The Patent Controversy

Today one of the most controversial issues in economic policy is that of patent law. Is a patent just an extension of property rights to the realm of ideas? Or is it an unwarranted interference by the government into the rights of individuals who have purchased goods and services to use them as they see fit? Should the Western system of patents be extended worldwide? Or should we get rid of patents entirely? Is the patent system responsible for modern miracle drugs? Or is it to blame for the millions dying of HIV in Africa? Do patents lead to greater innovation and economic growth? Or do they kill the goose that lays the golden egg?

The issue of whether patents are genuine property rights or unwarranted government interference cannot of course easily be answered by a natural experiment. We will leave that discussion to philosophers. The impact of patents on innovation does have an objective answer. In this case history instead of nature has been kind enough to provide us with a wonderful natural experiment. This experiment took place in the county of Cornwall, England, between 1772 and 1852. It was there, in the extreme southwest of England, in the wet depths of the Cornish copper and tin mines, far removed from the supply of coal in Wales, that the steam engine was pioneered.

To examine innovation in steam technology, we need a measure of how good a steam engine is. One important measure is the amount of work delivered by a given amount of fuel. This can be measured by the duty of a steam engine: the number of pounds of water that can be lifted one foot for each 94 pounds of coal consumed.

In 1772 steam engines were of the so-called Newcomen design of which the best had a duty of 10 million foot-pounds (10M). In 1777 Matthew Boulton and James Watt began selling the first steam engines with a separate condenser. These initially had a duty of 18M, rising by 1792 to a peak of 26M. There things rested until 1814 when the use of the high-pressure design of Richard Trevithick led to engines with a duty of 55M. The duty then rose relatively continuously until it reached a peak of 110M in 1852.

To summarize: During the 42 years from 1772 to 1813 duty rose 3.8 percent per year; during the 38 years from 1814 to 1852 duty rose more than twice as fast—8.5 percent per year. The evolution of the duty is charted in the figure. The state of innovation is best represented by the best engine currently being produced, but for completeness the average and minimum duty of constructed engines is reported. The decline in duty growth after 1852 reflects both the general decline of the Cornish mining industry and the more difficult conditions in which steam engines were forced to operate due to the deepening of the mines.

As it happens there is one critical difference between the earlier period and the later period. By patenting the separate condenser Boulton and Watt, from 1769 to 1800, had almost absolute control on the development of the steam engine. They were able to use the power of their patent and the legal system to frustrate the efforts of engineers such as Jonathan Hornblower to further improve the fuel efficiency of the steam engine. By way of contrast, and fortunately, Trevithick did not patent his equally innovative high-pressure design.

Ironically, not only did Watt use the patent system as a legal cudgel with which to smash competition, but his own efforts at developing a superior steam engine were hindered by the very same patent system he used to keep competitors at bay. An important limitation of the original Newcomen engine was its inability to deliver a steady rotary motion. The most convenient solution, involving the combined use of the crank and a flywheel, relied on a method patented by James Pickard, which prevented Watt from using it. Watt also made various attempts at efficiently transforming reciprocating into rotary motion, reaching, apparently, the same solution as Pickard. But the existence of a patent forced him to contrive an alternative less-efficient mechanical device, the sun and planet gear. It was only in 1794, after the expiration of Pickard’s patent, that Boulton and Watt adopted the economically and technically superior crank. The impact of the expiration of Watt’s patents on his empire may come as a surprise as well. Far from being driven out of business, Boulton and Watt for many years were able to charge a premium over the price of other steam engine manufacturers.

Here we see clearly the upside and the downside of the patent system in action. The upside is that it may be the case that the prospect of a 31-year monopoly induced Watt to spend three and a half years of his life—between late 1764, when he first was asked to repair a steam engine, and mid-1768, when he applied for patents on his improved design—working to improve steam technology.

The downsides are two. The first is that the reward to success bears no relation to the cost of invention. In what respect is it necessary, reasonable, or fair to grant a 31-year monopoly and make a man fabulously wealthy because he spent a few years working on a project that benefited his fellow man? Certainly this kind of inducement was not needed for Trevithick, whose contribution to steam technology raised the duty 110 percent as against Watt’s contribution, which raised the duty only 80 percent.

The second downside of the patent system is the devastating effect it has on incremental innovation. From 1786 to 1800 there was no increase in the duty of steam engines at all, as Boulton and Watt successfully sought to prevent competition by suppressing innovation. This should be a cautionary note for people who think that the current wave of patent litigation triggered by a system of software patents created by the courts is likely to have a beneficial impact on software innovation.

Collaborative Innovation

For the 11 years following the end of the Boulton and Watt monopoly, Cornish mining activities underwent a period of slackness, as the mine adventurers were content with the financial relief coming from the cessation of the premiums they had paid to Bolton and Watt. As a consequence they neglected the maintenance and the improvement of their engines. This situation lasted until 1811, when a group of mine captains decided to begin the publication of a monthly journal reporting the relevant technical characteristics, the operating procedures, and the performance of each engine. Their explicit intention was twofold. First, the publication of the reports permitted the rapid individuation and diffusion of best-practice techniques. Second, it introduced a climate of competition among the engineers entrusted with the different pumping engines, with favorable effects on the rate of technical progress. Joel Lean, a highly respected mine captain, was appointed as the first engine reporter. The journal would later be called Lean’s Engine Reporter. During the 31 years after 1811 this collaborative competitive effort at innovation raised duty by more than the great “breakthrough” of Watt ever did.

It is worth remarking another important feature of the process of technical change in Cornish engines during the collaborative period. Most engines were single-cylinder, high-pressure, single-acting engines, with a plunger pump of the type originally erected by Trevithick in 1812. Interestingly enough, however, alternative designs were never completely ruled out. For example, in different periods, engineers such as Arthur Woolf and James Sims continued to experiment with compound engines. Throughout this period, the development of the Cornish engine remained a fluid state and this facilitated a more thorough exploration of alternative designs.

The astute reader will no doubt notice that the collaborative innovation occurring after the expiration of the Watt patents resembles nothing so much as modern open-source software development. Like with open-source software, altruism and socialism played no role—just good old-fashioned capitalist incentives. Engineers were recruited by captains of the mine on a one-off basis to build and design an engine. Engineers were in charge of the design and they supervised the erection of the engine that was commissioned to them. They also provided directions for day-to-day working and maintenance of the engines they were entrusted with. Thus the publication of technical information concerning the design and performance of different steam engines permitted the best engineers to consolidate their reputation and improve their career prospects. Over time, this practice gave rise to a professional ethos favoring sharing and publication of previous experiences.

Much of the free/open-source-software industry operates this way today, with software engineers competing for future business through the quality of their current innovations. Sharing of information is a key part of this competition. If Linus Torvalds, creator of the Linux kernel, is not nearly so rich as Bill Gates, he is nevertheless richer than most of us. (See Michele Boldrin and David K. Levine, “Open-Source Software: Who Needs Intellectual Property?” The Freeman, January 2007.)

Even the modern controversy over the current effort of the Free Software Foundation to limit software patents through the General Public License Version 3 finds reflection in the earlier Cornwall experience. Familiar with the negative impact of the Watt patents on innovation, Cornwall mine engineers were reluctant to patent their inventions. From 1781 to 1852 Cornish residents took out a grand total of 15 patents on steam technology—against 994 patents on steam technology in all of England during that period. Will it surprise you to learn that the area with the fewest patents also was the area that contributed the most to the innovation and development of steam technology?

One may wonder why development in an obscure corner of England should draw our attention. As it happens, the design of fuel-efficient high-pressure steam engines did not only serve to improve the efficiency of pumping water out of mines in one small region. It is the fact that efficient high-pressure engines can be made light and compact and do not require much weight of fuel that made possible such modest advances as . . . the steam train, the steam boat, the steam jenny, and the steam just-about-everything-else. In short—the steam engine that we imagine as the centerpiece of the Industrial Revolution, the key link that took us from riding horses to being frequent fliers—was not the product of the inventive genius of James Watt. When the Boulton and Watt monopoly expired in 1800 steam engines were used only to pump water out of mines. The earth-shattering innovation of widely usable steam engines was the product of the efforts of Joel Lean and dozens of other equally anonymous Cornwall mining captains and engineers. It is equally a tribute to their steady innovation without making use of patents.

“He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me. That ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition, seems to have been peculiarly and benevolently designed by nature, when she made them, like fire, expansible over all space, without lessening their density in any point, and like the air in which we breathe, move, and have our physical being, incapable of confinement or exclusive appropriation. Inventions then cannot, in nature, be a subject of property.”

Jefferson then added, “Society may give an exclusive right to the profits arising from them, as an encouragement to men to pursue ideas which may produce utility, but this may or may not be done, according to the will and convenience of the society, without claim or complaint from anybody.” Here Jefferson assumes what most people assume: that patents may be necessary for innovation. Who would invest capital to create a new product if anyone may copy it? But we may ask how innovation will come from a system that protects patent holders from competition by barring others from building on previous innovations or that permits legal extortion (see the BlackBerry case)?

Leaving aside whether utilitarian considerations trump natural rights, we can address these questions in light of a transnational study of the pharmaceutical industry contained in the not-yet-published book Against Intellectual Monopoly, by Michele Boldrin, professor of economics at the University of Minnesota, and David K. Levine, Armen Alchian Professor of Economics at UCLA and coeditor of Econometrica (online at www.dklevine.com/general/intellectual/against.htm). The strongest case for patents is said to be in the pharmaceutical industry because the extraordinary R&D costs could not otherwise be recouped. If the utilitarian case cannot be sustained there, it would be a deadly blow to the case in general.

“In fact,” Boldrin and Levine write,“we shall see that the case for patents in pharmaceuticals is weak—and so, apparently, even under the most favorable circumstances patents are not good for society, for consumers, or in this case, for sick people. Patents are good for monopolists, but that much we knew already.”

Given the vastly different patent regimes from country to country and historically, with several countries having none at all, we might expect a pattern: “In particular, at least between 1850 and 1980, most drugs and medical products should have been invented and produced in the United States and the United Kingdom, and very little if anything in continental Europe. Further, countries such as Italy, Switzerland and, to a lesser extent, Germany, should have been the poor sick laggards of the pharmaceutical industry until the other day. Instead . . . the big time opposite is and has been true.”

Their most striking illustration is Italy, which had no pharmaceutical patents until 1978. Yet, “[d]espite this complete lack of any patent protection, Italy had developed a strong pharmaceutical industry: by the end of the 1970s it was the fifth world producer of pharmaceuticals and the seventh exporter….[T]he forty largest Italian firms did not simply imitate but developed their own products and innovated extensively.” After patents were introduced, the industry became more concentrated and its share of world drug development fell slightly.

As W.S. Gilbert might have put it, with patents “things are seldom what they seem.”

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Prior to the U.S. Court of Appeal’s decision in the Napster case, all indications were that the parties to the litigation were adjusting to a reality in which copyright might become a thing of the past.

TVT Records, one of the largest U.S. independent record labels, had become the first label to drop its copyright infringement lawsuit against Napster. TVT upstaged Bertelsmann AG, which strategically remained party to litigation against the song-swapping outfit while promising to forgo action once Napster transformed itself into a fee-based membership service.

Edel Music, too, had hopped on board. The players seemed to have sensed that they could no longer stem the tide: New technology had blown the lid off the anti–free-market protectionism that is copyright and patent law. In explaining TVT’s change of heart, president and founder Steve Gottlieb said: “I am afraid that copyright owners’ resistance to finding workable solutions with Internet music providers may result in consumers, artists, and the industry itself ultimately being harmed. . . . It is high time that the industry embraces a service that the public has so emphatically said they want.”

Once the dust settles, TVT and Napster will offer Napster’s 45 million-plus users the opportunity to exchange copyrighted music files online under a business model that compensates recording artists and record companies.

In the decision that followed these developments, the U.S. Court of Appeals for the Ninth Circuit found Napster liable for contributory and vicarious copyright infringement. Users were said to be engaging in direct infringement of the plaintiffs’ distribution and reproduction rights. The court conceded that Napster is capable of, and has the potential to, provide other non-infringing uses. While this would have acted as a legal defense against contributory infringement, it was outweighed by the fact that Napster possessed actual, specific knowledge of direct infringement.

The judge found that Napster was able to locate the infringing material and hence capable of properly policing its system. This, combined with a direct financial stake in the infringing activities, caused the court to find Napster liable as a vicarious offender as well.

One hope was that the Audio Home Recording Act of 1992 (AHRA) would grant Napster users protection on the grounds of “fair use,” since it allows audio music swapping for noncommercial use. This too failed. Because they got for free something they would ordinarily have paid for, Napster users were deemed to be engaging in commercial use. The judge further ruled that since a Napster user copies an entire work, he is harming the market by (1) reducing CD sales among college students, and (2) making it harder for the record companies to enter the arena of digital downloading.

This standard underscores that copyright aims at maintaining a market for certain interests through the force of the law, a good point from which to segue into the crux of the Napster saga: Are the legal rights that politicians gave to originators of ideas—as embodied in music, software programs, books, or practical inventions—justified? And what property rights should the law protect?

The answer depends on the definition of property and what makes it ownable.

Tangible goods, we all agree, are properly the objects of property rights. This is because they are economically scarce. But the notion that the mere act of creation confers ownership is problematic. Drawing on Lockean principles of homesteading, property theorists like attorney N. Stephan Kinsella reject it in favor of economic scarcity as “the hallmark of ownable property.”* Scholars like Sir Arnold Plant and Tom G. Palmer, along with virtually all property theorists of the Austrian school, recognize that scarcity precedes property.

Economic scarcity results when my use of an item conflicts with your use of it. While an abundance of computers can be had on the market, my use of this particular PC excludes your use of it. We might come to blows were we both to insist on occupying the thing. If I could conjure computers with a magic wand, they would be abundant, not scarce, and it would be immaterial if this one were removed. In the case of scarce resources, property rights are essential to prevent conflict.

Intangible Goods

Not so for intangible things such as the ideas copyright and patents protect. However valuable, ideas are not economically scarce: My listening to a piece of music doesn’t conflict with or exclude your doing the same. Ditto for a book: A copy made of the thing doesn’t remove from its author the configuration of ideas that is the book.

Granted, copyright law protects only the physical instantiation of an idea. Humming a song won’t secure copyright in it. The idea must be written down to become fixed in a tangible medium. Here is the nub: Copyright is vested in a physical object that can be owned quite legitimately by someone other than the author of the book, the singer on a CD or the code writer of a software program. It is in the rightfully owned property of others that the copyright owner acquires a stake.

Say I write a novel and you decide to film a movie based on my novel’s plot, using your own filming equipment. Were I only to proclaim I owned the ideas in my novel, I would merely be exercising my free speech. But when I want to prohibit you from using your equipment as you please, and can use the force of law to do so, I am violating your property right. Under the law as it now stands, my act of creation is all it takes for me to be able to exercise control over you.

Put another way, imagine you could reproduce at almost no cost copies of a scarce, tangible item like a desk I designed. Would I be justified in prohibiting you from using your copy of my desk simply because I possess the original item? Would it be right to demand that you pay me a stipend for every copy of my desk you made using your own desk copier, so that I might secure for myself a tidy source of revenue? If you dare resist my attempts at extortion, I will galvanize the law. After all, you are cutting into an income I imagine I am owed.

Copyright redistributes wealth, as the workings of the 1992 Audio Home Recording Act makes evident. Here, manufacturers like Yamaha or Philips that market digital audiotape recorders and CD-R burners must pay a statutory royalty as a penalty for making devices that could foreseeably be used to infringe copyright. Such manufacturers must pony up for the potential undermining of the value of copyrighted material. Notwithstanding the incoherence of assigning rights in some imagined value the copyrighted material may have, wealth here is distributed from manufacturer to music industry. Similarly, consumers who purchase blank recording media must pay special excise taxes to the music industry.

No less egregious is the patent monopoly. Consider the Prozac patent, recently—and surprisingly—struck down by an American court. Ordinarily, the patent monopoly held by Eli Lilly & Co. would have prohibited competitors from using their own property to make generic copies of the drug. This is all a patent is; it grants to the holder no more than the right to prohibit someone else from implementing an invention he may have arrived at quite independently.

Some conservative organizations, abandoning free-market principles, defend patent monopolies. The Fraser Institute, for example, has fiddled with econometrics in an attempt to show that denying Eli Lilly & Co. the Prozac patent monopoly causes a net loss to the economy, reducing wealth and the incentive to invent. Such staple utilitarian arguments, as Mr. Kinsella demonstrates, are not only unjust and unprincipled, but also incoherent.

The Fraser Institute compared the $3 billion savings to consumers from the introduction of competition from generic drugs with the $66 billion loss to pharmaceutical company shareholders after the removal of Eli Lilly’s patent protection. It then concluded that patent monopoly benefits the economy.

But as economist Ludwig von Mises wrote, “Just as there is no measurement of sexual love, of friendship and sympathy, and of esthetic enjoyment, so there is no measurement of the value of commodities.” Neither is there a “method available to construct a unit of value.” Values are subjective. While consumers gained from the removal of the Prozac patent monopoly, others—notably investors—lost. By what shift of logic does an expert decide that the loss to one party is more important than the gain to the other? Clearly, to sanction state-granted, exclusive monopoly privileges on the central-planning grounds that this redistribution of wealth promotes prosperity in society is not an enduring basis for principled legislation.

Legally Binding Promises

Rather than resort to discredited central planning and its attendant specious measurements to justify imposing patent monopolies, conservative organizations should rediscover the advantages of the free market. It offers other, much simpler, and much more elegant options—contracts are among them—to ensure that the originator of an idea receives a share of the profit. Under certain conditions and with certain provisos, promises made between parties become legally binding. Employees in high-tech companies, for instance, are bound by contract when they agree to keep quiet about trade secrets. A variety of contracts are available to allow parties to protect their assets and profits. Confidentiality, nondisclosure, royalty, and non-compete agreements can be expected to proliferate in copyright-free commerce. These arrangements differ from the current copyright regime in that they bind only parties to the agreement. Intellectual property (IP) rights bind everyone.

Given that protectionism distorts the market, its removal needn’t be dreaded, except by those who turn to government to capture wealth. Imitation haute couture and knock-off fragrances, paperbacks, and drive-in movies have not decimated the original articles or industries they emulated, although they may have scaled them back somewhat. In the case of music, no protection may indeed mean fewer of the three-chord warbles that currently pervade the industry. Why is that such a bad thing? And who says someone has a right to make others provide him with a market? Certainly no true free-market proponent.

IP rights are invariably enforced in the tangible world of scarce resources. Recognizing property rights in nonscarce intangible resources diminishes rights in tangible scarce resources. Laws that elevate rights in ideas to the extent they override rights in tangible property must give pause—more so given government’s penchant for imbuing things with economic value (such as occupational licenses and cable franchises) so as to grant monopoly to one interest or another.

The copyright system ought to be abolished because there can be no justification for the use of force against legitimate property owners. And force is, very plainly, what flows from the enforcement of the law. Since ideas should not be treated as property, laws that target those who have not violated person or property are wrong.

*See N. Stephan Kinsella, “Against Intellectual Property,” The Journal of Libertarian Studies, Spring 2001.