INTRODUCTION TO THE LAW AND ECONOMICS OF INTELLECTUAL PROPERTY LAW

1. The role of economics in IP Law 17 years ago, a distinguished lawyereconomist wrote the following statement [George Priest (1986)]. The inability of economists to resolve the question of whether activity stimulated by patent or other forms of protection of intellectual property enhances or diminishes social welfare implies, unfortunately, that economists can tell lawyers ultimately very little about how to enforce or interpret the law of intellectual property. As a consequence, I regret, the influence of the economist on the law of intellectual property will always be limited. The lawyer must look to other sources for guidance. Economic analysis is not the only valuable source of inspiration for lawyers in IP. It is not able to explain all IP Law. There is no underlying or overarching economic logic in IP Law.

 A whole range of structural and institutional factors, historical influences, public perceptions, and interest groups have contributed to make IP Law what it is today, in Europe and the US and elsewhere. But economics is best suited to evaluate the effects upon welfare of existing rules and policies in IP Law, and this places it in the best position to understand the present and shape the future of IP Law.

2. The Economic Problem(s) Underlying IP In legal terms, IP covers three basic distinct sets of rights: copyright, patents and trademarks. The economic rationale for having copyright and patent on the one side, and trademarks on the other, turns out to be very different. Copyright and patent are rights protecting interests in a commodity with some particular features: information or intellectual goods. And this particular type of commodity shows two important features (public-good characteristics). - Non-rivalry: the use I make from a piece of information or intellectual good (be it a novel, a computer program or an invention of a new product) does not decrease the possibility of use by others. Consumption of the information is non-rival

- Non-excludability: Without the intervention of the legal system, the producer of an intellectual good cannot prevent non-payers from consuming the good. Given that any buyer can redistribute the good at a price close to zero, the original producer of the good would not be able to recover the investments for the production of the information in the first place High fixed costs and very low variable costs of serving consumers of information. The combination of these 2 features leads to a significant incentive problem for the production of this type of commodity Severe problem of underproduction of informational goods Granting IP Rights: legal rights that allow the right holder to exclude competition from other sources of producing the informational good. This allows the right holder, in most cases, to charge a positive price for the good (above marginal cost, which may be considered as being close to zero), is one possible way to alleviate the incentive problem in the production of intellectual goods.

 Trademarks: The economic problem is basically different. The names, images or symbols protected by trademark do not constitute as such valuable informational goods, but derive their value from their use as communication devices with consumers. More specifically, through trademarks consumers associate the trademarked good with a certain brand or producer and therefore consumers search costs are reduced. This association in the mind of consumers gives producers of trademarked goods an incentive to keep consistent quality over time, or else the positive association value will be lost (and with it, the heavy advertising investments necessary to make the trademark familiar to consumers).

3. Social vs. Private Incentives to Produce Informational Goods Exclusive IP rights do not necessarily solve the problem of insufficient incentives to produce informational goods. Economic theory shows this with a simple model on the discrepancy between social and private incentives to invest in new information We call this discrepancy the replacement effect: pure incentive to innovate regardless of strategic considerations of preemptive innovation, potential entry deterrence and so forth. It is not the whole picture, because those factors left aside do play a big role in many real world scenarios (for instance, rentseeking, and a possible race to be the first to invent patent race models in session 8) The model was created by Arrow (1962). But I will try to present a graphical interpretation: A competitive prospective inventor: decision to invest in R&D in order to get a cost-reducing invention in a competitive environment but once she gets the invention, competition by others is not an issue a perfect and infinite patent ensues.

Monopolist deciding to invest in R&D to get the invention and thus the perfect and infinite patent. The model analyzes incentives for each of them and compares them with the socially optimal. Two kinds of invention. a/ Minor or non drastic (Figure 1). Pm2 Pc or Q after invention Qc b/ Major or drastic (Figure 2). Pm2 < Pc or Q after invention > Qc a/ Figure 1.
D Pm1 Pm2 Pc PC
F

D / D MR
Qm1 Qm2 Qc

In the competitive inventor case, once she has the patent, she is able to monopolise the entire industry (or calculate optimal royalty, as Arrow does) kinked demand curve and kinked marginal revenue curve. Profit (and incentive) will be (P - C) Q. But this incentive is less than the social incentive, which is the area (P E F PC), which is greater than (Pc- C) Qc. This means that even for a competitive firm expecting to receive a legal monopoly on the invention in the form of a patent, the incentive to invent is less than the optimal incentive from the point of view of social welfare. For the monopolist, optimal quantity and price change to Qm2 and Pm2. The incentive to innovate for the monopolist is the increase in profit with respect to the pre-invention situation: She obtained before the area under marginal revenue curve minus the area under marginal cost curve. If we deduct this pre-invention profit from profit post invention, the resulting incentive is less than the one for a competitive firm, that is, it is less than (Pc - C) Qc, and, a fortiori, less than the social incentive.

b/ Figure 2.

D Pm1 P P3 H F PC D E

Qm1

Q3

QC

The incentive for the competitive firm is now (P3 PC)Q3, because given the magnitude of the costreducing invention, the patent holder is not constrained by the competitors. This incentive is again lower than the optimal social incentive, which is (P E F PC). The incentive for the monopolist is again the difference between (P3 - PC)Q3 and the area (D H P), which is lower than the incentive for the competitive firm and still lower than the optimal social incentive.

4.

Intellectual Property Rights vs. Rewards

Economists have tried to compare two (but there are others) alternative organized systems to encourage innovation and production of new intellectual goods: Intellectual Property Rights legal monopoly or exclusive right to use the informational good. This system has 2 basic economic effects: - Incentives generated by future monopoly profit are lower than the pure social incentive (Arrow, 1962) - Static deadweight loss due to monopoly pricing (price>marginal cost) Public Rewards the Government will pay the creator a prize or reward, and then the informational good would be free, and available through competitive production. 2 claimed effects of this system: - Deadweight loss due to price>marginal cost disappears by definition.

- Incentive to create will be insufficient, exact or excessive depending on the relationship between the reward and the pure social incentive. Comparative efficiency between the two Under the reward system there is no deadweight loss because the intellectual good is supplied competitively. The importance of this advantage of the reward system depends on the magnitude of that loss. Under the IPR system the incentive to innovate depends on the monopoly profit after the good is in the market K (m (t)). Under the reward system, the incentive to innovate is a constant k (R), and depends of the size of the reward. Even if we assume that the Government knows the expected social benefit from the innovation, and equates the reward to it [R=E(s*)], this doesnt mean that the incentive will be optimal. It depends on whether it turns out that s*(t) > E (s*).
<

The closest are s*(t) and E(s*), the more attractive is the reward system.

On the contrary, if they are far apart, patent might approximate the first-best incentive better than the reward (even to an extent that it overcomes the deadweight loss advantage of the reward system).

Optional reward system The alternative system is a combination of the two: the inventor chooses whether to accept the reward or to get an IPR. The optimal reward system is strictly superior to the IPR system: given that the Government determines R, it can, at worst, fix it at a level in which no creator chooses the reward, and this is equivalent to the pure patent system. So fixing an R slightly over the minimum social benefit of the innovation, and the creator, if this turns out to be the case, chooses the reward, which increases (slightly) the incentives and, moreover, eliminates the deadweight loss.

 Informational requirements for the reward system In the model, the Government needs to know the density of the possible demand curves and the production cost. It is very unlikely that ex ante the Government will have this information at its disposal. But the Government may be able to observe sales ex post, and condition the reward on the demand curve being that one in which the quantity sold at the competitive price was the observed quantity. Moreover, this fact implies that the relevant comparison to calculate the relative informational advantages of the Government and the firm, is between the ex ante information of the firm and the ex post information of the Government.

 Drawbacks of the reward system 1.- Assumption that the Government seeks to maximise social welfare, but

- Myopia - Short-term incentives - Hold-up 2.- Adverse selection in the optional reward system. 3.- Global effects of innovation vs. national base of tax money need for an international mechanism taking into account global welfare and raising funds to pay the rewards incentives to free ride (typical collective action problem). 4.- Rent-seeking for subsequent innovations 5.- Administrative costs derivative works and

5. Intellectual Property Rights and Property Rights in tangible objects

Some Law and Economics scholars (Easterbrook, Kitch, Landes and Posner, Dam) have tried to challenge the idea that IP rights incorporate a plus of exclusion over ordinary property rights Claims: o IP rights do not involve market power or monopoly position for the right holder o IP rights are just property rights, with a different subject matter: an informational good capable of many, even infinite, physical embodiments or modes of delivery to consumers Counterarguments: o It is true that many IP rights do not confer significant market power or not at all, because there are close substitutes to the intellectual good protected by the IP right

o But some IP rights do in fact confer market power empirical tests of market power show that some patentees and copyright holders enjoy monopoly power. Empirically, some IP rights do confer market power, others do not o Theoretically, it is useful to model IP rights as involving decreasing demand, and it is justified because price of each use of informational good typically exceeds marginal cost (which often is virtually zero) o Costs of property rights are different in the world of tangible goods and the world of informational goods: Costs of defining property rights are higher for IP rights no physical boundaries Costs of transacting over rights are higher for IP tracing owner, number of higher, number of transactions is higher property costs of users is potential

 Costs of diversified property rights on the same asset: balance of costs and benefits changes number of potential rights, given multiplicity of nonconflicting uses increases, which allows flexibility, but adds complexity, potential bilateral monopolies and higher transaction costs Costs of rent-seeking to obtain property rights: overall, typically higher for IP Costs of protecting and enforcing property rights: higher for IP costs of defining and detecting infringement, deadweight losses due to pricing above marginal cost