Michele Boldrin and David K. Levine
Chapter 4. The Evil of Intellectual Monopoly
… The example of AIDS drugs brings out another feature of monopoly – their desire to price discriminate. That is, competitors charge the same price to everyone, while monopolies try to extract a higher price from those who value the product more highly. Economists usually argue that this is a good thing because monopoly without price discrimination is even worse than monopoly with price discrimination. Price discrimination, they argue, enables lower valued consumers to purchase a product that otherwise the monopoly would not sell to them. Relatively speaking – that is: relative to a word where the monopolist does not price discriminate – this is a correct statement. In the case of AIDS drugs, effective price discrimination would enable the large pharmaceutical companies to charge a low price to poor blacks without lowering the price they charge rich whites. A more successful example of price discrimination for drugs is the low price charged poor Canadians against the high price charged rich Americans.
In practice, however, it is both difficult and costly to price discriminate. Experience suggests that while it is relatively easy to find consumers who highly value a product and are willing to pay a high price, there is not much selling by monopolies at low prices to consumers who are only willing or able to pay a low price. Economic theory suggests two related reasons for this fact. In anonymous markets the monopolist has a hard time telling which consumers value its product a lot and which value it little, as the former would pretend to be the latter when given a chance. The second, even more straightforward, reason is that selling to some consumers at a low price creates competition for the monopolist. It creates an incentive to buy at the low price and resell at a medium price that undercuts the high price charged by the monopolist to the high valued consumers. In the case of Canada and the U.S., the lower price charged Canadians has led to a booming gray market for importing drugs from Canada into the U.S. – so much so that there have been efforts both to enshrine the right to import cheap Canadian drugs in U.S. law, as well as to make it illegal entirely.
In the case of AIDS drugs, the pharmaceuticals do not sell to Africa at a steep discount because they are afraid that a parallel market, reselling the cheap African product in the Western market, will undercut their profits. Do not let the pharmaceuticals’ laments confuse you. It is not that by selling to the African market at a low price they would be making a loss, for which to compensate they desperately need the U.S. and E.U. profits. Because the cost of producing a larger quantity of AIDS drugs is very small, the pharmaceuticals would be making a profit also by selling cheap to the African market. Their problem is the loss of monopoly profits in markets other than the African one. This example is, in fact, quite general: intellectual monopolists often fail to price discriminate because doing so would generate competition from their own consumers.
Effective price discrimination is costly to implement and this cost represents pure waste. For example, music producers love Digital Rights Management (DRM) because it enables them to price discriminate. The reason that DVDs have country codes, for example, is to prevent cheap DVDs sold in one country from being resold in another country where they have a higher price. Yet the effect of DRM is to reduce the usefulness of the product. One of the reasons the black market in MP3s is not threatened by legal electronic sales is that the unprotected MP3 is a superior product to the DRM protected legal product. Similarly, producers of computer software sell constrained products to consumers in an effort to price discriminate and preserve their more lucrative corporate market. One consequence of price discrimination by monopolists, especially intellectual monopolists, is that they artificially degrade their products in certain markets so as not to compete with other more lucrative markets. 1
The Cost of Patent
The second half of the 1990s witnessed an extraordinary increase in the number of new patents registered in the United States, and in the European Union as well. In the U.S. the yearly number of patent applications reached about 345,000 by the end of the 1990s, rising more than threefold from a value which had oscillated around 90,000 during the 1960s. In just four years, between 1997 and 2001, patent applications exploded by a spectacular 50%. 2 Part of the radioactive fallout from this explosion in patent applications was the increase in the membership of the intellectual property section of the American Bar Association, which went from 5,500 to almost 22,000. 3
If patents beget prosperity and innovation, we might expect that this explosion in patenting coincided with a vast technological improvement. Of course it did not. A common measure of technological improvement is the increase in Total Factor Productivity (TFP) – as mentioned in the previous chapter this measures how much additional output can be produced from a given combination of inputs by using those inputs better. Higher TFP means, for example, more and better cars from the same labor and other factors such as metal and plastic. Rough-and-ready aggregate measures of TFP growth do not display a strong trend during the last 50 years. They increased during the 1950s and early 1960s, then decreased from the late 1960s until the late 1980s or even early 1990s and then recovered, slightly, during the 1995-2000 period. After the 2001 recession the same measures have kept growing at their long-term average. More sophisticated measures of TFP show that, on the one hand, the late 1960s to late 1980s “productivity slowdown” may be nothing but poor measurement on our part while, on the other, the 1990s TFP-recovery either did not take place or is almost entirely due to the widespread adoption of IT technologies. The latter, as we documented in chapters 2 and 3, owe extremely little if anything to the presence of patents.
Similar findings apply to any OECD country, flying in the face of the claim that patents are a good measure of, let alone cause, true improvements in productivity. If they were, TFP should have increased remarkably, and its growth rate should keep increasing in proportion to the continuing increase in the number of patents. Neither happened.
The Patent Thicket 4
… There are other indications of the abuse of the patent system for legalistic reasons. The Polaroid vs. Kodak settlement is widely credited as an important signal of the value of defensive patenting. It is unclear what it is that society gained from that settlement, as all it did was to restore monopoly in a relatively important consumer market, and bring almost to bankruptcy an otherwise thriving company, Kodak. With the windfall payment it received, Polaroid neither created new innovations nor new employment and value added; it just enriched its lawyers, its executives, and, albeit marginally, its shareholders. Similarly we have the following statement from Roger Smith of IBM
The IBM patent portfolio gains us the freedom to do what we need to do through cross-licensing — it gives us access to the inventions of others that are key to rapid innovation. Access is far more valuable to IBM than the fees it receives from its 9,000 active patents. There’s no direct calculation of this value, but it’s many times larger than the fee income, perhaps an order of magnitude larger. 17
Using Patents to Block Competition
First off, patents and IP more generally are by definition aimed at blocking competition, as their main aim is to prevent other from competing with the innovator by producing the same thing either a little cheaper or of a little better quality. While this is trivial, and we have repeated it ad nauseam, it is good to keep it in mind. Now, let us move to the less obvious ways in which patents are strategically used to block competition. 18
The idea, widely advertised in business courses and management textbooks, that cross-licensing, patent pools, and patents more generally can be used to block entry and enhance collusion has not escaped the notice of firms. Following the increased enforcement of the anti-trust laws after World War II, the chemical and petrochemical industries pioneered the use of patent law as a legal method of colluding and blocking entry. As the number of possible examples is long, and the general principle is rather clear, we will be brief. Here is a sample
Both American Telephone and Telegraph and General Electric, for example, expanded their in-house laboratories in response to the intensified competitive pressure that resulted from the expiration of key patents … Patents also enabled some firms to retain market power without running afoul of antitrust law. The 1911 consent decree settling the federal government’s antitrust suit against GE left their patent licensing scheme largely untouched, allowing the firm considerable latitude in setting the terms and conditions of sales of lamps produced by its licensees, and maintaining an effective cartel within the U.S. electric lamp market … Patent licensing provided a basis for the participation by GE and Du Pont in the international cartels of the interwar chemical and electrical equipment industries. U.S. participants in these international market-sharing agreements took pains to arrange their international agreements as patent licensing schemes, arguing that exclusive license arrangements and restrictions on the commercial exploitation of patents would not run afoul of U.S. antitrust laws. 19
In recent years there have been innovative efforts to extend the use of patents to block competitors. For example we find
A federal trade agency might impose $13 million in sanctions against a New Jersey company that rebuilds used disposable cameras made by the Fuji Photo Film Company and sells them without brand names at a discount. Fuji said yesterday that the International Trade Commission found that the Jazz photo Corporation infringed Fuji’s patent rights by taking used Fuji cameras and refurbishing them for resale. The agency said Jazz sold more that 25 million cameras since August 2001 in violation of a 1999 order to stop and will consider sanctions. Fuji, based in Tokyo, has been fighting makers of rebuilt cameras for seven years. Jazz takes used shells of disposable cameras, puts in new film and batteries and then sells them. Jazz’s founder, Jack Benun, said the company would appeal. “It’s unbelievable that the recycling of two plastic pieces developed into such a long case.” Mr. Benun said. ‘There’s a benefit to the customer. The prices have come down over the years. And recycling is a good program. Our friends at Fuji do not like it. 20
Once again examples abound, so let us close with a particularly important one. We mention later in this chapter how the Wright brothers used their patents to try to block the emergence of a US aircraft industry. Interestingly, this pattern of behavior continued. In 1972 the US government charged the aircraft industry with an antitrust violation, basically because they kept using their patent pool and cross licensing to prevent entry. IP-inefficiency at its best.
We have previously observed that for a long time also, the software industry was free of patent protection. The long standing tradition of free competition and lack of intellectual monopoly began to crumble in 1981 with the Supreme Court decision in Diamond v. Diehr, collapsing completely with the publication of new examination guidelines by the U.S. Patent and Trademark Office in 1996, which made computer programs fully and clearly patentable. This change in the property right regime in the software industry was relatively fast; it constitutes, therefore, an interesting case study to test competing hypotheses on the determinants of patents and their impact on productivity. After carrying out a careful econometric analysis of the microeconomic evidence from the software industry, Bessen and Hunt reach three interesting conclusions. The first is that the shift in legal standards for patenting software was a potent incentive to increase expenditure in patents. It may in fact be one of the key factors behind the dramatic increase in the number of patents we reported earlier in this chapter. As we noted, the increase in the number of patents in the U.S. economy was not accompanied or followed by an equally visible increase in TFP or in any other economic measure of effective innovation and productivity. The second finding by Bessen and Hunt supports and reinforces this assertion
Thus, our analysis appears to decisively reject the incentive hypothesis during the 1990s. Software patents may have complemented R&D during the early 80s – when patenting standards were still relatively high – but they substituted for R&D during the 1990s. Regulatory changes increased the amount of patenting, but they are also associated with lower R&D. We can reject naïve arguments that more patents, relaxed standards, or lower patenting costs lead to more R&D. 26
Notice, in particular, that patenting is found to be a substitute for R&D, leading to a reduction of innovation. In the authors’ calculation, innovative activity in the software industry would have been about 15% higher in the absence of patent protection for new software. Finally, and most interestingly in our view, Bessen and Hunt point out that one of the channels through which relaxed patenting criteria and a judicial system more prone to entertain claims of patent infringement, negatively affect innovative activity is by increasing the risk of the return on innovations. Stephen P. Fox, associate general counsel and director of Hewlett-Packard highlights this
pervasive uncertainty about legal rights, both in terms of ability to enforce one’s own patents and ability to avoid rapidly escalating exposures to infringement claims by others. And that uncertainty heightens risks surrounding innovation investment decisions. 27
According to Cecil D. Quillen, Jr., former General Counsel at Eastman-Kodak,
If the uncertainties are such that you cannot be confident that your products are free and clear of others’ patents you will not commercialize them, or a higher return will be demanded if you do to compensate for the additional risk. And this probably means you will not do the R&D that might lead to low return (or no return) products. 28
… This form of legal blackmail was pioneered by George Selden, who patented the idea of a “road engine” in 1895. He first applied for a patent in 1879 and used all possible legal means to delay approval for sixteen years. This took place while the American car industry was developing and the technology of the road engine was being widely adopted and improved.
The Dilbert Factor 34
Monopoly has many costs. Some, like loss of social surplus and rent-seeking have been extensively studied by economists. A less well-known cost is the fact that not all innovators and managers are the clever individuals usually assumed in economic theory. In the history of innovation, examples abound of innovators, who far from maximizing their monopoly profits, have achieved closer to the minimum.
One exceptional example of innovators playing with less than full deck, is that of the Wright brothers. Despite their own rather modest contribution to the development of the airplane, in 1906 they managed to obtain a patent covering (in their view) virtually anything resembling an airplane. The application had been filed much earlier, meaning that between March 1903 and May 1906 they were capable of building an airplane or teaching other people how to do it, but did not. Further even after the patent was granted, rather than take advantage of their legal monopoly by developing, promoting and selling the airplane, the Wright brothers kept it under wraps, refusing for a couple of more years to show it to prospective purchasers. However, while refusing to devote any effort to selling their own airplane, they did invest an enormous amount of effort in legal actions to prevent others, such as Glenn Curtis, from selling airplanes. Fortunately for the history of aviation, the Wright brothers had little legal clout in France, where airplane development began in earnest in about 1907. 35
Another case in point takes place in England, also before the First World War. At that time the Badische Chemical Factory held a patent covering practically all chemical-based textile coloring products. Levinstein and Co. developed a new and superior process to deliver the same product. Badische Chemical sued and obtained a court restraint, preventing Levinstein from using the new process to obtain the old product. Did Badische take advantage of this legal victory to introduce the new and superior process in their own business? No, in fact Badische was apparently unable to figure out how the new process worked, and so did not make use of it. Levinstein, on the other hand, moved to the Netherlands, where the patent was not enforced. Badische was less fortunate, as competition from Levinstein eventually put them out of business. 36
… The music industry, in the form of the RIAA, has also engaged in a series of legal blunders. In 1998, the RIAA filed a lawsuit against a small relatively unknown company, Diamond Multimedia Systems. Diamond’s crime? They were engaged in selling a portable electronic device capable of playing music in a compressed format not widely known at that time – the MP3 format. Not only did the RIAA manage to lose the lawsuit – but the attendant publicity was an important factor in popularizing the format among consumers. As newspapers gave the case enormous coverage, music aficionados rushed to their computers to convert their inconvenient old CDs into convenient MP3 collections. 37
The massive conversion of CDs is largely responsible for the next chapter in the sad saga of the RIAA – the peer-to-peer network. With the advent of Napster in 1999, music lovers discovered that, especially with the advent of broadband connections, MP3 formatted songs could be conveniently shared over the Internet. The RIAA lawyers sued Napster. The lawsuit did little to prevent the spread of the technology – although it may have helped publicize it. Court filings indicate that at that time Napster had fewer than 500,000 users. By mid-2000, driven by the enormous publicity over the case, Napster reported nearly 38 million users worldwide. By 2001 the RIAA prevailed on appeal, and an injunction against Napster began the effective shutdown of the network. By 2002, Napster declared bankruptcy. 38 So effective has this shutdown been that it is now estimated that in the US alone, there are over 40 million people sharing files using “peer-topeer”, or p2p, networks. 39
“Being a monopolist” is, apparently, akin to going on drugs or joining some strange religious sect. It seems to lead to a complete loss of any sense of what profitable opportunities are and of how free markets function. Monopolists, apparently, can conceive of only one way of making money, that is bullying consumers and competitors to put up or shut up. Furthermore, it also appears to mean that past mistakes have to be repeated at a larger, and ever more egregious, scale. Consider the ongoing controversy over the Google Print project, which is now relabeled Google Book Search and is fighting to survive the legal obstacles we summarize next. The Authors Guild filed a lawsuit about two years ago trying to stop it; the lawsuit accuses Google of violating “fair use” and infringing upon its copyrights. Trying to prevent the very damaging effect that the lawsuits could have on its overall finances (it has become a very rich company, in recent times) Google seems to be caving in to all kinds of requests, modifying the Book Search product accordingly. Anyone who has used it both in 2004 and 2006 can appreciate the difference. The original Google Print was a wonderful tool for bibliographic research that made us purchase very many useful books; the current Google Book Search is an emasculated and frustrating program whose social value and marketability are unclear, to say the least.
Now, what did Google Print plan to do? It planned to scan all the books in a number of large university libraries around the world and to allow people to search their content via the Internet in the usual “Google-style.” Once an item is searched and results are found Google Print allows the user to see about one or two paragraphs, sometime a few pages, from the scanned book(s) in which the item is mentioned or referred. It will also link the user to various sites where the book can be easily purchased.
That is all. Instead of spending hours going to the library trying to find out which books write about the Dilbert Factor, one can just enter “Dilbert Factor” at print.google.com and find that dozens of interesting books discuss it. One can, for example, find amusing little texts such as When Did Ignorance Become A Point Of View: A Dilbert Book, by Scott Adams, and purchase it from one of the many online bookstores linked in the same page, as we just did. Why? Partly to compensate the Authors Guild for the dramatic loss of revenue that our book may cause them, and partly because one of us got interested by Adams’ proposal of a new way of making presidents of powerful countries accountable to their own people when using their mighty military power. Alternatively, one can avoid spending money purchasing bad books, as in most cases one only needs reading a few pages to spot one of them. Finally, you may search Google Print for “Authors Guild,” and spend an afternoon browsing numerous interesting books providing evidence of a society once run by smart people and not a shill for Disney.
One can hardly think of a better advertising cum shopping tool for books. This service is to be offered, absolutely free of charge, to authors and publishers alike. Still, not to allow the motion picture industry to outperform them in monopolistic blindness, the Authors Guild has sued and the publishers’ lobby followed soon after. 40
We have no reason to think that monopoly makes people unusually incompetent and hateful of others. The reader may wonder: why are incompetent monopolists more dangerous than, say, incompetent hamburger flippers? Simply put, competition tends to weed out the incompetent. Beyond this, a relatively simple mathematical result known as Jensen’s inequality shows that while 1 of 10 firms in an industry run by an incompetent is short-term amusement for the rest of the industry; 1 of 10 industries run by an incompetent is a social catastrophe.
Chapter 5. The Devil in Disney
The Economics of Music
The Recording Industry Association of America (RIAA) produces advocacy documents ranging from white papers to videos arguing that technological change makes it necessary for the government to intervene to prevent the “piracy” that is killing the industry. Certainly musicians should profit from their creations. But in the current system, does the money from the copyright monopoly go to the musicians, or to the seven major producers who act as middle man and gatekeeper? Courtney Love, a musician, reports the following
This story is about a bidding-war band that gets a huge deal with a 20 percent royalty rate and a million-dollar advance. (No bidding-war band ever got a 20 percent royalty, but whatever.) … They spend half a million to record their album. That leaves the band with $500,000. They pay $100,000 to their manager for 20 percent commission. They pay $25,000 each to their lawyer and business manager. That leaves $350,000 for the four band members to split. After $170,000 in taxes, there’s $180,000 left. That comes out to $45,000 per person. That’s $45,000 to live on for a year until the record gets released. The record is a big hit and sells a million copies. So, this band releases two singles and makes two videos. The two videos cost a million dollars to make and 50 percent of the video production costs are recouped out of the band’s royalties. The band gets $200,000 in tour support, which is 100 percent recoupable. The record company spends $300,000 on independent radio promotion … which are charged to the band. Since the original million-dollar advance is also recoupable, the band owes $2 million to the record company. If all of the million records are sold at full price with no discounts or record clubs, the band earns $2 million in royalties, since their 20 percent royalty works out to $2 a record. … 8
… With modern Internet distribution and laptop computer “recording studios” the cost of producing music is quite small. The allegedly large fixed cost to be recouped via monopoly profits is not due to the actual economic cost of producing and distributing the music, which modern technology has cut to a fraction of what it used to be. The large fixed cost that needs to be recouped via monopoly profits seems to be due to the … very existence of the system of copyright and large monopolies thriving on it. From there come the legal, agency and marketing costs contemporary monopolized music faces, and passes on to consumers.
There is a second important fact buried in this story, a fact many know, but that is often forgotten: in this case the “successful” professional musicians are earning only about $45K per year from their CD sales, that is to say: from that portion of their activity that is protected by intellectual monopoly. Most likely they are earning about the same or more from live-concerts, which are not protected by intellectual monopoly and do not benefit from it either.
… We cannot create great new music by modifying wonderful old music because all the wonderful old music is under copyright at least until the 22nd century. If we were to abolish copyright today we are confident that the most important effect would be a vast increase in the quantity and quality of music available.
Chapter 6: How Competition Works
Fixed Costs and Competition
… This is a powerful argument, so powerful in fact that it ought to apply to all industries. Take for example the shoe industry. A factory that produces shoes is expensive. Once the factory is built, shoes can be produced cheaply at a relatively low cost for each pair. If two shoe factories are built, competition between them will drive price down to the cost of producing a pair of shoes, leaving the factory owners with nothing left over to pay for having built the shoe factories. Why, then, do we not consider shoes to be a special entity among economic goods, also unsuitable for competitive markets? Why not special shoe laws entitling the shoe manufacturer to special rights over the lives of shoe buyers and sellers? The same could be said of gasoline and many other industries: an oil refinery is most certainly a very expensive plant. Building a refinery costs orders of magnitudes more than producing a gallon of gasoline from that same refinery once it is in place, still we are not troubled by the idea that the oil and refinery industry should be ruled by open competition.
… Eventually the competitive process increases capacity and reduces competitive rents, but not to zero. This is true in both the shoe and the idea industries. To the extent that even the last entrant must build a costly plant, she will have to earn some rents on the price of shoes, to pay for the cost of the plant. Similarly for the imitator who is trying to compete with an innovator: as long as imitating an idea and learning how to make copies of it involves some fixed cost, a positive distance will remain between the market price and the marginal cost of reproduction. Hence rents will be earned for a long while, and the rents earned by the innovator are commonly much larger than those earned by its imitators: the market shares of Aspirin, Coca Cola, and Tide are still very large, indeed.
… The preference for originals, signed or autographed copies and so forth, is just a special example of a more general phenomenon: the complementary sale. That is, a creation, while not terribly scarce in some markets, is often quite scarce in other markets, and the innovator, by virtue of being the innovator, can generally command a premium for his services in areas not directly related to his idea. Examples of this abound. In music, live performances will remain scarce, no matter what the price of electronic copies. Movies will be produced as long as first run theatrical profits are sufficient to cover production costs, and no matter how many copies are given away over the Internet for free. Books will continue to be produced as long as initial hardcover sales are sufficient to cover production costs. Substantial money is to be earned by authors or inventors by going on the talk-show circuit. Even t-shirts signed by a famous author may be enough to pay for the opportunity cost of his labor in producing his great literary work – amazingly enough, a number of small online comic strips have found it a profitable business model to give their strip away for free, and sell t-shirts.
Activities more mundane than great literary work may also suffice to make lots of money from complimentary sales, as the Spanish soccer team Real Madrid has repeatedly proven by covering the large salaries of its “galactic” soccer stars (Beckham, Owens, Raul, Ronaldo, Zidane) through the sale of clothing items bearing their names and numbers. Never mind if they never managed to win any serious competition, either in Spain or in Europe, during their galactic years: as innovators in the world-soccer circus they made plenty of money, plentiful imitators notwithstanding.
The Social Value of Imitation
… On the one hand, imitation is a technology that allows us to increase productive capacity. Innovators may increase productive capacity directly, while imitators increase productive capacity by purchasing one or more copies of the idea and then imitating it. Imitation, therefore, always requires an investment: not only do you need to purchase a copy of the idea (and if you try doing this shortly after the innovation has been released, it may be quite costly) but you also need to invest your time and other resources to carry out the imitation process. The output of the imitation process is additional productive capacity. As long as industry capacity is low enough that there are rents to be earned in selling copies of ideas at a price higher than marginal cost, people will make investment to increase capacity. Imitation is the main way in which such investments are implemented.
On the other hand, imitation is also a technology that allows further innovation. When you imitate you take as inputs a copy of the idea, various standard inputs available on the market, and your own skills; as output you get productive capacity for the idea. You do this because you are trying to collect as large a competitive rent as possible: making your copy of the idea a bit better, or cheaper, than the one the original innovators are selling is one way of increasing your rents. Indeed, it is a very powerful way of increasing your rents: it is the essence of competition. So, at the end, imitation is nothing else but an essential ingredient for competition, which may be characterized as imitation with lots of good imitators.
Intellectual monopoly greatly discourages imitation. For a monopolist, the worst possibility is losing the monopoly. If an imitator improves upon the product, or learns how to produce it at cheaper cost, regardless of prior licensing agreements, your competitor now has the upper hand and is a threat to your monopoly. Far more sensible simply to prevent imitation in the first place, by aggressive legal enforcement of patents and other forms of intellectual monopoly.
Chapter 7: Defenses of Intellectual Monopoly
Fixed Cost and Constant Marginal Cost
… There is an additional and important reason why the theoretical foundations of the new growth theory are shaky. A key element of the New Growth Theory is the assumption that after an imitator enters, price will be driven down to cost, and there will be no profits to pay for the original innovation. A moment of reflection shows that if there is any cost at all to imitation, then there will be no imitation, and the innovator will enjoy an unfettered monopoly. For the imitators correctly understand that if they were to enter, they would lose their fixed cost of imitation. That is, if we take seriously the argument as to why there should be no innovation without IP, we find that it means instead that there will be not be imitation without IP, thereby undermining the first argument.
The “Idea” Economy
… In the case of copyrightable creations, it can be argued that technological change – computers and the Internet – are greatly lowering the cost of reproduction, and so the conventional model in which ideas trade instantly at zero price is relevant. However, it is cost relative to the amount of competitive rent that matters. If indeed the Internet is reducing competitive rents, bear in mind that the same computer technology is reducing the cost of producing copyrightable creations. Take music, for example. Music editing capabilities that required millions of dollars of studio equipment ten years ago, now require an investment in computer equipment of thousands of dollars. And long before the Internet swamps the markets with music and movies, authors will be able to create movies on their home computers with no greater difficulty than writing a book – and entirely without the assistance of actors, cinematographers, and all the other people that contribute to the high cost of movie making. 36
The Public Domain and the Commons
… Landes and Posner express concern about Mickey Mouse: “If because copyright had expired anyone were free to incorporate the Mickey Mouse character in a book, movie, song, etc., the value of the character might plummet.” 41 The value for whom? It cannot be the social value of the Mickey Mouse character that plummets – this increases when more people have access. Rather it is the market price of copies of the Mickey Mouse character that plummets: normally, this is the socially good effect of an increase in output. Next they assert “the public [would] rapidly tire of Mickey Mouse…” 42 But this is in fact the ordinary consequence of an increase in output. If I eat a large meal, I am less hungry – the value to me of a meal is diminished, and restaurants will find I am not willing to pay them much money. No externality is involved: as more of a good is consumed, the more tired people become of it. For there to be an externality, it would have to be the case that my consumption of copies of Mickey Mouse from the public domain made you more tired of it – an improbability, to say the least.
The Global Economy
… In fact technological change is reducing the fixed cost for many creations, especially in music and movies, and value-based pricing here means a higher, and hence more distortionary price. As the economy expands, there is less need for these price distortions …
Chapter 8: Does Intellectual Monopoly Increase Innovation?
Intellectual Property and Innovation in the 20th Century
A number of scientific studies have attempted to examine whether introducing or strengthening patent protection leads to greater innovation using data from post WWII advanced economies. We have identified twenty three economic studies that have examined this issue empirically. 13 The executive summary: these studies find weak or no evidence that strengthening patent regimes increases innovation; they find evidence that strengthening the patent regime increases … patenting! They also find evidence that, in countries with initially weak IP regimes, strengthening IP increases the flow of foreign investment in sectors where patents are frequently used.
13 All the empirical studies listed in the long table can be found in the references at the end. The data about patents come from the 2003 Annual Report of the USPTO, which can be found on line at //www.uspto.gov/web/offices/com/annual, additional basic data is from http://www.cms.hhs.gov.
Chapter 9: The Pharmaceutical Industry
World Shortest History of Pharmaceutical Patents
… In Italy, pharmaceutical patents were prohibited until 1978, when the Supreme Court ruled in favor of eighteen pharmaceutical companies, all foreign, requesting the enforcement of foreign patents on medical products in Italy. Despite this complete lack of any patent protection, Italy had developed a strong pharmaceutical industry: by the end of the 1970s it was the fifth world producer of pharmaceuticals and the seventh exporter.
Chemicals Without Patents
… In 1862 British firms controlled about 50% of the world market, and French firms another 40%, Swiss and German companies being marginal players. By 1873 German companies had 50% of the market, while French, Swiss and British firms controlled between 13% and 17% each. In 1913 German firms had a market share of more than 80%, the Swiss had about 8%, and firms in the rest of the world had largely disappeared. During this entire period there was no patent protection at all in Switzerland, while in Germany processes become patentable in 1877 but products did not. In France, the U.K. and the U.S. both products and processes had been patentable all along. Indeed, the strong patent protection for this industry in France and its absence in Switzerland was largely responsible for the development of the important Swiss chemical, and then pharmaceutical, industry after 1864.It could be, and sometimes is, argued that the modern pharmaceutical industry is substantially different from the chemical industry of the last century. In particular, it is argued that the most significant cost of developing new drugs lies in testing numerous compounds to see which ones work. Insofar as this is true, it would seem that the development of new drugs is not so dependent on the usage and knowledge of old drugs. However, this is not the case according to the chief scientific officer at Bristol Myers Squib, Peter Ringrose, who
told The New York Times that there were ‘more than 50 proteins possibly involved in cancer that the company was not working on because the patent holders either would not allow it or were demanding unreasonable royalties. 18
The Pharmaceutical Industry Today
… A few additional facts may help the reader get a better understanding of why, at the end, we reach the conclusion we do. Sales are growing, fast; at about 12% a year for most of the 1990s, and still now at around 8% a year; R&D expenditure during the same period has been rising of only 6%. A company such as Novartis (a big R&D player, relative to industry’s averages) spends about 33% of sales on promotion, and 19% on R&D. The industry average for R&D/sales seems to be around 16-17%, while according to the CBO  report the same percentage was approximately 18% for American pharmaceuticals in 1994; according to PhRMA  it was 19% in 2006. … The point here is that the top 30 firms spend about twice as much in promotion and advertising as they do in R&D; and the top 30 are where private R&D expenditure is carried out, in the industry.
Next we note that no more than 1/3 – more likely 1/4 – of new drug approvals are considered by the FDA to have therapeutic benefit over existing treatments, implying that, under the most generous hypotheses, only 25-30% of the total R&D expenditure goes toward new drugs.
Where do Useful Drugs Come From?
… So, it seems, things are not changing: private industry pays for only about 1/3rd of biomedical R&D. By way of contrast, outside of the biomedical area, private industry pays for more than 2/3rds of R&D.
… Consulting a large number of medical journals leads to the pleasant discovery that the British Medical Journal, a most distinguished publication, has decided to inaugurate a new series by asking colleagues and readers something very close to our fundamental question: which medical and pharmaceutical discoveries are truly fundamental and where do they come from? … In no particular order, here are the selected fifteeen (we could not get hold of the group of seventy, which, we suspect, would have not moved the bottom line an iota):
Penicillin, x rays, tissue culture, ether (anaesthetic), chlorpromazine, public sanitation, germ theory, evidence based medicine, vaccines, the pill, computers, oral rehydration therapy, DNA structure, monoclonal antibody technology, smoking health risk. 30
How many entries in this list were patented, or were due to some previous patent, or were obtained during a research project motivated by the desire to obtain a patent? Two: chlorpromazine and the pill. … In the same issue (freely available on line) of the BMJ you can find references to other similar lists. A particularly interesting one was compiled since 1999-2000 by the US Centers for Disease Control and Prevention (CDC): a top 10 list of public health achievements of the 20th century in the United States. How do medical patents score on this one? Zero.