IRL lecture notes 08 September 2004
Stephen MartinDepartment of Economics
Krannert School of ManagementPurdue University
West Lafayette, Indiana 47907-1310USA
August 2004
Abstract
590U080904.pdf
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Contents
1 Estimated rates of return to R&D 31.1 Private return to R&D . . . . . . . . . . . . . . . . . . . . . . 31.2 Social return to R&D . . . . . . . . . . . . . . . . . . . . . . . 3
2 Intellectual property rights 52.1 Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52.2 A little bit of history . . . . . . . . . . . . . . . . . . . . . . . 72.3 Pros and cons . . . . . . . . . . . . . . . . . . . . . . . . . . . 92.4 Problems with current system . . . . . . . . . . . . . . . . . . 102.5 Imperfect appropriability . . . . . . . . . . . . . . . . . . . . . 112.6 Patents as protective devices . . . . . . . . . . . . . . . . . . . 132.7 Other types of government support for R&D . . . . . . . . . 16
3 Universities and innovation 18
4 Antitrust & intellectual property rights 194.1 Main provisions of US & EU antitrust (competition policy) . . 194.2 US IP decisions . . . . . . . . . . . . . . . . . . . . . . . . . . 204.3 EU IP decisions . . . . . . . . . . . . . . . . . . . . . . . . . . 21
4.3.1 IBM settlement . . . . . . . . . . . . . . . . . . . . . . 214.3.2 Hilti AG v. EC Commission . . . . . . . . . . . . . . . 21
4.4 R&D joint ventures . . . . . . . . . . . . . . . . . . . . . . . . 224.4.1 US legislation . . . . . . . . . . . . . . . . . . . . . . . 23
5 References 23
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1 Estimated rates of return to R&D
1.1 Private return to R&D
Extra profit, minus cost of development, of the innovator.
1.2 Social return to R&D
Gross benefits of a capital good innovation that lowers cost of production inusing industries:(a) part or all (depending on how competitive the using industries are) ofthe cost reduction will be passed on to consumers in the form of lower prices.The social benefit is the price reduction times the number of units that wouldhave been sold at the previously higher price, plus consumer surplus on unitsthat are sold at the lower price but would not have been sold at a higherprice;(b) Profits of the innovator, plus profits of imitative innovators, minus lostprofits of input suppliers displaced by the innovation, and minus costs ofunsuccessful innovators, are a social gain.The social benefit of new product innovation can be analyzed in a similar
way, but details are more complicated and are skipped here.Estimates of the private and social rates of return to investment in in-
novation are at best approximate, but show (for typical results, see Table1)
• that the private rate of return to investment in R&D is greater thanthe rate of return to other types of investment; and that
• the social rate of return to investment in R&D is greater than theprivate rate of return to investment in R&D.
These results suggest the existence of market failure in innovation – incontrast to other types of goods and services, it appears that society cannotrely on Adam Smith’s invisible hand of competition to produce the sociallyoptimal amount of innovation.
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Rate of return (%)Innovation Social PrivateNew type of metal that reduced cost of ap-pliances
17 18
Machine tool innovation – new computercontrols
83 35
Component for control system 29 7Construction material – reduce cost ofbuilding
96 9
Drilling material – reduce cost of drillingwells
54 16
Industrial equipment – new type of drafting 92 47New paper product that cuts cost of users 82 42New type of thread that cut costs of garmentmakers
307 27
New mechanism for doors 27 37New device that reduced costs of certainvideo tape operations
negative negative
Chemical product innovation– new productthat reduced costs of users
71 9
Chemical process innovation – reducedcosts of production
32 25
Chemical process innovation – reduced costof certain aromatic chemicals
13 4
Major chemical process innovation 56 31Household cleaning device – new productthat reduced cost of cleaning floors
209 214
New stain remover 116 4Dishwashing liquid – new product that cutcosts of operating dishwashers
45 46
Median 56 25
Table 1: Social and private rates of return from investment in seventeeninnovations. Source: Mansfield et al. (1977).
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A couple of points by way of digression:
• If resources are optimally allocated among all possible uses, the rate ofreturn on all types of investment (care being taken to allow for differentlevels of riskiness of different kinds of products) will be the same. Ifthe rate of return on investing in the construction of new apartmentbuildings in West Lafayette is low, and the rate of return to investing inthe development of energy-efficient motor vehicles is high, society wouldbe better off with more investment in energy efficient motor vehiclesand less investment in new apartment buildings in West Lafayette.
• Market failure occurs in the presence of common property resources –there are good cases to be made that a competitive system producestoo much pollution, and that competitive commercial fishing overfishesthe oceans.
• Market failure may arise in the presence of certain kinds of uncertainty:sellers of used cars take a loss on the “objective" value of a used carbecause it is known that some used cars are lemons, some are not, andbuyers cannot distinguish the two types of used cars at reasonable cost.
That there is market failure in innovation makes a case for public supportof innovation and of private investment in innovation.Public policies to promote innovation take many forms. One such policy
is the establishment of intellectual property rights.
2 Intellectual property rights
2.1 Definitions
Mansfield (1993, p. 108)
Intellectual property consists chiefly of patents, plant breeders’rights, copyrights, trademarks, and trade secrets.
United States Patent and Trademark Office(http://www.uspto.gov/web/offices/pac/doc/general/whatis.htm)
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A patent for an invention is the grant of a property right tothe inventor, issued by the Patent and Trademark Office. Theterm of a new patent is 20 years from the date on which theapplication for the patent was filed in the United States or, inspecial cases, from the date an earlier related application wasfiled, subject to the payment of maintenance fees. . . .The right conferred by the patent grant is . . . “the right to
exclude others from making, using, offering for sale, or selling”the invention in the United States or “importing” the inventioninto the United States. What is granted is not the right to make,use, offer for sale, sell or import, but the right to exclude othersfrom making, using, offering for sale, selling or importing theinvention.A trademark is a word, name, symbol or device which is used
in trade with goods to indicate the source of the goods and todistinguish them from the goods of others. A servicemark is thesame as a trademark except that it identifies and distinguishes thesource of a service rather than a product. The terms "trademark"and "mark" are commonly used to refer to both trademarks andservicemarks.Trademark rights may be used to prevent others from using a
confusingly similar mark, but not to prevent others from makingthe same goods or from selling the same goods or services undera clearly different mark. . . .Copyright is a form of protection provided to the authors of
“original works of authorship” including literary, dramatic, musi-cal, artistic, and certain other intellectual works, both publishedand unpublished. The 1976 Copyright Act generally gives theowner of copyright the exclusive right to reproduce the copy-righted work, to prepare derivative works, to distribute copies orphonorecords of the copyrighted work, to perform the copyrightedwork publicly, or to display the copyrighted work publicly.The copyright protects the form of expression rather than the
subject matter of the writing. For example, a description of amachine could be copyrighted, but this would only prevent othersfrom copying the description; it would not prevent others fromwriting a description of their own or from making and using themachine.
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Friedman et al. (1991, pp. 61—2):
A trade secret is an item of information–commonly a cus-tomer list, business plan, or manufacturing process–that hascommercial value and that the firm possessing the informationwants to conceal from its competitors in order to prevent themfrom duplicating it. . . .A trade secret is not property inthe usual sense–the sense it bears in the law of real and per-sonal property or even in such areas of intellectual property lawas copyright–because it is not something that the possessorhas the exclusive right to use or enjoy. If through accidentthe secret leaks out, or if a competitor unmasks it by reverse en-gineering, the law gives no remedy. The law does give a remedyif the secret is lost through a breach of contract–say by a formeremployee who had promised not to disclose what he learned onthe job . . . But the violation is not of a property right to the se-cret but of a common law right defined without regard to tradesecrets . . .
2.2 A little bit of history
The earliest patents – in late 15th-century Venice, in Elizabethan England– were not policies aiming to encourage innovation by establishing an inno-vator’s property rights over his innovation. Rather, patents were granted toskilled craftsmen from foreign parts who would agree to train locals in a hith-erto unknown art (as, the production of specialized textiles). The patentwas a protection of the skilled craftsman against too-prompt competitionfrom those he trained.The first English patents were for a period of 14 years, twice the standard
7-year apprenticeship.The earliest copyrights were not granted to establish an author’s right to
control his own work. Copyrights were sought by publishers in early 16th-century England and the Netherlands to control (prevent) ruinous competi-tion.For more on both these points, see David (1993).Legal basis of U.S. intellectual property law: Article I, Section 8 of the
U.S. Constitution grants to Congress the right
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To promote the progress of science and useful arts, by securingfor limited times to authors and inventors the exclusive right totheir respective writings and discoveries. . .
The desirability of a policy of patent protection has in the past beenvigorously debated (Machlup and Penrose, 1950) on terms that we will reviewbelow.Today the broad outlines of received intellectual property policy are usu-
ally defended by the governments of developed countries and challenged bythe governments of less-developed countries (pharmaceutical patents being afrequent target).It may, however, be noted that in the immediate aftermath of the Sep-
tember 11, 2001 terrorist attack on the United States, the U.S. governmentcontemplated the possibility of arranging production of large amounts of an-thrax vaccine by firms that were not licensed to do so by the patent holder.30 August 2003: World Trade Organization agreement to finesse strict
application of patent rules:
Under WTO rules, countries facing public health crises have theright to override patents on vital drugs and order copies fromcheaper, generic suppliers. However, until now they could onlyorder from domestic producers — a useless loophole for the hugemajority of developing countries that have no domestic pharma-ceutical industry.
U.S. pharmaceutical research companies were concerned that adeal allowing countries to import generic drugs would be abusedby generics manufacturers and could also lead to drugs beingsmuggled back into rich countries.
To satisfy those concerns, the document was accompanied by thenew statement setting out conditions for using the measure.
The statement says rules allowing countries to override patents“should be used in good faith to protect public health ... not be aninstrument to pursue industrial or commercial policy objectives.”
It calls for special measures to prevent drugs being smuggled backto rich country markets, including special packaging or differentcolored tablets. Developed countries would agree not to make useof the provision.
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Current controversy: fractalization of standards for receiving a patent.Atlantic Works v. Brady (107 U.S. 192 at 200), the U.S. Supreme Court
writing in a decision declaring a patent for a dredging boat invalid becausethe patented object was not sufficiently novel:
The design of the patent laws is to reward those who make somesubstantial discovery or invention, which adds to our knowledgeand makes a step in advance in the useful arts. Such inventors areworthy of all favor. It was never the object of those laws togrant a monopoly for every trifling device, every shadowof a shade of an idea, which would naturally and sponta-neously occur to any skilled mechanic or operator in theordinary progress of manufactures. Such an indiscriminatecreation of exclusive privileges tends rather to obstruct than tostimulate invention. It creates a class of speculative schemers whomake it their business to watch the advancing wave of improve-ment, and gather its foam in the form of patented monopolies,which enable them to lay a heavy tax upon the industry of thecountry, without contributing anything to the real advancementof the arts. It embarrasses the honest pursuit of business withfears and apprehensions of concealed liens and unknown liabil-ities to lawsuits and vexatious accountings for profits made ingood faith.
2.3 Pros and cons
Arguments in favor of patents and other forms of intellectual property rights:
• incentive to get inventor to invest time and resources needed to producean innovation
• incentive for firms to invest time and resources needed to commercializean innovation
• facilitate more rapid disclosure of the nature of innovations, thus stim-ulating follow-up innovation
Arguments against patents and other forms of intellectual property rights:
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• patents create a legal monopoly, and allow the patent holder to main-tain a price greater than marginal cost of production while the patentis in place. Strategic use of patents may allow the patent-holding firmto block the access of legitimate competitors to the market
• Because the price of the patented item/process can be held above themarginal cost of production, it is not used as much as it should be,from a social point of view.
• Patents are not in fact a particularly important appropriability mech-anism in most industries.
• Against the argument that the lure of economic profit is needed toinduce firms to invest in commercialization (this might be termed the“no gain, no pain" argument) is the counterargument that the threat ofthe economic losses that will be suffered if a rival firm commercializesfirst is just as powerful an incentive for business innovation (The RedQueen principle: it takes all the running you can do to keep in thesame place.)
2.4 Problems with current system
See handout, two columns by Gary Stix (Scientific American June and July2004), discussing
Jaffe, Adam B. and Josh Lerner Innovation and Its Discontents: How OurBroken Patent System is Endangering Innovation and Progress, andWhat to Do About It. Princeton: Princeton University Press, 2004.
• 1982: Congress creates Court of Appeals for the Federal Circuit (CAFC)to hear all appeals in patent cases
Theory:
• — eliminate “forum shopping”–hunting for an appeals court thoughtlikely to give a favorable ruling
— develop body of expertise on IP in court system
Practice: “regulatory capture”: CAFC rulings have strengthened patentrights in a way never thought possible and without any mandate fromCongressto do so.
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• early 1990s: regulatory capture once again – funding of U.S. Patentand Trademark Office is shifted from the general budget (taxpayerfunding) to fees it charges for processing patent & trademark appli-cations.
Result: widespread granting of patents for narrowly defined innovations,many of which are well known to practitioners in their technology area.Suggested resolution:
• screen patents
• wave minor innovations through
• for other applications, have a public process at which practitionerswishing to do so can present arguments/evidence that the “innovation”is already known or would be obvious to one skilled in the art.
A public process of this kind would relieve the workload of badly over-burdened patent examiners.
• Continue to allow appeals of patent decisions to the courts (trial byjudge, not trial by jury).
2.5 Imperfect appropriability
Table 2: on average (bottom row), rivals become aware of new product de-velopments in about a year, less rapidly for new processes.How does information about process and product innovations circulate?
• researcher job mobility
• professional publications, associations
• reliance on common pure science foundations
• indirect transmission of information by suppliers, customers
In some sectors – pharmaceuticals, for example – these kinds of infor-mation spillovers seem to be an essential part of the innovation process; fewfirms would bring innovations to completion without benefiting from someknowledge spillovers from other firms, and in the process of absorbing somespillovers, some of their own knowledge leaks out.Mansfield (1996, p. 119):
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New products New processesIndustry <6 6-12 12-18 >18 Total <6 6-12 12-18 >18 TotalChemicals 18 36 9 36 100 0 0 10 90 100Pharmaceuticals 57 14 29 0 100 0 33 0 67 100Petroleum 22 33 22 22 100 10 50 10 30 100Primary metals 40 20 0 40 100 40 40 0 20 100Electrical equip-ment
38 50 12 0 100 14 14 57 14 100
Machinery 31 31 31 8 100 10 20 30 40 100Transportationequipment
25 50 0 25 100 0 67 0 33 100
Instruments 50 38 12 0 100 33 33 33 0 100Stone, clay, andglass
40 60 0 0 100 0 20 20 60 100
Other 31 15 15 38 100 27 0 36 36 100Average 35 35 13 17 100 13 28 20 39 100
Table 2: Percentage distribution of U.S. firms, by average number of monthsafter development before the nature and operation of an innovation are re-ported to be known to riivals. Source: Mansfield (1985, 1996).
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The extent to which the social benefits from R&D are appropri-able depends on how much competition the potential innovatorfaces and on the kind of research or development activity in ques-tion. The more competition there is, and the more basic the R&Dactivity, the less appropriable the benefits are likely to be.
2.6 Patents as protective devices
Levin et al. (1988) survey R&D executives in R&D-intensive industries onthe effectiveness of secrecy, lead time, learning-curve effects, sales and serviceefforts and patents as appropriability mechanisms. They (Nelson, 1992, pp.62—3)
. . . distinguished three broad classes of means through whichfirms are able to appropriate returns to their innovations–throughthe patent system, through secrecy, and through various advan-tages associated with exploiting a head start. . .. . . in most industries, a head start and such associated advan-
tages as ability to move down the learning curve ahead of one’scompetitors, or getting ahead in sales and service, were rated asthe most effective means [for appropriating returns to productinnovation].semiconductors, computers, telecommunications, aircraft . . .
imitation of a new product is time consuming and costly even ifit isn’t protected by patents.Patents important in
1. “industries where chemical composition is a central aspect of design:pharmaceuticals, industrial organic chemicals, plastic materials, andsynthetic fibers."
2. “industries producing products that one might call devices: air andgas compressors, scientific instruments, power-driven hand tools, etc."(where reverse engineering is relatively straightforward).
Secrecy is effective in protecting process but not product in-novation.
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Product innovations % Process innovations %Lead time 52.76 Secrecy 50.59Secrecy 51.00 Complementary manu-
facturing facilities andknow-how
43.00
Complementary manu-facturing facilities andknow-how
45.61 Lead time 38.43
Complementary sales andservice
42.74 Complementary sales andservice
30.73
Patents 34.83 Patents 23.30Other legal mechanisms 20.71 Other legal mechanisms 15.39
Table 3: Mean percentage of innovations for which appropriability mecha-nism is considered effective. Source: Cohen et al. (2000, Table 1, Table2).
Cohen et al. (2000) present the results of a follow-up 1994 survey of morethan a thousand managers of manufacturing industry R&D laboratories onmethods used to protect income flows generated by intellectual assets.The survey asked managers to rank the effectiveness of patent protection
and five other strategies in protection their firm’s competitive advantagefrom innovations during the three years preceding the survey. The other fiveprotective mechanisms were the lead time that comes from first innovation,secrecy, possession of complementary manufacturing facilities and know-how,and legal protections other than patents. Taking responses from all indus-tries, patents were ranked next-to-last in effectiveness for both product andprocess innovations (Table 3). The three leading protective strategies aretaking advantage of lead time, secrecy, and complementary manufacturingfacilities and know-how, although the ranking of the three differs betweenproduct and process innovations.Much previous research suggests that patents are not generally impor-
tant in allowing firms to appropriate the income that flows from intellectualproperty,1 but that patents are effective in some industries, in particular
1Jaffe (2000, p. 555) concludes that “patents are not central to appropriating thereturns to R&D in most industries.”
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Product innovations Medicalequipment
Drugs Specialpurposemachinery,nec
Autoparts Computers
Lead time 58.06 50.10 59.69 64.35 61.40Patents 54.70 50.20 48.83 44.35 41.00Complementary salesand service
52.31 33.37 46.33 44.84 40.20
Secrecy 50.97 53.57 45.08 50.83 44.20Complementary man-ufacturing facilitiesand know-how
49.25 49.39 51.09 53.06 38.00
Other legal mecha-nisms
29.03 20.82 23.05 15.65 27.20
Table 4: Mean percentage of product innovations for which appropriabilitymechanism is considered effective, 5 industry groups. Source: Cohen et al.(2000, Table 1). “nec” indicates “not elsewhere classified.”
pharmaceuticals.2 Table 4 reports the results of the Cohen et al. surveyfor the five industry groups for which patents were most effect in protectingcompetitive advantage. Even for these industry groups, at least one otherprotective mechanism was ranked as being more effective than patents.Survey results indicate that the most important reasons firms decided not
to patent an innovation were the difficulty in demonstrating to the patentoffice that the innovation was in fact novel.3 The next most important reasonswere the ease of inventing around a patent4 and the amount of informationthat had to be disclosed to obtain a patent. That disclosure requirementsoften discourage firms from filing for patent protection negates one of themain arguments for a system of patent protection, and is consistent with the
2Caves et al. (1991) study 30 drugs that lost patent protection in the decade 1976—87and find that after patent protection expired, the patented variety suffered only modestreductions in market share, even though generic substitutes sell at substantially lowerprices. Marketing efforts aimed at prescribing physicians apparently create a productdifferentiation advantage that survives well after the introduction of generic substitutesand allows innovators to collect substantial economic profits.
3This is one of the requirements to obtain a patent; see page 9.4See the discussion of Mansfield et al. (1981) and Mansfield (1985) on page 11.
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Reasons to patent Product innovations Process innovationsPrevent copying 95.8 77.6Blocking rivals’ at-tempts to patent a re-lated invention
81.8 63.6
Prevent infringementsuits
58.8 46.5
Enhance reputation 47.9 34.0Use in negotiations 47.4 37.0Licensing revenue 28.3 23.3Measure internal per-formance of own tech-nology personnel
5.8 5.0
Table 5: Per cent of respondents by reason, 765 product innovations, 674process innovations. Source: Cohen et al. (2000, Figure 7, Figure 8).
high ranking of secrecy as a protective device.The survey results also shed light on why firms do patent, when they
do. For the sample as a whole, the most important reason (Table 5) wasto prevent copying, followed closely by strategic attempts to block compet-ing innovation by rivals. Patents are also important assets in interactionswith rivals, whether to neutralize patent infringement suits by being able tothreaten countersuits or have something to offer in return when a license issought for use of another firm’s intellectual property.Intellectual property may serve other purposes. In the U.S. semiconduc-
tor industry, patents historically served as bargaining chips that allow a firmto trade licenses for access to technology covered by patents held by otherfirms. In such cases, patents promote the diffusion of technology.
2.7 Other types of government support for R&D
Table 6 outlines reasons why insufficient innovation may occur in differentsectors, and indicates the types of public support for innovation that may beeffective.In row 1, innovation is afflicted by the lemons problem.In row two, effective support is delivered by something like the Agricul-
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Main mode of in-novation
Main sources ofmarket failure
Typical sectors Policy instrument
Development of in-puts for using in-dustries
Financial markettransactions costsfacing SMEs; riskassociated withstandards fornew technology;limited appropri-ability of generictechnologies
Software, equip-ment, instruments
Support for ven-ture capital mar-kets; bridging in-stitutions to fa-cilitate standardsadoption
Application ofinputs devel-oped in supplyingindustries
Small firm size,large externalbenefits; limitedappropriability
Agriculture, lightindustry
Low-tech bridginginstitutions (ex-tension services)to facilitate tech-nology transfer
Development ofcomplex systems
High cost, risk,limited appro-priability (par-ticularly forinfrastructuretechnology)
Aerospace, electri-cal & electronicstechnology, tele-com/computertechnologies,semiconductors
R&D coopera-tion, subsidies;bridging institu-tions to facilitatedevelopment ofinfrastructuretechnology
Applications ofhigh-science-content technology
Knowledge baseoriginates outsidecommercial sector;creators may notrecognize potentialapplica-tions oreffectively com-municate newdevelopments topotential users
Biotechnology,chemistry, ma-terials science,pharmaceuticals
High-tech bridginginstitutions to fa-cilitate diffusion ofadvances in basicresearch
Table 6: Innovation modes, sources of market failure, and policy responses.Source (Martin and Scot, 2000).
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tural Extension Service.Row three is the type of industry where subsidies and R&D cooperation
are effective. Governments have tended to rely on R&D cooperation topromote innovation in sectors where it is not likely to do so, no doubt in partbecause R&D cooperation does not require active commitment of governmentresources.Row four covers sectors where university research parks can effectively
promote innovation.Despite much study, it is not clear that government support programs,
particularly direct subsidies, actually increase the amount of R&D that takesplace.Despite much study, it is not clear that government support programs,
particularly direct subsidies, actually increase the amount of R&D that takesplace.Difficulties are
• the possibility that firms may take government money to fund R&Dthat they would have done anyway (displacement)
• if not enough R&D takes place because R&D is risky and uncertain,what one wants of government programs is that they channel fundsto risky R&D projects, leaving the less-risky ones for private sectorfunding. But government agencies face pressure to show that theyhave backed successful projects, so that funding can continue.
• government agencies do not necessarily have the expertise to evalu-ate candidate R&D projects (which suggests the possibility of indirectgovernment funding of R&D by making low-interest loans to venturecapital firms)
3 Universities and innovation
As noted in last week’s lecture, universities (historically, at least) have con-centrated on basic research, suggesting that they have a comparative advan-tage there.Acs et al. (1993) study the impact of university R&D spending and the
number of corporate patents, by state, on the number of innovations devel-oped by small firms (as recorded by the U.S. Small Business Administration).
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They find (p. 14)
spillovers are facilitated by the geographic coincidence of universi-ties and research labs within the state. How are these small, andfrequently new, firms able to generate innovative output while un-dertaking generally negligible amounts of investment into knowl-edge generating inputs, such as R&D? At least one answer . . . isthrough exploiting knowledge created by expenditures on researchin universities and on R&D in large corporations.
4 Antitrust & intellectual property rights
4.1 Main provisions of US & EU antitrust (competi-tion policy)
At the risk of much, much simplification:U.S.Sherman Act (1890) Section 1: prohibits contracts, combinations, and
conspiracies in restraint of trade – collusion (see the Sotheby’s—Christie’sart auction house conspiracy decision that cost Sotheby’s $45 million andlanded 78-year-old A. Alfred Taubman in the slammer).Sherman Act Section 2: prohibits monopolization (Microsoft Corp. has
been found guilty of monopolization.)There are other U.S. antitrust laws, but we will not discuss them here.EUEC Treaty Article 81 prohibits agreements that affect trade between the
Member States and have the object or effect of preventing, restricting, ordistorting competition on the ground that they are incompatible with thecommon market.EC Treaty Article 82 makes it incompatible for one or more firms to abuse
a dominant market position.One can say that Article 81 of the EC Treaty corresponds in a general
way to Section 1 of the U.S. Sherman Act, and that Article 82 of the ECTreaty corresponds in a general way to Section 2 of the EC Treaty.
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4.2 US IP decisions
U.S. v. General Electric Company 272 US 426 (1926): General Electric,which held patents on electric light bulbs, marketed them under licenses thatrequired sellers to adhere to prices and other terms of sale set by GeneralElectric. The U.S. government challenged these licenses as contracts inrestraint of trade in violation of Section 1 of the Sherman Act.When the case reached the Supreme Court, it wrote
If the patentee . . . licenses the selling of the [patented] articles,may he limit the selling by limiting the method of sale and theprice? We think he may do so, provided the conditions of saleare normally and reasonably adapted to secure pecuniary rewardfor the patentee’s monopoly. One of the valuable elements of theexclusive right of a patentee is to acquire profit by the price atwhich the article is sold. . . . The higher the price, the greaterthe profit, unless it is prohibitory. When the patentee licensesanother to made and vend, and retains the right to continue tomake and vend on his own account, the price at which his licenseewill sell will necessarily affect the price at which he can sell hisown patented goods. It would seem entirely reasonable that heshould say to the licensee,“Yes, you may make and sell articlesunder my patent, but not so as to destroy the profit that I wishto obtain by making them and selling them myself.”
Hartford-Empire Company v. U.S. 323 US 386 (1945): by way of theGlass Container Association of America, Hartford owned or had licenses un-der more than 600 patents covering process to produce glass bottles.Patent licenses were obtained, and cross-licenses granted, to other leading
glass bottle producers (Corning, Owens, others).Terms of the licenses were used to allocate market shares among the
patent-owning and other firms. The patent licenses covered 94% of 1938output of glass bottles in the United States.The patent pool was found to be a contract in restraint of trade in viola-
tion of Section I of the Sherman Act. Companies continued to have the rightto license their own patents as they saw fit, but they could not cross-licensepatents in a way that had the effect of restricting competition.
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4.3 EU IP decisions
The EU has a track record of challenging product design decisions that it re-gards as having anticompetitive consequences (abuse of a dominant positionunder Article 82 of the EC Treaty).
4.3.1 IBM settlement
The European Commission argued that IBM had a dominant position in thecommon market for its System-370 mainframe computer and that IBM hadabused this dominant position
• by withholding interface information essential for independent produc-ers to supply compatible equipment;
• which also interfered with development of standard computer network-ing procedures;
• bundling CPUs and main memory; and
• by bundling CPUs and software.
IBM agreed to unbundle CPUs and main memory and to make interfaceinformation available to independent hardware and software producers andnetwork designers.
4.3.2 Hilti AG v. EC Commission5
Product markets: nail guns and associated products, used in building andconstruction.Hilti, based in Liechtenstein, held patents on its nail guns, on nails for its
guns, and on cartridge strips by means of which nails could be inserted intoits nail guns.Hilti tied the sale of nails and cartridge strips to the sale of its nail
guns; it obliged its dealers not to supply cartridge strips to independent nailproducers.The European Commission found, and the Court of First Instance agreed,
that Hilti’s 55% in the supply of nail guns in the Community as a whole gaveit a dominant position.
5Case T-30/89 [1990] ECR II-1439; [1990] 4 CMLR 16.
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Hilti argued that nail guns, nails, and cartridge strips were componentsof a single product.The Court found that nail guns, Hilti-compatible nails, and cartridge
strips were three distinct product markets.Despite the fact that Hilti held patents on the products it was distribut-
ing, the Court found that its marketing practices were abusive in the senseof Article 82, because they had the effect of raising entry costs ([1990] ECRII-1483):
The strategy employed by Hilti against its competitors and theircustomers is not a legitimate mode of competition on the part ofan undertaking in a dominant position. A selective and discrimi-natory policy such as that operated by Hilti impairs competitioninasmuch as it is liable to deter other undertakings from estab-lishing themselves in the market.
This decision shows that when a firm has a dominant position in a marketfor a differentiated product, EU courts will treat products that are compatiblewith the product of the dominant firm as a distinct product. In the EU,intellectual property rights – whether based on product design or on patentrights – will not, under EU competition law, permit a dominant firm todivide the common market or to raise rivals’ entry costs.
4.4 R&D joint ventures
EU, Japan, and US policymakers all take a benign view of R&D joint ven-tures.The US attitude in particular is a reaction to the perceived success of
Japanese R&D joint ventures in the field of semiconductors in the 1970s.Most Japanese R&D joint ventures do not involve joint R&D in the sense
of independent firms setting up a common laboratory, or assigning scien-tists and engineers from one company to work at a laboratory of anothercompany. Firms in Japanese R&D joint ventures typically circulate resultsof own research among participating firms. Japanese R&D joint venturesare also provide an administrative framework through which the governmentsubsidizes business research.
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4.4.1 US legislation
The National Cooperative Research Act (NCRA) of 1984 provided that R&Djoint ventures that filed with the government would be subject to singlerather than treble damages for subsequent antitrust violations; whether ornot antitrust laws had been violated would be decided under a rule of reasonrather than a per se rule, increasing the burden of proof that would need tobe met by a government or private plaintiff.One of the motivations for this attitude is the belief that a single firm,
unable to fully appropriate the returns from R&D, will have less of an in-centive to invest in R&D than is socially desirable. If the possibility of jointresearch increases expected appropriability and therefore the expected payoffto R&D, it can be expected to encourage investment in R&D and improvetechnological performance.U.S. antitrust, to the best of my knowledge, records one antitrust case
involving an R&D joint venture.6 The government’s theory in that case wasthat auto makers had used an R&D joint venture to delay the development ofenvironmentally motivated emission control equipment. The case was settledby a consent decree.The NCRA has not triggered a noticeable increase in the formation of
R&D joint ventures involving U.S. firms. A reasonable explanation is that inmost sectors, firms were not discouraged from forming R&D joint venturesby the threat of antitrust prosecution, so reducing that threat did not havemuch of an effect on business decisions.
5 References
Acs, Zoltán J., David B. Audretsch, and Maryann P. Feldman “Innovationand R&D spillovers,” CEPR Discussion Paper 865, December 1993.
David, Paul A. “Patents, copyrights, and trade secrets in economic the-ory and history,” in Michael B. Wallerstein, Mary Ellen Mogree, andRoberta A. Schoen, editors Global Dimensions of Intellectual PropertyRights in Science and Technology. Washington, D.C.: National Acad-emy Press, 1993, pp. 19—61.
6United States v. Automobile Manufacturers Association 1969 Trade Cases (CCH)Para 72,907 (C.D. Cal. 1969) (consent decree), modified 1982—3 Trade Cases (CCH) Para65,088 (C.D. Cal. 1982).
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Friedman, David D., William M. Landes, and Richard A. Posner “Someeconomics of trade secret law,” Journal of Economic Perspectives 5(1),1991, pp. 61—72.
Levin, Richard C., Alvin K. Klevorick, Richard R. Nelson, and Sidney G.Winter “Appropriating the returns from industrial R & D,” BrookingsPapers on Economic Activity 1988, pp. 783—820.
Machlup. Fritz and Edith Penrose “The patent controversy in the nine-teenth century,” Journal of Economic History 10(1), 1950, pp. 1—29.
Mansfield, Edwin “How rapidly does new industrial technology leak out?”Journal of Industrial Economics 34(2) December 1985, pp. 217—23.
– “Unauthorized use of intellectual property: effects on investment, tech-nology transfer, and innovation,” in Michael B. Wallerstein, Mary EllenMogree, and Roberta A. Schoen, editors Global Dimensions of Intel-lectual Property Rights in Science and Technology. Washington, D.C.:National Academy Press, 1993, pp. 107—45.
– “Contributions of new technology to the economy,” in Bruce L. R. Smithand Claude E. Barfield, editors Technology, R&D, and the Economy.Washington, D. C.: The Brookings Institution and American Enter-prise Institute, 1996, pp. 114—139.
Martin, Stephen and John T. Scott “The nature of innovation market failureand the design of public support for private innovation”Research Policy29(4-5), April 2000, pp. 437—47.
Nelson, Richard R. “What is ‘commercial’ and what is ‘public’ about tech-nology, and what should be?,” in Nathan Rosenberg, Ralph Landau,and David C. Mowery, editors Technology and the Wealth of Nations.Stanford, California: Stanford University Press, 1992, pp. 57—71.
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