Table of Contents I. Introduction II. Economic Foundation: Growth Not Efficiency A. Business Ventures: Innovation's Engine B. Patents' Effects III. Legal Foundation: Separation, Fertility, and Overtaking A. Separation Principle B. Fertility Principle C. Welfare Overtaking IV. Optimal Strength of Patents A. Duration B. Breadth C. Remedy V. Doctrine and Policy A. Weakening Patents Against Innovation i. Idea Piggybacking ii. Experimenting iii. Improving B. Weakening Patents Against Production i. Holdout ii. Uncertainty VI. Conclusion I. Introduction
Patent policy is losing its economic compass. During the Trump administration, under the banner of curtailing "evergreening," Congress has seen an unprecedented number of bills suggesting reforming the patent system to prevent innovative companies from scaling up drug prices that burden consumers' welfare. (1) Trump himself situated the issue at the top of the nation's agenda in his State of the Union speech in 2018, (2) then again in 2019. (3) Similarly, during the Obama administration, under the banner of curtailing "trolling," Congress saw an unprecedented number of bills suggesting reforming the patent system to prevent uncommercialized patent rights from imposing a drag on the producers of patented technologies. (4) Obama himself "became the first president to elevate patent reform to a national meat-and-potatoes issue" when urging Congress to address patent trolls in his 2014 State of the Union speech. (5) Various academics, reporters, and other stakeholders have followed suit, describing the patent system as a "mess," (6) "broken," (7) "rotten," (8) and other similar superlatives. (9)
Although issues such as the escalating prices of prescription medicine or abusive litigation by nonpracticing entities (NPEs) are of outmost social importance, they are also ancillary to patent theory, policy, and reform. The United States Constitution authorizes Congress to make patent law to "promote the progress of science and the useful arts." (10) Only by causing progress does patent law fulfill its constitutional purpose. To measure progress, economics uses cost-benefit analysis, net national product, the quality of life, and similar indexes. To predict progress, economics uses growth theory. Thus, growth economics explains the extent to which intellectual property law fulfills its constitutional purpose in the United States and some other countries. (11)
The foundations of patent law in growth economics are easily explained but not widely understood. In this Article, we fill this glaring gap. Patents are served to increase an innovation's price, which transfers wealth from buyers to the innovator. The transfer's effect on growth depends on whether the buyer uses the innovation to consume, produce, or innovate. Consuming and producing are static activities, whereas innovation is a dynamic activity. If buyers use the innovation to consume or produce, the patent transfers wealth from the buyers' static activities to the seller's dynamic activity. The transfer increases the average profitability of innovating, which causes more innovating. Thus, to promote growth, patent protection should be strong against using an innovation for consuming or producing. Unlike the simplified patent troll debate, for example, in the absence of aggravating circumstances, NPEs' enforcement of uncommercialized patents against the producers of patented technology generally promote growth. (12)
Conversely, the effect is different when the buyer uses the innovation to innovate. In that case, buyer and seller are both innovators. The patent redistributes wealth from the buyer's dynamic activity to the seller's dynamic activity. Some resources are lost through redistribution ("deadweight loss"), and the average profitability of innovating usually decreases. (13) The decrease in profitability causes less investment in innovating and slower growth. Thus, to promote growth, patent protection should be weak against using an innovation for innovating. For example, all other things equal, NPEs generally degrade growth when they enforce patents against innovators, experimenters, or improvers of patented technology.
In sum, the first principle of the economics of patents is the separation principle: to promote progress in the useful arts, patent protection should be strong against using an innovation to consume or produce, and weak against using an innovation to innovate. This Article uses the separation principle for prediction, evaluation, and interpretation of contemporary patent policy. The separation principle predicts that strong patents against consuming or producing promote growth, and strong patents against innovating retard growth. Meaningful studies of the effect of patents on innovation must distinguish these activities. Unfortunately, many legal discussions of the effects of patents on growth are unilluminating because they combine the positive effect of patents against consuming and producing with the negative effect of patents against innovating. Such studies reveal little about the contribution of patents to the rate of innovation.
In addition, conventional legal discussions unnecessarily complicate the evaluation of the welfare effects of patents. A patent enables its owner to increase the price of the innovation above the cost of production. Pricing above cost is the static inefficiency caused by monopoly. However, pricing above cost yields profits that are an incentive to innovate. This is the tradeoff between access to the product and incentives to innovate. Thus, the conventional normative analysis of patents balances access and incentives. A patent increases human welfare when the gain from faster innovation exceeds the loss from static inefficiency.
Instead of this balancing test, a simpler justification usually suffices. As we will show, patent law often applies to conditions where the welfare gains from faster innovation quickly overtake the welfare losses from static inefficiency. We call this proposition the overtaking principle. In these circumstances, balancing innovation and static efficiency is unnecessary. We can evaluate patent law by focusing on the gains from innovation and ignoring the losses from static inefficiency. Thus, in contrast to the simplified debate about "evergreening," in the absence of aggravating circumstances, escalated consumer products' prices should not justify a patent reform. (14)
Turning from evaluation to interpretation, progress is patent law's constitutional purpose, which we interpret as growth in welfare from innovation. Given two possible interpretations of a patent law, the interpretation that causes more innovation satisfies its constitutional purpose more fully. The interpretation that satisfies a law's constitutional purpose most fully is often its correct interpretation. Thus, by identifying the growth-maximizing interpretation of a patent law, the separation principle helps to find the correct interpretation.
This Article identifies, coins, and develops the separation principle of patent law and the overtaking principle of welfare analysis. In Part II, we contrast growth and efficiency as alternative foundations of patent economics. In Part III, we use growth economics to explain the separation and overtaking principles. In Part IV, we apply these principles to the three dimensions of patent strength: duration, breadth, and remedy. Finally, in Part V, we show how separation is translated into legal policy and recommend further doctrinal adjustments. We also mention exceptions to the separation principle, such as in cases of holdout and uncertain rights, but emphasize that these cases should remain secondary considerations. A short conclusion follows.
11. Economic Foundation: Growth Not Efficiency
To develop patent economics, two different economic traditions are available. The first is efficiency economics. Economies become more efficient by allocating resources better, which improves the mix of the same goods made using the same techniques. Because the goods and techniques are the same, efficient resource allocation is called "static efficiency." Efficiency economics is already assimilated into legal scholarship, and it is mathematically elegant. The second tradition is growth economics. Economies grow by innovating, which makes better goods using better techniques. Compared to efficiency economics, dynamic economics is unassimilated into legal scholarship, and it is mathematically inelegant. However, for patent law, growth economics is far more important than efficiency economics.
Business Ventures: Innovation's Engine
In efficiency economics, the basic analysis focuses on the competitive firm. In growth economics, however, the basic analysis focuses on the business venture, as we will explain. A bold ship's captain in seventeenth-century England proposes that investors outfit a ship for a voyage to Asia for spices. (15) The voyage is costly and risky, but if it succeeds, the spices will be worth a fortune. Seventeenth-century spice voyages involved up-front investment, high risk, and high return. Similarly, an engineer in Silicon Valley in 2010 has an idea for a new computer chip. Development is costly and risky, but if it succeeds, it will be worth a fortune. Like seventeenth-century spice voyages, twenty-first-century technological innovations involve up-front investment, high risk, and high return.
A profitable business venture often has a life cycle like the one depicted in Figure 1. The venture begins with the development of a new idea in period 1, which costs 8. By developing the idea into a product, the innovator acquires a valuable secret or patent, or perhaps a cluster of secrets and a portfolio of patents. Because patent protection requires disclosing the invention to the public, the innovator must choose between secrecy and patent protection. (16) The innovator makes this choice after developing the innovation...