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Legal Restrictions on Exploitation of the Patent Monopoly: an Economic Analysis

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Legal Restrictions on Exploitation of the Patent Monopoly: an Economic Analysis The Yale Law Journal Volume 76, No. 2, December 1966 Legal Restrictions on Exploitation of the Patent Monopoly: An Economic Analysis William F. Baxter* I. A Frame of Reference The patent laws confer on a patentee power to exclude all others from making, using or selling his invention.' In furtherance of a con- stitutionally recognized goal-"To promote the Progress of Science and the useful Arts"-Congress has thus adopted a constitutionally authorized means--"securing... to Inventors the exclusive Right to their respective . Discoveries."2 The constitutional clause is re- markable in several respects. Its recognition of the possibility that invention might require encouragement implies not only that techno- logical innovation is desirable but also that, but for legal subsidization, the quantity of innovation forthcoming would or might be less than optimum. This recognition, coming on the morn of an era during which the tendency of a free market to achieve optimality in all activ- ities was greatly and religiously overestimated, 3 prompts brief inquiry into the soundness of the supposition. Several considerations support the view that the market would yield less than optimum innovative activity.4 Invention consists primarily of knowledge; and he whose research, experimentation and insight has * Professor of Law, Stanford University. A.B. 1951, LLB. 1956, Stanford University. 1. 35 U.S.C. § 154 (1964). 2. US. CoNsr. art.I, § 8. 3. Cf. JAFFE, A m mTr LAw, CASES AND MATERus 3-8 (1954). 4. See, e.g., Arrow, Economic Welfare and the Allocation of Resources For Invention, in THE RATE AND DIRECTION or INVENTIVE Acrrvry: ECONOMIC AND SOCIAL FAcTOrtS 609 (1962); Machiup, An Economic Review of the Patent System, Study #15 of the Sub. committee on Patents, Trademarks and Copyrights of the Committee on the Judiciary of the U.S. Senate, 85th Cong., 2d Sess. 58-62 (1958) [hereinafter cited as Machiup, Study #15]. 267 The Yale Law Journal Vol. 76: 267, 1966 created it has no obvious means of appropriating it to his own reward. It is fruitless unless used, but any extensive use virtually assures dis- closure and, in time, equal availability to all. As a form of economic activity, invention is attended by much risk even apart from the prob- lem of appropriation, and difficulty of appropriation greatly increases the economic risk. A man debating whether to commit his resources to manufacturing shoes can estimate with tolerable accuracy both how many shoes he can produce in a month and their worth upon com- pletion. If, alternatively, he considers committing those resources to the process of innovation, he can have little confidence in either the quantity of his informational output or its worth when and if pro- duced. A production process characterized by highly uncertain outputs as a function of given inputs will generally attract less than optimum inputs.' For these reasons innovative activity is subsidized in some way and to some extent in almost all advanced economies.0 But to conclude that some subsidization is appropriate is a very short step down the road to firm conclusions about "how" and "how much." This paper is addressed principally to issues raised by the question: "how"; the very little that can be said on the question: "how much," is best said immediately. In the abstract, the criterion for how much subsidy is appropriate is simply stated. Innovative activity should be subsidized as much and no more than is necessary to attract to that activity those inputs which, if invested in any other activity, would yield a product of lesser social value. 7 Market forces can generally be relied upon in areas where no substantial disparity exists between private and social value of either inputs and outputs. Private investment will be attracted to activities in which the private value of output most exceeds private cost of in- puts; and if social and private valuations are comparable, activities with outputs of high social value will not be neglected. The input costs of innovation, both privately and socially valued, are often very large and so too is the social value of its outputs. But the private value of innovative output, if left to be determined by market forces, would usually be small because of unappropriability. Hence private investment in innovation would stop at the point where the next private dollar invested would yield greater private gains if 5. Arrow, supra note 4, at 610-14. 6. WHITE & RAVENSCROFT, PATENTS THROUGHOUT THE WORLD (2d ed. 1944). 7. This is the classic economic criterion for optimal allocation. See, e.g., IBouLDINo, ECONOminc ANALYSIS 168-72 (3d ed. 1955). 268 Patent Monopoly invested elsewhere. Yet the social value of additional innovative out- put, being greater than its private value, would exceed the social value of the output to which investment had been diverted. Corrective diversion of investment from other activities to innovation is desirable because the social value of output gained thereby exceeds that of the outputs lost. That corrective diversion can be accomplished by subsidy. Though subsidy is thus shown to be desirable, the question of how much subsidy is desirable could only be answered by a controlled experiment that would permit measurement of the social value of innovative output and of unsubsidized alternative outputs at each of a series of subsidy levels. Any such experiment is well beyond the reach of present techniques.8 Implicit in the assertion that there is an optimum amount of sub- sidization and that it cannot be determined with any precision is the further assertion that the present amount probably is somewhat too large or too small. Consequently the resources presently being devoted to innovation probably are somewhat too large or too small. The fact that we may already be devoting too many resources to innovation seems worth emphasis because so many commentators accept as abso- lute truth the contrary assumption that additional encouragement of research, or at least the present amount of encouragement, is desirable. 9 That too many resources could be, and perhaps are being, devoted to innovation becomes obvious once it is noted that total resources available are not infinite and that there are competing activities of great social utility to which resources would move if the subsidy for innovative activity were decreased. If fewer hours of highly skilled manpower and lesser quantities of expensive equipment were devoted to innovation, as a society we could have more medical care, education, housing and police protection, just to give a few examples. This would be true even if the output of innovative activity were directly pro- portionate to input at all levels of input; but presumably the law of diminishing returns applies with as much validity to innovative activ- ity as to other activities. The now frequent example of simultaneous 8. Machiup, Study #15, at 60-62. 9. This is true not only of pro-patent writers from whom the assumption might be expected, see, e.g., Frost, The Patent System and the Modern Economy, Study #2 of the Subcommittee on Patents, Trademarks and Copyrights of the Committee on the Judiciary of the U.S. Senate, 84th Cong., 2d Sess. 1-20 (1957), but also from anti-patent writers who are forced by the assumption into the position that the patent s~stem does not significantly encourage innovative activity and does have undesirable side effects. See, e.g., Kahn, Deficiencies of American Patent Law, 30 Am. EcoN. REv. 475 (1940). 269 The Yale Law Journal Vol. 76: 267, 1966 independent discovery of some new process or product is an illustra- tion of diminishing returns. 10 As is implied in the foregoing paragraphs, subsidization by direct payments from tax revenues and subsidization by conferral of a legal monopoly are analogous from the standpoint of their capacity to in- crease, and perhaps to increase too much, the flow of resources to in- novative activity. One might argue that over-investment in innova- tion could not be induced by the monopoly approach. That argument would run as follows. Conferral on the inventor of a monopoly over his invention is a direct attack on the problem of unappropriability and thus tends to equalize the private and social values of the invention. Resource alloca- tion to innovation approximating the optimum would result if in- ventors were granted a total and permanent monopoly over their in- ventions. The inventor could then garner from all who wished to use it the value of his invention in each context in which it was useful, and its private value to the inventor would equal its utility to society. Since no prospective user could be induced to pay more than the value of the invention to that user, private value to the inventor could never exceed social value; and over-investment in innovation would not occur. The argument is unsound because it fails to take into account in- direct costs not borne by the inventor that the monopoly device im- poses on society. These costs diminish the net social value of the invention and upset the private value-social value equation. One of these indirect costs is the following: The monopoly over the inven- tion decreases the incentives of innovators other than the initial pat- entee to engage in further research within the field covered by the monopoly. For any improvement discovered will be subservient to the initial patent and useless in the hands of anyone but the initial patent holder; and in dealing with the initial patent holder the subsequent inventor will occupy a weak bargaining position since he faces a mo- nopsonistic buyer. The extent of this dampening effect increases as the legal life of the initial monopoly is made longer.
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