An Economic Review of the Patent System1*


Fritz Machlup

Patent, the adjective, means "open," and patent, the noun, is the customary abbreviation of "open letter." The official name is "letters patent," a literal translation of the Latin "litterae patentes." Letters patent are official documents by which certain rights, privileges, ranks, or titles are conferred. Among the better known of such "open letters" are patents of appointment (of officers, military, judicial, colonial), patents of nobility, patents of precedence, patents of land conveyance, patents of monopoly, patents of invention. Patents of invention confer the right to exclude others from using a particular invention. When the term "patent" is used without qualification, it nowadays refers usually to inventors' rights. Similarly, the French "brevet," derived from the Latin "litterae breves" (brief letters), is a document granting a right or privilege, and usually stands for "brevet d'invention."
Defined more accurately, a patent confers the right to secure the enforcement power of the state in excluding unauthorized persons, for a specified number of years, from making commercial use of a clearly identified invention. Patents of invention are commonly classed with other laws or measures for the protection of so-called "intellectual property" or "industrial property." This class includes the protection of exclusivity for copyrights, trademarks, trade names, artistic designs, and industrial designs, besides technical inventions; other types of "products of intellectual labor" have at various times been proposed as worthy of public protection. It has seemed "unjust" to many, for example, that the inventor of a new gadget should be protected..., while the savant who discovered the principle on which the invention is based should be without protection and without material reward for his services to society. Yet, proposals to extend government protection of "intellectual property" to scientific discoveries have everywhere been rejected as impractical and undesirable.
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The oldest examples of grants of exclusive rights by kings and rulers to private inventors and innovators to practice their new arts or skills go back to the 14th century. Probably the first "patent law," in the sense of a general promise of exclusive rights to inventors, was enacted in 1474 by the Republic of Venice. In the 16th century, patents were widely used by German princes, some of whom had a well-reasoned policy of granting privileges on the basis of a careful consideration of the utility and novelty of the inventions and, also, of the burden which would be imposed on the country by excluding others from the use of these inventions and by enabling the patentees to charge higher prices.
Some of the exclusive privileges were on new inventions; others on skilled crafts imported from abroad. Some... for limited periods; others forever. (For example, the canton Bern in Switzerland granted in 1577 to inventor Zobell a "permanent exclusive privilege.") Some... privileges granted protection against imitation and... thus created monopoly rights. Others, however, granted protection from the restrictive regulations of guilds, and thus were designed to... increase competition. In view of the latter type of privilege, patents have occasionally been credited with liberating industry from restrictive regulations by guilds and local authorities and with aiding the industrial revolution in England. In France, the persecution of innovators by guilds of craftsmen continued far into the 18th century. (For example, in 1726, the weavers' guild threatened design printers with severe punishment, including death.) Royal patent privileges were sometimes conferred, not to grant exclusive rights, but to grant permission to do what was prohibited under existing rules.
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The Chief Arguments for Patent Protection
While the early opinions on the patent system were expressed merely in occasional comments and remarks contained in general treatises on political economy, economists during the great patent controversy of the second half of the 19th century wrote articles, pamphlets, and books on the economics of exclusive rights. The arguments for and against the patent system have not changed much since that time.
Patent protection for inventors is advocated on ethical grounds - in the name of "justice" or "natural right" - or on pragmatic grounds - in the name of "promotion of the public interest." In some views, ethical and pragmatic considerations are combined.... Others recognize the possibility of conflict between requirements of justice and material usefulness to society, and they may seek justice even at the expense of material benefits, or material benefits at the expense of justice.
The four best-known positions on which advocates of patent protection for inventors have rested their case may be characterized as the "natural-law" thesis, the "reward-by-monopoly" thesis, the "monopoly-profit-incentive" thesis, and the "exchange-for-secrets" thesis.
The "natural law" thesis assumes that man has a natural property right in his own ideas. Appropriation of his ideas by others, that is, their unauthorized use, must be condemned as stealing. Society is morally obligated to recognize and protect this property right. Property is, in essence, exclusive. Hence, enforcement of exclusivity in the use of a patented invention is the only appropriate way for society to recognize this property right.
The "reward-by-monopoly" thesis assumes that justice requires that a man receive reward for his services in proportion to their usefulness to society, and that, where needed, society must intervene to secure him such reward. Inventors render useful services, and the most appropriate way to secure them commensurate rewards is by means of temporary monopolies in the form of exclusive patent rights in their inventions.
The "monopoly-profit-incentive" thesis assumes that industrial progress is desirable, that inventions and their industrial exploitation are necessary for such progress, but that inventions and/or their exploitation will not be obtained in sufficient measure if inventors and capitalists can hope only for such profits as the competitive exploitation of all technical knowledge will permit. To make it worthwhile for inventors and their capitalist backers to make their efforts and risk their money, society must intervene to increase their profit expectations. The simplest, cheapest, and most effective way for society to hold out these incentives is to grant temporary monopolies in the form of exclusive patent rights in inventions.
The "exchange-for-secrets" thesis presumes a bargain between inventor and society, the former surrendering the possession of secret knowledge in exchange for the protection of a temporary exclusivity in its industrial use. The presupposition again is that industrial progress at a sustained rate is desirable but cannot be obtained if inventors and innovating entrepreneurs keep inventions secret; in this case, the new technology may only much later become available for general use; indeed,
technological secrets may die with their inventors and forever be lost to society. Hence, it is in the interest of society to bargain with the inventor and make him disclose his secret for the use of future generations. This can best be done by offering him exclusive patent rights in return for public disclosure of the invention.
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Some Basic Economic Questions
Patents, by giving their owners exclusive rights to the commercial exploitation of inventions, secure to these owners profits (so-called "quasi-rents") which are ultimately collected from consumers as part of the price paid for goods and services. The consumers pay; the patent owners receive. Are the consumers - the non-patent-owning people - worse off for it?
"No; they are not," says one group of economists. Patents are granted on inventions which would not have been made in the absence of a patent system; the inventions make it possible to produce more or better products than could have been produced without them; hence. Whatever the consumers pay to the patent owners is only a part of the increase in real income that is engendered by the patent-induced inventions.
"Wrong," says another group of economists. Many of the inventions for which patents are granted would also be made and put to use without any patent system. The consumers could have the fruits of this technical progress without paying any toll charges. Even if some inventions are made and used thanks only to the incentives afforded by the patent system, consumers must pay for all patented inventions and, hence, lose by the bargain. Moreover, if patents result in monopolistic restrictions which hold down production and hinder the most efficient utilization of resources, it is possible that total real income is less than what it would be without the patent system. Of course, there is impressive technical progress and a substantial growth of national income under the patent system, yet perhaps less so than there would be without patents.
This is but one of the fundamental conflicts in the economics of the patent system. There is another, which is quite independent of any profits collected by the patent owners and of any monopolistic restrictions imposed on production. This second basic problem relates to the overall allocation of productive resources in a developing economy and to the question whether at any one time the allocation to industrial research and development is deficient, excessive, or just right.
It is easy to conceive of the possibility that such allocation is too meager. But can there ever be too much? Is not more research and development always better than less? Is it possible that too much is devoted to the inventive effort of the Nation? This depends on what it is that is curtailed when inventive activity is expanded. More of one thing must mean less of another, and the question is, what it is of which there will be less. The best of the possibilities would be that there will be less "involuntary leisure...." ....
The next best possibility would be that "voluntary leisure" is given up; that qualified people are ready, with some inducements, to devote more time to inventive activity, not at the expense of any other productive activity, but at the expense of some of their leisure time. Persons with a bent for tinkering and inventing, busy with other jobs during their regular hours, may be glad to use their free evenings and weekends for inventive activity. Others, employed in research and development, may be willing to work overtime. This second pool of potential resources may be of great importance for the implementation of "crash programs" of research and development in a national emergency. But long-run programs, not directed
toward specific goals (like winning a war or an international race for a particular technical feat), but designed for "progress in general," cannot successfully be based on the continuous and continual supply of overtime labor. The other source of volunteer labor - the free time of amateur researchers and tinkerers - can probably be drawn upon regularly. (To have mobilized these "individual inventors" is perhaps one of the achievements of the patent system in times past.) But this is a very limited source of supply, perhaps already fully utilized; in addition, the role of the "evening-and-Sunday inventors" has become quite insignificant in our age of organized research and development. Thus, the possible sacrifice of leisure cannot be counted on to provide the labor for additional inventive activity.
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Evaluation of the Patent System as a Whole
A comparison, even though speculative, of the incremental benefits and costs associated with a little more or a little less patent protection, is more feasible than is an attempt to assess the "total effects" of the system. An economic evaluation of the patent system as a whole implies an analysis of the differences between its existence and non-existence - perhaps a hopeless task. Nevertheless several different effects, some beneficial, some harmful, have been attributed to the operation of the patent system, and must be reviewed in an attempt at evaluation.

That the patent system succeeds in eliciting the disclosure of technological secrets is a claim widely asserted, though often denied. The chief question is whether, by and large, the period over which inventions could be kept secret, or in which the first invention would not be duplicated..., is longer than the period for which patents are granted. A negative answer is strongly suggested by the simple reflection that inventions probably are patented only when the inventor or user fears that others would soon find out his secret.... It would follow that the patent system can elicit only those technological secrets which without a patent system would be likely to be dispersed even sooner than they become free for public use under patent protection.
This conclusion disregards the possibility that all the competitors who eventually find out about the novel technology or find it independently will try to keep it secret. However, this would be a "secret" shared by all whose knowledge really matters. If there is enough competition among those who are "in the know," the interests of the community are safeguarded. But there is another advantage in prompt and full disclosure..., which is not secured through the process of individual detection or multiple invention. Disclosure of an invention through the patent grant may give "ideas" to technicians in other industries who would not, as a rule, go out of their ways to "find" the technical information in question but may be glad to take a hint when it is "thrown" at them... in the official gazette. In other words, dissemination of technical ideas to outsiders should be considered separately from the availability of the invention to those who would like to use it in competition with the first inventor.
The claim that the patent system serves to disseminate technological information, and that this accelerates the growth of productivity..., is not questioned. In some countries, though not in all, the patent offices have collected and made publicly available the vast amount of technical information contained in the hundreds of thousands of patents, current and past. But, while this store of knowledge in public print is a very desirable byproduct of the patent system, it is not necessarily dependent on it; conceivably, similar collections of technical knowledge could be compiled, perhaps no less efficiently, by special agencies in the absence of patents.
Apart from any effects upon the size of the national income, the patent system affects the distribution of income. Indeed this is its purpose from the point of view of the "just reward" theory: to transfer some of the income increase produced by newly invented technology to the people responsible for it. The recipients of this income transfer are often pictured to be those ingenious, independent fellows called "garret inventors" or "basement inventors"; it was said that they would be helped by the patent system in their endeavors to go into business for themselves or to sell their rights for practical application of the inventions. Yet this is not how things work today. The majority of "inventors" are employees... working on the staff of research departments of very big firms. The income transferred from the consumers is received by the corporations to cover their research and development cost (if written off immediately), or as part of their profit either to be reinvested (perhaps in research equipment and innovations) or to be distributed to stockholders. Is what the consumers pay on this score (as part of the price of the goods and services they buy) more, or is it less, than the increase in real income which results... from the corporate research and development work? If it is true that the total outlay for such work is increased under the patent incentive, this increase means more demand for research personnel and thus will raise the salaries of the entire staff, old and new, although it is only the additions to the staff that will increase the rate at which new technology is created. If the supply of research workers should be completely inelastic, there will be only increased salaries but not more inventing; and if the corporations should know this, or for any other reasons fail to increase their outlays for inventive and innovating activities, there will be only increased corporate profits resulting from the patent system. But one never can tell, perhaps the income redistribution accomplished by the system is only a modest portion of the increase in national product that the system induces and which would not occur without it.
The incentive effects of the patent system, which are supposed to yield the new inventions and innovations which in turn produce an increase in national output, are the result of profit expectations based on restrictions of the output produced with the aid of the patented inventions. These... are the very essence of the patent system because only by restricting output below the competitive level can the patent secure an income.... ....
These incentives are supposed to generate technological inventions plus innovations - innovation being the first commercial application of a new idea. Invention without application is useless; practical application may depend on patent protection even where invention does not. Thus, even if the patent system were proved to be unnecessary for the promotion of invention - that is, if an adequate flow of inventions were forthcoming without patent incentive - patents might still be needed as encouragement for investment and enterprise to introduce untried techniques and products.
To be eager to do something is not enough if the necessary funds are lacking. Some observers have placed less emphasis on the need for patents as an incentive for investment in industrial research, development, and practical innovation than on the need for them as sources of finance for such investment. They have argued that only the monopoly profits derived from existing market positions based on past patents can provide the funds for new incentive work and innovating ventures. This argument was perhaps suggested by the observation that the largest research laboratories are in fact maintained by corporations with the strongest patent positions and with high and stable earnings. This, however, does not mean that other firms, not drawing on patent-monopoly profits, could not afford to invest in research. What it probably does mean is that the patent system, because of certain scientific and technological developments of the time, favors certain types of industry, such as chemical and electronic, and that this occasions both the accumulation of masses of patents and the intensive search for new patentable inventions in these industries. But even this explanation probably exaggerates the role of patent monopolies in industrial research. It seems very likely that even without any patents, past, present, or future, firms in these industries would carry on research, development, and innovation because the opportunities for the search for new processes and new products are so excellent in these fields that no firm could hope to maintain its position in the industry if it did not constantly strive to keep ahead of its competitors by developing and using new technologies.
We find ourselves confronted with conflicting theories. On the basis of the theory of the "competitive compulsion to keep ahead" one might think that firms would invent and innovate even without patent protection. But on the basis of the theory of the "competitive elimination of profits" one might think that without patent protection it would not pay to invent and to innovate, and that firms could not afford to invest in research and development. On the strength of the theory of the "sufficiency of the innovator's headstart" one might think that many innovators would have enough time to recover their costs of innovation. But on the strength of the theory of the "nearly perfect competition from imitators" one might think that few innovators would get away without losses.
No conclusive empirical evidence is available to decide this conflict of theories. That the automobile industry developed partly despite patents (when it still had to overcome the barrier of the basic Selden patent) and partly independently of patents (since it refrained from enforcing the exclusive rights obtained) is some presumptive evidence against the theory of the need for patent protection. That in Switzerland and the Netherlands industrial development proceeded rapidly when these countries had no patent laws is not conclusive because, one might say, they shared the fruits of the patent systems elsewhere and profited from the free imitation of technologies developed abroad - an instance of sharing the benefits without sharing the cost. That experts in the chemical, electronic, and other industries testify that their firms could not maintain their research laboratories without patent protection may persuade some, but probably should be discounted as self-serving.... That countries with patent laws have made rapid technical progress does not compel the inference that their progress would have been slower without patent laws. None of the empirical evidence at our disposal and none of the theoretical arguments presented either confirms or confutes the belief that the patent system has promoted the progress of the technical arts and the productivity of the economy.
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It should be said... that scholars must not lack the courage to admit freely that there are many questions to which definite answers are not possible, or not yet possible. They need not be ashamed of coming forth with a frank declaration of ignorance. And they may make a contribution to knowledge if they state the reasons why they do not know..., and what kind of objective information they would have to have ....
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If one does not know whether a system "as a whole" (in contrast to certain features of it) is good or bad, the safest "policy conclusion" is to "muddle through" .... If we did not have a patent system, it would be irresponsible... 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. This last statement refers to a country such as the U.S. - not to a small country and not a predominantly nonindustrial country, where a different weight of argument might well suggest another conclusion.
While the student of the economics of the patent system must, provisionally, disqualify himself on the question of the effects of the system as a whole on a large industrial economy, he need not disqualify himself as a judge of proposed changes in the existing system. .... Factual data of various kinds may be needed even before some of these decisions can be made with confidence. But a team of well-trained economic researchers and analysts should be able to obtain enough information to reach competent conclusions on questions of patent reform. The kind of analysis that could form the framework for such research has been indicated in the present study.
1* Study No. 15, Subcomm. Patents, Trademarks and Copyrights of the U.S. Senate Judiciary Comm., 1-2, 20-21, 44-45, 76-80 (1958) (heavily annotated).