Tag Archives: Intellectual Property

The Entrepreneurial State: the important role of government in innovation (part 2)

As I said in The Entrepreneurial State: the important role of government in innovation (part 1), Mariana Mazzucato has written an important book even if I do not agree with all her arguments.

We agree on the issue of funding of technologies, inventions and innovations. It has been generally understood that the commercialization of products and their prior development is the responsibility of the private sector in a capitalist economy. The funding of research (at least basic research) is generally the mission of the state, but applied research (though I never really understood what this is) might be done by the State as well as by the private sector.

Let me open a short parenthesis here: I am not of big supporter of the concepts of basic and applied research, but I understand better other concepts from an early to later stage. Here they are:
Public-and-private-sector

Research has no known output a priori, except knowledge, whereas at a later stage the objectives are a little clearer. This being said, I am not fully comfortable about the arguments Mazzucato brings on the table when she says the State is doing a lot in innovation. But she clearly shows there is a grey zone between the 3 stages I have above. I belong (at least for now) to the group of people who believe it is the mission of the State to be active in the first two ones, and the private sector being in the third. Nothing forbids the private sector to go earlier and the public sector to be more active later, but it is seldom the case. Here are my notes on Chapters 3 and followings:

Chapter 3 – Risk-taking state : from « de-risking » to « bring it on ! »

During a visit of President Mitterand to Silicon Valley, Thomas Perkins which fund started Genentech extolled the virtues of the risk-taking investors who finance the entrepreneurs. Perkins was cut off by Stanford Professor and Nobel Prize Paul berg. He asked, “Where were you guys in the 50’s and 60’s when all the funding that had to be done in the basic science?” [Page 57]

Entrepreneurship, like growth, is one of the least-well understood topics in economics. According to Schumpeter, an entrepreneur is a person willing and able to convert a new idea or invention into a successful innovation (i.e. product, service or process). Entrepreneurship employs the “gale of creative destruction” to replace, in whole or in part, inferior innovations, simultaneously creating new products including new business models. Each major new technology leads to creative destruction. [Page 58]

[Again I need to react: where I fully agree with the Entrepreneurship and Innovation definitions, I am skeptical about the comment on technology: some major new technologies never destroyed anything because they were not commercially successful (artificial intelligence, speech recognition for example and there are many others). I would say major new successful innovations lead to creative destruction. This is important because as Mazzucato rightly says, there is no linear process for innovation and a lot of uncertainty too.]

Entrepreneurship is about risk and is highly uncertain. R&D investments that contribute to technological change not only take years to materialize into new products, but most products developed fail. Silicon Valley model tells a story of “freewheeling entrepreneurs and visionary venture capitalists and yet misses the crucial factor: the military’s role in creating and sustaining it. [Mazzucato shows the same issues in Pharma where the big players develop me-too drugs and let the State fund radical innovations in universities, as is shown in the anecdote above with Mitterand, Perkins and Berg.]

R&D-Funding

Again, I have some concerns with this decription. First in the image above, I would have liked to see the R vs. D and not only the fundamental R vs global R&D. Mazzucato is right in the funding of research, no doubt about it. I used such data for many years where the funding of research in universities by the industry is 4-7% whereas the federal funding is around 60%! You can look at Figures 1 and 2 below. But then, when it comes to innovation, I do not see where the State produced the biotech or IT industry. It made inventions available. You still needed the visionary entrepreneurs and investors as I told about in the Genentech case on my blog a few years ago [see Bob Swanson & Herbert Boyer: Genentech
and Robert Swanson, 1947-1999]

Federal-Private-Res-GEN
Figure 1: Federal and Industry funding of university research in the USA.

Federal-Private-Res-Stanford-MIT
Figure 2: Federal and Industry funding of research at Stanford University and MIT.

Chapter 4 – The US entrepreneurial state.

In this short chapter, Mazzucato shows through four examples how the US government fostered innovation. These are DARPA (the funding of American research by the military), SBIR (The Small Business Innovation Research), Orphan Drugs and Nanotechnologies.

On Darpa, “A series of small offices, staffed with leading scientists, are given considerable budget autonomy, … funding a mix of university-based researchers, start-ups, established firms and consortia… helping firms to get products to the stage of commercial viability”. [Page 78 ] Again the impact of DARPA in funding research is a no brainer. And Yes, I should be said. Mazzucato is right about too much silence on the role of the State. Check as a great reference Rebecca’s Lowen “Creating the Cold War University – the Transformation of Stanford”.

I am less convinced about the SBIR. “Government agencies designate a fraction of their research funding to support small, independent, for-profit firms.” Mazzucato claims Apple was funded with such a fund, Continental Illinois Venture Corp. but I checked Apple IPO document and CIVC was not at the origin of the company. Arthur Rock and Don Valentine convinced Markkula to help the two Steve and invested in January 1979. Even if CIVC invested that early, it was a minority and passive shareholder. Furthermore, CIVC was the VC arm of a bank, so not a purely State investment… She also quotes Lerner and Audretsch, leading professors as references. In a recent book (Boulevard of Broken Dreams – Pages 125-126), the same Lerner explains that the lack of flexibility of SBIR and ATP was detrimental (it had to be pre-commercial funding for ATP; start-ups had to be 51% owned by US citizens or residents, to the point that the presence of venture capital could exclude the firm from SBIR funding!) I have been struggling for years to find the real impact of SBIR and could never find convincing data of an important role. State direct role in VC funding has been a recurrent debate with unclear answers for years.

I do not know about orphan drugs, but I am skeptical about nanotechnologies. “Nanotechnology is very likely to be the next general purpose technology”. [Page 83] “It will be even more important than the computer revolution.” “Today it does not yet create a major economic impact because of the lack of commercialization of new technologies, due to the excessive investments made in research relative to the lack of investments in commercialization. […] This raises a question: if government has to do the research, fund major infrastructure investments and also undertake the commercialization effort, what exactly is the role of the private sector?” [Page 86]

Well again many things are unclear and somehow contradictory in the arguments. If nanotechnology was just another low hanging fruit thanks to the State investment, we should have already seen early results. The US initiative on Nanotech was launched in 2000. There has been a very visible start-ups such as Nanosys or A123 to a lesser extent. Next is Nanosys cap. table as of 2004. One can read the then and additional funding from private sources.

I am now reading chapter 5 and will come back on Mazzucato’s book in a part 3!

Nanosys

The Entrepreneurial State: the important role of government in innovation (part 1)

Mazzacuto’s Entrepreneurial State is I think an important book. The author claims we have been unfair with the role in innovation of government and the public sector in general, which has provided funds for most not to say all R&D (Pharma, IT, Space). I share the blame as I am a strong supporter of start-ups, venture capital, Silicon Valley being the ultimate model. And the idea that the State should just provide the basics (education, research, infrastructure) and let the private sector innovate may have been a big mistake (of mine included). I will not take the blame on the second argument as I always shared with the author the idea that tax breaks and tax evasion makes the judgment even more unfair. Finally, the private sector is very risk averse so that there is less innovation (not only venture capital but corporate R&D, compared to the past when corporate R&D labs at IBM, Bell or Xerox were big or when VCs really contributed to innovation in semiconductor, computers and biotech in the 60s and 70s)

9780857282521_hi-res_2

Let me now quote Mariana Mazzacuto following her book linearly. You can also listen to her when she gave a talk at TedX.

While innovation is not the State’s main role, illustrating its potential innovative and dynamic character – its historical ability, in some countries, to play an entrepreneurial role in society is perhaps the most effective way to defend its existence. (Page 1.)

Entrepreneurship is not (just) about start-ups, venture capital and “garage tinkerers”. It is about the willingness and ability of economic agents to take on risk and real Knightian* uncertainty, what is genuinely unknown. (Page 2.)
Note: *Knightian uncertainty relates to the “immeasurable“ risk, i.e. a risk that cannot be calculated.

Even during a boom most firms and banks (would) prefer to fund low-risk incremental innovations, waiting for the State to make its mark in more radical areas. (Page 7.) Examples are provided from the pharmaceutical industry – where the most revolutionary new drugs are produced mainly with public, not private funds. (Page 10.)

Apple must pay tax not only because it is the right thing to do, but because it is the epicenter of a company that requires the public purse to be large and risk-taking enough to continue making the investments that entrepreneurs like Jobs will later capitalize on. (Page 11) Precisely because State investments are uncertain, there is a high risk that they will fail. But when they are successful, it is naive and dangerous to allow all the rewards to be privatized. (Page 12)

Chapter 1 – (The Innovation Crisis)

The emphasis on the State as an entrepreneurial agent is not of course meant to deny the existence of private sector entrepreneurship activity, from the role of young new companies in providing the dynamism behind new sectors (e.g. Google) to the importance source of funding from private sources like venture capital. The key problem is that this is the only story that is usually told. (Page 20)

It is naive to expect venture capital to lead in the early and most risky stage of any new economic sector today** (such as clean technology). In biotechnology, nanotechnology and the Internet, venture capital arrived 15-20 years after the most important investments were made by public sector funds. (Page 23) The State has been behind most technological revolutions and periods of long-term growth. This is why an “entrepreneurial” state is needed to engage in risk taking and the creation of a new vision.
Note: ** Well maybe not in the 50s to the 70s, certainly in the last 10 years.

Big R&D labs have been closing and the R of the R&D spend has also been falling. A recent MIT study (1) claims that the current absence in the US of corporate labs like Xerox PARC (which produced the graphical user interface technology that led to both Apple’s and Windows’ operating systems) and Bell Labs – both highly co-financed by government agency budgets – is one of the reasons why the US innovation machine is under threat. (Page 24) Rodrik (2004) states that the problem is not in which types of tools (R&D, tax credits vs. subsidies) or which types of sectors to choose (steel vs. software), but how policy can foster self-discovery processes, which foster creativity and innovation – the need to foster exploration trial and error (and this is the core tenet of the “evolutionary theory of economic change” in chapter 2)
References
[1] MIT 2013. Innovation Economic Report, web.mit.edu/press/images/documents/pie-report.pdf‎
[2] Rodrik, 2004. Industrial Policy for the 21st century. CEPR Discussion Paper 4767

Chapter 2 – Technology, Innovation and Growth.

Progressive redistribution policies are fundamental, but they do not cause growth. Bringing together the lessons of Keynes and Schumpeter can make this happen. (Page 31) Solow discovered that 90 per cent of variation in economic output was not explained by capital and labor, he called the residual “technical change”. (Page 33)

An “evolutionary theory” explains this as a constant process of differentiation among firms, based on their ability to innovate. Selection does not always lead to “survival of the fittest” both due to the effects of increasing returns and also to the effects of policies. Selection dynamics in products markets and financial markets may be at odds.

Innovation is firm specific and highly uncertain. It is not the quantity of R&D, but how it is distributed throughout an economy. The old view that R&D can be modeled as a lottery where a certain amount will create a certain probability of successful innovation is criticized because in fact innovation would be an example of a true Knightian uncertainty, which cannot be modeled with a normal (or nay other) probability distribution. (Page 35 – the Black Swan again)

Systems of innovation are defined as the “network of institutions in the public and private sector whose activities and interactions initiate, import, modify and diffuse new technology”. (Equilibrium theory cannot work; rather than using incremental calculus from Newtonian physics, mathematics from biology are used, which can explicitly take into account heterogeneity, and the possibility of path dependency and multiple equilibria.) (Page 36) The perspective is neither micro nor macro, but meso. The causation between basic science, to large scale R&D, to applications to diffusing innovation is not linear, but full of feedback loops. One must be able to recognize serendipity and uncertainty that characterizes the innovation process. […] Using Japan as an example, “the contributions of the development state in Japan cannot be understood in abstraction from the growth of companies such as Toyota, Sony or Hitachi aside from the Japanese State’s public support for industry”. (Page 38)

Regional systems of innovation focus on the cultural geographical, and institutional proximity that creates and facilitate transactions between different socioeconomic actors, including local administrations, unions and family-owned companies… The State does this by rallying existing innovation networks or by facilitating the development of new ones that bring together a diverse group of stakeholders. But a rich system of innovation is not sufficient. The State must develop strategies for technological advance.

Mazzacuto finishes Chapter 2 with 6 myths about innovation I totally agree with!

Myth 1: Innovation is about R&D. “It is fundamental to identify the company-specific conditions that must be present to allow spending on R&D to positively affect growth.”

Myth 2: Small is Beautiful. “There is confusion between size and growth.” What is important is the “role of young high-growth firms. Many small firms are not high-growth. […] Most of the impact is from age.” “Targeting assistance to SMES through grants, soft loans and tax breaks will necessarily involve a high degree of waste. While this waste is a necessary gamble in the innovation process,” it should be targeted on high growth and not SMEs, i.e. support “young companies that have already demonstrated ambition”.

Myth 3: Venture Capital is Risk-Loving. “Risk capital is scarce in the seed stage; it is concentrated in areas of high-growth potential, low technological complexity and low capital intensity.” […] “The short-term bias is damaging to the scientific exploration process which requires longer-term horizon and tolerance to failure.” “Rewards to VC have been disproportional to risks taken”, but Mazzacuto also recognizes that “Venture capital has succeeded more in the US when it provided not only committed finance, but managerial expertise.” Finally “The progressive commercialization of science seems to be unproductive”.

Myth 4: Patents. “The rise in patents does not reflect a rise in innovation”. [I will not come back here on the topic, read again Against Intellectual Monopoly]

Myth 5: Europe’s problem is all about Commercialization. “If the US is better at innovation, it isn’t because university-industry links are better (they aren’t) or because US universities produce more spinouts (they don’t). It simply reflects more research being done in more institutions, which generate better technical skills in the workforce. US funding is split between research in universities and early stage technology development in firms. Europe has a weaker system of scientific research and weaker and less innovative companies.”

Myth 6: Business Requires Less Tax. “The R&D tax credit system does not hold firms accountable as whether they have conducted new innovation that would not otherwise have taken place, or simply pursued routine forms of product development.” “As Keynes emphasized, business investment is a function of the gut instinct of investors about future growth prospects.” This is impacted not by tax break, but by the quality of the science base, education, credit system and human capital. “It is important for innovation policy to resist the appeal of tax measures of different kinds”.

More will follow when I have read chapters 3 and followings. Now I need to share some of my concerns, first by quoting again:

“Entrepreneurship by the State can take on many forms. Four examples: DARPA, SBIR, the Orphan Drug Act, Nanotechnology. (…) Apple is far from the “market” example it is often used to depict. It is a company that not only received early stage finance from the government (through the SBIC program) but also “ingeniously” made use of publicly funded technology*** to create “smart” products.” (Pages 10-11)
Note: *** Internet, GPS, Touch screen, Siri.

“Many of the most innovative young companies in the US were funded not by private venture capital but by public venture capital, such as that provided by the Small Business Innovation Research (SBIR) program.” (Page 20)

My concerns are that
– research is not innovation & the transfer is where entrepreneurship occurs so that investing in research is not innovating or even being entrepreneurial. This is at least my experience in the field.
– SBIR real impact unclear
– Green and nano-tech impact also unclear
But I have not finished reading yet…

Against Intellectual Monopoly – (final) part 3

Here is my third and final post on Boldrin and Levine’s book. I cover here the final two chapters and the pharma industry (chapter 9) and their conclusions (chapter 10). As lazy as usual, it is mostly some copy-pastes. As a reminder you can find here part 1 and part 2.

The Pharmaceutical Industry

The traditional model predicts that there should be many potential producers of a medicine, that the industry should be dynamically competitive, and therefore highly innovative with newcomers frequently challenging incumbents by means of innovative superior drugs. […] Some people esteem the pharmaceutical industry and some people despise it: there is little middle ground. The pharmaceutical industry is the poster-child of every intellectual monopoly supporter. It is the vivid example that, without the sheltering patents provide inventors with, the outpouring of new wonder drugs we have grown accustomed to would have not materialized, our life expectancies would be a lot shorter, and millions of people would have died of the diseases Big Pharma has instead managed to cure. In the opposite camp, Big Pharma is the scourge of humanity: a club of oligopolistic white men that, by controlling medicine around the globe and refusing to sell drugs at their marginal cost, are letting millions of poor people die. […] This sounds utterly complicated, so let us handle it with care and, for once, play the role of the wise fellows: in media stat virtus, et sanitas. […] How strong is the case for patents in pharmaceuticals? While Big Pharma is not necessarily the monster some depict, the case for patents in pharmaceuticals is a lot weaker than most people think. [Pages 242-243]

The authors make a long and interesting analysis of the history of the chemical industry with France and the UK blocking while Germany and Switzerland could innovate.

[Page 249] Here is how Murmann summarizes the main findings from his historical study of the European synthetic-dye industries during the 1857-1914 period. British and French synthetic dye firms that initially dominated the synthetic dye industry because of their patent positions but later lost their leadership positions are important cases in point. It appears that these firms failed to develop superior capabilities in production, marketing and management precisely because patents initially sheltered them from competition. German and Swiss firms, on the other hand, could not file for patents in their home markets and only those firms that developed superior capabilities survived the competitive home market. When the initial French and British patents expired, the leading German and Swiss firms entered the British and French market, capturing large portions of sales at the expense of the former leaders.

The authors also analyze Italy and India, which did not have until recently strong IP policies. “Interestingly though, we have not been able to find a single independent analyst claiming that the additional amount of pharmaceutical innovation patents may stimulate in the Indian industry, will be substantial and large enough to compensate for the other social costs. More to the point, the positive consequence of patent adoption in countries like India is, according to most analysts, a consequence of beneficial price discrimination. The argument goes as follows: monopoly power allows price discrimination – that is, the selling the same good for a high price to people valuing it a lot (usually people richer than average) and for a low price to people valuing it little (usually people poorer than average). Due to the absence of patent protection, there are very many new drugs that are not marketed in poor countries by their original producer, as the latter is not protected by reliable patents in that country.” [Page 253]

[Another] doubt comes from the following observation: if it were really true that imitating and “pirating” new drugs is that easy, absent patent protection local firms would be already producing and marketing such drugs in the country in question. [Page 254]

Pharma today
A few additional facts : 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. [Page 255]

Summing up and moving forward, here are the symptoms of the malaise we should investigate further.
– There is innovation, but not as much as one might think there is, given what we spend.
– Pharmaceutical innovation seems to cost a lot and marketing new drugs even more, which makes the final price for consumers very high and increasing.
– Some consumers are hurt more than others, even after the worldwide extension of patent protection. [Page 256]

Where do drugs come from? [Pages 257-260]
Useful new drugs seem to come in a growing percentage from small firms, startups and university laboratories. […]Next there is the not so small detail that most of those university laboratories are actually financed by public money, mostly federal money flowing through the NIH. The pharmaceutical industry is much less essential to medical research than their lobbyists might have you believe. In 1995, […] about $11.5 billion came from the government, with another $3.6 billion of academic research not funded by the feds. Industry spent about $10 billion. However, industry R&D is eligible for a tax credit of about 20%, so the government also picked up about $2 billion of the cost of “industry” research. […] In 2006, total was $57 billion while the NIH budget in the same year (the largest but by no means the only source of public funding for biomedical research) reached $28.5 bn.[…] it is wise to remember that the modern “cocktail” that is used to treat HIV was not invented by a large pharmaceutical company. It was invented by an academic researcher: Dr. David Ho.

It is a fact that, without the strong incentive the prospect of a successful patent induces, those researchers would not be working as hard as they do. That is true, so let us think the issue through once again. We observe that, while the incentive to patent and commercialize their findings should have been increased by the Bayh-Dole act allowing patentability of such research results, there is no evidence whatsoever that, since 1980 when the act was passed, major medical scientific discoveries have been pouring out of American universities’ laboratories.

It therefore remains an open question: did patentability of basic biomedical innovations create an incentive for engaging in more socially valuable research projects and investigations? Which medical and pharmaceutical discoveries are truly fundamental and where do they come from?

Here are the selected fifteen most important medical milestones: 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. 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. […] Now the “list of Top Pharmaceuticals”, these are the current pharmaceutical products selling the most worldwide, and there are 46 of them. Patents had pretty much nothing to do with the development of 20 among the 46 top selling drugs. […] Notice though that of these 26, 4 were discovered completely by chance and then, 2 were discovered in university labs before the Bayh-Dole Act was even conceived. Further, a few were simultaneously discovered by more than one company leading to long and expensive legal battles, however, the details are not relevant to our argument. The bootom line is more than half of the top selling medicines around the world do not owe their existence to pharmaceutical patents.

Rent-seeking and redundancy. [Pages 260-263]
The next question then is, if not in fundamental new medical discoveries, where does all that pharmaceutical R&D money go? […] 54% of FDA-approved drug applications involved drugs that contained active ingredients already in the market. […] 35% were products with new active ingredients, but only a portion of these drugs were judged to have sufficient clinical improvements over existing treatments to be granted priority status. In fact, only 238 out of 1035 drugs approved by the FDA contained new active ingredients and were given priority ratings on the base of their clinical performances. In other words, about 77% of what the FDA approves is “redundant” from the strictly medical point of view. […] Sad but ironically true, me-too or copycat drugs are largely the only available tool capable of inducing some kind of competition in an otherwise monopolized market. ..] The ironic aspect of me-too drugs, obviously, is that they are very expensive because of patent protection, and this cost we have brought upon ourselves for no good reason. […] Insofar as new drugs are replacements for drugs that already exist, they have little or no economic value in a world without patents – yet cost on the order of $800 million to bring to market because the existence of patents forces the producers to “invent something” the USPTO can pretend to be sufficiently different from the original, patented, drug.

Libraries have been written on the obvious connection between marketing and the lack of competition. The pharmaceutical industry is no exception to this rule, and the evidence Professor Sager, and many others, point to has a simple and clear explanation: because of generalized and ever extended patenting, large pharmaceutical companies have grown accustomed to operating like monopolies. Monopolies innovate as little as possible and only when forced to; in general they would rather spend time seeking rents via political protection while trying to sell at a high price their old refurbished products to the powerless consumers, via massive doses of advertising.

The authors finish with an economic analysis of the social cost and benefit of patents and without patents, and propose solution in the final chapter.

Conclusion: The bad, the Good, and the Ugly

Edith Penrose, concluded that “If we did not have a patent system, it would be irresponsible, on the basis of our present knowledge of its economic consequences, to recommend instituting one. But since we have had a patent system for a long time, it would be irresponsible, on the basis of our present knowledge, to recommend abolishing it

But the authors claim: “On the basis of the present knowledge” progressively but effectively abolishing intellectual property protection is the only socially responsible thing to do. […] A realistic view of intellectual monopoly is that it is a disease rather than a cure. It arises not from a principled effort to increase innovation, but from a noxious combination of medieval institutions – guilds, royal licenses, trade restrictions, religious and political censorship – and the rent-seeking behavior of would be monopolists seeking to fatten their purse at the expense of public prosperity. [Pages 277-78]

A myriad of other legal and informal institutions, business practices and professional skills have grown up around them and in symbiosis with them. Consequently, a sudden elimination of intellectual property laws may bring about collateral damages of an intolerable magnitude. Take for example the case of pharmaceuticals. Drugs are not only patented, they are also regulated by the government in a myriad of ways. Under the current system, to achieve FDA approval in the United States requires costly clinical trials – and the results of those trials must be made freely available to competitors. Certainly, abolishing patents and simultaneously requiring firms that conduct expensive clinical trials to make their results freely available to competitors, cannot be a good reform. Here patents can only be sensibly eliminated by simultaneously changing also the process by which the results of clinical trials are obtained, first, and, then, made available to the public and to competitors in particular. [Page 278]

The authors look at many intermediate solutions including deregulation, private contracts, subsidies, social norms but they are clearly convinced (and convincing) that an evolution is needed, even if they are pessimistic:

Where, today, is a software innovator to find safe haven from Microsoft’s lawyers? Where, tomorrow, will be the pharmaceutical companies that will challenge the patents of “big pharma” and produce drugs and vaccines for the millions dying in Africa and elsewhere? Where, today, are courageous publishers, committed to the idea that accumulated knowledge should be widely available, defending the Google Book Search initiative? Nowhere, as far as we can tell, and this is a bad omen for the times to come. The legal and political war between the innovators and the monopolists is a real one, and the innovators may not win as the forces of “Stay the Course” and “Do Nothing” are powerful, and on the rise. [Page 299]

Certainly the basic threat to prosperity and liberty can be resolved through sensible reform. But intellectual property is a cancer. The goal must be not merely to make the cancer more benign, but ultimately to get rid of it entirely. So, while we are skeptical of the idea of immediately and permanently eliminating intellectual monopoly – the long-term goal should be no less than a complete elimination. A phased reduction in the length of terms of both patents and copyrights would be the right place to start. By gradually reducing terms, it becomes possible to make the necessary adjustments – for example to FDA regulations, publishing techniques and practices, software development and distribution methods – while at the same time making a commitment to eventual elimination. [Page 300]

Against Intellectual Monopoly – part 2

I promised a continuation to my post Against Intellectual Monopoly and here it is. The book is really a must-read for anyone interested in innovation. But maybe you want to begin with an direct explanation by the authors. Check the following audio interview.

So, as a follow-on, here are some very interesting elements about:
– Does IP increase innovation?
– Non-compete labor contract clauses inhibit innovation.

This is something I have been particularly sensitive to, as you will see below through past links. But before this, let us follow the book from where I had stopped.

Criticism of the Schumpeterian Theory
“Although originally not a mainstream view in economics, the Schumpeterian view is now close to becoming an orthodoxy in most circles. Schumpeter celebrates monopoly as the ultimate accomplishment of capitalism. He argues that in a world in which intellectual property holders are monopolists, competition is a dynamic process that is implemented via the process of creative destruction. […] How many industries can [one] mention where the mechanism described in the Schumpeterian model has been at work, with innovators frequently supplanting the incumbent monopolist, becoming a monopolist in turn to be ousted shortly after by yet another innovator?” [Pages 189- 190]

About secrecy and disclosure through patents/copyrights
“A common argument in favor of patent law is that in order to get a patent you must reveal the secret of your invention. […] Suppose that each innovation can be kept secret for some period of time, with the actual length varying from innovation to innovation, and that the length of legal patent protection is 20 years. Then the innovator will choose secrecy in those cases where it is possible to keep the secret for longer than 20 years, and choose patent protection in those cases where the secret can be kept only for less than 20 years. In this case, patent protection has a socially damaging effect. Secrets that can be kept for more than 20 years are still kept for the maximum length of time, while those that without patent would have been monopolized for a shorter time, are now monopolized for 20 years. Indeed, it is important to realize that outside the pharmaceutical industry, where the regulatory system effectively forces revelation, trade-secrecy is considerably more important than patent. Repeatedly, in surveys of R&D lab and company managers only 23%-35% indicate that patents are effective as a means of appropriating returns. By way of contrast, 51% argue that trade-secrecy is effective.” [Page 186]

“If instead there is a race for a patent, the incentive is to keep intermediate results secret so as to keep competitors from winning the race. In fact there is much evidence that secrecy and legal monopoly are complementary rather than alternatives. Despite copyright, producers of books, music and movies have aggressively attempted to encrypt their work with Digital Rights Management (DRM).” [Page 187]

Worse, [for Amazon 1-click purchase patent], “as can be seen, the “secret” that is revealed is, if anything, less informative than the simple observation that the purchaser buys something by means of a single click.” [Page 189]

“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. […]Whether price falling to zero implies revenue falling to zero depends on the elasticity of demand, the mathematics of infinity times zero is complicated at times and this is one of them. If, in fact, demand is elastic, then price falling to zero implies (because so many more units are sold) revenue increasing to infinity. [Pages 193-194]

About the global economy
One often finds the argument that the increasingly freer trade, the growth of many Asian economies, and the lowering of transportation costs are creating a dangerous mix for our economic stability. In particular, it is argued, our ideas and products are increasingly being “unrightfully copied”, and this requires some kind of serious intervention by our governments. In other words, globalization is risky for our innovators, and we need to strengthen intellectual property protection and force emerging countries to do the same we do. [Page 194]

There is a […] perhaps more subtle but certainly not less relevant argument. As market size increases, two things happen. More consumers are added for all those ideas you are already producing or you would have produced in any case. Let us call these “good” ideas since they were good enough to be profitable even when the market was small. Also, additional ideas from new guys getting into the game become available. Let us call these “marginal” ideas, since if they had been good ideas they would have been introduced even when the market was small. Now, lowering intellectual property protection decreases the monopoly distortions for all consumers of the “good” ideas. With a larger market, many more consumers benefit from the greater usefulness and availability of all these “good” ideas. Second, lowering intellectual property protection makes it harder for “marginal” ideas to make it into the market. But in a larger market, more of these “marginal” ideas are going to be produced anyway, as there are more consumers to pay for the cost of inventing them. So the bottom line is that as the size of the market increases, by lowering intellectual property protection, you can get a lot more use out of “good” ideas at the cost of not getting quite as many “marginal” ideas as you would have.

“This simple rule of thumb would be that if the size of market grows by 4%, the length of protection should be cut by 1%. […]Unfortunately, in the case of copyright, terms have been moving in the wrong direction; they have grown by a factor of about four, while world GDP has grown by nearly two orders of magnitude. Hence, if the copyright term of 28 years at the beginning of the 20th century was socially optimal, the current term should be about a year, rather than the current term of approximately 100 years!” [Page 196]

And the authors add regularly that only already successful ideas are copied, not all of them, so yes there is less revenue and profit. Again how much is enough…?

Does IP increase innovation? [Chapter 8]
“A number of economic historians, Douglass North and his followers foremost among them, have argued that the great acceleration in innovation and productivity we associate with the Industrial Revolution was caused by the development of ways to protect the right of inventors, allowing them to profit from their innovations. Central among such ways was the attribution of patents to inventors, and their upholding either by Parliament or by the courts. Relative to the very poorly defined contractual rights of pre-seventeen century Europe, plagued by royal and aristocratic abuses of property and contracts, there is no doubt that allowing individuals a temporary but well defined monopoly over the fruits of their inventive effort was a major step forward. Even monopolistic property is much better than a system that allows arbitrary seizure by the rich and powerful. This does not, however, contradict our claim that widespread and ever growing monopolistic rights are not as socially beneficial as well defined competitive property rights.” [Page 209] “The issue, then, is the one we posed at the outset: does monopoly really lead to more innovation, on average, than competition? Theory gives an ambiguous answer, so let us look at evidence, supported by a bit of statistical common sense.” [page 210]

After an interesting analysis of music composition before and after copyrights [pages 211-213], the authors analyze patenting. “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. 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.” [Page 216]

Innovation may lead to more patenting but more patents and stronger patent protection do not lead to more innovation. [Page 219]

About labor contract clauses: [Pages 224-227]
(Route 128 and Silicon Valley and restrictive “non-compete” labor contract clauses)

Legally preventing workers from spreading the knowledge they acquired in previous occupations is an inefficient way to internalize knowledge spillovers.

In 1965 both Silicon Valley and Route 128 were centers of technology employment of equal importance, and with similar potentials and aspirations for further growth. … By 1990, Silicon Valley exported twice the amount of electronic products as Route 128, a comparison that excludes fields like software and multimedia, in which Silicon Valley’s growth has been strongest.

What explains this radical difference in growth of the two areas? […] The only significant difference between the two areas lay in a small but significant difference between Massachusetts and California labor laws: A postemployment covenant not to compete prevents knowledge spillover of an employer’s proprietary knowledge not, as does trade secret law, by prohibiting its disclosure or use, but by blocking the mechanism by which the spillover occurs: employees leaving to take up employment with a competitor or to form a competing start-up. Massachusetts law is generally representative of the approach taken toward postemployment covenants not to compete by the great majority of states. California law governing covenants not to compete is both unusual and radically different from that of Massachusetts. “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.

The paradox of Silicon Valley was that competition demanded continuous innovation, which in turn required cooperation among firms. [Quoted from Saxenian. This is as you know one of my favorite topics as you might read from Silicon Valley – more of the same? or The spin-off virtuous circle].


The (not so) famous Wagon Wheel Bar, incarnation of knowledge spillover.

We know that there are good economic reasons why it must be so: competition is the mechanism that breeds innovation, and sustained competitive innovation, paradoxical as that may sound to those that do not understand it, often is best implemented via cooperation among competing firms.

While Route 128 companies spent resources to keep knowledge secret – inhibiting and preventing the growth of the high tech industry – in California this was not possible. And so, Silicon Valley – freed of the milestone of monopolization – grew by leaps and bounds as employees left to start new firms, rejoined old firms and generally spread socially useful knowledge far and wide.

About simultaneous inventions [Pages 229-235]
The authors add interesting examples when simultaneous discoveries were made, including the sad story of tesla vs. Marconi. “So, why did N. Tesla Broadcasting Co. not hold a complete monopoly over radio communications in the U.S. until late in the 1920s? Why did Nikola Tesla die poor while Marconi enriched himself, on his way to a Nobel prize? Because now like then, the game of patenting and intellectual monopoly is not all that democratic and open to the little guys as Ms. Khan’s recent and altogether interesting book would have us to believe. So it is the case that Marconi, supported by the likes of Edison and Carnegie, kept hammering the U.S. Patent Office until, in 1904, they reversed course and gave Marconi a patent for the invention of radio. We read that “The reasons for this have never been fully explained, but the powerful financial backing for Marconi in the United States suggests one possible explanation.”[…] The story of injustice to Nikola Tesla has a tragicomic ending: in 1943 the U.S. Supreme Court upheld Tesla’s radio patent reversing the earlier decision of the U.S. Patent Office. Of course, Tesla was dead by this time – and indeed that is why he was awarded the patent. The United States Government had been sued by the Marconi Company for use of its patents during the First World War. By awarding the patent to Tesla, they eliminated the claim by Marconi – and faced no similar claim from Tesla, who, being dead, was unable to sue. [Pages 232-33]

For reference Khan, Z. [2005], The Democratization of Invention. Patents and Copyrights in American Development, 1790-1920. Cambridge University Press.

More in part 3, soon…

Against Intellectual Monopoly

Last October I published a post about the article The Case Against Patents by Michele Boldrin and David K. Levine. I had mentioned at the end that there was also a book, entitled Against Intellectual Monopoly. I am not finished with it yet but it is so strange, powerful and complex that I will talk about it in two parts. More in a few days…

It’s a very strange book (and the authors have been known for their arguments for a few years now) because it gives arguments against intellectual property (“IP”). They are not always easy to follow. This is a book about economics which sometimes, often (but not always) confirms the intuition that there is something wrong about IP. Yes inventors, innovators, creators need to be able to protect their creation against thieves. Does it mean they should be given a monopoly (patents) or a right to prevent copy of their work (copyright)? This is what the authors try to address. You can now read my comments but I strongly advise you to read the book and its complex and fascinating arguments, even if in the end, you disagree with them! As a provocative statement, they finish their 1st chapter with: “This leads us to our final conclusion: intellectual property is an unnecessary evil”. [Page 12]

One of their strongest arguments is the following: “It is often argued that, especially in the biotechnology and software industries, patents are a good thing for small firms. Without patents, it is argued, small firms would lack any bargaining power and could not even try to challenge the larger incumbents. This argument is fallacious for at least two reasons. First, it does not even consider the most obvious counterfactual: How many new firms would enter and innovate if patents did not exist, that is, if the dominant firms did not prevent entry by holding patents on pretty much everything that is reasonably doable? For one small firm finding an empty niche in the patent forest, how many have been kept out by the fact that everything they wanted to use or produce was already patented but not licensed? Second, people arguing that patents are good for small firms do not realize that, because of the patent system, most small firms in these sectors are forced to set themselves up as one-idea companies, aiming only at being purchased by the big incumbent. In other words, the presence of a patent thicket creates an incentive not to compete with the monopolist, but to simply find something valuable to feed it, via a new patent, at the highest possible price, and then get out of the way.” [Page 82]

The following is nearly as strong: “The incentive to share information is especially strong in the early stages of an industry, when innovation is fast and furious. In these early stages, capacity constraints are binding, so cost reductions of competitors do not lower industry price, as the latter is completely determined by the willingness of consumers to pay for a novel and scarce good. The innovator correctly figures that by sharing his innovation he loses nothing, but may benefit from one of his competitors leapfrogging his technology and lowering his own cost. The economic gains from lowering own cost or improving own product, when capacity constraints are binding, are so large that they easily dwarf the gains from monopoly pricing. It is only when an industry is mature, cost-reducing or quality improving innovations are harder to come around, and productive capacity is no longer a constraint on demand that monopoly profits become relevant. In a nutshell, this is why firms in young, creative, and dynamic industries seldom rely on patents and copyrights, while those belonging to stagnant, inefficient, and obsolete industries desperately lobby for all kinds of intellectual property protections.” [Page 153]

You can stop here! Or read additional extracts below. Or as I advised go to the book…

“The crucial fact, though, is that the following causal sequence never took place, either in the US or anywhere in the world. The legislative branch passed a bill saying “patent protection is extended to inventions carried out in the area X”, where X was a yet un-developed area of economic activity. A few months, years, or even decades after the bill was passed, inventions surged in area X, which quickly turned into a new, innovative and booming industry. In fact, patentability always came after the industry had already emerged and matured on its own terms. A somewhat stronger test, which we owe to a doubtful reader of our work, is the following: can anyone mention even one single case of a new industry emerging due to the protection of existing patent laws? We cannot, and the doubtful reader could not either. Strange coincidence, is it not?” [Page 51]

In Italy, pharmaceutical products and processes were not covered by patents until 1978; the same was true in Switzerland for processes until 1954, and for products until 1977. [Page 52]

The firms were asked whether particular methods were effective in appropriating the gains from an innovation.The table below shows the percentage of firms indicating that the particular technique was effective. The numbers in parentheses are the corresponding figures for the pharmaceutical and medical equipment industries respectively: these are the two industries in which the highest percentage of respondents indicated that patents are effective. [Page 68]

Blodrin-IPeff

“While patent pools eliminate the ill effects of patents within the pool – they leave the outsiders, well, outside.” [Page 70]

“Later in the book we talk about the Schumpeterian model of “dynamic efficiency” via “creative destruction.” The latter dreams of a continuous flow of innovation due to new entrants overtaking incumbents and becoming monopolists until new innovators quickly take their place. In this theory, new entrants work like mad to innovate, drawn by the enormous monopoly profits they will make. Our simple observation is that, by the same token, monopolists will also work like mad to retain their enormous monopoly profits. There is one small difference between incumbents and outsiders: the formers are bigger, richer, stronger and way better “connected.” David may have won once in the far past, but Goliath tends to win a lot more frequently these days. Hence, IP-inefficiency.” [Page 76]

“We understand that the careful reader will react to this argument by thinking “Well, the AIDS drugs may be cheap to produce now that they have been invented, but their invention did cost a substantial amount of money that drug companies should recover. If they do not sell at a high enough price, they will make losses, and stop doing research to fight AIDS.” This argument is correct, theoretically, but not so tight as a matter of fact. To avoid deviating from the main line of argument in this chapter we simply acknowledge the theoretical relevance of this counter-argument, and postpone a careful discussion until our penultimate chapter, which is about pharmaceutical research. For the time being, two caveats should suffice. The key word in the former statement is “enough”: how much profits amount to “enough profits?” The second caveat is a bit longer as it is concerned with price discrimination, and we examine it next.” [Page 77] There is a full chapter about Pharam, I will probably cover in part 2 of this article.

Jerry Baker, Senior Vice President of Oracle Corporation: “Our engineers and patent counsel have advised me that it may be virtually impossible to develop a complicated software product today without infringing numerous broad existing patents. … As a defensive strategy, Oracle has expended substantial money and effort to protect itself by selectively applying for patents which will present the best opportunities for cross-licensing between Oracle and other companies who may allege patent infringement. If such a claimant is also a software developer and marketer, we would hope to be able to use our pending patent applications to cross-license and leave our business unchanged.” [Page 80]

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.”[Page 84]

“Notice, in particular, that patenting is found to be a substitute for R&D, leading to a reduction of innovation. In the authors [Bessen and Hunt]’ calculation, innovative activity in the software industry would have been about 15% higher in the absence of patent protection for new software.” [Page 92]

An example of extreme aberration in U.S. Patent 6,025,810: “The present invention takes a transmission of energy, and instead of sending it through normal time and space, it pokes a small hole into another dimension, thus, sending the energy through a place which allows transmission of energy to exceed the speed of light.” [Page 101]

Arguments in favor of IP are known and quoted again by Levine and Boldrin… “In order to motivate research, successful innovators have to be compensated in some manner. The basic problem is that the creation of a new idea or design … is costly… It would be efficient ex post to make the existing discoveries freely available to all producers, but this practice fails to provide the ex ante incentives for further inventions. A tradeoff arises… between restrictions on the use of existing ideas and the rewards to inventive activity.”[Page 176]

More in part 2….

The Case Against Patents

Thanks to colleagues in France with whom I exchange on the French innovation system, I was given the opportunity to know more about Michele Boldrin and David K. Levine.

Their Case Against Patents (full pdf here) is a strange work given its extreme position. I do believe it is worth reading this 25-page document but if you are too in a hurry, here are some excerpts with my comments in italics. I have already mentioned my concerns about IP in Is Intellectual Property out of Breath? or Patents inhibit innovation, let’s delete them! (though I was not the author of this title!) or finally Is there something rotten in the kingdom of VC?. So you see the topic is not new to me.



[Page 1]
There is no empirical evidence that they serve to increase innovation and productivity […] there is strong evidence, instead, that patents have many negative consequences.

[Page 2] There is little doubt that providing a monopoly as a reward for innovation increases the incentive to innovate. There is equally little doubt that granting a monopoly for any reason has the many ill consequences we associate with monopoly power – the most important and overlooked of which is the strong incentive of a government granted monopolist to engage in further political rent-seeking to preserve and expand his monopoly or, for those who do not yet have it, to try obtaining one.

About the Diffusion of Innovation [pages 2-3]
A second widely cited benefit of patent systems – although not so much in the economics literature – is the notion that patents are a substitute for socially costly trade secrecy and improve communication about ideas. […] More to the point, companies typically instruct their engineers developing products to avoid studying existing patents so as to be spared subsequent claims of willful infringement.
This I can confirm with the following answer I got once, when trying to licence IP for firm XXX: “The XXX lawyers advise the XXX employees not to read patent applications or patents from non-employees because that might preclude the XXX employees from future invitations in that area. If you are interested in selling the intellectual property, the only time XXX has ever bought IP is when there was already a start-up trying to market that IP.”

About Pharma [pages 4-5]
Generally the fixed cost of producing software is low – although it is estimated that Apple spent 150 million USD developing the iPhone. This, however, pales in comparison to the cost of developing new medicines – which is estimated to have a present value of closer to 1 billion USD – the same way it does in front of that for developing a new model of automobile, which is in the same range. Interestingly it is also true that – according to both survey and anecdotal evidence – patents play an important role in encouraging innovation in the pharmaceutical industry while playing a minor one in that of cars, insofar as new components and even plants are often developed by consortia or joint-ventures of otherwise fiercely competitive producers marketing different automobile’s brands. The relevance of patents in the pharmaceutical industry is most likely not due to the high fixed costs but rather the fact that disclosure in the case of drugs is more meaningful than in that of cars and most other products [Semiconductor is another good example similar to automobile]. The chemical formula and the efficacy of the cure as established by clinical trials are available to competitors essentially for free and it is the second (a public good, privately produced due to a political choice) that accounts for about 80% of the initial fixed cost. […] Hence various economists, holding differing views about intellectual property, have nevertheless argued that if government intervention is indeed needed in this market a system of prizes would be far superior to the existing system of monopolies.

About IP and Mature Innovations [page 5]
As the industry matures, demand stabilizes and becomes much less elastic; the scope for cost-reducing innovations decreases, the benefits of monopoly power grow and the potential for additional product innovation also shrinks. Typically there is a “shake-out” in which many firms either leave the industry or are bought out. The automobile industry is a classical historical example but the much more recent “bursting” of the dotcom “bubble” is, in fact, one we may recall better and that makes this point even more forcefully. At this stage rent-seeking does become important and patents are widely used to inhibit innovation, prevent entry, and encourage exit.
[Page 11] Nor, apparently, most industrial organization researchers, seem interested in figuring out why patents are either ignored or scarcely used in new and competitive industries while being highly valued and over-used in mature and highly concentrated ones.
[Page 20] In new industries such as biotechnology and software where innovation was thriving in the absence of patents – patents have been introduced. Given this continued extension has there been a substantial increase in innovation in recent years? On the contrary, it is apparent that the recent explosion of patents in the U.S., the E.U. and Japan, has not brought about anything comparable in terms of useful innovations and aggregate productivity.

I add here that neither the microprocesseur, nor the Internet were ever patented; when the internet was finally opened to commercial applications or when the patent on the transistor was licensed to many players in the 50s (which is quite close to putting it in the public domain), then new innovations multiplied.

About Patent Trolls and NPEs (Non Practicing Entities) [page 8]
Despite the fact that patents are mostly used for arms races and that these, in turn, are driven by patent trolls, there are not formal models of the way in which this can inefficiently inhibit entry. In the arms race theory, if all firms get counterbalancing patent portfolios and all innovate, then they would have innovated in the absence of patents – hence patents do not serve to encourage innovation. On the other hand if (like Microsoft or other patent trolls) you do not produce a marketable product you cannot be countersued, and so you can use patents to share the profits without doing the work – hence patents do discourage innovation and are a pure waste from a social standpoint.

The Patent System is Broken, But can it be Fixed? [Pages 9-10]
There is little dispute among economists that a well-designed patent system would serve to encourage innovation. There is dispute among economists about whether the patent system as it exists serves to encourage innovation – but, again, there is little dispute among economists that the patent system as it exists is broken.[…] If a well-designed patent system would serve the intended purpose, why recommend abolishing it? Why not, instead, reform it? To answer the question we need to investigate the political economy of patents: why has the political system resulted in the patent system we have? Our argument is that it cannot be otherwise. […] On the one hand we find the traditional advocacy of ideal patents as designed by a benevolent planner and, on the other hand, the recognition that patent laws are mostly designed by interest groups keen to increase their monopoly rents, not aggregate welfare.

No Incentive for Reform [page 12]
The basic public choice observation recalled earlier implies that there are many players in the patent game but that “consumers” are not among them. On the side of the potential patentees there are individual inventors, corporate inventors and patent trolls who invent nothing but never-the-less fill out patent applications making claims. On the other side is the patent office that issues patents, the patent lawyers who file and litigate patents, and the courts where the litigation takes place. The rules of the game are established – although only in part – by the executive and legislative branches of government, and insofar as the interests of the general public are concerned, it is these players who represent them. Since patenting is a technical subject about which few voters know anything with clarity – and hardly any are likely to have a detailed empirical knowledge of the consequences of patent systems – the interests of voters are not well represented at all, but rather the competing interests of the other players. […]It should be clear, then, that given this set of players and their incentives, the patent game can have only one equilibrium over time, which is the one we have observed. […]At each stage of this process of enlargement the main driving force were the rent-seeking efforts of large, cash rich companies unable to keep up with new and creative competitors. Patent lawyers, patent officials and wannabe patent trolls usually acted as foot soldiers.

Abolishing Patents[page 20]
Abolishing patents may seem “pie-in-the-sky” and there are certainly many interim measures that can be taken to mitigate the damage: properly interpreting obviousness, requiring genuine disclosure of working methods and an independent invention defense against patent infringement are useful and – among economists – relatively uncontroversial measures. But why use a band-aid to staunch a major wound? Economists fought for decades – and ultimately with great success – to abolish trade restrictions. It will not escape the careful reader that patents are very much akin to trade restrictions as they prevent the free entry of competitors in national markets, thereby reducing the growth of productive capacity and slowing down economic growth. The same way that trade restrictions were progressively reduced until reaching (almost complete) abolition, a similar (albeit, hopefully less slow) approach should be adopted to “get rid” of patents. Moreover the nature of patents as time-limited makes it relatively easy to phase them out by phasing in ever shorter patent durations. This conservative approach has also the advantage that if reducing patent terms indeed has a catastrophic effect on innovation the process can easily be reversed.
[…]
Patents should be allowed only when monopoly power is justified by evidence about fixed costs and actual lack of appropriability.
[…]
The results of federally subsidized research cannot lead to the creation of new private monopolies but should be available to all market participants. This reform would be particularly useful for the pharmaceutical industry.

I have not read (yet) their Against Intellectual Monopoly but I should given the depth of their thought. As they themselves claim, this may all be “pie in the sky”, irrealistic and therefore useless, and I also see the Libertarianism behind all this. But once again, I believe it is worth thinking about it twice, and longer than just reading this long summary.

Is Intellectual Property out of Breath?

Here is my second paper published by Entreprise Romande after the one on the Challenges of Innovation.

Copyrights, patents, trademarks. Never intellectual property (“IP”) has seemed so visible, but would it be a victim of its success? It is indeed becoming an almost exclusive tool of the rich and powerful and even worse, it may be hindering innovation whereas it was supposed to encourage it.

In July 2011, a consortium including Apple, Microsoft, Sony bought 6,000 patents from now deceased Nortel for $ 4.5 billion. In August 2011, Google replied by acquiring patents from Motorola Mobile for $ 12.5 billion. Finally in September 2011, the United States announced a major reform of patent law, the America Invents Act. These three events in a single summer confirm the increasingly dominant position of IP in the business world. Yet I think it is bad news!

New privileges

If a patent application only requires a few hundred dollars and tens of thousands to maintain over 20 years, should a company enter in legal dispute over it, it might cost millions in damages and attorney fees. Any fragile business might be dead long before winning a case or proving its innocence. Woe to the weak! Large companies are not the only ones to have understood: companies specialized in the valuation of IP portfolios (“patent trolls”) have emerged in recent years and these companies have no ambition to sell products or services around their IP. And Europeans should not think that the problem is American only as illustrated by the recent battle between Nokia and Germany’s IPCom.

IP is now a far cry from the original patent and copyright statements made by the revolutions of the late eighteenth century. It was then about ending the monopoly of corporatism and about supporting inventors and creators. Far be it from me to push the disappearance of intellectual property. I only here mention the example of the laser patents whose saga has at least allowed a wonderful book, closer to a thriller than the complex physics from which ir was born, Laser: The Inventor, the Nobel Laureate, and the Thirty Patent-year War. But I’m not at all convinced that IP could now enable what was possible almost 50 years ago with the laser. And already in the nineteenth century an abolitionist movement had appeared, aware of the limitations of a system that set new privileges.

Hindering innovation

The other debate about IP is best summed up in a recent article in the ParisTech Review: “Are patents hindering back innovation?” The story is old: Boldrin and his coauthors [1] argue that the developments of the steam engine were hindered by patents filed in 1769. Do we know that the microprocessor from Intel was never protected, nor of course the Internet, and it is more or less constrained that Bell Labs granted licenses on the transistor, an event that is perhaps at the origin of Silicon Valley culture: “In the 70s and 80s, many engineers from Fairchild, National and others met over a beer to talk about problems they encountered in the production or sale of semiconductors. The Wagon Wheel Bar was a meeting place where even the fiercest competitors exchanged ideas.” Having recently visited LinkedIn, I’ve heard engineers explain how they solve problems with competitors from Facebook. Discussing with Apple or Google seems much more difficult today.

Intellectual property is not the answer to everything and in its current development, it poses more new problems than it solves. The U.S. patent reform has already attracted much criticism. As for Europe, it seems stuck in its national self-interest as there is no European patent and the lack of patents on software or business models does not give it any advantage. In a globalized and dematerialized world, the IP must protect the creative people, to better enable the dissemination of ideas and techniques. The “open source” software movement as well as recent experiments in the diffusion of artistic works exclusively on the Internet show that new approaches are possible without killing business or innovation. But it seems that the fears of the established players outweigh the passion and creative risk-taking culture.

-[1] Do Patents Encourage or Hinder Innovation? The Case of the Steam Engine. Patent Law Is Highly Controversial. Michele Boldrin, David K. Levine, and Alessandro Nuvolari.
Laser: The Inventor, the Nobel Laureate, and the Thirty-year Patent War. Taylor, Nick (2000). New York: Simon & Schuster
Are patents hindering innovation? Paristech Review, September 2011

PS: When writing this paper, I had not measured yet the impact of the Apple-Samsung litigation

Patents inhibit innovation, let’s delete them!

My first post for 2012 is a translation of an interview I gave to French magazine La Recherche. It was published last December and you can have an electronic version of the French version here or a pdf document by clicking on the cover page below. It is followed by my own translation. Now I should say that I was a little surprised by the title which I had not expected. I was more thinking in something like “start-ups are the forgotten children of innovation!” The title focused on my cautiousness about IP and patents in particular. It is certainly too strong, but that is what titles are made for…

Patents inhibit innovation, let’s delete them!

Innovation is a matter of culture. An admirer of Silicon Valley, which he has known for twenty years, Hervé Lebret calls for Europe to be inspired by the dynamism and creativity of its start-ups. But is it good to take everything in this model?

La Recherche: A report of the Commission of the European Union stresses that the EU is more increasingly lagging behind the U.S. in terms innovation with a comparable level of research [1]. How do you explain that?
Hervé Lebret: The main reason for this innovation gap in Europe is cultural. I was always struck by how much the students are interested in the applications of research in the U. S., while in Europe we think more in terms of knowledge. And then there are the role models of young entrepreneurs who have experienced success. It is striking in Silicon Valley: Bill Gates was 20 when he founded Microsoft, Steve Jobs 21 when he founded Apple, Larry Page and Sergey Brin, 25 when they created Google. They are powerful models to which a young student can identify to.
La Recherche: The same report argues that another reason for the gap is partly related to differences the patent system which would be more complex and more expensive in Europe. What do you think?
HL: I am skeptical about legislation or rules in general as an explanation in the differences. It is in the people’s head that things happen. In the U.S., they want to try; they have no fear of failure. I am not convinced that we are more innovative because we would have more patents. Look at Switzerland, which has the largest number of patents per capita: this country does not create many start-ups. Incentives and policies are only working if there is a favorable cultural terrain.
La Recherche: But aren’t patents the key for an innovative company, whose value often relies on its intellectual property?
HL: Software is not patentable, and this did not prevent Microsoft to be successful. With the risk that you see me as iconoclastic, I think that patents are an obstacle to innovation. I wonder whether we should not remove them, except perhaps in specific areas, such as biotechnology, where a patent corresponds more specifically to a manufacturing process of a molecule.
But in most industrial fields, you need to own thousands of patents to protect the innovation which is commercialized. The maintenance of this portfolio of patents is extremely expensive and that money could be better used in research and development. Whereas in the past the patent favored the inventor, it has become a defensive weapon to protect dominant positions. Look at the war between Apple and Google: the first alleges that the second has developed its operating system Android by violating certain of its patents. This goes against the theory that the traditional patent protection the weak inventor, who can develop an idea during years without fear of being stolen.
Does the weakness of venture capital, which would deprive young innovative companies from the capital needed for their development, explain some of the shortcomings of innovation in Europe?
H.L. Contrary to general belief, there has always been venture capital in Europe, especially in France. This is not a quantitative but qualitative problem: venture capital in Europe is run by people from finance or consulting, not entrepreneurs.
Again, this is a cultural difference. But this is changing. Former entrepreneurs have recently begun to create venture capital funds or to become business angels. In France, I think of Bernard Liautaud, founder of software company Business Objects, or Xavier Niel, founder of Free, the phone operator, who both joined venture capital firms. The founders of Skype have created Atomico, their own funds.
You do not hide your admiration for Silicon Valley. If the secret of its strength is, as you support, cultural, how can we be inspired in Europe?
H.L. We can draw on customs, practices, an important one being cooperation. In Silicon Valley, curiosity is shared. People know that the exchange of ideas is successful, and are not afraid of ideas being robbed. The two Google founders were PhD students in two different laboratories at Stanford University, but they have talked! It is not unusual o talk to your competitor to solve your own problems: in the 1960s, the major industry semiconductor players in California met at the Wagon Wheel bar in Mountain View to discuss their work. In Europe, many laboratories, academic and probably more private, have a culture of secrecy, they fear the exchange.
What do you put in place at the Ecole Polytechnique Federale de Lausanne (EPFL), where you teach, to develop a taste for innovation and entrepreneurship among students?
H.L. I strongly believe in the role of exemplary models. So I organize conferences with successful entrepreneurs who share their experience. This shows students that these are passionate people, who are not afraid to try, even if just one in a thousand will be successful. These models inspire. But inspiration is nothing without resources. Hence the program “Innogrants”: a salary of one year for a young researcher who is released from its research and teaching in order to concentrate on her or his innovative projects. If it works, it is hoped that the private sector will further invest. Fifty Innogrants were awarded in five years. Half of them have led to the creation of companies in life sciences, micro-or nano or information technology. And five of them have found private investors.
It nevertheless remains modest …
H.L. Yes, we must remain humble: all we can do is create a breeding ground for the creation of innovative companies, as we do with Innogrants. In total, in the last fifteen years, EPFL innovators have created about a dozen start-ups per year. Fifteen have raised venture capital, 300 million Euros in total. Four or five have been sold to industry groups, sometimes these were nice exits. Endoart, founded in 1998 at EPFL specialized in the production of remotely controllable medical implants; it has been sold nine years later for 100 million dollars to Allergan! But we feel there is a kind of modesty, self-restraint of European entrepreneurs compared to their American counterparts.
A former researcher at EPFL criticized the leadership of the university of “copy as closely as possible the American university model” [2]. Do you think everything is good in the American model?
H.L. These criticisms focus on science, not on innovation. The competitive standing of researchers, the instability of the statutes is not a good idea in research. It is very important to let the imagination speak. There is a danger to keep people under permanent pressure. But in terms of innovation, the U.S. model works.
You estimate that at most one in a thousand start-ups meets success. Isn’t this a huge waste?
H.L. We should not measure everything in terms of money or performance. What counts is creativity. For me, the Silicon Valley is the new Athens. As Greece, it is a culture: what this region brought in fifty years is fabulous. Digital technologies that were invented forever changed the way we inform, we cultivate and entertain ourselves. This is probably why the death of Steve Jobs, who was an iconic character, had so many repercussions in October. Furthermore, if one thinks in macroeconomic terms, I do not think that the American model is based on waste only. In the U.S., venture capital weighs about twenty billion dollars a year. For twenty years, 400 billion have been invested. And one company, Google, is now worth $200B. Finally, the creation of economic value is similar to the money invested. It is a collective success, even if it is based on thousands of individual failures, which are often very hard humanely.

The entrepreneur should be at the center of innovation policy

Isn’t the $200 billion market capitalization of Google exaggerated when compared to the actual value of the company?
H.L. The world of venture capital has unfortunately become a financial asset like any other. It is no longer a world of former entrepreneurs who pursue their business while investing in those of others. There is too much money, too much speculation in the U.S. venture capital. But I remember that the start-ups appeared before the Nasdaq, the stock market where shares of high technology companies are traded. Silicon Valley began in the 1960s and 1970s in the context of the counter-culture in California. Steve Jobs did not hesitate to say that some of his creativity came from drugs when he was young. The growing role of finance in the economy only started in the 1980s. Originally, the financiers were the patrons of great artists. That said, I think the current trend of large groups limiting their spending in research and development is catastrophic. Shareholders want 15% return and push to cut spending on research. Good start-up can only emerge if there is also good private research.
Do we see a slowing of the technological innovation?
H.L. I am indeed concerned about the lack of success in current innovation: the 1970s were marked by the transistor, the 1980s by the personal computer; the 1990s by the networks. But in the 2000s, I see nothing new. The Web 2.0 is not a technological revolution, it is a consolidation. More generally, biotechnology was rather disappointing; there is no revolution in energy, chemistry. It is not clear that nanotechnologies are really promising technological breakthroughs. I fear that the 2000s did not create start-ups which are equivalent to Intel in the 1960s, Apple, Microsoft or Genentech in the 1970s, Cisco in the 1980s, or Google in the 1990s. There is Facebook, but this company does not rely on high technology innovation. That said, there has always been a general pessimism about the future of innovation, so I hope to be wrong!
You mention companies in information technology or biotechnology. Is this model of start-up transferable to capital-intensive areas, and where there are already major players, such as aerospace, automotive, chemicals?
H.L. The established players are not necessarily the most innovative. Clayton Christensen from Harvard Business School, showed in 1997 that an established company is great at improving existing products [3]. It is innovation by evolution, not revolution. Renault can invent the electric car, but not a new mode of transportation. Besides, the idea of the minivan, which was then copied, did not come from internal R&D at Renault, but from the company Matra, who did not have the same experience in automotive, which made it more creative. It is also for this reason that the big companies, especially pharmaceuticals, outsource their innovation: they prefer to leave the start-up take the risks, and then buy them. Even an old startup such as Cisco replaces the term “research and development” by “acquisition and development”.
Why do you insist so much on start-ups? An academic institution can also license its patents to the industry, or form mixed private / public laboratories…
H.L. The basic problem is towards whom an innovation policy is directed. My belief is that the entrepreneur must be central. This is not what is done in France: the clusters are clusters of established companies, not tools to promote creativity and entrepreneurship. I insist on start-ups because I think they are the forgotten piece of innovation policies. Of course there is innovation in large groups. But I wonder if they can do disruptive innovative. They can set a goal – the flat screen, the smart phone, or, today, the electric car – that will come out in twenty years. But can they do something entirely new, as did Google? Or Genentech, which revolutionized the manufacture of drugs using genetic engineering techniques? I believe that only start-ups are able to do so. Christensen said if you want to make a major innovation, create a branch and place it as far as possible of your research center as the worst enemy of innovation in a company is conservatism. Innovation is the highest in small teams: this is what happens in the start-up.

■■ Interview by Nicolas Chevassus-au-Louis

[1] European commission, Innovation Union Competitiveness Report 2011, http://ec.europa.eu/research/innovation-union.
[2] Libero Zuppiroli, La Bulle universitaire. Faut-il poursuivre le rêve américain ? Éditions d’en bas, 2010.
[3] Clayton Christensen, The Innovator’s Dilemma, Harper’s, 1997.

Hervé Lebret. A graduate of Ecole Polytechnique and Stanford University, with a Ph.D. in electronics, he worked, after a few years as a researcher, as a venture capitalist, in Geneva from 1997 to 2004. Since then he has been teaching management of technology and manages a seed fund at the Ecole Polytechnique Federale de Lausanne.

> Hervé Lebret, Start-up. What we may still learn from Silicon Valley Create Space, 2007. www.startup-book.com
> www.oecd.org/sti/scoreboard An oecd study on patents
> http://vpiv.epfl.ch/innogrants The site of the Innogrants at EPFL.

Smasher, another Silicon Valley mystery

Smasher is the second Silicon Valley thriller from Keith Raffel that I read. After reading dot.dead, I found this one more complex, and certainly as interesting. A mixture of a traditional thriller where the hero’s wife is smashed by a car, together with a good start-up story where the leader in the field is trying to smash the hero’s company and an academic story of intense competition between researchers in the physics field of [smashed] particles. Hence the title Smasher.

I already mentioned novels about start-ups or Silicon Valley (dot.dead, but also The Ultimate Cure). I have never mentioned though Po Bronson (I loved The First 20 Million Is Always the Hardest) or Michael Wolff (Burn Rate). I have not read (yet) Kaplan’s Start-up. On the academic side, there is Small World by the great David Lodge which I have not read (either…) There are of course many essays on the start-up or academic worlds (I mentioned many in my past posts in the must read category) but there are clearly not so many novels based on these worlds,

Raffel loves to take inspiration from real individuals in Silicon Valley. I had played at recognizing a few in dot.dead. Here it is less obvious; the academic smasher is a mixture of Feynman and Gell-Man. The start-up smasher looks more like Larry Ellison with his dark suits and love for Japanese architecture. But there is a little from Steve Jobs as well. The other characters existed in the first novel. I will not talk about the story and only shortly about the particle physics. I will say more about the start-up and broader Silicon Valley context. Smasher talks of Quarks and quirks, of Murray Gell-Man who got the Nobel prize for their discovery and of SLAC, the Stanford Linear Accelerator (a small CERN). You may identify SLAC both on the map and picture below.

There is indeed a link between particle physics and the start-up world. Raffel reminds us that the World Wide Web was invented at Cern thanks to Tim Berners-Lee. Slac had other spin-offs, but this is another story. Slac was also a home for the Homebrew Computer Club (see [1] and extract from page 214 below)

Smasher is also about women and science. “Stanford was on a campaign to recruit female undergraduates, Ph.D. candidates, and faculty to the natural sciences. My mother’s late aunt had been the first woman in the physics department back in the 1960s. In an effort to honor her and to appeal to what was still the second sex in the realm of natural sciences, the university was naming its particle physics lab after her. I’d lived in Palo Alto all my life and couldn’t recall a building, library, school or academic chair at Stanford labeled with a name except in return for a donation of dollars, euros, yens, dinars, or other convertible currency. So maybe Stanford was really serious about recruiting women.” And the invited professor for the ceremony adds: “We all follow in the footsteps of our predecessors. When I was a girl in France, I wanted to be Marie Curie. After two years as a graduate student at Stanford, after two years of hearing about her legacy, I wanted to be your great aunt.” (Page 12)

What may not be realistic is that this French professor smokes Gauloises (page 213). I know I left France a long time ago but I doubt professors still smoke them! It is pure work of fiction of course but Raffel adds in his acknowledgments that he found inspiration in Rosalind Franklin‘s life. A sad story which shows the complexity of being a woman in science or high-tech

A funny (sorry for the jump for sadness to humor) quote and apparently true [2] on the academic world is Clark Kerr once said his job as president of the University of California was to provide football for the alumni, sex for the students, and offices for the faculty. [The physics and Nobel prize professor] sanctum was twice the size of the [professor of English literature]’s but only a third the size of the business school professor [who is on the board of the hero’s start-up].” (Page 34)

It is also about VCs and term sheets. “VCs, bah. When you had no need for their money, investment offers would cascade over you like a tropical waterfall. When you could use a capital infusion – like now – the money flowed like water in a wadi, a riverbed in Sahara. In other words, it did not.” (Page 20)

“I drove west of Sand Hill Road. This was familiar territory, the Vatican of venture capitalism. In the bubble days of the late 1990s, office space on Sand Hill was the most expensive in the world. Here’s where the founders of Google, eBay, Amazon and Cisco had come, hat in hand, seeking the dollars required to turn the base metal of their dreams into stock market gold.” (Page 41)

Raffel has a few notes on Silicon Valley culture:
“The value of Silicon Valley company wasn’t in inventory or patents. It was in the brain of its employees.” (page 33)
“I had learned in the Valley that no more than two people could keep a business secret and that only worked if one of them was dead.” (Page 45 )
“Under an NDA? I asked. Non-disclosure agreements didn’t usually do much good in the Valley, which was built on loosey-goosey dissemination of intellectual capital, but having one couldn’t hurt. We had a raft of patent applications pending on the technology, but if they stole what we had, we would be defunct by the time we won any lawsuit.” (Page 94)
“Ron Qi, the inventor [of the technology incorporated in our product] and now head of engineering looked down as if examining the polish on his shoes. The other three around the table, Samantha Maxwell, our Korean-born MIT-educated marketing genius; Ori Mohr, the ex-Israeli paratrooper and kick-ass head of operations, and Bharat Gupta, the CFO, all moved their eyes back to me.” … “I saw Ron, who’d been brought up in the more deferential milieu of Taiwan…” (Page 44) [Immigrants again]
“I asked the engineers how the tweaking of the product was going, the sales rep what I could do to help them close their big deals, and the bean counters how much work was left to close the books for the latest quarter. What I heard from them was unfiltered by the vice presidents who reported to me. (The business professor) had told me that I could ask any employee anything but I could only tell my direct reports what to do. Managing the others was – who’d’ve thunk of it? – the jobs of their managers. As I popped into offices or cubicles, I was following the footsteps of the Founding Fathers of Silicon Valley, Bill Hewlett and Dave Packard, who advocated MWBA – management by walking around.” (Page 102)
“Thirty minutes later, I walked into a building named after Robert Noyce, one of the “traitorous eight” whose departure from Shockley Semiconductor loomed as large in Valley history as the exodus from Egypt did in the Bible. One of the founders of both Fairchild Semiconductor and Intel, Noyce was the co-inventor of the microprocessor, the electronic brain that ran everything from cell phones to server farms.” (Page 194)

A few more things on the academic world:

“It seems that the only way for a Stanford professor to win prestige is to start a successful company.
– Americans may not be interested in how the universe is made. I can tell you though, in Silicon Valley, they definitely want to know how money is made.
A researcher at CERN wanted to share information with others physicists. He invented a language to send it around and we ended up with the World Wide Web.
– Of course you would know our wonderful Sir Tim. […] The computer nerds at SLAC in the early 1970s hosted meetings of what they called the Homebrew Computer Club [1]. Steve Jobs and Steve Wozniak came.” … “And from that came Apple Computer and the whole PC industry. So you’re saying Silicon Valley wouldn’t be much without the physicists?”
(Page 214)

as well as

“I caught sight of a new photo over the desk. His head flanked by two earnest student types. He followed my eyes. “Another sign of my vanity.” Sergey Brin and Larry page developed their search algorithm as Stanford grad students and, of course, started their company to exploit it. Stanford got shares in the venture in return for their ownership of intellectual property.
– And how many millions did that piece of Google add to the university coffers?
– Three hundred and thirty six”
(Page 218)

Smasher is certainly not about literature, but it is (really) entertaining; nor does it belong to the category of the mystery masterpieces. Raffel does not have the genius (or experience) of James Ellroy, or even George Pelecanos and Henning Mankell but he is a real pleasure to read, I appreciate his talent, imagination and his interesting description of SV culture, history and dynamics.

[1] Homebrew Computer Club: “One influential event was the publication of Bill Gates’s Open Letter to Hobbyists, which lambasted the early hackers of the time for pirating commercial software programs.” http://en.wikipedia.org/wiki/Homebrew_Computer_Club. Another site is Memoir of a Homebrew Computer Club Member

[2] Another legacy was his wit—after writing a serious book “The Uses of the University”, Kerr surprised an audience with this riposte–“The three purposes of the University?–To provide sex for the students, sports for the alumni, and parking for the faculty.” From http://content.cdlib.org/view?docId=kt687004sg&chunk.id=d0e21648&brand=calisphere&doc.view=entire_text

Is there something rotten in the kingdom of VC?

Following my recent post, Is there something rotten in the state of IP, I could not avoid to add this provocative statement despite all my respect for venture capital. When Kleiner Perkins, one of the best West Coast VC (not to say one of the best VC ever), Charles River, one of the best East Coast VC and Index, one of the best European VC co-invest in an IP company (a “Patent Risk Manager”) such as RPX, I thought there had been a major event. And Randy Komisar who is mentioned in my latest post is on the board… Now RPX is filing to go public so as I do usually, here is the cap. table. All these data remain subject to the IPO date and share price which I just had to imagine… You may also be interested to know that the founders of RPX come from Intellectual Ventures…