The economics of intellectual property law*
Unità 00
* Based on François Léveque and Yann Ménière, The Economics of Patents and Inventions, 2004, http://www.cerna.ensmp.fr/ Documents/FL-YM-eBookIP.pdf, ch. I.
Intellectual property applies to creative work Intellectual property law system of exclusive and transferable rights that protect various kinds of intellectual property: Trademarks Technical innovations Databases Literary works Music Films Plant varieties Genes
Two conflicting aims: • Providing incentives for innovators and creators • Enabling access to consumers
Why are incentives and access conflicting goals? K.J. Arrow (1962) assimilates works of intellect to the production of information.
1. Information is a non-excludable good It is impossible to exclude an individual from the consumption of a piece of information (work of intellect) even if she does not contribute to the cost of producing it free rider. Consequence: lack of incentives for producers of these goods, since they cannot cover their costs of production No such good is produced loss of welfare for the community.
2. Information is a non-rival good When an individual consumes a piece of information (work of intellect), she does not reduce its availability to other consumers. The marginal cost of serving an additional consumer is zero. If the producer charges for his service, consumption is needlessly rationed: consumers whose willingness to pay is lower than the price are excluded from consumption, although they would have benefited from it at zero costs. Social welfare is not maximized.
Compromise: intellectual property law it addresses these two goals sequentially. • The work of intellect is made legally excludable for a certain period. Users have to pay royalties to use the good. Inventors and creators have an incentive to produce it • Subsequently the good passes into the public domain: all consumers have access to it free of charge. Social welfare is maximized. Example: Cost of invention = 70 000 Euros Value for society = 100 000 Euros Duration of patent = 20 years Royalties per year = 3 000 Euros the invention is not produced Royalties per year = 4 000 Euros the invention is produced
Economic theory views this problem as a trade-off between static and dynamic efficiency - Static efficiency requires that in every circumstance the allocation of resources maximizes the total surplus - Dynamic efficiency requires that the allocation of resources promotes technological change and improvement of the quality of goods as a result of investment in R&D, design and creation
We assume perfect competition and long term prices = average total costs zero profit Innovating company: - Before the invention: - q0 = quantity - p0 = price - total surplus = area I (consumer surplus) - During the lifetime of patents: - q0 = quantity - p0 = price - c1 = new cost of production - license revenue = r = c0 – c1 - total surplus = area I (consumer surplus) + area II (producer surplus appropriated by the inventor) - deadweight loss = area III
€ I p0 II III c0 c1 D 0 q0
- Total revenue = p0 × q
Q
Companies (other than the inventor): - Total costs = (c1 + r) × q0 = p0 × q0 - Zero profit - The inventor is the only winner
0
When the patent passes into the public domain: - The price falls from p0 to p1 - The total surplus increases of the area III - Total surplus = I + II + III (all consumer surplus) - Inventor’s profits = 0 - Consumers are the only winners
€ I p0 II p1 III c0 c1 D 0 q0 q1 Q
NB. It is impossible to move straight from the invention to public domain no invention would be produced because inventors would not be able to recover R&D expenses.
Alternatives: • Subsidization (typical solution for public goods) Shortcomings: a. Taxation is required to fund subsidization b. The amount of subsidies may be mismatched to the social value of innovations 2. Secrecy (Coca Cola) Shortcomings: (Permanent) deadweight loss for consumers Patent Law obliges inventors to describe the invention so that it can be reproduced by others (at the expiry of the license). Patents promote technical progress. Patents protect inventors from ingenious competitors NB. Secrecy is impossible when the information is incorporated in the product (literary and artistic works, plant varieties, industrial techniques reverse engineering)
Exclusive rights and market power Intellectual property gives an exclusive right to inventors and creators over the work produced. This does not imply that they obtain a monopoly over the market Case 1. two inventions which produce an identical product (e.g. insuline) Case 2. invention of products or technologies with substitutes. Case 3. nondrastic innovations. Only drastic innovations create a monopoly, nondrastic innovations generate a simple market power. In all these cases, to exclude rivals, the innovator must set a lower price than in the alternative case.
Question: which market structure is most conducive to innovation: monopoly or perfect competition? Schumpeter (1942): monopoly monopolies have strong R&D departments
Arrow (1962): perfect competition monopolists have already high profits, whereas competitors must raise profits over zero
Gilbert & Newberry (1982): it depends whether the market is contestable or not through innovations race to patents: - If the incumbent fails to win, it will lose both R&D costs and investments - If the entrant comes second, it will lose only R&D cost The incumbent (monopolist) has stronger incentives to innovate.
Property rights and static efficiency Intellectual property, just like physical property has the fundamental function of ensuring the fruit of one’s own labor. Transferability is as important as exclusivity as an attribute of intellectual property: it ensures that the asset is used by the party which values it most. ------------------------------------Example: an integrated movie studio (A) makes a hit film Commercial exploitation in the studio’s own movie theaters would generate a discounted net revenue = 100 millions $ A rival exhibitor (B) with a larger network of theaters could generate a net revenue of 120 millions $ A sells to B its property rights for a price 100 millions < x < 120 millions $ Efficient allocation of resources
Negotiating transfers of property rights is the subject of the Coase Theorem: Negotiation results in allocative efficiency as long as property rights are clearly defined and there are no transaction costs. Moreover, resource allocation is efficient regardless of the initial allocation of property rights
Transaction costs: 1. Drafting contracts 2. Monitoring the execution of the contract 3. Inflicting penalties to violators NB. If transaction costs are higher than the benefit of the transaction, the property right will remain in the hands of the less efficient party.
Role of public authorities 1. Granting the property right to the most efficient party Example: non-technical ideas remain in the public domain. This avoids negotiations every time a phrase is pronounced 1. Facilitating the transfer of property rights by reducing transaction costs. Examples: - Associations of authors collect royalties from radio stations and concert and events organizers (in Italy: controversial role of SIAE) - Pools of patents, as in the case of the MPEG2 standard (compression of
video data).
Delimiting intellectual property rights In the case of artistic creation it is easy to identify the boundaries of each property right: the work is protected against literal copying (piracy) The case of inventions is much more cumbersome. The definition of the scope of an invention is left to the inventor himself. Legal requirements: 1. Novelty 2. Non-obviousness 3. Technical feasibility
Detecting and punishing infringements It is generally left to holders of patents to monitor and detect offenses Most disputes are settled out of court because of the high cost of litigation. Economic theory of crime (Becker 1968): In order to be dissuasive, a fine must take into account the probability of detection. A potential economic criminal will abide by the law as long as the benefit he derives from his crime is lower than the penalty multiplied by the likelihood of being caught The lower the probability the higher must be the penalty: this is not the case of most violations of intellectual property rights. High costs of transaction inefficient allocation
The tragedy of anti-commons (Heller-Eisenberg 1998) Several individuals own rights of exclusion. By exercising those rights, they restrict access to common resources. Example: a technology based on two patents held by different innovators To use this technology, companies must negotiate with both innovators higher transaction costs than in the case of a single owner Moreover, the two innovators set prices separately. If one innovator lowers her price, she will sell more licenses. This produces a positive externality on the other innovator, who does not lower his price: he will sell more! lack of incentives to lower prices the technology will be underutilized. This case is exactly the reverse of the tragedy of commons, where a public resource is overexploited.