The Political Economy of Intellectual Property

Political economy is very relevant for a discussion of intellectual property, especially because so many people seem to regard intellectual property as the pinnacle of a modern market economy. In reality, intellectual property represents a dilemma that neither markets nor conventional economics can successfully resolve.

Economists teach that competition is what makes markets more efficient than planned economies. Competition sparks innovation and drives prices down toward marginal costs – the cost of producing one more unit of output.

The problem is that marginal costs are trivial in the case of intellectual property. If competition were allowed to take effect, producers could not stay in business. How much does the production of a new copy of Microsoft Windows cost? To prevent the price of intellectual property from falling to that level, the government grants Microsoft and other holders of intellectual property monopoly rights to stamp out competition.

Of course, monopoly is a violation of the sacred principles of free markets. For that reason, traditional laissez‑faire economists opposed intellectual property rights as a violation of market principles.

The contradictions continue. The cost structure of modern industry resembles that of the production of intellectual property. For that reason, the problem of market incompatibility extends to modern industry. For example, in the railroad business, the cost of carrying one more ton of freight is insignificant because that cost does not include previously sunk costs.

During the late 19th century, industry discovered first how to effectively harness the power of fossil fuel on a large scale, creating what might be called "The Real Industrial Revolution." These new methods depended upon heavy investments in expensive capital goods. Much as reproducing a pharmaceutical pill or a computer program costs very little, the cost of adding another ton of freight or producing another ton of steel costs very little relative to the underlying capital costs. For that reason, in the late 19th century, the prices of industrial products tumbled. For example, the Bessemer process reduced the price of steel rails by 88% from the early 1870s to the late 1880s; electrolytic refining reduced aluminum by 96%; synthetic blue dye production costs fell by 95% from the 1870s to 1886 (Jensen 1993: 835). As this pricing problem spread, the economy experienced what was called "The Great Depression" until another episode acquired that label.

As waves of bankruptcies spread across the country, faith in markets quickly dissolved. Terrified business leaders took refuge from competition by consolidating industries into operations large enough to control prices. Of course, this behavior more or less eliminated the imagined workings of a market economy.

The absence of competition allowed for higher prices to redistribute wealth and income to the already‑well‑endowed. In addition, without the prodding of competition, business no longer felt pressure to develop more efficient methods of production. In effect, manufacturing was operating much like businesses today that profit from the ownership of intellectual property.

The political economy of intellectual property

According to two distinguished scholars of intellectual property, Fritz Machlup and Edith Penrose, "At the end of the 1860s the cause of patent protection seemed completely lost." But with the onset of the Depression, those principled free traders who opposed intellectual property rights as a violation of laissez-faire lost ground to the protectionists. In the words of Machlup and Penrose (1950: 5), "The idea of patent protection regained its public appeal when, after the crisis of 1873, protectionists won out over free traders." In the midst of this horrific market failure, arguments that intellectual property represented a violation of free‑market principles carried little weight.

Conveniently, intellectual property rights allowed major corporations to circumvent the recently enacted Sherman Antitrust Act of 1890. Before this legislation, corporations had routinely ignored the intellectual property of independent inventors. Intellectual property rights also helped to reinforce the powers of giant corporations, which could afford their own research laboratories and then take advantage of the protections afforded by intellectual property rights to create monopolies that got around the Sherman Act.

For example, the faltering of the US economy at the end of the 1960s set off a panic in many corners of the economy. To make matters worse, the longstanding surplus in the US balance of trade turned negative. US corporations were rapidly losing ground to foreign competitors as manufactured goods poured into the United States. Government leaders agonized about finding ways to increase exports. This conflict between expediency and the principles of political economy came to the fore again. Strengthening intellectual property rights seemed to be a logical strategy for promoting exports from the United States while transferring money from consumers to business.

In conclusion, rather than symbolizing the pinnacle of market success, intellectual property rights are an expression of the failure of the market. Patents and other intellectual property rights come to the fore when markets threaten to self‑destruct.

The most powerful multinational corporations in the United States took advantage of this climate and energetically lobbied for stronger intellectual property rights (Granstrand 2000: 39, 53; Ryan 1998). A valuable journalistic study of the subject described the change in the perception of intellectual property:

[A]s a flood of imports washed away millions of domestic manufacturing jobs, attitudes toward patents and their role in the economic equation began to change. The interests of industry and labor coalesced in the search for viable weapons in the fight against foreign competition. The election of Ronald Reagan further shifted the mood toward protection of intellectual property. The major philosophical argument against patent protection – that it was inherently monopolistic – was no longer politically or, even more to the point, economically correct in an era of increasing trade competition. The policy of using antitrust laws against companies that refused to license their patent technologies was reversed by the Justice Department. (Warshofsky 1994: 8; see also R. Hunt 1999: 19)

The US government's first reaction to growing exports was to coerce individual countries to restrain their exports. In the words of Paul David, an economic historian who specializes in matters concerning science and technology:

[D]uring the 1980s, the U.S. government responded to the concerns of American producers – especially chemical, pharmaceutical, electronic and information technology industries – by trying to reverse the trend of the preceding two decades. Acting with some encouragement from other industrially advanced countries, the United States pursued a direct, unilateral course of action. It did not make any major effort to negotiate agreements within the framework of the Paris Convention for the Protection of Industrial Property (patents and trademarks); the Berne Convention for the Protection of Literary and Artistic Works (copyrights) or other international conventions, nor did it offer some quid pro quo to other developing nations that would agree to such conventions. Instead, by threatening within the context of bilateral trade negotiations to impose sanctions on developing and newly industrialized nations whose retaliatory leverage was quite limited, the United States achieved considerable leverage in convincing foreign governments to acquiesce to its position on the treatment of various forms of intellectual property. (David 1993: 20)

Then, the government reversed course, but not without prodding. In the words of Edmund J. Pratt, Chairman Emeritus of Pfizer, published on the company website:

In 1983, Pfizer joined with other corporations such as Merck, Johnson & Johnson, Bristol‑Myers, IBM, Hewlett Packard, General Motors, General Electric, Rockwell International, Du Pont, Monsanto, and Warner Communications to form the Intellectual Property Committee to advocate intellectual property protection. The committee helped convince U.S. officials that we should take a tough stance on intellectual property issues, and that led to trade‑related intellectual property rights being included on the GATT agenda when negotiations began in Punta del Este, Uruguay, in 1986.

Six months earlier, before the negotiations for the Uruguay Round of the General Agreement on Tariffs and Trade, the chief executive officers of 12 major corporations belonging to the committee met again. The result was profound: "The IPC [Intellectual Property Committee], in conjunction with its counterparts in Europe and Japan, crafted a proposal based on existing industrialized country laws and presented its proposals to the GATT Secretariat. By 1994, the IPC had achieved its goal in the Trade Related Aspects of Intellectual Property (TRIPs) accord of the Uruguay trade round.... In effect, twelve corporations made public law for the world" (Sell 1999: 169, 172).

Domestic law also changed to enhance intellectual property rights. The history of the semiconductor industry exemplifies this trend toward changing the legal structure to help firms gain a competitive advantage from intellectual property rights rather than from developing an edge in productive capabilities.

As late as 1981, Roger S. Borovoy, vice‑president and chief counsel for Intel Corporation, complained about the need to strengthen the hold of intellectual property rights because "In the electronics industry, patents are of no value whatsoever in spurring research and development" (Anon. 1981). A recent study published by the Philadelphia branch of the Federal Reserve System describes the dramatic transition that came soon after Mr. Borovoy's evaluation of the importance of the patent system to his industry:

Within the US semiconductor industry, reverse‑engineering was a well‑established practice. But by the late 1970s, American firms objected to similar behavior by Japanese firms when they began to increase their market share in the more standardized products, such as computer memory chips. The level of competition eventually became so intense that, by the mid‑1980s, most American companies abandoned these segments entirely.

When it became clear they could no longer dominate Japanese firms on the basis of production technology alone, American firms attempted to consolidate their comparative advantage in research and development. To do this, they would have to find ways of reducing their competitors' ability to reverse‑engineer their products. To that end, American companies began to lobby Congress to increase intellectual property protection for their semiconductor designs. In 1984, Congress created a new form of intellectual property right, called mask rights, especially tailored to address the needs articulated by the industry. (Hunt 1999: 19‑20)

During this period, Texas Instruments and National Semiconductor were both tottering on the verge of bankruptcy. Irving Rappaport, former vice‑president and associate general counsel for intellectual property at National Semiconductor recalled:

I'm not exaggerating when I tell you that National Semiconductor was only weeks away from bankruptcy in late 1990.... All the papers had been signed before it was decided to continue the business and give licensing a more aggressive push. And without a doubt, patent fees bought us valuable time in which to complete our restructuring process. For a while there, in fact, three‑quarters of our revenues came from patent licenses. (Rivette & Kline 2000: 125‑26)

Texas Instruments struck first. Typically license fees ran about 1 percent of revenues. In 1987, Texas Instruments raised its royalties on chips to 5 percent (Dwyer et al 1989: 79). The company filed a suit against one Korean and eight Japanese semiconductor companies, accusing them of infringing on semiconductor patents. The settlements yielded the company more than $600 million in payments, according to a 1990 report. The company became so aggressive in seeking royalties that by 1992 it earned $391 million in royalties, compared to an operating income of only $274 million (Warshofsky 1994: 111).

In effect, these companies were beginning to transform the semiconductor industry from a manufacturing industry to a service industry, just as the postindustrial utopians would have them do it. According to one industry insider, James Koford of LSI Logic, "Silicon Valley and Route 128 are worlds of intellectual property, not capital equipment and production. Most of the employees of U.S. high technology live in southeast Asia" (cited in Kenney & Florida 1990: 237). Some, like George Gilder, applaud this arrangement, arguing that these companies will rationally maximize their profits by specializing in the design of computer chips (Gilder 1989). But this new legal framework allowed some of the most important high‑tech enterprises to become a perverse kind of service sector. Rather than directly providing services, they merely demanded payment for their intellectual property.

Not only did the administrative arm of government become more sympathetic to the rights of intellectual property; the judicial system, with vigorous support from the legislative side, also moved to embrace intellectual property rights more warmly. In 1982, the Federal Courts Improvement Act established the Court of Appeals for the Federal Circuit as a central patent appeals court to streamline the litigation process and create a judicial body for appellate review of the patent infringement decisions of the lower courts (Warshofsky 1994: 9).

This court has been very sympathetic to the claims of patent holders. Previously, the percentage of court decisions that upheld patents had been increasing from roughly 60 percent in the 1950s to more than 70 percent in the 1970s, suggesting a possible weakening of standards (Scherer 1980: 155, 449). The new court now upholds patents 80 percent of the time (Warshofsky 1994: 9).

Prior to 1986, federal courts frequently decided the validity of a patent based on a preponderance of the evidence standard, that is, which side presented more convincing evidence. In 1986, the Federal Circuit ruled that a patent should be presumed to be valid until proven otherwise by clear and convincing evidence, a more difficult standard, based on several legal precedents (Hunt 2001, referring Medtronics Inc., Intermedics Inc., and Hybritech Inc. v. Monoclonal Antibodies Inc.

This trend toward upholding a larger share of patents comes at a time when the scope of patents has broadened at an unprecedented rate. For example, in recent years, the patent system has begun granting claims for computer software, life forms, and even business practices. When moving into such previously uncharted terrain, a growing number of questionable proposals would be expected to come up for consideration. Nonetheless, the proportion of patents approved has continued to increase.

Each year, the US government moves to strengthen intellectual property rights still further. Patents now last 20 years instead of 17, despite the fact that high technology typically becomes obsolete in less time than ever before. In addition, a new law recently has transformed many types of copyright infringement into criminal offenses.

At the time of this writing, furthering the powers of domestic holders of intellectual property in the international marketplace is one of the highest priorities of US economic policy, if not the highest. The creation of the World Trade Organization (WTO) in 1995 symbolized this expanding role of intellectual property. The forerunner of the WTO, the General Agreement on Tariffs and Trade, had the mission of liberalizing trade in goods. The WTO, in contrast, vigorously enforces trade in intellectual property.

The costs of intellectual property

Intellectual property was intended to rescue capitalist interests. It did so to the extent that intellectual property managed to transfer considerable amounts of money from the public to a narrow swath of the corporate sector. Nonetheless, the unintended consequences of intellectual property seem to have proved counterproductive.

To begin with, control of intellectual property rights put a premium on antisocial behavior. Most absurdly, patent trolls buy up bankrupt companies for their patents, which they then use to sue other companies for violations of intellectual property rights. For the most part, paying off these patent trolls is cheaper than going through a multimillion-dollar lawsuit. The resources wasted in this way are a deadweight loss to the economy.

The problem was made worse by largely defunding the US Patent Office, making it dependent on the fees it charges. This policy had a twofold negative effect. First of all, patent examiners' wages are very low relative to those of a private patent attorney. Second, because of the need for fees, examiners were expected to pump out patents too quickly be able to effectively evaluate them. The result is to create a web of confusion due to overlapping patent claims, leading to wasteful legal processes.

This arrangement means that developers of intellectual property must go to great pains in order to figure out how they can navigate the complex patent thicket without being liable for violating somebody else's virtual property. Another defensive measure is to attempt to patent everything but the kitchen sink. Whoever might be tempted to sue for violations of intellectual property would then have to face a countersuit. In doing so, the patent thicket is made even thicker.

Secrecy is a major form of defending intellectual property because others would like to claim the same work as their own intellectual property. Of course, science and technology depend upon the cross fertilization of information. In fact, one of the major justifications for the patent system was to make inventors reveal their work in return for what was a relatively short period of monopoly.

That the system turned out to create incentives for secrecy is further evidence of the dysfunctionality of the whole system of intellectual property. As if the damage from secrecy were not enough, a simultaneous defunding of higher education took a serious toll. As a substitute for public funds, research universities increasingly turned to seeking profits from the production of intellectual property, often under contract with major corporations. This arrangement distorted a good deal of higher education. First of all, the bulk of new developments in science and technology come from university or government research, both of which have been defunded (except that related to military needs). Universities have shifted away from the development of basic science, the economic payoffs of which are uncertain. However, a good number of breakthroughs in basic science have had revolutionary benefits for society.

The new emphasis on applied science at the expense of basic science – often done at the behest of large corporate interests – promises quick profits at the expense of the kind of research that drives breakthrough science and technology. To make matters worse, in this new effort to finance universities, excessive resources are channeled to those parts of the university most likely to generate valuable intellectual property. In addition, in order to increase the probability of intellectual property bonanzas, secrecy becomes a priority, damaging the future prospects of science and technology.

Intellectual property creates another serious form of waste. Although intellectual property is intended to block others from using a particular kind of knowledge or technology, competitors devote considerable time and energy trying to reverse engineer technology by working around pre‑existing claims – in effect, reinventing wheels.

Reverse engineering, in turn, creates another form of waste; namely that corporations take competitors to court for their efforts to reverse engineer. Such court cases can routinely cost tens of millions of dollars. These costs do not include the public expenses for paying for judges and other personnel, over and above the constructing and maintenance of the physical infrastructure used for conducting the trials. One might also count the time jurors waste, hearing these trials that can last for months. Finally, highly paid lawyers and other experts spend considerable time and expense in bringing themselves up to date in the intricacies of technology and the state of intellectual property law in order to participate in the highly lucrative business of overseeing the bickering of greedy corporations. Probably even greater than all these costs is the value of the scientific and technical progress that might have occurred in the absence of intellectual property.

An international inversion

For most of the nineteenth century, the United States was notorious for its unwillingness to respect copyrights from other countries. As soon as an important publication appeared in England, representatives of American publishers rushed across the sea to pick up a copy to reprint without paying royalties.

Once the United States had matured to the point where it became more of a producer of intellectual property in the late nineteenth century, copyrights were also strengthened. Many developing countries behave similarly for the same reason as the United States did – because they were mostly consumers rather than producers of intellectual property.

While the new regime of intellectual property is corroding the US economy, other countries are seriously funding higher education in order to produce a more vibrant system for developing science and technology. As this new version takes hold, the United States, still the primary cheerleader for intellectual property, finds itself more as a customer than as a producer for new intellectual property.

Concluding remark

One of Karl Marx's most interesting insights was that efforts to overcome contradictions in capitalism tend to create new contradictions that can be even more troubling than the initial problem. Intellectual property is a case in point for two reasons. First, an analysis of intellectual property provides evidence of a serious defect in the supposed science of economics. While competition is presumed to be the driver of a market economy, intellectual property demonstrates how competition can also be the destroyer of a market economy.

Second, as a strategy for overcoming the immediate economic contradictions of competition, intellectual property creates new problems because it impairs both scientific progress and the competitive pressure required for the development and application of new science, technology, and design. In short, while competition is presumed to be the driver of a market economy, competitive pressures left to themselves will cause a market economy to self-destruct unless it has external supports – such as intellectual property rights – to limit competition.

References

David, Paul A. 1993. "Intellectual Property Institutions and the Panda's Thumb: Patents, Copyrights, and Trade Secrets in Economic Theory and History." Mitchel B. Wallerstein, Mary E. Mogee, and Robin A. Schoen, eds. Global Dimensions of Intellectual Property Rights in Science and Technology (Washington, D.C.: National Research Council): 19‑62. www.nap.edu/books/0309048338/html/19.html

Dwyer, Paula et al. 1989. "The Battle Raging Over 'Intellectual Property'." Business Week (22 May): 78‑89.

Gilder, George. 1989. Microcosm: The Quantum Revolution in Economics and Technology (New York: Simon & Schuster).

Granstrand, Ove. 2000. The Economics and Management of Intellectual Property: Towards Intellectual Capitalism (Northampton, MA: Edward Elgar).

Hunt, Robert M. 1999. "Patent Reform: A Mixed Blessing for the U.S. Economy?" Business Review of the Federal Reserve Bank of Philadelphia (November‑December): 15‑29.

___. 2001. "You Can Patent That? Are Patents on Computer Programs and Business Methods Good for the New Economy?" Business Review of the Federal Reserve Bank of Philadelphia (First Quarter): 5‑15.

Jensen, Michael C. 1993. "The Modern Industrial Revolution: Exit and the Failure of Internal Control Systems." Journal of Finance, 48: 3 (July): 831‑80.

Kenney, Martin and Richard Florida. 1993. Beyond Mass Production: The Japanese System and Its Transfer to the U.S. (New York: Oxford University Press).

Machlup, Fritz and Edith Penrose. 1950. "The Patent Controversy in the Nineteenth Century." Journal of Economic History, Vol. 10, No. 1 (May): 1‑29.

Rivette, Kevin G. and David Kline. 2000. Rembrandts in the Attic: Unlocking the Hidden Value of Patents (Boston: Harvard Business School Press).

Ryan, Michael P. 1998. Knowledge Diplomacy: Global Competition and the Politics of Intellectual Property (Washington, D.C.: Brookings Institution Press).

Scherer, Frederick M. 1980. Industrial Market Structure and Economic Performance, 2nd. ed. (Chicago: Rand McNally).

Sell, Susan K. 1999. "Multinational Corporations as Agents of Change: The Globalization of Intellectual Property Rights." in Private Authority and International Affairs, eds. A. Claire Cutler, Virginia Haufler, and Tony Porter (Albany: State University of New York Press): 169‑98.

Warshofsky, Fred. 1994. The Patent Wars: The Battle to Own the World's Technology (New York: Wiley).