The Patent Dilemma

In simple terms patent law is frustrating. There is a strong rational argument for keeping patents and abolishing them. Those who innovate deserve some kind of compensation for their efforts, however even temporary monopoly leads to inefficiency and does not best benefit society. In the following I will consider the arguments for and against patents.

There are four central arguments that were used to justify the patent system of the 19th century. Taken from the book “The Patent System and Inventive Activity” by H.I. Dutton.

The Natural-Law Thesis

This thesis is based on the assumption that individuals have a natural right to property of their own ideas. Using others ideas was tantamount to theft as it was private property. Even supporters of the patent system would not go far to advance this argument. William Hindmarch noted that an inventor couldn’t have any natural right to prevent another person from making or using a similar invention summarises the breakdown of this thesis, on the basis that being loosely defined no boundaries are set as to what is a unique and individual idea.

Reward by Monopoly Thesis

The base argument of this thesis is that inventors should be rewarded according to the usefulness of their invention, since market forces may not always guarantee it. Adam Smith and John Stuart Mill were patrons of this argument as he noted the importance of the rule of law, and the institutional framework, which corrected market failure.

This is beneficial because allowing inventors monopoly ensured a period where they would gain sufficient return for the effort, without this protection competitors could in theory lower their costs at no cost. Introducing the free riding problem to the benefit of others inventions. In any case there was the argument they were harmless, market forces would determine the profitability from the invention, if it were a useless invention then there would be no reward.

Jeremy Bentham also distinguished between two categories of labor. In that there was the physical variety whereby it could be imitated with similar reward. Then the skilled variety where progress would reduce cost of production, rather than simply add to production.

Monopoly Profit Thesis

Private rewards was a clear incentive to invent, it differs from the rewards argument as it concerns itself with the duration and exclusiveness of the monopoly. Noting that it is economic growth for society that is ultimately desired. So in this sense growth and private profit would go hand in hand. There is evidence for this link in that many claimed that patents were integral to the creation of the most valuable inventions.

There was also the aspect of the speed at which innovation was carried out when patents were under use, this applied to foreigners and domestic inventors as the patent system enabled both equally to pursue invention, while securing the industrial basis of the economy.

Exchange-for-Secrets Thesis

This was based on the 18th century idea of contract, whereby a bargain occurred as one received protection and the other received knowledge. This thesis emphasised the importance of disclosure. This theory was not concerned with output but rather the dissemination of information of the existing technologies.

This had led to the more complex nature of patents, requiring full disclosure of the technology or inventions in a specification, in order for law officers to make provisions for the patent, established in 1734, and emphasised in 1778. Simply put by John Farey patent is the price of disclosure.

Anti-Patent

The greatest fear about patents was the manner in which monopoly was pursued, noting the particular evils associated with monopoly to ward off the use of patents. The counter-argument was rather that patents had brought what was private discovery into the common, and that just because the monopoly existed did not mean that market would demand it, or that an artificial price increase could be maintained. There was also the notion by William Spence that monopoly prompted a specific type of competition.

The main ideology behind the anti-patent movement was on the basis of free trade and the emancipation of industry. This had gained better grounding after the Corn Laws were repealed and the navigation acts took place.

  • Dangers of monopoly, negative effects on workers, manufacturers, etc.
  • No longer necessary due to a mature economy, firms able to compete normally without special privileges
  • The Economist argued it was immoral and economically unsound
  • The lottery nature of patents, whoever got the idea first by chance
  • The inefficiency of how patents were administered, and the lack of protection they actually offered is the main factor that put off inventors.

Against Intellectual Property – Boldrin & Levine

The example of James Watt’s new engine shows the limitations of patents, after initially having to spend six months obtaining a patent, he then spent time combating off rival inventors, to which the patent was then extended. Then after a period of commercial production his advanced engine had only sold 449 units of the 2250 steam engines around. A patent also limited him with the technology he required being the property of James Pickard.

This situation effectively describes Watt as not only an inventor but able to exploit the legal system, noting that his partner had strong connections in parliament. The legal system was used to limit competition, with evidence of limited adoption of steam engine innovation due to Watts’s monopoly. It is also worth noting that Watt spent more time on legal matters rather than inventing. This is summarised as rent seeking behaviour; this is shown through the patent extension that was not needed but favourable for Watt. In the conventional monopoly manner high prices prevented others from entering the market.

Most often attributed to the patent system are the evils of monopoly, corrupt rent seeking, legal suppression of innovation, reduced economic growth, and the los of personal freedom. It is argued that innovation would thrive in the absence of intellectual monopoly. This is brought up next to the concept of free trade and what used to be extreme protectionism. With the authors arguing that today there is the violation of intellectual property laws in that consumers desire cheap books, music, etc. in convenient format and are willing to violate law for it.

The legal framework is as follows in levels of protection of intellectual property: Patents, Copyrights, and Trademarks. Copyright tends to the specific, whereas patents provide broad protection over a general idea. The Right of Sale is a fair concept in that inventors should be able to profit from their work, the right to control however results in prosecution carried out by government.

Intellectual monopoly may be denoted as the right of the owner of the intellectual property to dictate how the purchaser uses the idea and or limiting them. Concept of first mover advantage, should still command a fair premium on the market? Economists favour competition over monopoly on the basis of freedom of contract and well-defined property rights. Shrink-wrap agreements are effectively enforcing collusive contracts. Their argument suggests that the right of sale should be present but then whoever completes a legal purchase and owns a copy now has the right to use the technology however they would like to. The law inhibits the potential of creativity. Similar analogy created between intellectual property and trade restrictions, looking at the transmission of goods being superior under free trade. The reward for invention argument is limited.

Milton Friedman notes the dangers of occupational licensure, but makes a notable point in that there seems to be support for such laws, as the producer group will always be more concentrated then the consumer group (Capitalism and Freedom, Page 143).


The outline of these arguments shows that there is validity in either approach, making the next requirement a look at examples. But rather than making a solution clearer, it goes on to complicate it further.

Take one of the most popular examples: pharmaceutical companies. We understand that there are high costs associated with the research and development of new drugs, therefore firms would like to be compensated for their effort and innovation. However, this tends to price drugs at a level unaffordable for the vast majority of society. Then on the consumer side this means the lack of consumption of a merit good. In the United Kingdom the National Health Service subsidises the cost of drugs in order to ensure and encourage consumption, such as free drugs for those in full time education. Nevertheless, this is limited as the NHS must choose which drugs to subsidise, and what degree to subsidise them. Firms may aggressively price increasing the burden on the NHS, this is often the case with brand new drugs.

Now if we consider paracetamol, the moment the patent ended the market was flooded with new brands all delivering the same product. Now a consumer can get paracetamol of 500mg pills from Sainsbury’s at £0.55, this effectively allows it to be consumed by anyone. The low price a consequence of extreme competition, and economies of scale resulting in mass production.

If we take the idea of altruism and greatest social benefit, we would look to reduce the comprehensiveness of patents. This brings forward the question of how much innovation should be rewarded it terms of length of patent, we leave the market forces to decide how well the innovator fares, but regardless it may stop others from innovating, lead to legal disputes, and tends towards what we see as the “evils of monopoly”. I personally believe that the anti-patent argument tends to over emphasise first-mover advantage, as in a world where communication occurs at increasingly higher speeds, information can be spread quicker then a firm may act.

Copyright Almog Adir © 2014 · All Rights Reserved · My Website

Iron Laws & The Foundation of Economics

When one asks who the founder of economics is, one would struggle not to say Adam Smith. Almost every book on the subject has at some point referenced or quoted Smith, he is as Galbraith would remark “the central tradition”.  I have recently taken some issue with seeing Smith as the central foundation of economics, especially as his work has become and has been the central part of conventional wisdom.

David Ricardo & Thomas Robert Malthus may have come after Smith but their significance is often disregarded, whether it is at schools teaching economics or some universities courses. This can firstly be attributed to the bleaker image of life that Ricardo and Malthus portray. Secondly, there seems to be a disparity between economic thinking and the way it is taught, as economic history is experiencing a renaissance of types in regards to its importance.

Ricardo often receives acclaim in his contribution to comparative advantage, trade, and protectionism.  However, he was an integral part in the development of our understanding of wages, developing the “Iron Law of Wages”. Malthus is most well-known for his dictation of the “Malthusian Catastrophe”, which ultimately defines the bounds of scarcity and ultimately poverty in relation to wages. As such one reason Smith may be a more popular source is due to his optimism, but in that he does not pay too much attention to the issues of inequality, distribution of capital, and the existence of poverty. Smith concentrates on the development of wealth and where the individual pursuit of wealth helps society as whole which are far more appealing ideas. Whereas Ricardo and Malthus both reached conclusions that were far from pleasant, to some extent a result of the society they lived in.

The Iron Law of Wages can be considered through the Malthus foundation where population growth occurs as a consequence of wages being above subsistence levels, and population decline occurs as a consequence of wages being below subsistence levels. As below subsistence levels the labourer cannot complete labour. This was concluded in his “catastrophe” where eventually population would surpass agricultural production, ultimately reducing all of society to subsistence levels. Now there are a variety of critiques to Malthus’s conclusion, especially now considering modern conditions as one can consider “surplus population” as a condition that is met where there is surplus wealth. Additionally, one can consider the development of science and technology which can lead to substantial increase in production with little or no change in population, so to some extent one can argue that Malthus’s reasoning is outdated.

Ricardo’s foundation for the Iron Law of Wages draws upon greater flexibility denoting natural prices and market prices. Where the natural price of labour is at subsistence level, but the market price could exceed this level indefinitely if there is a constant increase in capital. As he reasons that an increase in capital facilitates in a greater demand for labour. This is all accumulated in his Law of Rent which considers the return from land in regards to production, which then corresponds with wages. This ascertains that wages are not dependent upon the productivity of labour but in a sense marginal land where production is dependent upon the quality of land. This to some extent argues that the Iron Law of Wages fails to predict wages in the same manner that considering land does; it also disenfranchises the landowner from deciding land rents as it is wholly dependent upon the productivity of the land. Yet again this leaves one with the feeling of outdated concepts as we no longer have such a dependency on land as the central form of capital.

Even though the economics that Ricardo and Malthus respectively developed was applicable at their time it is less so now. But what is important to realise is the influence these concepts of wage, rent, and profit had and have on modern economics. Karl Marx had to some extent based his approach on Ricardian thought, examining the productivity of labour in regards to wages, but viewing labour as a unit of production rather than as a human source.  Thereby, Ricardo and Malthus had influenced one of the most dramatic economic deviations in recent history, on the basis of uniform productivity from a unit of labour exclusive to some degree of market forces. Even more so it allows a comparison of how wages are set now, and to what degree do workers get paid in regards to their marginal productivity or contribution, versus market created prices.

It is possible that we have spent far too much time including Smith in our teaching of economics, that we have not appreciated the contribution of other significant economists. The use of economic history can provide a strong foundation of economic thought and its development, as long as the study involves both orthodox and heterodox views. Let me take this opportunity to lament that Alfred Marshall should be far more involved in IB/A-Level textbooks than just the Marshall-Lerner condition, considering the importance of his Principles of Economics in 1890.

The question is shall I talk about Piero Sraffa next, or back off economic history for a while, and take it back to microeconomics and types of markets?

Comparative Advantage

Figs and Peaches

Two fruits which until today I have rarely regarded important to my life, and more so important to understanding economics. But today I was humbled by the simplicity of fruit and trade. No I didn’t walk to a supermarket and compare the prices of what is ultimately the same fig or peach at varying price levels. I sat down in a classroom and considered the opportunity cost in the production of peaches or figs, within the scenario of being on an island which exclusively produces figs or peaches (i.e. a nation capable of trade).

The premise of what seemed like an amiable task, turned out to reveal the essence of trade and the benefit gained from engaging in trade. The simple definition of trade is the exchange of goods between two parties, but the real question to ask is what motivates us to trade?

Now as I am meandering my way into the topic of trade, and its benefits I must bring forward what has become an economic cliché of mentioning Adam Smith’s thoughts on the matter. Obviously, he was not the first to consider aspects of trade but it was his critique of Mercantilism alongside his development of what was to become the explanation for the need to trade. This extract summarises the basis of what was going to become the critique of mercantilism and the purpose of trade:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished, no more than that of the above-mentioned artificers; but only left to find out the way in which it can be employed with the greatest advantage.”

Adam Smith, The Wealth of Nations Book IV, Chapter II

Here, Smith notes the existence of a trade-off that benefits both parties involved. As the terms of trade are established in order to allow two nations who have specialised in the production of a given good to gain an advantage. The critique of mercantilism is clearer in David Hume’s use of the bullion example, which was in essence a supply of money issue. But Smith highlights the mercantilist’s inability to recognise absolute and comparative advantage. The final remark suggests that Smith was thinking in terms of what we would now consider a Production Possibility Frontier (PPF) in which trade will allow us to operate at a point outside of our original output.

Significantly, Smith had developed what was to become classical economics based on a Laissez-Fair approach, which encouraged free trade (removal of tariffs, and protectionism). However, it was not until the early 19th century when David Ricardo had begun to build up the theory of comparative advantage which facilitated the need for free trade and the benefits of trade even when a country has an absolute advantage in the products being traded.

Comparative Advantage:
“A country can produce a good at a lower opportunity cost than its direct competitor”

Absolute Advantage:
“A country is able to produce more of a good or service with the same amount of resources”

Now back to the figs and peaches, firstly it is important to establish why a country would be able to produce a product “better” than its competitor. This is where the factor of endowment comes into place; in accordance with this example it can take the form of an investment into human capital in order to educate the workforce so they know the correct growing conditions for peaches or figs.

Let’s assume that the islands are producing the following goods in the amounts stated, where they will specialise in the production of one good as they cannot maximise the production of both at the same time.

Picture1

Opportunity Cost:

If country A produces 300 peaches it gives up 600 figs, and if it produces 600 figs it gives up 300 peaches. Providing the ratios:

1 Fig – ½ Peach
1 Peach – 2 Figs

If country B produces 100 peaches it gives up 300 figs, and if it produces 300 figs it gives up 100 peaches. Providing the ratios:

1 Fig – ⅓ Peach
1 Peach – 3 Figs

So should there be trade?

Well, first who should export figs or peaches and who should import figs or peaches.

Country A has a lower opportunity cost in the production of peaches in comparison to country B, therefore, Country A should produces peaches as the only lose 2 figs per peach. So A has a comparative advantage in the production of peaches.

Country B has a lower opportunity cost in the production of figs in comparison to Country A, therefore Country B should produce figs as they only lose a 1/3 of a peach per fig. So B has a comparative advantage in the production of figs.

Terms of Trade:

Country A should trade 1 peach for between 2 figs & 3 figs. Below 2 figs they can produce it more effectively themselves, but above 3 country B can produce peaches themselves.

Country B should trade 1 fig for between ⅓ peach & ½ peach. Below ⅓ peach they can produce it more effectively themselves, but above ½ country A can produce figs themselves.

So the (approximate) terms will be:

1P: 2.5F for Country A
&
1F: 0.4P for Country B

This identifies the direct benefit of trade as the ability to go beyond the country’s original PPF, as now Country A can have approximately 150 more figs than before, and Country B can have approximately 20 more peaches. Even though Country A has an absolute advantage in the production of both peaches and figs, the differing comparative advantage means there is still a benefit to trade.

Is this the best model?

Well, not really. It is clear there are some major flaws in this ultimately very simply model of how trade occurs. Firstly, it can be noticed that once a third country is involved a different formulation is necessary, and the existence of a large range of goods makes it difficult to have a clear trade-off. Secondly, the model is based on the immobility of capital, of which we are living in a world where capital is increasingly mobile. Finally, the model would suggest that agrarian nations would remain agrarian thereby not developing but specialising in natural resource production, this would create a larger technological gap and also led to an increasing inequality gap between nations. One alternative is the competitive advantage model, but it fails to provide an outlook on the trade-off and opportunity cost, and has a greater dependence upon the assumption that labour and natural resources are abundant and don’t necessarily effect the economy.

Growth & Structural Reform

Production Possibility Frontier & Aggregate Supply:

There are many determinants for a shift in aggregate supply; this would mean an increase in real output without an increase in the price level.

Picture2

Some examples of the determinants are:

  • Education: Increased productivity, capabilities, and efficiency of the labour force
  • Innovation/R&D: The product may become more useful or easier to manufacture
  • Government Regulation or Subsidy: Encourages production, or deregulates an immobile market.
  • Transport/Infrastructure: If there was better transport then people could work more often rather than waste time in traffic,  development of infrastructure develops efficiency.

p2


Analysis from Article:

Using Evidence from the Article Explain the Impact of Investment on the UK’s PPF?

Increasing the quality of university education and teachers may mean that the workforce becomes more efficient and productive. The article highlights the need to invest in human capital. This would lead to an outward shit for the PPF because there is a greater potential for production. If this potential were to be realised there would be a shift to the right for the aggregate supply curve.

The article mentions that the government should target investment towards equipment rather than property, increasing government investment into R&D and general innovation. The lack of innovation is identified through the lack of patents submitted. The issue surrounding R&D and capital investments are the long pay-off periods, whereas financial products pay-off in the short term. If more money were to be invested in long term research and development projects there is an outward shift for the PPF as there is a higher possibility of products being manufactured with greater efficiency.

Finally, the article recognises that British infrastructure is considered “mediocre” being ranked 24th in the world. It relates this to government failure, and the amount of time it takes to get energy bills through and the time it takes for projects to come to fruition. If there were to a boost in infrastructure spending, then there is the potential for an increase in productivity leading to an outward shift in the PPF.

Evaluate the Argument That Structural Investments Alone Are Not Enough to Stimulate Growth?

There are many theories and manners of approaching how best to stimulate growth, the article heavily leans toward the Salter Cycle. This can be summarised as an increase in productivity and efficiency, resulting in reduced inputs of land, labour, and capital while achieving a great output. This what the article highlights as structural investment, i.e. improving education, improving transport, and stimulating research and development. This does work to stimulate growth however it must be realised that humans can only ever be so efficient or productive, and that factors such as capital and land become scarcer in developed countries.

It is true that the government needs to stimulate development within Britain; it is unacceptable to continue supporting financial institutions that don’t contribute to growth. Energy and energy efficiency are two factors which are integral to stimulating growth within an economy, simply because when there is a greater quantity of energy and at a cheaper price more is used. This is where the American government unlike the British government took a lead and has effectively introduced shale fracking to slash gas prices down and increase consumption. The British government has been slow to develop supporting infrastructure and R&D for the implementation of fracking, when a recent geology report displayed the abundance of shale formation across Britain. This highlights the need for structural investments, but into sectors that have optimistic prospects for the future.

The other methods of approaching growth stimulus can be equally as effective. There is the classical approach of increasing free trade between countries, and the development of trade agreements to stimulate production resulting in general economic growth. In the article there is a display of a real GDP per person graph, it shows that Britain had the highest real GDP in 1870. This was a time when Britain had abundant trade from its colonies (without restriction due to naval dominance and to an extent exploitation), and the expansion of trade into the “new world”.

Structural investment will assist Britain in re-modernising; however it can be argued that it is best suited to developing economies that still have a greater abundance of land, labour, and emerging capital. One possible route is the development of military infrastructure; this would mean creating more aircraft carriers and submarines. This has worked to an extent to help stimulate American growth as it announced that two new aircraft carriers are going to be developed, and the roll out of the successor to the F-22 Raptor.

Another possible approach to growth stimulation is to induce a state of semi-isolationism which had worked for East-Asian economies in the 90s. The crash for the East-Asian economies can be attributed to the liberalization of markets which had stifled growth due to speculation. Creating a state of semi-isolation reduces the inefficiency of market speculation, and makes a country more self-dependent, and this may be realised through structural investment. Overall, it can be recognised that structural investment are a necessity, but it must be coupled with a new economic approach to achieve not only growth but sustainable growth.