2012-09-27

A Case Against Patents

I was recently engaged in a debate among acquaintances about patents. Some - like most of my acquaintances - feel that patents foster innovation by granting special rights to innovators. I, on the other hand, oppose patents on grounds that are moral, economic, and philosophical. Perhaps I have spent too much time in the libertarian vortex, because I had nearly forgotten that this is a controversial issue. Indeed, when I first started blogging, I myself was undecided on the issue.

Part of my indecision was the major shortcomings of the Rothbard-oriented arguments against intellectual property. My opinion on those shortcomings still stands, and regular, attentive readers already know that my position on Rothbard in general is one of extreme criticism.

Nevertheless, the notoriety of Stephan Kinsella's Against Intellectual Property speaks for itself: His work has made a major impact on the world's view of copyrights in general, and nothing I say can take that away from what is obviously an important work on the subject.

While his argument is primarily philosophical, I'd like to put forth a more practical set of arguments against patent legislation, and eschew as many Robinson Crusoe arguments as I possibly can. What follows is an attempt to do just that.

Specifically, I will show:
  • There is no evidence to support the claim that patents actually succeed at being reliable incentives for innovation.
  • Patent protection does not offer disproportional benefits to smaller firms relative to big ones.
  • It is, in fact, patent protection that allows a firm to grow so large as to impede the progress of smaller firms in the first place.
If I succeed, then I will have made a robust case for why the patent system is a net burden on society, and that we would all be better off if it were eliminated entirely.

The Virtues Of A Robust Patent System
In order to properly argue against the patent system, we must first understand what its supposed benefits are. According to (the remarkably forthcoming) James Yang, the benefits of patents are: (1) Higher profit margins via market exclusion; (2) Reduced competition via barriers to entry; (3) Incentive to financially settle disagreements rather than litigate; and (4) Expanded market share via patent licensing agreements.

Of course, all of this must be understood in the context of the core claim that patents protect small, start-up investors by allowing them exclusivity while they build their businesses.

A final claim about the patent system is that it provides incentives to innovate. This is the first claim I will attempt to address.

Innovation Incentives
The innovation claim is remarkable in that there is absolutely no evidence to support it. More remarkable still is the fact that major advocates of patents - such as law firms, consultants, and government patent offices - never even mention innovation as a major incentive.

We don't live in a world without patents; patents are the status quo. Any claim that innovation would decrease in absence of patent protection is pure speculation. Therefore, my challenge as a patent critic is to address a non-falsifiable claim for which there is no evidence. Because that is impossible, I am going to focus on the best case patent advocates can make in favor of innovation: pharmaceuticals.

The argument goes that developing pharmaceutical products is such a lengthy (15-20 years sometimes) and expensive process that pharma companies would be unable to do so without their having patents to protect their resources as they develop their drugs. This claim can only be true if one or both of the following conditions are true: (1) Brand pharmaceutical companies require patent protection during the drug development phase, and/or (2) Brand pharmaceutical companies require monopoly profits to compensate them for the development phase.

To the first point, patents are wholly unnecessary for drug development. Regulations mandate that every pharmaceutical product must be thoroughly tested and demonstrated as safe and effective prior to being taken to market. This means that, during the development phase, no company could ever profit from "stealing" any other company's intellectual property without having to undergo clinical research and regulatory navigation. In short, the cost of bringing a stolen patent to market is identical to the cost of bringing a legitimately owned patent to market.

The second point is likewise demonstrably false. (And again, I reiterate that this claim is mere speculation.) That there are insufficient profits to justify research and development would certainly come as news to the multi-billion-dollar market for generic pharmaceutical products. Many of these generic drug manufacturers, by the way, produce their products under patent license of the original brand firm - no joke. In fact, even now, brand companies often produce their own generic versions of drugs they themselves developed. (!)

Given the above evidence, which deals with the industry that supposedly profits most from a robust patent system, I contend that it is fully unreasonable to claim that patents are required for product innovation in that or any other industry

Finally, Bessen and Meurer have shown that "the patent system discourages investment in innovation by the average publicly traded American firm."

Protecting The Little Guy
Having dealt with what I believe to be the most difficult argument in favor of patents, I now turn my attention to the other arguments I listed above. Let's quickly review the pro-patent argument.

Advocates state that patent protection helps the "little guy" by offering the little guy (1) higher profits from exclusivity, (2) greater market share from barriers to entry, (3) a pro-settlement/anti-litigation environment, and (4) access to an expanded market share via patent licensing.

First, let us acknowledge that (1) and (2) are really two ways of saying the same thing. Patent owners earn higher profits because they are the only ones entitled to sell their products. Thus, as monopolists, their market share is obviously 100% and they may charge higher prices free from worrying about competition.

Second, let me make clear that I dispute none of the above claims. They are factual benefits of patent ownership.

The assumption in all of the above, however, is that the patent owner and the "little guy" are the same person. In other words, every benefit of patent ownership is as true for the "big guy" as it is for the "little guy." There is nothing intrinsic in the benefits of a patent that default the scenario in favor of the "little guy."

The "patents protect the little guy" viewpoint took a decided hit on August 24th, when Apple became both the largest company in the history of the world and the recipient of the largest punitive patent settlement in the history of law. For my money, no further remarks are necessary for showing that patent law primarily protects behemoth corporations.

But a few additional points should be noted here:
  • The "little guy" often sells his patent to the "big guy" long before the two ever choose to compete. This is because it is often more profitable to the little guy to sell the rights to his invention outright than to attempt to build a business around it. In these instances, the "big guy" is no worse off than if he had simply stolen the technology and had subsequently been forced to recompense the inventor in a court settlement ex post facto. In fact, this phenomenon is known among economists as the Coase Theorem, named after Nobel laureate Ronald Coase.
  • The above point deals with supposed patent benefit (3), above, too. Whether a patent is legitimately purchased by the big guy or a compensatory agreement is reached later on, the "little guy" is always out-matched. A larger firm will always have greater access to legal resources than a smaller one; therefore, if a "big guy" really intends to steal a patent, the "little guy" is no better protected in an environment in which he cannot afford equal access to the legal system than he would be if there were no patent issue at all.
  • Bessen and Meurer furthermore have it that "patents also impose expected costs on innovators as defendants in litigation." 
Therefore, patent ownership is not a "strict win." It is a win with conditions, a win with costs. One can only reap the benefits of a patent if one has sufficient financial means to defend one's patent in the first place.

The Big Guy Is Only The Big Guy Because He Owns The Patent
Perhaps the most important reason why patents are bad for "the little guy" (and for the consumer) is that it is only through patent protection and corporate welfare that a company can grow so large as to defeat the little guys in the first place.

Absent a patent monopoly, any little guy could copy a product and sell it at a cheaper price (assuming that little guy could capture sufficient economies of scale to do so). If the large firm truly is a coercive monopolist, then it is possible for the large firm to sell the product at a loss for a while, until the "little guy" is out-competed. This, of course, is the very fear held by patent advocates.

It is possible for that to occur for a while. But, in real-world circumstances, we are no longer talking about a single "little guy" up against a single "big guy." When forced to compete against myriad little guys, the large firm cannot possibly sell a product at a loss long enough to put every little guy out of business. It is an economic fact that, with a sufficient number of competitors, no one company however large or small can sell a product for anything other than the equilibrium price in the long run.

Indeed, it is only through monopoly protection that a company can avoid competing with other firms. Thus, it is this very patent protection that enables a firm to grow sufficiently large as to be able to obstruct the "little guy's" market.

One important final note here: If it happens that one firm in a given market captures economies of scale so significant that it can under-cut the price of all other competitors in the long run, then the net gains to consumers of this product are no different than the purely competitive outcome. (See your Fundamentals of Microeconomics course for details here.)

Conclusion
Above, I have shown the following:
  • The innovation incentives of patent law are, at best, highly over-stated with little evidence to support them; and they are, at worst, entirely false and baseless claims.
  • All direct financial benefits to patent holders apply equally to large firms and small firms, therefore patents offer no disproportional benefit to "little guys."
  • The largest single beneficiary of patent legislation also happens to be the largest corporation in the history of the known universe.
  • Large companies only grow as large as they grow because they hold legally enforceable monopolies that enable them to exclude competitors from the marketplace; absent that legal protection, no firm would ever grow so large - and even if it did, the long-run outcome would be equivalent to the purely competitive market.
Considering the above, I consider all arguments in favor of a robust patent system to be thoroughly defeated. ;)