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We are all familiar with the argument that patents incent investments in innovating activity by helping inventors appropriate more than their costs. Yet, interpretations of the classical ex ante justification for patents often misconstrue the cost of innovation, and thereby underestimate the role of patents. The first major misconception of the cost of innovation equates it with the cost of copying an invention, while the second considers only the finished product as pertinent to overall cost of invention. These arguments generalize about the entire innovation process after overly limiting scope of analysis, and consequently distorting the amount inventors need to appropriate.
The first misconception of the cost of innovation looks at merely the cost necessary to copy an invention after it exist. Years ago Professor Kitch addressed this argument when he brilliantly outlined common flaws in analyzing IPRs: "...the marginal cost of making copies is not the relevant... cost... marginal cost should include all ...costs necessary to bring the good to market...” Recently, Solveig reiterated Kitch’s argument by explaining how Coase's marginal cost model is of value in furthering Newtonian analysis, not in actually calculating the cost of innovation, since transaction-information costs are simply one part of the picture in invention.
The second misconception of cost of innovation relates the cost only to the finished product. In the business of innovation, this argument runs into practical impossibility. Firms never get it right in one shot. Testing, configuration with complementary and upstream/downstream technologies and adapting a product for the market are expensive and risky ventures that require investment. As with any other kind of investment, these aspects of innovating activity will be underperformed without means of appropriation, such as patents. Investors need to recoup the cost of their finished inventions, but also costs incurred in arriving at those inventions. In Innovation and its Discontents, Jaffe/Lerner explain: For the overall “game” of investing in new technology to be worthwhile, the successes must earn enough profit to cover not only their own costs and reasonable return, but also the costs and a reasonable return on those costs for all of the failures. Otherwise, the overall investment strategy will be a loser.
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…many R&D investments produce large negative returns. That is, you may invest $100 and simply lose it all. It is easy to see that this likelihood increases even further the profit that must be earned on the “successes,” if the overall return on a portfolio of investments is to be adequate.
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…the high risk associated with R&D tends to discourage firms from undertaking it, even if the rewards are reasonably high. Investment in new technology is therefore handicapped by its riskiness, when compared with other forms of spending… Arguments that take a small part of innovation as the overall cost of innovation assume several things. First, analyzing only costs of copying finished products or those directly relating to finished products implicitly put forth a static model of innovation, since they assume the existence of an invention. Second, patent critics will often try to generalize by focusing on the small things. Whether it be critiquing one patent at a time to judge all patents, taking one example of an innovative firm that does not leverage patents to argue that patents are never important, or looking at only a few cases to argue the litigation impact of patents, patent critics often side-step analysis of the aggregate and focus instead on molehills. The aim of patents is to further innovation, and innovation should not be deterred by patent policy analysis that fails to look at the larger picture.
posted by Noel Le @ 8:26 AM | Academia, Patents
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