Seen and Unseen Cost of Patents by Jeffrey A. Tucker

Drugs patents took it on the chin a few years ago, when major drug companies refused to sell cheap AIDS drugs in Africa. Presuming the drugs work, countless lives might have been saved. But the desire to protect the high price on the patented drug – despite the low marginal cost for producing additional units – trumped the humanitarian impulse to save lives. The large drug companies refused to budge, despite protests from all over the world.

Defenders of the drug companies say: well, sure it is cheap to produce mass quantities of drugs after they have been developed. But the costs of getting there are sky high. If companies can't charge high prices, they won't develop the drugs in the first place.

Boldine and Levine, in chapter four, offer an interesting response to this claim but it requires a bit of thought. They point out that the drugs can still be sold profitably at vastly lower prices, in the same way that many other products can be sold profitably at low prices. Items of super high cost – think of passenger airlines or cruise ships – recoup those costs through volume sales over time. It is the same with drugs, or could be.

So why wouldn't the pharmaceutical companies budge in the African case? It is due to the fear of re-importation, that is, that the drugs would make their way back to the US and Canada and be sold at cheap prices, thereby undercutting the monopolistic price.

Why not just price discriminate? It not so easy to price discriminate in a global economy. Rather than take that risk, companies settled for not selling at all. This reflects a general principle articulated by Boldine and Levine: "Intellectual monopolists often fail to price discriminate because doing so would generate competition from their own consumers."

Think about this principle. It helps explain why large software manufacturers routinely degrade their products available to consumers while reserving their better products for the more lucrative corporate market. This is why the versions of operating systems and end-user software are dumbed down on the consumer market. The companies don't want to permit cross-selling between markets, even though the costs of selling better products across markets are virtually identical. Only IP allows them to get away with this sort of behavior.

So, yes, there are some benefits to patents in the same way there are benefits to all monopolists. The Post Office benefits from the prohibition against private delivery on letters. Public schools benefit by regulations on private education and mandatory funding. The electric company benefits from its statutory guarantee against competitive intrusion.

But that is not the same as saying that all groups benefit. Boldrine and Levine examine data from Total Factor Productivity in cross-national studies and show that the astounding increase in patents in the 1990s – rising more than three-fold from a stable rate in previous decades – has had no effect on increase prosperity and innovation.

Meanwhile, there are huge costs, even for those who acquire and own the patents. Oracle software, for example, spends vast resources on what can be called defensive patents. They must get them before someone else does else risk having to pay huge fees to someone else. Cross-licensing is the only way to develop software now, so the patent route has been forced on everyone. The word "thicket" is the one everyone uses. What it really amounts to is a cold war between patent holders – a patent race that is very much like an arms race. This is why Nokia own 12,000 patents and Microsoft is adding 1,000 patents a month to its arsenal. Intel's CEO spoke for many when he said he would be glad to cut patents to a tenth of its current rate provided that others did the same.

Conventional patent theory says they are necessary for generating revenue to fund research and development, and to inspire innovation. This is supposedly the economically valuable contribution of patents. Then there is the real world. A Carnegie Endowment survey of firms shows that businesses themselves report that this function of patents is mentioned as important only 6% of the time. The main reason businesses say that they want patents is to enforce monopoly – preventing people from developing similar but better and cheaper products – and to prevent lawsuits.

They authors describe the result of patents as not a competitive market for innovation but an oligopolistic market structure around patent-pool mechanisms. This affects every industry, as patent battles hinder economic development. A good example is the ongoing battle over who and what can lay claim to the title "basmati" rice. A Texas company called RiceTec won a patent in 1997, infuriating Indian and Pakistani companies that have been making Basmati for hundreds of years. These companies have been fighting back with their own attempts to register patents on the rice. What this has to do with the consumer and the dinner table and the need for cheap and delicious food being made widely available is the unanswered question.

A peculiar form of patent abuse comes in the form of the submarine patent. This is a patent taken out early while the production of the product itself is delayed as long as possible. When someone else finally goes to market with a product, the patent emerges from the deep as a method of blackmailing the company that has gone to market.

Boldine and Levine explain that this tactic dates to George Seldon's patent on the "road engine" in 1895. It commanded 1.25% on the sale of every car in the US. He sold his patent for $10,000 and 20% of royalties to a syndicate in 1899. As the car actually started to make it to market, the Associated of Licensed Automobile dealers formed a cartel around the patent. The authors comment: "if you were wondering why the U.S. automobile industry developed so quickly into the oligopoly we know and hate, a fair share of the roots lie in bad 'intellectual property' legislation and the intellectual monopoly it created."

Personally, I find that revelation remarkable. More than a hundred years later, we are still paying the price for this car-cartel-creating patent. Something similar happened to airplanes, when the Wright Brothers managed to get a patent on anything resembling an airplane, despite their own meager contribution to the technology. They were so aggressive in blasting all competitors that all serious innovation in airline technology ended up taking place overseas in France.

The authors make a statement that I wish could be made more prominent, since it comports with everything I know about businesspeople and patents. It is the most common thing in the world for a businessperson to use every market-oriented skill to get a product to market: a good product at a good price that becomes the market leader. At this point, and for some odd reason, the businessperson gets confused. He thinks that it his IP that is the key to his success and ends up fighting for it with all his might, even at his own expense.

Here is the statement by Boldrine and Levine: "'Being a monopolist' is, apparently, akin to going on drugs or joining some strange religious sect. It seems to lead to a complete loss of any sense of what profitable opportunities are and of how free markets function. Monopolists, apparently, can conceive of only one way of making money, that is bullying consumers and competitors to put up or shut up. Furthermore, it also appears to mean that past mistakes have to be repeated at a larger, and ever more egregious, scale."

A clear case in point concerns the Recording Industry Association of America, which managed to make itself appear as the devil incarnate in the eyes of an entire generation of music downloaders. Another example concerns Google Print. This work of genius would have brought all the world's libraries to one central location so that users could search the books and purchase them. Wonderful! But the Authors Guild sued, and the suit has gutted Google Print as a useful tool. The dream of all educated people from the ancient world to the present – a single accessible repository of all the world's wisdom – was stopped for no good reason.

The authors conclude chapter four with a restatement of the theme: the benefits of patents are small and narrow, while the costs are large and broad. The biggest costs are the unseen ones that Bastiat speaks of. These are innovations we don't see, the products that don't come to market, the efficiencies that we never experience, the companies that don't come into existence, and the investment that would have taken place with the resources that are expended on patent acquisition and enforcement. Here are the real costs of patents, and they are incalculable.