals, and hundreds of design patent applications are

filed ith the 7#<5H every month, mostly for the "enefit of the

layers that ta(e care of filing those applications. $oever, it is

*uite clear from everyday e!perience that in design imitation is as

idespread and common as sand in the #ahara desert. )eneraldesign concepts, and even *uite particular and specific ones, are de

facto not patenta"le "ecause, on the one hand, too many features of

the design of a useful o"?ect are dictated "y utilitarian concerns and,

on the other, even very minor ornamental variations are enough to

ma(e a certain -design different from the original one. <ractically

spea(ing, hat this means is that car companies imitate each other

in shaping and styling their cars+ architects and engineers do the

same ith "uildings and "ridges not to spea( of university halls+

furniture ma(ers copy each otherFs "eds, sofas, and coffee ta"les+

lamp ma(ers are continuously coming up ith yet another variationon the design of ArtemideFs 5i8io+ all female tailleurs are copycats

of ChanelFs K and so on and so forth.

'hile design is not all that there is in a coat or in a sofa, it is

more and more the factor around hich a competitive edge is "uilt.

1ven the most casual of o"servers can scarcely "e unaare of the

enormous innovation that occurs in the clothing and accessories

industry every si! months, ith a fe top designers racing to set the

standards that ill "e adopted "y the ealthy first, and idely

imitated "y the mass producers of clothing for the not so ealthy

shortly after. And -shortly after, here, means really shortly after.5he no orld>ide phenomenon of the #panish clothing company

2ara and of its many imitators shos that one can "ring to the

mass mar(et the designs introduced for the very top clientele ith a

delay that varies "eteen three and si! months. #till, the original

innovators (eep innovating, and (eep "ecoming richer.

#imilarly in the fine arts, hile individual or(s can "e

protected "y copyright, methods, techni*ues, styles, and -concepts

cannot "e patented. arnedoe provides vivid documentation of the

enormous inventive activity in the modern figurative arts % and the

e*ually rampant imitation that occurred in that field % all in thecomplete a"sence of intellectual monopoly. $is discussion of

idespread e!perimentation % "y a variety of artists % on the use of

perspective is "ut one e!ample. 9inally, consider the enormous

groth of the contemporary -lesser "rother of the fine arts,

advertising and mar(eting. Its economic impact is one or to orders

of magnitude greater than that of the traditional fine arts sector

although the "orders have "een getting more and more "lurred

/4




during the course of the last century and, also in this sector, neither

patents nor copyrights play a relevant role. #till, and almost "y

definition, if there is a sector of economic activity for hich

innovation and novelty are the (ey factors, advertising is certainly

the prime candidate.

Sports

'hen e!amining the social merit of pu"lic institutions, a

useful *uestion to as( is hether the same institutions are used in

the private sector. 9or e!ample, government "ureaucracies are

idely thought to "e inefficient. Get e o"serve, for e!ample, in the

very competitive I5 industry that IBMFs internal "ureaucratic

structure has survived, and indeed thrived, over many years. $ence,

e have to conclude that it is li(ely that "ureaucracies do achieve

some socially desira"le goals.

'e can as( the same *uestion a"out intellectual monopoly.If intellectual monopoly is a good idea in the pu"lic sector as a ay

of encouraging innovation, is it used in the private sector for that

purpose A case in point is sports leagues. 5ypically, these leagues

have a near a"solute poer over an entire sport and the rules "y

hich it is played+ they also have full control of the commercial

part, and stand to "enefit from anything that increases demand for

their product. Innovation is also important in sports, ith such

innovations as the 9os"ury 9lop in high ?umping, the triangle

offense in "as(et"all, and of course the many ne American

foot"all plays that are introduced every year, serving to improve performance and provide greater consumer satisfaction. Indeed, the

position of the sports leagues ith respect to innovation in their on

sport is not apprecia"ly different from that of the "enevolent social

planner invo(ed "y economists in assessing alternative economic

institutions.

)iven that sports leagues are in the position of ishing to

encourage all innovations for hich the "enefits e!ceed the cost,

they are also in the position to implement a private system of

intellectual property, should they find it advantageous. 5hat is, there

is nothing to prevent, say, the ational 9oot"all League fromaarding e!clusive rights to a ne foot"all play for a period of time

to the coach or inventor of the ne play. #tri(ingly, e (no of no

sports league that has ever done this. Apparently in sports the

competitive provision of innovation serves the social purpose, and

additional incentive in the form of aards of monopoly poer do

not serve a useful purpose.

/@




As alays, there is an ironic footnote to this triumph of

competition: some legal analysts in the 7nited #tates no argue that

the government should enforce patents on sports moves.

Patent Pools

In addition to sports leagues, there is another significant andidespread e!ample of private companies voluntarily relin*uishing

intellectual property. 5hese are the so>called -patent>pools. A

patent pool is an agreement, generally "y a num"er of "usinesses in

the same industry, to share patents. Although it is sometimes the

case that hen the pool is set up, a company that has fe patents

ill ma(e a payment to a company that has many patents, once the

pool is operating, there is no payment "eteen companies for

patents. Any patent "y any company in the pool is freely availa"le

to any other company in the pool. In some cases patent pools ta(e

the form of cross>licensing agreements in hich firms agree toautomatically cross>license all patents falling into certain categories.

=espite the apparent communistic nature no -intellectual

property for the in>group of these arrangements, patent pools have

"een idely used.

In the +nited States, in a number of industries, processes of

9collective invention: were implemented by means of patent

pools. 6ote that in some cases, patent pools were created

after having experienced phases of slow innovation due to

the existence of bloc1ing patents. In the -;s, producers of 5essemer steel decided to share information on design

plants and performances through the 5essemer Association

&a patent pool holding control of the essential patents in the

production of 5essemer steel'. (he creation of this patent

pool was stimulated by the unsatisfactory innovative

performance of the industry under the 9pure: patent system

regime. In that phase, the control of essential patents by

different firms had determined an almost indissoluble

technological deadloc1. Similar concerns over patent

bloc1ages led firms operating in the railway sector to adopt the same expedient of semi*automatic cross*licenses and

1nowledge sharing.

At the current time, patent pools are generally mandatory for

participants in recogni8ed standard setting organi8ations such as the

International 5elecommunications 7nion and American ational

#tandards Institute. Large microprocessor corporations, such as

/2




IBM, Intel, Nero! and $elett><ac(ard engage in e!tensive cross

licensing. Important computer technologies, including the M<1)3

movie standard and other elements of == technology are part of a

patent pool.

)iven the idespread illingness of large corporations to

voluntarily relin*uish patent protection through cross>licensing and patent pools, you might onder hy eliminating patents ould even

"e necessary. 7nfortunately, hile patent pools eliminate the ill

effects of patents ithin the pool % they leave the outsiders, ell,

outside. If the e!isting firms in an industry have a patent pool, then

the prospects of a necomer entering are "lea( indeed. #o hile

patent pools may give a strong indication that patents are not a

terri"ly good idea, and that competition has many "enefits % they do

not unfortunately undo some of the most important harm of

government enforced monopoly % that of preventing entry into an

industry.

Pro!its "ithout Patents

<atenting is high and groing "y historical standards. 5he

total num"er of 7.#. patents has increased 0;, to //4,34/ "eteen

/; and /@. Get it turns out "usinesses do not regard patents as a

significant factor in their decision to innovate. 5here are to

surveys of D&= research directors in hich this clearly emerges.

5his first is the -Gale #urvey ta(en in /;0, and the second is the

-Carnegie #urvey done in 3666. 'e focus on the more recent and

more detailed Carnegie #urvey, "ut the same facts emerge from theearlier Gale #urvey.

5he Carnegie #urvey reports in 3666 that it received

responses from ///; firms for product innovations, and /6;0 for

process innovation. 5he firms ere as(ed hether particular

methods ere effective in appropriating the gains from an

innovation. 5he ta"le "elo shos the percentage of firms

indicating that the particular techni*ue as effective. 5he num"ers

in parentheses are the corresponding figures for the pharmaceutical

and medical e*uipment industries respectively: these are the to

industries in hich the highest percentage of respondents indicatedthat patents are effective.

Product Process

secrecy @/.66 @.@0, @6.0 @6.@2;./, 4.34

lead time @3.02 @6./6, @;.62 ;.4@.@3, 4@./@

complementary

manufacturing

[email protected]/ 4., 4.3@ 4.6644./0, 4.@@

/0




complementary

sales/service

43.04 .0, @3.@/ [email protected]/, 3./3

patents 4.; @6.36 ,@4.06 3.62./@, 4.63

other legal 36.0/ 36.;3, 3.6 /@./2.64, 33.30

5he most stri(ing fact is that legal means, "oth patents and other

legal means are regarded as the least effective method of

appropriating rents. Hnly a"out /rd of respondents feel that patents

are effective. #ecrecy, lead time % the advantage of "eing first, and

complementary manufacturing are rated as the most effective.

Indeed, in the case of products, "eing first is vieed as the most

effective means of appropriation. 5he to e!ceptional industries,

hich report a relatively high importance of patents are the

pharmaceutical and medical e*uipment industries. Indeed, these

industries, especially the pharmaceutical industry, are often held up

as e!amples of hy it is essential to have patents. Get even in theseindustries, only a"out half the respondents rate patents as an

effective means of appropriation. Also stri(ing is that in these

industries, other means such as lead time, complementary

manufacturing and secrecy are regarded as a"out e*ually effective

as in other industries. $ence, hile patents are vieed as more

effective in these industries, non>legal means are still *uite effective

in appropriating rents.

Also of interest are the reasons for hich patents are

considered valua"le "y "usiness firms. 'ith 0@@ product, and 204

process respondents, the Carnegie #urvey reports the folloing percentage of respondents indicating the particular motivation for

see(ing a patent.

Product Process

measure performance @.0@ @.64

licensing revenue 3;.30 3.3@

use in negotiations 40.; .2

prevent suits @;.00 42.@6

prevent copying @.;/ 00.2/

blocking ;/.;/ 2.@;enhance reputation 40./ 4.6

otice that licensing revenue % the sale of ideas, is relatively

unimportant. 5he achievement of monopoly poer through the

prevention of copying is *uite important. But notice also the

importance of pure rent>see(ing: use in negotiations, preventing

/;




suits, and "loc(ing competition have a cumulative score of /;0.2

for product innovations and /@6.64 for process innovations. 5his

can "e ta(en as a crude indication that the amount of loss due to

rent>see(ing attri"uta"le to patents e!ceeds the amount of additional

monopoly profit generated % not e!actly a strong reason for a patent

system.

#oncluding Remarks

5here are several e!amples that do not fit neatly into the

category of innovation ithout intellectual monopoly "ecause of a

strong presence of government su"sidies, "ut these e!amples are too

dramatic to "e "ypassed completely. 5he first is progress in "asic

science. Basic scientists have never "een entitled to a monopoly on

their research+ in modern times this research is heavily su"sidi8ed,

"ut eton, =arin, and 1instein received neither intellectual

monopoly, nor government su"sidy % and there are of course manyother less prominent e!amples. As alays, there is a fly in this

ointment. 5raditionally university and government su"sidi8ed

research did not "enefit from intellectual monopoly. =espite the

a"sence of any apparent lac( of university research, or adoption in

industry, recently pu"lic policy in the 7nited #tates, under the guise

of so>called -pu"lic>private partnership, has "een to encourage

universities to apply for intellectual monopolies even for

government su"sidi8ed research.

9inally, the remar(a"le pace of innovation during the

#econd 'orld 'ar should not escape notice. In /46, the Britishgovernment as a"le to employ //4 style "iplanes to help sin( the

"attleship Bismarc(. By /4@ the )ermans deployed ?et aircraft, and

"oth cruise and "allistic missiles. =evelopments in electronics and

cryptography ere e*ually dramatic, and no development perhaps

so dramatic as that of the fission "om". Intellectual monopoly

clearly played no role in these developments, and indeed the

environment of colla"oration ithin the com"atant nations

possi"le in its a"sence seems to have had a (ey role in the dramatic

acceleration of technological progress. 'hile government su"sidy

as significant, any reading, for e!ample, of the history of theManhattan pro?ect, or Bletchley <ar(, ma(es clear that the enormous

effort provided "y individual scientists as not a response to an

e!pectation of financial reard, either from the government or

private sector.

But the e!ample of the #econd 'orld 'ar is important for a

second reason. 'e often thin( of government su"sidy as an

alternative to intellectual monopoly % "ut in the #econd 'orld 'ar,

/




the competition "eteen governments illustrates clearly ho a

competitive mar(et produces innovation in the a"sence of

intellectual monopoly. 5a(e the fission "om" as an e!ample. 5he

potential innovators ere not individuals, "ut rather the different

governments % most importantly the 7.#., a8i )ermany, and the

#oviet 7nion. 5he country that first succeeded in inventing thefission "om" o"viously as not going to "e granted an e!clusive

legal monopoly "y its rivals, so the conditions ere those of

competition. Imitation as a ma?or concern % and the evidence

suggests that the cost of "eing second % "y the #oviets % as

su"stantially less than the cost of "eing first, and the cost of "eing

third Britain, fourth 9rance and fifth China % less yet. In the

a"sence of intellectual monopoly, trade secrecy played an important

role in creating incentives for innovation. $oever, despite heroic

efforts % violation of trade secrecy in this case carrying ith it the

death penalty % it too( only four years for the #oviet 7nion tofollo the e!ample of the 7.#. % *uite a "it less than the seventeen

years granted under international patent la at that time.

ever>the>less there as a huge advantage in "eing first. At

the end of the ar ith )ermany, the 7.#. and its estern allies

ere heavily outnum"ered "y the #oviets in 1urope % and the

#oviets had "etter tan(s and shorter supply lines. 5he fear of #oviet

invasion of 'estern 1urope as sufficiently high that it has often

"een argued that a rationale for 5ruman e!ploding the second "om"

at agasa(i as a signal not to Japan, "ut to the #oviet 7nion.

Degardless, the fact that the 7.#. as first certainly played asignificant role in assuring the freedom of 'estern 1urope after the

ar. 5he advantage of "eing first % even though it lasted for only a

short hile % provided incentive for the most massive research

pro?ect ever underta(en+ the Manhattan pro?ect cost over a hundred

times more than the most e!pensive movie or pharmaceutical

research pro?ect ever. Get, the incentives that induced this huge

pu"lic investment ere not different from those that arise in private

competitive mar(ets: innovate or get "eat "y your competitors and

perish.

36




Notes

5he technical literature on the life>cycle of industries is very

large, still only a fe authors seem to have paid attention to the

correlation "eteen competition and the degree of technological

innovation on the one hand, and o"solescence and demand for

monopolistic restrictions on the other.#tigler O/@2P argues against the #chumpeterian vie that

monopoly is a good thing "ecause it "rings forth innovation. As

indicated "y the *uotations in the te!t, his vie, li(e ours, is that

plentiful innovation occurs under competition.

A classical account of the vie that the Industrial

Devolution ould, at least, have "een greatly retarded had not

patents "een availa"le and enforced in 1ngland at the end of the

eighteenth century can "e found in orth O/;/P. 5he Cornall

mining industry e!perience is studied in uvolari O3664P. An

analogous episode is that of ClevelandFs iron producers % Cleveland, 7.E., not Hhio % deftly documented and discussed in

Allen O/;P. Around the middle of the nineteenth century they

managed to fiercely compete hile alloing technical information

on the development and improvments of the "last furnace to flo

freely from one company to the other. 5hat 5revithic( did not patent

his invention is documented in Doe O/@P. A good and relatively

succinct survey of the history of technology is in =erry and

'illiams O/26P.

An historical analyses of the agricultural sector "efore the

advent of patenting can "e found in McClellan O/0P, for the 7#,and Camp"ell and Hverton O//P, for 1urope. =etailed studies of

the -nineteenth and early tentieth century O...P stream of "iological

innovations in 7# agriculture are, for e!ample, Hlmstead and

Dhode O3663P, for grain and cereals, Hlmstead and Dhode O366P,

for cotton, and Barragan Arce O366@P, for fruit trees. Hlmstead and

Dhode O366P also document ho, in the cotton farming sector,

-inventors, during an early phase of the product cycle, actually

encouraged consumers to copy and disseminate their intellectual

property. Crop yield data is from the ational Agriculture #tatistics

#ervice, information on patents of corn hy"rids from 7r"an O3666P.5he history of -maglioni in the Italian orth 1ast comes

mostly from the first hand e!perience of one of us, a chronology of

Benetton is at .museedelapu".org. 5he satellite images of

Almeria are from A#A and are reproduced idely, for e!ample at

.i"erianature.com. More detailed facts are in Costas and

$euvelin( O3666P. In case you dou"t our statement that AlmeriaFs

horticulture is pro"a"ly the most efficient agricultural enclave in the

3/




orld, chec( out edis.ifas.ufl.edu. Hne of the many stories of

innovation ith imitation and competition e have not told, "ut that

should "e told, is that of the e!tremely successful 5aianese

machine tool industry, an account of hich is in #ono"e, Eaa(ami

and Htsu(a O366P. Quoting only this, though, amounts to doing an

in?ustice to so many others ... "ut even "oo(s have limited capacity.Innovation in the financial industry prior to patents is

documented in to papers "y 5ufano O/;, 3663P and "y a recent

paper "y $errera and #chroth O3664P. A less academic vie of the

investment "an(ing industry can "e found in Leis O/;P. 5he

"usiness practices patent dates to the /; Court of Appeals for the

9ederal Circuit decision in -#tate #treet Ban( v. #ignature

9inancial. In one of the most dramatic e!amples of ?udicial

legislation, they found that there is no prohi"ition in 7.#. la on

patents for "usiness methods as long as they are ne, useful, and

non>o"vious. 5his is mentioned in Ladas and <arry O366P ho also provide a useful summary of (ey developments in 7.#. <atent La.

5he #tate #treet Ban( Case is also discussed at .gigala.com.

'olfgang <esendorfer O/@P models the fashion cycle

along lines that are perfectly consistent ith competitive creation.

Innovation in the figurative arts is discussed, in arnedoe O/6P.A proposal for patenting sports moves is Eu((onen O/;P.

5he *uotation a"out the Bessemer patent pool is from uvolariO3664P. Most of the remaining information a"out patent pools isfrom #hapiro O366/P.

5he -Gale #urvey is descri"ed in Levin et al O/;0P and

Elevoric( et al O/@P. -5he Carnegie #urvey is descri"ed in

Cohen et al O3666P. A study of the impact of the increased role of

universities in patent and other forms of intellectual monopoly can

"e found in Colyvas et al O3663P.

chapter 4 - innovation without patents

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