International Think-Tank on Innovation and Competition
The Role of Intellectual Property Rights in Promoting Innovations:
between the Pharmaceutical Sector and the New Economy
September 6th, 2005
Economic research has repeatedly emphasized the positive relation linking patents to investments in innovation and these investments to technological progress and growth: this is the main focus of the research by Joseph Schumpeter in the first half of the last century. Today we can fairly say that in high-tech sectors (think of hardware, software, pharmaceuticals, biotechnologies,…) firms compete mainly by innovating. This is possible as long as there are well defined IPRs, and especially patents, defending their innovations and investments, which is ultimately what leads technological progress in our economies.
Moreover, even if most economists are used to thinking about market leaders as firms with weaker incentives to invest in R&D, recent theoretical and empirical research has also noticed that market leaders play a crucial role in the innovation sector for competitive markets (see The Economist, Slackers or Pace-setters? Monopolies may have more incentive to innovate than economists have thought, Economic Focus, May 2004). Market leaders invest a lot in R&D: for instance, in the last years Microsoft spent more than 16 % of its turnover, Pfizer and Novartis (leaders in the pharmaceuticals sector) spent more than 15 %, Intel spent 11,5 %, Motorola 11,8 %, Nokia 8,5 %, IBM, Hewlett Packard and Xerox between 5 and 6 %, and so on. The fact that these companies remain at the top of the technological frontier in their respective industries is not the sign of a monopolistic position in the traditional sense, but the fruit of their investments and of the competitive threat deriving from other firms and potential entrants. Theoretical research on the endogenous market structures has recently clarified the mechanics of these results. In a sense, patents drive competition through innovation in these markets and induce technological progress led by market leaders.
To understand the role of IPRs in promoting innovation we rely on a old argument by William Nordhaus. In general, the arguments goes, patents create a temporary monopolistic power for the innovators, which creates price distortions and hence a social cost, but they also create the incentives for many firms to invest and try to gain market leadership, and this investment leads to social benefits through technological progress and growth. Clearly social benefits and costs can be different for different inventions and in general for different fields of technology. For simplicity and to avoid discriminations between fields of technology, patents have typically a uniform length. Nevertheless, from a strictly economic point of view one may question such a uniformity and evaluate the advantages for different levels of protection in different sectors (at least this could avoid the inefficient choice of radically excluding certain innovations from patentability rather than allowing a more limited protection). More importantly, an evaluation of the social benefits and costs of patents for different fields is essential in judging the net benefit of a patents system.
Let us consider an example concerning the pharmaceutical sector, where the role of patents on new drugs is, to say the least, at the basis of competition in the market and of scientific progress in the world. These kinds of patents have been often criticized for jeopardizing health defense around the world and especially in developing countries, where western drugs are very important but very expensive: in other words the social cost of patents on drugs can be high. Nevertheless, one should not forget that those same patents induced many firms to invest and some of them to invent new drugs which are now available, something which would have hardly happened otherwise: in other words the social benefit of patents on drugs is very high. Fortunately there are ways to reduce the problems related with the pricing of drugs and their adoption depends mostly on the public sector. For instance, governments could buy drugs and distribute them at lower prices through the medical system, or just pay part of the prices. They may even directly buy the same patents from the innovators and produce the drugs (or outsorce their production) and sell them at lower prices. Finally, western governments could redirect their international aids toward similar initiatives in favour of developing countries. These solutions, widely discussed in the economic literature, may preserve the proper incentives to invest and discover new drugs while spreading their effects globally. Ultimately, this suggests that patents in the pharmaceutical sectors are a crucial determinant of innovations and should be enforced while finding alternative solutions to guarantee health defense for poor classes and poor countries.
Consider now another example which is essentially related with the New Economy and the main kind of research which is underlying it: that concerning computer based innovations. This is quite interesting since in the last years the European Union tried to complete a process of harmonization of the patent system for computer-implemented inventions with the aim to provide proper incentives to invest and innovate in the New Economy, something which was realized in the United States since the 80s. After a long procedure, the Common Position adopted by the European Council in March 2005 proposed the patentability of computer implemented innovations when they provide a technical contribution to a field of technology. While this positive proposal simply reaffirmed the requirements already adopted in Europe for the last two decades and it excluded from patentability any pure software, business methods and consulting practices (which are patentable in US), part of the European Parliament proposed a number of amendments aimed at radically changing the current situation which excludes most of the innovations in the Information and Communication Technology from patentability. As a consequence of such a confusing situation, the European Parliament ended up rejecting the all Directive in July 2005. While this avoided the introduction of those dangerous restrictions on patentability, there is still a need for a deeper harmonization of the European patent systems (not just for computer based ones, but for all fields since each one of the Member States still has its own patent system!) and the debate is likely to continue in the near future. Notice that the rationale for patents on computer based innovations is quite strong. While the main social gain from all patents on computer based innovations is to promote innovation in the most dynamic sectors, the social cost, traditionally associated with market power of patentholders, is smaller than for other patents since in these sectors competition mainly works through frequent price-reducing and quality-improving innovations. Neglecting these traditional economic insights, opponents of the patent system have often claimed that patents stifle innovation. Unfortunately, even the evidence on the US experience provided by few works against these patents does not convincingly support such a view. The extension of patent protection to software related inventions started in 1980 (the first patent of this kind was granted by the US Patent and Trademark Office in 1981) and it was associated with a clear increase in R&D investment during the eighties. The R&D/sales ratio for US firms innovating on computer, telecommunications and electronic components (the relevant field here) increased from 5.5% to above 8% in 1989. Moreover, the works against patentability did not compare investment in computer based innovations with investment in other technologies and did not take into account other (macroeconomic or sector-specific) factors, hence there is no any rigorous econometric evidence against patents which could be drawn from the American experience. Nevertheless a misleading interpretation of this research has created a lot of confusion in the debate on patent protection.
These examples and the economic research underlying them allow us to draw a number of conclusions and suggestions for the future debate on rules for high-tech patents, with particular reference to the European debate:
- protecting IPRs is necessary to properly promote innovations, but an optimal patent system should trade-off social benefits and costs, eventually enforcing more IPRs in those fields, as the New Economy, where the net benefits of patents are higher or those fields, like the pharmaceutical sector, where social benefits are higher and there are proper policies which can reduce the social costs;
- restrictions to the patentability of innovations in high-tech sectors for one country or a group of countries could severely jeopardize investment in innovation and technological progress in the leading high-tech sectors with negative consequences on growth and competition in the global economy and would shift investments toward other countries where IPR are better protected; moreover, limitations to the enforcement of the current patent system would open doors to foreign low cost productions which, without patent protection, would be free to imitate even high-tech production, with negative consequences on employment and on innovative firms;
- improvements of the effectiveness of the current patent systems should rather promote access to patents especially for SMEs, traditionally less able to exploit this opportunity (in this sense, it would helpful to establish institutional ways to provide financial, technical and administrative support to SMEs dealing with patents);
- enhancement of the spillovers created by the patent system on the diffusion of knowledge could be obtained through further requirements on a disclosure of the patented inventions which should be sufficiently clear and complete to be carried out by a person skilled in the art.
For more on this subjetc see the Innovation debate.
