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Description
We develop an equilibrium search model of innovation with the possibility of multiple independent discovery. We distinguish innovations from ideas, and we view patents as probabilistic property rights that are constrained by the innovators' option to keep the innovation secret. We find that the patent system can simultaneously stimulate innovation, information disclosure and welfare. An optimal patent may provide more or less protection than secrecy, and in many cases, it provides less, suggesting that its main function is information spreading rather than rewarding the costs of the innovative activity.
1. Introduction
* The standard view about patents and intellectual property rights (IPRs) is that, as they grant the inventor a temporary monopoly, they provide inventors an incentive to innovate. Without such a reward, the innovators would not be willing to invest as much because they would be afraid of someone else expropriating their ideas. The trade-off here is between the inefficiency of the monopoly and the incentive to innovate. This view underlies much of the extensive research on patents that has been accumulated since Nordhaus's seminal work (1969) (for surveys see, e.g., Denicolo, 1996; Langinier and Moschini, 2002). Evidence does not seem to fully support this view, though. There are numerous studies suggesting that secrecy typically offers better protection than patents (see, e.g., Cohen, Nelson, and Walsh, 2000; Arundel, 2001). This raises the question of why firms engage in costly patenting.
Active patenting by firms is even more puzzling because another traditional rationale for the patent system is to stimulate public disclosure of private information. A patent application should contain sufficient information to allow a skilled person to reproduce the particular innovation. It is not clear how the two aims of the patent system, to enhance the incentive to innovate and to disseminate information, can be reconciled; there seems to be an inherent tension between them. On one hand, if patenting enhances the incentive to innovate by improving appropriability, how can it simultaneously spread information and thereby the possibilities to imitate the patented innovation? On the other hand, if patent protection stimulates information disclosure rather than investments in innovation, as Gallini (2002) suggests in a survey of the empirical evidence, then why do firms patent?
The aim of this study is to compare the effects of the patent system and secrecy on the incentive to innovate, information spreading and welfare. We provide an explanation why firms patent even if they have the option to resort to secrecy offering better protection. We find that, if a patent system is effective in the sense that innovators patent their innovations rather than keep them secret, it can stimulate both the innovative activity and information disclosure and, as a result, improve welfare. An effective patent system can provide less protection than secrecy. To see this, suppose that the innovators first invest in R&D and then, after finding out whether they succeeded in producing an innovation, but when still unaware of other potential developers of the same innovation, decide whether to patent the innovation or keep it secret. Then under a patent system, it only pays to keep the innovation secret when the probability that a competitor comes up with the same innovation and patents it is sufficiently small. If the probability is large, it pays to apply for the patent even if it confers only weak protection because, otherwise, someone else gets it, and the innovator risks infringement if she tries to capitalize her innovation. In other words, when innovators contemplate patenting, the typical choice is not between patenting or keeping the innovation secret but between patenting or letting the competitors patent.
Critics of strong patent protection argue that the strengthening of patent rights over the past decades has only resulted in an increase in patenting without a corresponding increase in the innovative activity (see, e.g., Jaffe and Lerner, 2004). Our model also incorporates this view. If patent protection is enhanced when some innovators resort to secrecy and some patent, all that happens is that more innovators begin to patent but R&D expenditures remain the same. Only if everyone patents, does stronger patent protection encourage innovation.
Our view, according to which the patent system can both accelerate the pace of innovation and spread information, necessitates that firms frequently make similar innovations. As discussed in Granstrand (2002), the phenomenon of independent or nearly simultaneous discoveries is well documented in 'traditional' industries, but we think that it especially characterizes network industries such as software, Internet, telecommunications and payment media where standardization limits the possible paths for future technologies and, accordingly, firms concentrate their R&D activities on the same fields. Similar views are expressed by Rahnasto (2003) and Varian, Farrell, and Shapiro (2004). Rahnasto (2003), in particular, argues that intellectual property protection should be reconsidered because of increased relevance of simultaneous innovation.
To highlight the intuition of one of our basic results, one can rely on the following simple example: Two firms are engaged in R&D that results either in an innovation or failure. Suppose first that the innovation is protected by secrecy and leaks out with probability 1 - [alpha]. When this happens, the innovation is publicly available and production is at the competitive level. If only one firm succeeds in R&D and the innovation does not become public, the firm earns monopoly profit [[pi].sup.M]. If both firms succeed and their innovation does not become public, each firm earns duopoly profit [[pi].sup.D] < [[pi].sup.M]. Assuming that the probability of success [beta] is independent across firms, a firm's expected profit is [beta](1 - [beta])[alpha][[pi].sup.M] + [[beta].sup.2][alpha][[pi].sup.D]. If the innovation can be protected by a patent, the firms have to decide whether to file for a patent (P) or resort to secrecy (S). This decision has to be made before learning whether the competitor has succeeded or not. If both firms are successful and file for the patent, each firm obtains it with probability 1/2. Let us measure patent protection by the probability that a patent holder can exclude the competitor from using the innovation. This probability is denoted [[alpha].sub.p] below.
The expected payoffs given a competitor's patenting strategy are represented in Table 1, which displays the row player's payoff in each cell. From the table, it is immediate that patenting is a strictly dominant strategy when [[alpha].sub.p] = [alpha]. Hence, by continuity, there exists an [[alpha]'.sub.p] such that patenting is a strictly dominant strategy even though the protection offered by the patent is weaker than that offered by secrecy. Note that we impose no specific demand structure or form of the duopolistic competition. For example, the argument could accommodate a standard decreasing inverse demand function and Cournot or Bertrand competition. We could even assume that the firms can collude in the product market if they are both successful so that [[pi].sup.D] = (1/2)[[pi].sup.M]. Furthermore, the example generalizes readily to the case of n firms.
The example shows the logic of our result at its simplest. It incorporates some key elements of our model, notably the decision to patent and the probabilistic view of IPRs. Our model is, however, richer in several respects. Because the economics of IPRs is an area where policy considerations are important, we use an equilibrium search model with nontrivial demands so that we can calculate welfare measures. The model naturally yields the possibility that more than one innovator comes up with the same innovation. We assume that there is a large number of innovators as well as ideas, i.e., potential innovations. The relative number of innovators to potential innovations tells roughly how mature and competitive an industry is, and this varies across industries. We also allow for the possibility that the innovations become obsolete. The optimal strength of the patent system depends on these variables, and these effects cannot be addressed in the two-agent example. Moreover, unlike most previous studies of IPRs, we distinguish actual innovations from unknown ideas (for an exception, see O'Donoghue, Scotchmer, and Thisse, 1998). Finally, to study the incentive effects of IPRs, we assume that the innovators can decide how much to invest in R&D. The investment determines the probability of success, and it depends on whether there is a patent system available and the strength of protection it offers.
Although information spreading has been a main purpose of the patent system since its origins, it is relatively little studied in economics (Granstrand, 2002). Since the seminal article by Horstman, MacDonald, and Slivinski (1985), there are only a few studies where secrecy is regarded as a viable option to patenting. The works that are the closest to ours are Anton and Yao (2004) and Denicolo and Franzoni (2004). Like Horstman, MacDonald, and Slivinski (1985), Anton and Yao (2004) build a signalling model to study the strategic disclosure of information through patenting and find that small innovations are fully revealed but large innovations are mainly kept secret. Reminiscent of our findings, they show that small innovations are patented even if patents afford weak protection. In our model, innovators either keep their innovations fully to themselves or they become fully public, and matters of signalling do not arise. Like us, Denicolo and Franzoni (2004) find that patenting is in general socially preferable to secrecy. They, however, focus on the question of prior user rights in a model of sequential innovation. Using logic similar to ours, Arora, Fosfuri and Gambardella (2001) show how the incentive to license is decreasing in the degree of product differentiation of an industry. In their model, licensing is an equilibrium even though it increases information spreading.
The rest of the article is organized as follows. We present the model in the next section. In Sections 3 and 4, we consider an economy without a patent system; in Section 3, we solve for the equilibrium and, in Section 4, we study its welfare properties. Patents are introduced in Section 5. Much of the section is devoted to the analysis of the choice between patenting and secrecy. In Section 6, we study the incentive effects of the patent system. Finally, in Section 7, we consider the welfare effect of patents and optimal patent policy. In Section 8, we present conclusions and discuss the first-inventor defense. The proofs and calculations omitted in the main text are collected in the Appendix and the supplementary Appendix at www.rje.org/sup-mat.html.
2. The model
* We study an infinite horizon, discrete-time economy, where time is discounted using a common discount factor, [delta] [member of] (0, 1). There are risk-neutral agents, innovators, who conduct R&D and produce the resulting innovations. The innovation process involves the Schumpeterian distinction between inventions, which we here call ideas, and innovations. The process has two stages, where the innovators first come up with an idea and invest amount j in it. In the second stage, they find out whether they succeeded in producing an innovation or not. We introduce uncertainty inherent to an innovation process by assuming that, with probability 1 - [e.sup.-j], an innovator is successful in developing the idea into an innovation. (1) Thus, the probability of success is increasing and concave in the investment. When there are no IPRs, choosing the level of investment, j, is the only decision the innovators have to make. Once we introduce patent policy in Section 5, the innovators also have to decide whether to... |
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