The monopoly factory: want to fix the economy? Start by fixing the Patent Office.

• Author: Roth, Zachary

In 1993, Purdue Pharmaceuticals of Stamford, Conn. applied for the first in a series of patents on a drug it called Oxycontin--a painkiller to which Rush Limbaugh would later become addicted. The U.S. Patent and Trademark Office (PTO) granted those patents based on the manufacturer's contention that the drug contained a novel innovation: It had been engineered so that only a very small dose--between 10 and 40 milligrams--was required for the drug to be effective for 90 percent of patients. On the strength of those patents, which in essence granted the company a monopoly license, Purdue went on to reap over $1 billion in annual revenue from sales of Oxycontin.

Seven years later, a generic drug maker, Endo Pharmaceuticals, applied to the FDA for permission to sell its own, lower-priced version of Oxycontin. Purdue sued Endo, claiming patent infringement. During the trial, Endo's attorneys argued that Purdue had conducted no clinical studies, and in fact had no evidence whatsoever to support the claim that the drug worked in small doses for 90 percent of patients, an assertion which had been crucial to its patent application. The judge agreed, and invalidated Purdue's patent, allowing Endo to introduce its own version of Oxycontin in January 2004. By law, however, Purdue was allowed to keep the billions of dollars in monopoly profits it had garnered with patents it should never have won.

How did the patent office wind up agreeing to give Purdue the patent in the first place? It simply took Purdue's word for it that the assertions it made about its drug were accurate. As Purdue noted archly in its press release about the court decision, "Purdue never made the claim in the patent application that it had done experiments to establish this property and the patent examiner never asked for such information."

The Oxycontin patent was just one of thousands of instances of lax scrutiny at the patent office in recent years. Paxil and Prozac are two other multibillion dollar drugs that earned monopoly profits for their makers before their patents were struck down. And the office's errors range far beyond the pharmaceutical industry to include everything from software to biotechnology to e-commerce. Greg Aharonian, a Bay-Area patent consultant who sends out an almost-daily email newsletter on every patent-related development under the sun (an item from February was headed, "Kazakhstan Patent Office Runs Out of Paper") highlighted one recently granted patent, which included a "graphical traceroute"--a technology used to map online traffic events to physical locations. As he points out, had examiners simply Goggled "graphical traceroute," they would have found, under the first entry, an excellent example of the technology, along with a link to an explanatory paper, published by a different team of technologists in November 1999--more than two years before the patent application was filed.

No one knows how many mistaken patents the office issues each year. But the results of one patent office experiment suggest that, in some areas, as many as half of those issued may be faulty. Faulty patents may be doing immense damage to the economy. They not only allow patent-holding firms to gouge consumers with exorbitant prices, but they also inhibit innovation and research, put a drag on economic growth, and may even create an investment bubble. (See sidebar, "The Patent Bubble.")

The cause of the problem is easy to pinpoint. Over the last decade and a half, the patent office has been set up in such a way that it's an easy mark. The system overwhelms many patent examiners, operates under laws and bureaucratic incentives that favor applicants, and can potentially be hoodwinked. A recent Federal Trade Commission report, which laid out these criticisms, concluded that in key industries such as pharmaceuticals, software, biotechnology, and the Internet, the office now "hamper[s] competition that would otherwise stimulate innovation." For some companies, armed only with dubious claims, the patent office has become not something to fear but a patsy, as easy to fool as those elderly couples who send cash to the Nigerian prime minister's wife.

Rent control

Ever since Thomas Jefferson personally reviewed the first patent application (for an improvement in the making of potash--it was granted), the basic method of the patent office has remained essentially unchanged. Examiners receive applications, then search through the available record to determine whether the invention is genuinely unique.

Patents give inventors the right to reap the fruits of their (often costly and speculative) research. It typically takes years of tinkering and development to turn an innovative idea into a money-maker, and many ideas never pan out at all. Understandably, an innovator needs to know that if he invests time and money in a project, competitors won't be able to copy his idea the minute it goes on the market, preventing him from profiting. The patent system ensures the innovator that this won't happen by giving him--if his invention is genuinely novel and useful--a 20-year, government-enforced monopoly. In addition, because the system requires him to disclose the details of his invention when applying for a patent, it encourages the dissemination of technological information that might otherwise be kept a secret.

But it makes little economic sense to award a patent when the animating idea is already in wide distribution. If you were to issue a patent for the nail today, for instance, everyone who wanted to hang a picture or hammer two boards together would have to pay fees to the patent-holder, or else simply abandon all construction. Unjustified patents, then, instead of spurring innovation, simply give patent-holders the right to extract what economists call "rents," raising the cost of doing business and acting as a drag on innovation and economic growth.

The classic example of such "rent-taking" comes from the early automobile industry. In 1879, George Selden, a politically connected amateur inventor and patent lawyer, applied for a patent on a rudimentary car powered by an internal combustion engine. Selden was no genius engineer, and the crude design he submitted to the office simply involved putting a gasoline engine on a chassis to make a moving vehicle--something hundreds of automotive inventors, corporations, and tinkerers across the country were already doing. A car built from Selden's designs couldn't have run for more than five minutes.

But Selden had worked with the patent office many times and had figured out how to take advantage of its weaknesses--at the time historians say, the office in chaos. Selden exploited this institutional confusion by repeatedly modifying his application, so that it covered technological advances made by others after the original filing date; this trick is known as a "submarine" patent and, while somewhat more difficult today, is still sometimes attempted.

Sixteen years after the patent application was first filed, despite overwhelming evidence that Selden's invention was neither unique nor particularly useful, the patent office approved Selden's request. Just before the turn of the century, Selden sold the patent for a hefty price to a group of automakers, who formed the Association of Licensed Automobile Manufacturers in 1903, allowing them to charge a royalty on every car sold. Ownership of the patent also allowed the consortium to deny licenses altogether to rivals whom they feared might be capable of making better, cheaper cars--which is what they did when Henry Ford, who already had a rudimentary factory churning out a few cars each year, applied for a license. Finally, in 1910, after battling the cartel for seven years...