New Dourado and Tabarrok Paper on Intellectual Property

I’m pleased to announce that Alex Tabarrok and I have a new working paper out from the Mercatus Center today, “Public Choice and Bloomington School Perspectives on Intellectual Property.” The paper will appear in Public Choice in 2014.

Here’s the abstract:

We mine two underexplored traditions for insights into intellectual property: the public choice or Virginia school, centered on James Buchanan and Gordon Tullock, and the Bloomington or Institutional Analysis and Development school, centered on Elinor Ostrom and Vincent Ostrom. We apply the perspectives of each school to issues of intellectual property and develop new insights, questions, and focuses of attention. We also explore tensions and synergies between the two schools on issues of intellectual property.

The gist of the paper is that the standard case for intellectual property—that a temporary monopoly is needed in order to recoup the sunk costs of innovation or creation—ignores issues raised by the two schools we investigate.

From a public choice perspective, a temporary monopoly provides enormous opportunities for rent seeking. Copyright and patent owners are constantly manipulating the political environment to expand either the duration of the monopoly or the scope of what can be monopolized. We document the evolution of intellectual property in the United States from its modest origins to its current strong and expansive state.

From a Bloomington perspective, the standard case for IP wrongly treats the commons as a kind of wasteland. In fact, numerous innovations and sprawling creative works occur without monopolization—just look at Wikipedia. Innovation occurs when the right institutional structures are in place, and intellectual property that is too severe can hamper the smooth operation of these institutions. Too much IP can harm as much as too little.

Read the whole thing, cite it copiously, etc.

The Brookings Patent Report is Bogus

Brookings has a new report out by Jonathan Rothwell, José Lobo, Deborah Strumsky, and Mark Muro that “examines the importance of patents as a measure of invention to economic growth and explores why some areas are more inventive than others.” (p. 4) Since I doubt that non-molecule patents have a substantial effect on growth, I was curious to examine the paper’s methodology. So I skimmed through the study, which referred me to a technical appendix, which referred me to the authors’ working paper on SSRN.

The authors are basically regressing log output per worker on 10-year-lagged measures of patenting in a fixed effects model using metropolitan areas in the United States.

$\ln y_{i,t} = c + \beta_{1} \ln ( patenting_{i,t-10}) + \beta_{2} \ln ( Population_{i,t-10}) + \beta_{3} \ln ( y_{i,t-10}) + \beta_{4} \ln ( \text{predicted productivity}_{i,t-10}) + \beta_{5} \ln ( \text{educational attainment}_{i,t-10}) + \text{place and dummy variables} + \varepsilon_{i,t}$

The model is structured in this relatively standard way to reduce endogeneity—there might be more patents filed where labor productivity is highest, rather than higher labor productivity where the most patents are filed. And if the only concern were reverse causality, then it would be a good way to study the question of patents and innovation.

The authors find positive coefficients on the patenting variables and conclude that patents drive economic growth both in local areas and in general.

This report documents how a strong national innovation system plays out across a dispersed array of U.S. metropolitan areas, contributing to economic growth in both local places and across a large and diverse country.

Clear in these pages is the continued vibrancy of the U.S. innovation as well as the general utility of the nation’s patenting system. (p. 28, emphasis added)

These conclusions are unwarranted given the model and findings expressed in the paper. To see that this is the case, assume temporarily that patents do nothing to incentivize real innovation, and that they merely transfer wealth from consumers at large to the patent holder through firm profits. If this were the case, then we would find that measured output per worker was higher in metropolitan areas with more patents—exactly what the authors found!—because they are gaining profits at the expense of consumers in metropolitan areas with fewer patents. In other words, the authors could be laboring under a fallacy of composition. Just because patents enrich the MSAs that generate them doesn’t mean that they are a source of prosperity for the nation as a whole or that they increase social welfare.

Alternatively, assume temporarily that patents do nothing to incentivize real innovation, but that firms that produce valuable innovations must defensively patent them to avoid being taken to court for using their own inventions. If this were the case, then patents would correlate with real innovation, and therefore with output per worker, but they would not cause an increase in productivity. In addition, at least some of the measured increase in output would come from an influx of highly-paid intellectual property attorneys, which by assumption does not represent real added productivity. Note that the top-patenting MSA in the study is Silicon Valley, the part of the country where people are most concerned about defensive patenting. But the word “defensive” does not appear even one time in the report, the appendix, or the working paper.

The authors have done nothing to identify the effect of patents on productivity, which is to say, nothing to rule out either of the possible assumptions above. They are simply relying on the assumption that more patents means more innovation.

This flaw in the paper makes all of their policy conclusions suspect. For example, if patents represent a mere transfer, then encouraging patent-generating institutions is socially destructive. It might nevertheless be rational for a single MSA to encourage such institutions, because residents of the MSA would enrich themselves at the expense of other MSAs. In this case, we should adopt federal policies to discourage patent-generating institutions. If patents merely correlate with innovation due to defensive patenting in some domains, then the U.S. patent system is not working as intended, which is again the opposite of what the authors conclude.

On point, the Winter 2013 Journal of Economic Perspectives is out this week, featuring a four-paper symposium on patents. The lead article is by Boldrin and Levine, entitled “The Case Against Patents.” Here is the first paragraph:

The case against patents can be summarized briefly: there is no empirical evidence that they serve to increase innovation and productivity, unless productivity is identified with the number of patents awarded—which, as evidence shows, has no correlation with measured productivity. This disconnect is at the root of what is called the “patent puzzle”: in spite of the enormous increase in the number of patents and in the strength of their legal protection, the US economy has seen neither a dramatic acceleration in the rate of technological progress nor a major increase in the levels of research and development expenditure.

Petra Moser’s article does a historical comparison of countries with strong and weak patent laws and concludes:

Overall, the weight of the existing historical evidence suggests that patent policies, which grant strong intellectual property rights to early generations of inventors, may discourage innovation. On the contrary, policies that encourage the diffusion of ideas and modify patent laws to facilitate entry and encourage competition may be an effective mechanism to encourage innovation. (emphasis in original)

I hope that policymakers don’t rely on Brookings’s strong reputation and infer that our patent system is the strong engine of economic growth that Rothwell et al. suggest it is.

Copyright Reform and the Incentive to Create

Mercatus has a new book out on copyright, edited by Jerry Brito, called Copyright Unbalanced: From Incentive to Excess. I am pleased to be one of an otherwise-illustrious group of contributors.

I expect that the book will create some controversy in policy circles. In this post, I want to address what is likely to be a knee-jerk response from our critics, that copyright reform will substantially decrease the incentive to produce creative works.

Content creators anticipate that their products will generate some amount of revenue each year after they are released. The expectation is generally that the creative work will generate the highest revenue in the first year, and less revenue in each subsequent year. To model this revenue stream, I’m going to assume exponential decay. Exponential decay lets us pick a half-life, $h$, and assume that $h$ years after the work was released, it will generate revenue at half the initial rate. After $2h$ years, it will generate revenue at one-fourth the rate, and so on.

In year $t$, the revenue that the content creator will receive if there is copyright is $e^{\frac{-t \ln2}{h}}$ times the initial revenue. Consequently, the total revenue that a copyright holder will receive over the life of a 95-year copyright term is

$\sum\limits_{t=0}^{94} e^{\frac{-t \ln 2}{h}}$

times the initial revenue.

However, content creators prefer revenue now to revenue 90 years from now. In order to calculate the present value of this revenue stream, we need to apply a discount rate $r$. The ex ante value of the revenue stream generated by the 95-year copyright term is therefore

$\sum\limits_{t=0}^{94} \dfrac{e^{\frac{-t \ln 2}{h}}}{(1+r)^t}$

times the initial revenue.

And of course, this calculation generalizes to different copyright terms. If we returned to a 28-year term, as Tom Bell advocates in his chapter of our book, the ex ante revenue stream would be valued at

$\sum\limits_{t=0}^{27} \dfrac{e^{\frac{-t \ln 2}{h}}}{(1+r)^t}$

times the initial revenue.

We’re now at a point where we can start to run some numerical calculations based on plausible values for $h$ and $r$. What is a reasonable ex ante expectation about the half-life of the revenue stream of a new creative work? I expect that for our book, the half-life will be something like 1 year or less; we will probably sell less than half as many books in the second year the book is out as in the first. But let’s not use $h=1$. Let’s estimate that $h=10$ to be extremely conservative and generous to our critics.

What about $r$? Again, how about if we are conservative and give $r$ a low value, like $r=0.02$?

Now we can run some calculations. Using the values above, the ex ante present value of a 95-year copyright is around 11.726 times the initial revenue. The ex ante present value of a 28-year copyright is around 10.761 times the initial revenue. Consequently, shortening the copyright term from 95 years to 28 years (less than 30% of the current term!) retains about 91.8 percent of the incentive effect of the current copyright term.

It is unlikely that such a small decrease in the present-value of the revenue stream would reduce the amount of content production by much. To the extent that content producers cannot or do not substitute easily into other fields, they would simply take the 8.2 percent decline in compensation per project as a decrease in wages (not the end of the world), and there would be no decline in content production. To the extent that content producers can substitute into other fields, we would get less content, but we would also get more of other stuff—the welfare effects of less content are ambiguous, since there is a knowledge problem regarding the optimal amount of content.

If you want to do the calculation with different half-lives and interest rates, be my guest. I am confident that for all plausible values of $h$ and $r$, you will find that shortening the copyright term will have at most a modest effect on the incentive to create.

How about the value of the public domain? This is a little harder to model, because we care about the ex post value of works, not just the ex ante expectation that content creators have. In practice, there turn out to be works with much longer half-lives than others. This fact complicates any back-of-the-envelope calculation. We also don’t know exactly by how much content creation would fall.

But let’s abstract from this and model the value of the public domain as the revenue stream for a given project that otherwise would have gone to copyright holders above. One difference for the public domain is that it no longer makes sense to discount the stream of value—future generations aren’t sitting around, waiting to be born so that they can watch Star Wars for the first time. Therefore, normalized to our original, first-year revenue stream, an estimate of the value of the public domain under a 95-year term is

$\sum\limits_{t=95}^{\infty} e^{\frac{-t \ln 2}{h}}$.

Under a 28-year term, the value is

$\sum\limits_{t=28}^{\infty} e^{\frac{-t \ln 2}{h}}$.

Plugging in the value we selected earlier for $h$, 10, the former expression yields around 0.021 and the latter about 2.144. In other words, the value of the public domain would be around 100 times higher per creative work if we shortened the term to 28 years. Again, this value is highly dependent on our selection of $h$, but the reason I am doing these calculations is so that my critics can repeat them with values they find more plausible, if they so choose.

This analysis has been highly stylized, but it is also extremely conservative. The half-life of most creative works is probably much shorter than 10 years, and when valuing an uncertain revenue stream, most artists—and even content corporations—probably discount at a rate of higher than 2 percent. The value of the public domain has been understated in this analysis, because there are many works that turn out ex post to have longer half-lives (but it is still the ex ante estimate of value that matters for investment). I have also not factored in the gains from those derivative works that are impossible under the current regime due to transaction costs, or the savings in enforcement costs from having a shorter time during which enforcement is necessary, or indeed, many of the other issues discussed in our book.

I would be interested in reading further analyses like the one above from anyone who supports the current copyright term or a longer one. How do you justify such a long term? You don’t have to use my assumptions, just make your own explicit so that people can see what they are and quarrel with them. How many fewer works do you really think would be created if we shortened the term from 95 years to 28 years? Would we really be worse off? Please show your work.

If Samsung Copied Apple, Why isn’t it Worth \$600B?

You’re probably tired of reading about Apple v. Samsung, but I just wanted to make one point that I haven’t seen made elsewhere. I have not followed and do not really care about the legal minutia of the case, but from what I understand, Samsung was found to have willfully infringed on Apple’s patents.

But here’s the rub: does anyone actually believe that a Samsung phone is the same as an iPhone? I found an amusing story about customers who interpret the result of the case as a ruling that Samsung devices are as good as Apple devices, so why not buy the cheaper Samsung devices? But this is an unenlightened view of user experience design, and it’s unsupported by actual market results.

I certainly don’t believe Samsung phones are equivalent to iPhones. Samsung devices are a vastly inferior substitute. And I am confident that this would not change if Samsung were allowed to use every one of Apple’s patents. The whole mentality of checking off features that have been implemented is totally contrary to how we experience technology. The details of the implementation matter a lot, and cumulatively over all the innovations we are talking about, there is no way that Samsung can copy Apple’s implementation.

I’ve read a lot of arguments along the lines of “Apple’s innovations are trivial and should not be patentable.” I disagree with the premise: Apple is one of the most innovative companies in the world, and yes, that includes a lot of innovations that look obvious in retrospect. But I agree that Apple should not have patent protection, because nobody can copy Apple in the first place. How do I know? Let’s take a look at the results in the mobile phone market.

According to a recent article at Fortune, Apple sells 8.8% of mobile phones, but it has 73% of profits in the market. Samsung sells 23.5% of phones and earns 26% of profits. Everyone else is barely breaking even or losing money.

This does not look like a market in which Apple’s competitors are successfully copying it. It looks like a market in which Apple’s competitors are trying to copy Apple, and failing.

The point of patents is to incentivize innovation through a grant of monopoly. But what Apple’s success, pre-verdict, clearly shows is that in many markets, mobile computing among them, it’s a lot harder to copy innovations than you think. Apple’s real innovation is putting designers in charge and building a corporate culture in which everything is subordinated to making elegant products that people want to use. I’d like to see Samsung try to copy that, but I think the difficulty of doing so gives Apple all the monopoly it needs.

In honor of the SOPA blackout, here are some thoughts on copyright law. But first, a brief detour into murder law.

There are a positive number of murders each year. If we put more resources into investigating and prosecuting murders, there would be fewer murders. Nevertheless, it is not at all clear that we are spending too little on murder. The optimal number of murders is positive, not zero. The best policy with respect to murder is to try to maximize the net benefits of the policy, not to minimize murders.

Suppose a new technology were introduced that made it easy to get away with murder (e.g., David Friedman’s plan for Murder Incorporated). This technology makes it extremely costly, though, say, not impossible, to stop murders from occurring. What happens to the optimal amount of murder enforcement? The amount that must be spent to deter each murder has gone up, so the price of deterrence has gone up. Consequently, society should aim to deter fewer murders. Under some extreme circumstances, we might even be better off if murder were legalized (and if people were advised to just be more polite to each other).

Similarly, whatever your prior belief about copyright enforcement, the Internet has made it easier to get away with copyright infringement. The amount that must be spent to deter each instance of copyright infringement has increased. Consequently, society should aim to deter fewer instances of copyright infringement, not more instances as SOPA supporters advocate.

In fact, the cost of deterrence has increased so much that we should begin to rethink copyright law. We could increase the benefits of deterrence if we targeted only high-value infringements. This means that we should shorten the term of copyright, since high-value IP tends to be newer IP (in fact, copyright terms have increased in recent decades, a move in the wrong direction). We might consider expanding “fair use” copyright exemptions to include more non-commercial uses, since commercial infringements are more likely to diminish the value of a copyright. Most importantly, we should withdraw public resources from the enforcement of IP violations. Private enforcement through the tort system has a built-in safety valve: when the cost of enforcement rises, people will do less of it. But the criminal system is essentially a public subsidy for enforcement; no wonder that pro-copyright factions are attempting to criminalize copyright infringement through SOPA and other legislation.

The bottom line is that recent expansions of copyright terms and enforcement powers get the comparative statics exactly backwards. In an age of costly enforcement, it’s time to give up, at least at the margin, on copyright. And at the margin, content creators should just be more polite to content consumers.

Steal this Necklace Design: Why there should be no IP in Fashion

There are various laws and norms that protect intellectual property. Urban Outfitters seemed to have violated one of those norms last week when it was revealed that some of its jewelry is very similar to that of an independent designer’s on Etsy. It turns out that it’s a very common, completely unoriginal design, much ado about nothing.

A discussion of the Urban Outfitters debacle on Twitter (in which I alleged IP norm-enforcing hypocrisy) got me thinking about the optimal level of IP protection in the fashion industry. I’m pretty well convinced it’s zero, for two reasons.

First, the optimal level of IP protection varies inversely with how useful it is to create small variations off other people’s innovations. In a field in which every innovation is something truly new, you want more extensive IP protection. But in fashion, most innovations are similar to past innovations. To enforce IP in such an industry would be to create what Michael Heller calls The Tragedy of the Anticommons.

The tragedy of the anticommons is analogous to the tragedy of the commons. The latter occurs when too many owners have the right to use some property, leading to overuse. The former occurs when too many owners hold rights of exclusion, leading to underuse.

“Too many owners” may be even one owner. If every fashion design now in existence were assigned to a single owner with the right to exclude use of the design, it would be a nightmare for anyone trying to create new designs. Every new design is similar to an old one, which entails costly negotiations and royalties to be paid to the originators. It’s better just to let everyone rip everyone else off.

The second reason to oppose IP protection in fashion is that it is an industry that is almost entirely about signaling. Inframarginally, signaling generates information and serves a useful social function, but at the margin, it’s better if fewer resources go into signaling. For instance, if you impose a tax on the signal that causes everyone to signal half as much, information is preserved and the status of every individual remains the same, but fewer resources are consumed.

We can prevent resources from flowing into the fashion industry at the margin by ensuring that innovators are not rewarded. If necklace designers on Etsy die in poverty and obscurity that is partially a good thing, because it encourages other people not to become necklace designers. But if instead they were getting payments from Urban Outfitters for their designs, this would draw valuable human capital into the fashion industry and away from some other more socially useful field.

The astute reader will notice that there is a reading of my second argument that refutes my first one. If innovation in fashion (at the margin) is bad, then what better way to prevent it than by making the whole industry a giant anticommons through very strong IP protection? Points for cleverness, astute reader, and maybe someday the government will make it happen, but in the meantime we should stick to considering small changes to the status quo.

There are very few legal protections of intellectual property in the fashion industry, but consumers’ norms about “stealing” from independent artists and the threat of boycott got Urban Outfitters’s attention. These norms strike me as poorly thought out. What is unseen is that they make us poorer. They cause companies to spend resources on legal departments and PR teams, and everyone else to spend more of them on signaling than we otherwise would. We’ll be richer when we lighten up.