Background

2.1 Property rights

Property rights are social constructs that confer exclusive use-rights of a specific item upon an individual. Although these use-rights are exclusive, they are not unlimited. An individual who owns property rights to a specific item is constrained in its use by the usual libertarian criterion that one cannot infringe upon another individual's civil rights. Thus, for example, an individual has the right to possess a firearm, but the uses to which it may be put are limited. An individual's use rights are further constrained by society's reservation of the right to removal for the social good. Precedents for this removal of individuals' property rights include expropriation of land for public infrastructure building and seizure of goods allegedly obtained through illicit means. An individual's remaining use rights can, however, be protected in many ways. These include maintaining important related secrets, developing brand identities, and acquiring patents, trademarks, or copyrights. The legal methods of protection are the subject of this paper since they are a state- sanctioned institution that, at times, can conflict with society's aforementioned right of removal.

Contrary to popular belief, intellectual property rights (IPRs) are no different than traditional property rights. IPRs, like traditional property rights, are a social mechanism to formally recognize ownership. They confer upon an individual who purchases a specific item, whether that purchase is through monetary expenditures or through expenditures of mental and physical labor, the right to be compensated for the use of that item. Confusion abounds, though, because the specific items purchased under these different nomenclatures are often fundamentally different. Traditional property rights usually refer to an item that is embodied in some physical object (such as land), whereas IPRs often refer to an item that is fundamentally an idea and is, therefore, often disembodied.

The fundamental difference between embodied and disembodied items is often characterized as being rival or nonrival in use. A physical object, such as a computer, is characterized as a rival good because only one person is able to use it at any given time. It is, therefore, quite easy for the owner of the property right to exclude others from using the item. A disembodied item, such as the knowledge of how to build a computer, is characterized as nonrival because more than one person can use that knowledge at the same time. Since these disembodied items are often "new ideas," once they are produced, excluding others from using them is often difficult because monitoring and enforcing the exclusive use-right is very costly. Establishing IPRs in law is one possible way to reduce these transaction costs. Many individuals will not willingly break the law, thus monitoring and enforcement become unnecessary in many situations. However, choosing to employ the legal system involves assuming its own unique set of transaction costs, and the outcome of the relevant cost/benefit analysis is far from assured.

In effect, establishing effective IPRs transforms an inherently nonexcludable, nonrival "new idea" into the same circumstances as an excludable, rival good. This is important because without excludability, it is difficult to extract rent in return for the production of the good. Thus, IPRs are necessary to provide the incentive that motivates the employment of private resources in the production of the inherently nonrival good. In other words, IPRs allow the market mechanism to "pull" the production of new ideas. However, even with IPRs, not all new ideas will be produced privately—particularly those with high sunk costs and high monitoring/enforcement costs. In Sections 3 and 4 a model is developed of the social decision in choosing an IPR regime, and the associated welfare implications are discussed.

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