The innovation effects of changes in IP market strength and structure are best examined through the impacts of these changes on IP owners' net revenues and IP users' net costs. Owners' net revenues are their nominal contract revenues minus contract enforcement costs. Users' net costs are their nominal contract costs plus the product of their conditional contract compliance costs (i.e. assuming technology use is detected) and the probability that the use will be detected. Nominal contract revenues and costs are those implied by the contract licensing clause itself and, provided the contract is enforced, represent the value transferred from IP user to owner.
Innovation effects of intellectual property market strengthening
Much of the economic literature on patent policy focuses on isolated innovations, emphasizing the static trade-off between the incentive to innovate and the deadweight loss of monopoly. The underlying assumption is that each innovation stands alone; the character of one invention has no effect on the incentives to produce another. Although the debate about the static efficiency of IPR has not yet been settled, there is little doubt that strength of patent protection is positively related to innovation in a static sense, in which only the patent owner's incentives are considered. As explained earlier, stronger patent rights reduce the owner's contract enforcement costs and, ceteris paribus, increase his or her net revenue,
Secrecy in basic science
increasing the scope of risky projects in which he or she is motivated to invest. Declining owner enforcement costs brought about by rising patent strength are represented by the downward sloping curve in Fig. 14.1.
The importance that patent enforcement costs have for enabling a firm to appropriate the returns to its R&D likely differs between large and small firms. In some studies (e.g. Mansfield, 1986; Cohen et al., 2000), research firms have reported that factors such as getting a head start, establishing their own production facility, and developing effective marketing and distribution channels are more important than patents in allowing the firm to profit from its inventions. These studies focus primarily on established firms, which generally have access to complementary manufacturing and distribution assets. But for start-up firms with few such complementarities, strong patent rights tend to be the necessary ingredient for the licensing, joint venture, or acquisition activities through which compensation is achieved. Indeed, the highly innovative small to medium-sized firms that specialize in biotechnology research would never have emerged had they not anticipated patent protection (Mazzoleni and Nelson, 1998).
Rising property rights, especially over rather basic molecular research findings, also have a negative side. Scientists intending to publish their findings are motivated to announce their efforts, through working papers or seminars, as quickly as possible in order to claim recognition for the underlying idea. Those intending to patent their findings are motivated instead to maintain secrecy, as no property awards are available for half-developed inventions. Scientists operating in a patenting culture operate in secrecy. While secrecy environments are appropriate for motivating effort when success occurs in such discrete and cumulatively expensive forms, such as a new tomato variety, it is inappropriate when progress is more incremental, as when a molecular biologist develops an initial chart of a biosynthetic pathway. In particular, the veracity of basic scientific claims is best established in a culture in which the claims are openly exposed to challenge, and this is possible only if every finding is quickly and freely available. The growing university incentive to patent has palpably increased the incidence of secrecy in many academic bioscience laboratories and is the source of much concern in the university, and even the industry, life science community. The scientific secrecy which a property rights culture encourages is represented by the positively sloping line in Fig. 14.1.
In sum, as IPRs grow, society gains in the form of declining contract enforcement costs, hence raising incentives to innovate. At the same time, society loses in the form of declining scientific communication, hence declining confidence in the basic science upon which applied biotechnology depends. Changes in IP market strength induce a trade-off between producer incentives and user information. As every scientist is both a producer and a user, the choice of an optimal balance between incentive and information is delicate, best achieved piecemeal in the decentralized interaction among innovators, courts, patent office, and state and federal legislators.
Innovation effects of intellectual property market fragmentation
In what Merges and Nelson (1994) call a systems technology, product manufacturing typically involves the use of components that are already patented by other parties. Agricultural biotechnology is one such systems technology, in which innovations are increasingly dependent on an array of separately held techniques, genetic materials, and laboratory instruments. As this array becomes further fragmented with the deterioration in the scope and quality of the average biological utility patent, the laboratory user's compliance cost - the informational, organizational, and negotiating expenses of obtaining from the supplying patent-holders the permission to commercialize the user's own innovation - rises. Such costs are quite apart from any royalties that the user eventually pays once the negotiations are complete and acts as a substantial drag on innovation. A striking example is the development of Golden Rice at Cornell University, which turned out, ex post, to involve more than 50 separate units of patented IP, permissions from each of which had to be granted before the rice could be developed for sale.
A case in which patent fragmentation would especially severely inhibit innovation is what Heller and Eisenberg (1998) called the 'tragedy of the anticom-mons.' Each supplying patent-holder may become aware that his own permission is critical to the user's enterprise. Each, then, may be tempted to demand excessive compensation, especially in so far as other patent-holders are known to have already granted their rights. The same hold-up arises when certain small property owners, finding they are the last to sell, block a major civic construction project until excessively bribed. In sum, patent fragmentation boosts users' IP costs, and thus total innovation costs, through its influence on both compliance costs and hold-out compensation demands. These innovation-retarding effects are indicated by the upward sloping line in Fig. 14.2.
Although some patent fragmentation likely increases the number of separately held inventions that are mutually complementary to the user's laboratory work, other fragmentation, as indicated earlier, probably enhances patent substi-tutability. Such substitutability militates against owner market power by providing users with greater choice in laboratory methods. To the extent that patent fragmentation is substitution-boosting, it reduces laboratory users' IP costs and
Market power in
Compliance costs input"'P Market
Compliance costs power
More concentrated < claims
Less concentrated claims
thus stimulates innovation. This effect is represented by the downward sloping line in Fig. 14.2. An innovation-maximizing patent fragmentation policy would be one that balances fragmentation's compliance and hold-up costs with its market-power-reducing benefits. Such balance clearly depends on the proportion of patents that are complementary to, rather than substitutive with, one another in the laboratory tool kit. An analysis similar to Fig. 14.2 can be constructed for the distribution of IP among firms rather than patents.
We have outlined the strength and structure of intellectual bio-property markets, examining the impacts of these two market elements on IP suppliers and users, market performance, and the rate of innovation. Before 1980, weak IPR left suppliers of agricultural biotechnology with few innovation incentives. In an immediate sense, at least, laboratory and consumer users held sway. Since then, IP supplier interests have gained heavily at the expense of IP users. Improvements in communication and stronger legal protections have reduced contract enforcement costs, increasing the expected net earnings from new inventions. On the other hand, fragmentation in agricultural biotechnology markets has boosted user contract compliance costs, impairing downstream users' own innovation incentives. In a word, the strengthening and expansion of the patenting culture and infrastructure has, while protecting supplier interests, substantially impaired user interests. Many argue that agricultural bio-property markets have moved too far in the favour of suppliers, isolating scientists from useful germ-plasm, genes, and procedures, and forcing them - inefficiently - to invent around patented technologies. Solutions to this problem range from more restrictive patenting policies to the development of patent pools, exchanges, and other IP market mechanisms.
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