Proxy signals: capturing private information for public benefit.

• Author: Mandel, Gregory N.
• Position: Introduction through II. Proxy Signals: Capturing Private Information for Public Benefit, p. 1-25

INTRODUCTION I. INNOVATION AND INTELLECTUAL PROPERTY LAW A. The Relationship between Patent Law and Innovation B. Conventional Approaches to Optimizing Patent Rights II. PROXY SIGNALS: CAPTURING PRIVATE INFORMATION FOR PUBLIC BENEFIT A. The Externalities of Innovation B. Private Industry Preferences C. Leveraging Innovation Market Dynamics III. PRIVATE INDUSTRY PROXY SIGNALS A. Industry Variation in Innovation B. Industry Innovation Characteristics 1. Variation in Technology Characteristics 2. Variation in Patenting Characteristics 3. Variation in Market Structure Characteristics C. Industry Characteristics as Proxy Signals for Social Preferences D. Identifying Optimal Innovation Characteristics E. Innovation Industries with Optimal Signals F. Refining Proxy Signal Analysis 1. Dynamic Proxy Signals 2. Subindustry Diversity 3. Effects of Uniform Patent Law 4. Measuring Industry Preferences 5. Selecting Innovation Characteristics 6. Extraterritorial Innovation 7. Real World Limitations CONCLUSION Introduction

Vociferous patent reform debates have sprawled across the judiciary, Congress, and the Executive Branch for the past dozen years. The most recent iterations of the disputes center on the newly enacted America Invents Act (1) and recent Supreme Court decisions in Mayo v. Prometheus, (2) Microsoft v. i4i, (3) and Bilski v. Kappos. (4) Ironically, adversaries on all sides of these patent debates agree on their normative objective: to design a patent system that will optimize the incentives to innovate for society. (5) The parties disagree, however, on what form of patent law will achieve this treasured goal. Will ratcheting up patent protection generate greater incentives to drive technological advance, or create barriers to access that stifle future innovation? Will weakening patent protection make complex innovation no longer worth the effort, or produce a more open, synergistic, and generative innovation environment?

Trying to parse the relationship between patent law and innovation presents an extremely challenging question. Innovation is a complex social phenomenon involving significant uncertainty, varied creative and motivational influences, and convoluted spillover and feedback dynamics, all of which are difficult to measure or predict. Layered on top of the social phenomena of innovation is the complex legal system of patent law, muddying the analysis even further. It is not surprising that the myriad efforts undertaken to understand the effects of the patent system have produced a mass of information, but limited awareness concerning whether any given legal change actually promotes or retards innovation. (6)

This Article introduces a novel empirical methodology designed to identify which patent laws will best promote incentives to innovate for society, and where patent law currently stands in relation to providing optimal incentives to innovate. This method is based on confronting complex social welfare issues from a new direction. Instead of trying to evaluate the relationship between patent law and innovation directly, this methodology develops an original public choice approach that captures private market and industry innovation information to indicate how patent incentives can be optimized.

The most fundamental question in patent law, on which both proponents and opponents of patent reform agree, concerns how to identify the level of patent protection that will optimize the incentives to innovate for society. (7) Too little protection reduces incentives to invest resources and to innovate in the first instance. But, too much propertization creates its own barriers to innovation, stifling the further development and dissemination of innovation products. Patent law seeks the level of protection that balances the trade-off between the benefit of incentives and the cost of limiting access so as to produce the greatest net incentives to innovate for society. (8)

Conventional patent analysis involves attempting to measure and balance the well-recognized trade-off between incentives and exclusivity directly. (9) Decades of effort appear to establish that we cannot accomplish this task. Rather than attempting to identify laws that produce optimal trade-offs directly, the framework introduced here develops a method that instead relies on indirect signals to indicate where current law stands in relation to the optimum. This method uses empirical information about the characteristics of innovation in different industries to identify particular private entities that both (1) face trade-offs equivalent to those that society faces as a whole, and (2) possess far superior information concerning how best to balance such trade-offs. Where private entities satisfy both criteria, their private preferences will happen to align with social objectives. In these select situations, private preferences can be leveraged as proxies to obtain previously unrecognized, socially beneficial information about how to best design the law.

This proxy signal approach involves four general steps: first, identifying structural industry characteristics that affect a private industry's preferences with respect to patent law; second, evaluating which industry characteristics will tend to cause an industry to face the same incentive and exclusivity trade-offs as society; third, selecting industries with trade-offs that mirror the socially desired balance (i.e., industries that are proxies for social incentive objectives); and fourth, evaluating the selected industries' legal preferences, such as by studying their legislative and judicial advocacy efforts, to obtain indirect proxy signals concerning socially beneficial law. These steps are described in more detail below.

Step One. It is now well recognized that different industries interact with the patent system in widely different manners. This variation arises due to differences in industry innovation characteristics. Some industries (e.g., pharmaceuticals) require costly research and development to innovate; others (e.g., software) do not. (10) Some industries (e.g., semiconductors) have many alternatives to patent protection to profit from their innovation; others (e.g., medical devices) do not. (11) Because industries vary in their innovation characteristics, they also vary in how they are affected by the incentives and exclusivity costs of patent law. (12) This variation, in fact, is exactly why the country's most powerful technology industries have been locked in a decade-long battle over patent reform. (13)

Step Two. Innovation routinely produces both positive external spillovers and negative external limitations on access. Due to these innovation externalities, most industries do not face socially optimal incentives to innovate, but instead are incentivized to desire stronger or weaker patent protection than is socially optimal. (14) The industry innovation characteristics identified in Step one can be evaluated to determine which industries have characteristics that tend to produce relatively fewer innovation externalities. These industries will face incentive versus exclusivity trade-offs that are more similar to society as a whole. Whether an industry is a net producer or net consumer of innovation provides an illustration. Society as a whole desires patent law that balances the production and consumption interests in innovation: we cannot consume innovation that we do not produce, and we do not want to pay more to use innovation than the minimum amount necessary for its production. (15) Private industries, however, do not necessarily balance producer and consumer interests. Some industries need relatively few patented inputs in order to produce and commercialize their own innovation. Such industries will face relatively low exclusivity costs from patent protection, but may receive particularly high benefits. Consequently, these industries would tend to favor stronger patent protection than is socially optimal. other industries are in the opposite position.

Step Three. Some industries may happen to face, due to their particular innovation characteristics, socially balanced trade-offs between the production and consumption of innovation. That is, these industries need about the same value of innovation as inputs (consumption) as the value of innovation that they develop as output (production). Such industries will tend to prefer, for purely self-interested reasons, intellectual property law that balances the production and consumption interests in innovation. Consequently, these industries will desire, to a first order approximation, similar patent protection to that which society desires for this balance. Though this example only covers a single innovation characteristic (the production versus consumption of innovation), it provides a flavor for the analysis. In practice, multiple characteristics affect the incentives and exclusivity costs of patent protection...