IP Protection Incentivizes Innovation and Creates Jobs: A Message Worth Repeating

I recently received an inquiry from an IPWatchDog reader, posing several questions about the links between intellectual property protections, innovation and job creation. (Thank you, Marcus!) The interrelated nature of IP, innovation and jobs is essential to economic prosperity and important enough to explore again.

Marcus:   I’m curious about two positions that are taken in your writing. First, you state that without sufficient IP protections, innovation would not happen. Can you give further proof that this is the case?

Given that it is very difficult to prove why something does not happen, this issue is most easily approached by examining where innovation happens and the corresponding strength of their intellectual property protection environments. I propose that the importance of sufficient intellectual property rights to innovation is substantiated by the following:

  • The economic fundamentals of production characterized by high fixed costs and low marginal costs,
  • An examination of where innovation happens, in nations with strong IP environments,
  • A consideration of the value of IP ownership to securing venture capital investments, and
  • For industry specifics, evidence from the pharmaceutical industry, derived from the development and launch of new therapies and cures.

 

The Economic Fundamentals

Intellectual property rights – patents in particular – are perhaps most critical in industries characterized by high fixed costs of development and low marginal costs of production. The pharmaceutical industry well exemplifies this situation. The cost of researching and developing a new pharmaceutical therapy (fixed cost) is extraordinarily high.[1] Current estimates, though admittedly controversial, place this calculation at more than $2 billion. At the same time, after the costs of development have been born by the innovative firm, the marginal cost of production, the cost of producing one additional dose/pill/tablet, are relatively modest. Moreover, the final product is easily replicated.

As a result, no firm has an incentive to spend the billions of dollars needed for development without an assurance that they will be able to capture the returns to their investment. Rather, every firm has the incentive to let another firm bear that cost, while they wait to merely copy the drug that has been developed. Without patent protection, and other forms of intellectual property rights (e.g.: data exclusivity), to protect an innovator’s investment, pharmaceutical drug development will not take place.

Industries characterized by high fixed costs of development and low marginal costs of production suffer from a market failure that is corrected by intellectual property protection. Without patent rights and other forms of IP protection, firms in these industries have no incentive to invest and innovation evaporates.

 

Where Innovation Happens

The correlation between strong intellectual property rights and innovation is also established through an examination of where innovation happens. Quite simply, innovation happens where intellectual property rights are protected. Evidence of this nature may be found in a host of sources. First, consider Figure 1, from Lewis (2007).[2] Drawing on data from Porter, Michael E., Klaus Schwab, and Augusto Lopez-Claros (2005)[3], Figure 1 depicts the relationship between the extent of intellectual property protection and international competitiveness.

Figure 1: IP Protection and International Competitiveness

Source:  Lewis (2007).  Data from Michael E. Porter, Klaus Schwab, and Augusto Lopez-Claros, The Global Competitiveness Report, 2005-2006: Policies Underpinning Rising Prosperity, London: Palgrave Macmillan, 2005.

Source: Lewis (2007). Data from Michael E. Porter, Klaus Schwab, and Augusto Lopez-Claros, The Global Competitiveness Report, 2005-2006: Policies Underpinning Rising Prosperity, London: Palgrave Macmillan, 2005.

 

A similar story is told by more recent data from additional sources, reinforcing the evidence of this relationship. The Global Intellectual Property Center (GIPC) recently began an annual evaluation of the strength of intellectual property protection by country. Evaluating IP protection across 30 indicators, the GIPC index evaluates the intellectual property environment of 30 nations. These countries comprise close to 80% of the global economy (GDP).   The GIPC’s ranking of overall IP scores is shown in Figure 2 below.

Figure 2: Overall IP Scores by Country

Source:  GIPC (2014). [4]

Source: GIPC (2014). [4]

The information in Figure 2 is most useful when placed in perspective with innovative activity. According to Bloomberg.com, the ten most innovative nations (in rank order) are: South Korea, Sweden, United States, Japan, Germany, Denmark, Switzerland, Finland, and Taiwan. Table 1 below combines the information from the GIPC on IP protection with information on innovation from Bloomberg.

Table 1: IP Protection and Innovation

Source:  GIPC and Bloomberg.com.

Source: GIPC and Bloomberg.com.

 

Table 1 reveals a clear correlation between the proliferation of innovation and the protection of intellectual property rights. The correlation between the two series is 0.86, establishing an undeniable relationship between IP protection and incentivizing innovation.

 

Venture Capital Investments

As described in an earlier post[5], intellectual property rights, especially patents, both safeguard a firm’s innovation and serve as a signal for potential venture capital (VC) financing. In a 2009 study, Haeussler, Harhoff & Muller[6] explore the ways in which patent applications and grants held by new firms impact their ability to attract VC financing. The study demonstrates that investors rely on patents as signals to overcome the tremendous uncertainty involved in assessing the prospects of potential portfolio companies. VC financing occurs earlier in the presence of patent applications. this study further establishes that for startup firms the patenting process generates valuable quality signals which assist them in obtaining funding, confirming the findings of earlier work by Hall and Ziedonis (2001). [7] These studies establish that patents reduce information asymmetries between financiers and innovators, thus spurring market entry by startups. Fundamentally, patents facilitate access to VC financing, market entry and job creation. It is through patents and an effective IP environment that the value of these firms is established and they are able to secure their funding.

 

Evidence from the Pharmaceutical Industry

Finally, consider the evidence provided by the pharmaceutical industry, both in the research and development of new therapies and cures, and in the launch of new drugs. Figure 3 depicts the number of medicines in development (clinical trials) by country. The numbers are revealing, if not shocking. The United States undeniably provides the most comprehensive intellectual property rights (product and process) for pharmaceuticals, as well as an environment free of price controls. The consequence is an unmatched level of innovation relative to other nations.

Figure 3: Medicines in Development by Country (2011)

Source: Source: Medicines in Development by Country, Adis R&D, 2011.

Source: Source: Medicines in Development by Country, Adis R&D, 2011.

 

While numerous factors influence whether a new drug is available in a particular market, it is important to recognize that the strength of a national intellectual property environment is a critical factor in determining a product’s launch speed in a particular country. Lanjouw (2005) first showed that stronger product and process IP protections correspond to faster launch times for new drugs.[8] Table 2, below, shows that this correlation continues to hold for available targeted cancer therapies.

Table 2: Correlation between Available Drugs and IP Protection

Table 2

Source: Data on the available targeted cancer therapies is taken from SCRIP Intelligence[9], and GIPC Score is taken from GIPC[10].

Lanjouw writes, “less than one-half of the new pharmaceutical molecules that are marketed worldwide are sold in any given country, and those that are sold are often available to consumers in one country only six or seven years after those in another. Both price regulation and intellectual property rights influence these outcomes.” [11] Clearly sufficient intellectual property rights protection drives the launch of new treatments and cures. Where IP rights are secure, innovation is embraced and available.

Marcus:   So far as I know, innovation happens for a number of reasons, only one of which is a consideration of whether intellectual property regimes might provide adequate opportunities for monetization. Other considerations for innovation may include necessity, and competition. For example, Facebook and Apple probably didn’t create new programming languages because they could patent or copyright them (which they likely could not have done anyway), but because it works for their respective systems and gives them some degree of increase in efficiency and/or competitiveness.

Yes, innovation does happen for many reasons, including necessity. Among the top reasons, we can also include “happy accidents”.  (Consider the origins of Viagra, found here.[12]) That said, to incentivize innovation, intellectual property rights are essential. If we are content to let things happen accidentally and by happenstance, we don’t need intellectual property rights, but most businesses and national economic advisers aren’t willing to leave profits and prosperity to chance. In today’s economy, innovation is expensive and requires hard-sought investment and deliberate planning. These investment of time, talent and financial resources only take place when incentivized by the potential returns that IP protection protections.

Marcus:   Second, you make the assertion that IP protection stimulates job growth. And in some cases, such as India, that may be the case. But when you consider the type of products being protected, many of them remove jobs from the playing field. For example, technologies that allow people to order goods from their home may lead to a loss of jobs while creating only a few jobs for Amazon. Do you think you can address these ideas in a future piece?

Yes, it is important to acknowledge the process of “creative destruction” as Schumpeter described it.

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. (Schumpeter, Joseph. “Capitalism, Socialism, and Democracy (1942), p.83.)

While some jobs are lost, innovation is responsible for the creation of entire new industries.   Although this continues to happen today, one of the best examples is the mechanization of U.S. agricultural production. Jobs were lost, but the industrial revolution created far more and expanded the set of available opportunities to absorb the workers who were displaced.  The share of Americans in directly employed in agriculture has shifted from 70-80 percent of the U.S. population in 1870 to less than two percent of the population in 2008. This phenomenon is depicted in Figure 4 below.

Figure 4: 1840 – 2010 Labor Force by Sector

Source: Johnson (2012).[12]

Source: Johnson (2012).[13]

Moreover, it is important to remember that job creation is both direct and indirect. The jobs created at Amazon.com are just the tip of the iceberg. Other jobs are generated at FedEx, and in the companies that are made more efficient by utilizing the services of Amazon.com. Two of my earlier contributions to IPWatchDog describe the importance of these jobs – those both directly and indirectly created by intellectual-property-dependent –industries – to economy prosperity: IP Protection is Key to U.S. Job Creation[14] and What if we don’t have sufficient intellectual property rights? [15].   Including both direct and indirect job creation, the number of IP-related jobs are tremendous. Figure 5, below, maps the distribution of IP jobs by state, across the United States.

Figure 5: Map of IP Jobs by State

Source: Global Intellectual Property Center (2012).[15]

Source: Global Intellectual Property Center (2012).[15]

I am grateful to Marcus for asking these questions and for giving me the opportunity to address the issues of intellectual property, innovation and job creation in greater depth. The importance of IP to economic prosperity is undeniable and I appreciate the chance to revisit this issue and further clarify the finer points of this interconnectedness.

 

______________________________

[1] The R&D costs are considered a fixed cost. In economic terms, this is a cost that a firm is unable to recover and one that this independent of the quantity produced. That is, the $2 billion required to develop a new therapy does not change, regardless of the number of doses produced (1 or 1,000 or 1,000,000). In contrast, he cost of producing one additional dose is the marginal cost of production, a cost that we would expect to be relatively low once the development process is complete.

[2] Lewis, James C. “Intellectual Property and Innovation Policy: Executive Summary,” Center for Strategic and International Studies, December 2007.

[3] Porter, Michael E., Klaus Schwab, and Augusto Lopez-Claros, The Global Competitiveness Report, 2005-2006: Policies Underpinning Rising Prosperity, London: Palgrave Macmillan, 2005.

[4] Lybecker, Kristina M. “What if we don’t have sufficient intellectual property rights?”, IPWatchDog, 3 April 2015.

[5] Haeussler, Carolin, Dietmar Harhoff, and Elisabeth Muller. “To Be Financed or Not.. – The Role of Patents for Venture Capital Financing,” GESY discussion paper no.253, Governance and the Efficiency of Economic Systems, January 2009.

[6] Hall, B.H., and R.H. Ziedonis. “The Patent Paradox Revisited: An empirical Study of Patenting in the U.S. Semiconductor Industry, 1979-1995,” RAND Journal of Economics, 2001, 32, pp.101-128.

[7] Lanjouw, Jean O. “Patents, Price Controls and Access to New Drugs: How Policy Affects Global Market Entry,” NBER working paper series, Working Paper 11321, May 2005.

[8] Young, Donna. “Cancer drug spending reaches $100bn; access varies widely,” SCRIP Intelligence, 5 May 2015.

[9] Global Intellectual Property Center (GIPC). “Unlimited Potential,” Third Edition, 4 February 2015.

[10] Lanjouw, Jean O. “Patents, Price Controls and Access to New Drugs: How Policy Affects Global Market Entry,” NBER working paper series, Working Paper 11321, May 2005.

[11] Wilson, Jacque. “Viagra: The Little Blue Pill that Could,” CNN.com, online edition, 27 March 2013.

[12] Johnson, Louis D. “History Lessons: Understanding the Decline in Manufacturing,” MinnPost, online post, 22 February 2012.

[13] Lybecker, Kristina M. “IP Protection is Key to U.S. Job Creation,” IPWatchDog, online posting, 23 March 2015.

[14] Lybecker, Kristina M. “What if we don’t have sufficient intellectual property rights?” IPWatchDog, online posting, 3 April 2015.

[15] Global Intellectual Property Center, “IP Jobs Map”, May 2012.

The Author

Dr. Kristina Lybecker

Dr. Kristina Lybecker is an Associate Professor of Economics at Colorado College in Colorado Springs. She earned a B.A. from Macalester College, with a double major in Economics and Latin American Studies, and received her Ph.D. in Economics in 2000 from the University of California, Berkeley.

Dr. Lybecker's research analyzes the challenges surrounding intellectual property rights protection in innovative industries: incentivizing pharmaceutical research and development especially on neglected diseases, addressing the difficulties of strengthening intellectual property rights protection in developing countries, battling the problems related to pharmaceutical counterfeiting and the unique nature of protection for biotech therapies. Recent publications have also addressed alternatives to the existing patent system, the balance between pharmaceutical patent protection and access to essential medicines, and the markets for jointly produced goods such as blood and blood products. Kristina has testified in more than a dozen states on the economics of pharmaceutical counterfeiting. She has also worked with US Food and Drug Administration, Reconnaissance International, PhRMA, the National Peace Foundation, the OECD, the Fraser Institute, the Macdonald Laurier Institute, and the World Bank, on issues of innovation, international trade, and corruption.

CLICK HERE to contact Dr. Lybecker.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 19 Comments comments.

  1. Benny June 9, 2015 5:53 am

    Marcus does raise a couple of points which I am not sure you completly answered:
    1. Companies (such as ours) invest in innovation with no guarantee of exclusive rights – Products are often placed on the market before any relevant patents are granted, and in many cases the patent applications are denied or narrowed such that they are no longer effective. The innovation is already in place, though.

    2. IP rights do more to re-distribute jobs than to create them outright – If our company increases market share with exclusive rights to innovative products, it will likely be at the expense of our competitors. We will be hiring, but they will be firing.

    3. I sometimes get the impression that IP lawyers are losing sight of our goals.We invest in R&D in order to profit from selling products, not in order to obtain patents.

  2. Anon June 9, 2015 10:33 am

    Benny,

    As I have often pointed out, you are the one losing sight of the goals.

    A business is to make profit, yes. But that profit comes from multiple channels, only one of which is the actual sale of goods.

    You are trying too hard to have a too limited view of the world.

  3. Benny June 9, 2015 10:44 am

    Anon,
    I work for a company which generates millions of dollars annually from the manufacture and sale of goods. Our company has no other source of income. We file patent applications, yes, but we do not sell patents. We sell products.
    What other channels of profit were you referring to, and would you like to speak to our CFO about them?

  4. Anon June 10, 2015 9:19 am

    Good morning Benny,

    As I have previously explained to you the multiple channels of worth that can come from obtaining patents on more than just your product going out the door, I will decline your offer to repeat myself.

    As to speaking to your CFO, thanks but no thanks as well. I am sure that any able patent counsel would be capable of helping your CFO understand that which you seem insistent on not understanding. Your product-only, engineering-only mindset is a detriment, not a benefit, a bug, not a feature. Offering up the seeming defense of generating millions of dollars is a facade, when you quite possibly could be leaving millions of dollars on the table because of your singular “product-only” mindset.

    And please, let me remind you – I have been in yours shoes (and in similar shoes as your CFO). If you insist on your myopia, well that is one thing. But if you insist on that myopia, and wish to join a conversation on patent law, thinking that your myopia is a “good thing,” well, you are simply and sadly mistaken.

  5. Benny June 10, 2015 9:56 am

    Anon,
    I don’t see how your comment adds information to the discussion. Yes, patents can force my competitors products off the shelves to make room for more of my products (all to often we find ourselves pushed rather than shoving), but we are still only profiting from the sale of goods.

  6. K. David Crockett June 10, 2015 3:17 pm

    The correlation between strong patent systems and innovation is strong, but correlation is not causation. Something is missing here. If a company can access both the US markets and Indian markets and the company can access both the USPTO and the IPO, it shouldn’t matter whether they are located in the the US or India. A drug researcher in India looking for a cure to cancer seems to have the same incentive as a drug researcher in the US. Something else must explain why more innovation takes place in the US, because access to patents and access to markets is the same regardless of location of potential innovators, or some unidentified factor limits equal access (that is, my premise that OUS companies have access to US markets and the USPTO could be wrong).

  7. Benny June 11, 2015 2:18 am

    Davy Crockett,
    “Innovation taking place in the US” is not in direct correlation with “patents filed in the USPTO”. Many companies outside the US – mine included – file patent applications primarily with the USPTO.
    – Because excluding a global player from the US market can render their entire business case unworkable (we would not launch a product aimed solely at the EU market)
    – Because a US patent will likely be granted within a shorter time than an EPO patent
    – Because , in too many cases, US examiners are not up to the job and might grant patents for applications which are not truly eligible. (This is an opnion expressed by our independent and highly experienced patent attorney)

  8. Anon June 11, 2015 9:25 am

    Benny @ 5,

    That you “don’t see” is exactly the point. That’s a “you” problem my friend.

  9. Benny June 11, 2015 10:03 am

    Anon,
    You have made a wise career choice in life. Your failure to clearly communicate information would have hindered your success had you chosen engineering instead, where mortals like myself are relagated to bullet points on power point slides and terse, laconic documents.
    If Gene is pondering whether to banish me for injecting personal remarks, I apologize in advance.

  10. Gene Quinn June 11, 2015 11:01 am

    K. David Crockett-

    You say: “correlation is not causation.”

    That is true, but it is the familiar retort in this argument by those without any evidence. The evidence that a strong patent system is required for innovation is overwhelming. Overwhelming evidence in the face of no evidence is telling. Indeed, it is irrefutable that a strong patent system is a prerequisite to innovation. We prove this all the time in repeated articles, so it is amusing that this response persists. Look anywhere in the world where there is no innovation and there is no patent system. Look anywhere in the world where a patent system with strong rights is adopted and innovation follows. A strong patent system is an absolute prerequisite to innovation. If patents harmed innovation you would see run away innovation in places without a patent system, but that isn’t what we see today and isn’t what we have seen at any time throughout history. Thus, those who believe a strong patent system is not necessary bear a very heavy burden because all of the objective evidence suggest we are right and you are wrong.

    You also say: “If a company can access both the US markets and Indian markets and the company can access both the USPTO and the IPO, it shouldn’t matter whether they are located in the the US or India.”

    That may seem logical, but it isn’t reality. Companies have always located where patent rights are the strongest. You may wish that not to be true, but wishing something to be true does not make it true.

    You can believe there is something else that explains the fact that the US and all other countries that have a strong patent system have strong innovation, but merely concluding that there has to be a different explanation because you don’t like patents is to ignore the evidence.

    -Gene

  11. Benny June 11, 2015 11:17 am

    Gene,
    Allow me to disagree with a couple of points:
    Is it possible that strong patent systems arise in countries where there is innovation, and not vice versa?
    Why does it matter if a company is located in the US? Companies file for IP protection in where their markets are, not necessarily in their own back yard. This is especially true of companies with R&D centers located where talent is relatively cheap and plentiful. (according to one report from 2010, 80 Fortune 500 companies operate R&D centers where I live, outside the US).

  12. K. David Crockett June 11, 2015 3:25 pm

    Gene- I love patents. That’s how I make my living. Don’t know how you come to believe otherwise.
    The reality is, as you and Lybecker point out, that countries with strong patent systems have strong innovation. But when your charts show, for example, that neither Mexico nor Canada have any drugs in development, and both have relatively low IP scores, I wonder why this happens given that innovators in Canada, the US and Mexico all have equal access to our huge market with its top IP score.
    I think you are correct when you say a patent system spurs innovation. So my question could be cast as “Why, given the strong patent systems of biggest economies (US, EP, JP, etc.) to which everyone has equal access, is there a disparity in innovation?” It is a very neutral academic question. It assumes the facts Lybecker presents are correct. And the question admits that I myself do not have the evidence, and might be looking to academics like Lybecker for a fuller explanation. I am not trying to prove something, I am trying to understand something.

  13. K. David Crockett June 11, 2015 3:36 pm

    Benny@7:
    “Innovation taking place in the US” is not in direct correlation with “patents filed in the USPTO”. I think that follows from the point I was making, doesn’t it? Your OUS company has access to the US market and the USPTO. and so avails itself of the incentives offered by “a strong patent system.”
    Why don’t your competitors in lower ranking countries do the same? I don’t know, but maybe Lybecker has put some thought into it.

  14. Anon June 12, 2015 8:20 am

    Benny @ 9, your comment fails of its own weight, as law is my third career, after successful careers in both engineering and management.

    You are simply far more clever in your own mind than in reality.

    It is not so much the personal remarks that might earn banishment, it is more that those personal remarks are simply unfounded.

    Do take care.

  15. Anon June 12, 2015 8:25 am

    It appears from the comments that people are forgetting the nature of patent law: patent law applies (largely) within a sovereign.

    I realize that there are several forces** that seek to cloud this very basic understanding, but it is an understanding that should rest at the foundation of these discussions.

    **For example, forces such as the Big Multi-national Corporations that owe allegiance to no one single nation and seek to have a “universal” patent system more for the ease of its own internal systems than for any one nation’s laws.

  16. Anon June 12, 2015 8:32 am

    The adage “correlation is not causation” is often incorrectly wielded as if to dismiss even a correlation. The logical construct to meet that incorrectly wielded statement is to ask the wielder to provide even a single example of the opposite (with either cause or correlation) – that is, provide a single example of a modern advanced society teeming with innovation that has made the conscious decision NOT to have a strong patent system.

    If NOT having a strong patent system were such a boon to innovation, surely this would be a very easy task.

    (…and I do not even have to get into a discussion on politics and how even States that are communist and seek not to recognize personal property bend their ideologies in order to partake in what A. Lincoln called the fuel of interest)

  17. K David Crockett June 12, 2015 3:27 pm

    Anon@16
    All gorillas have hair. All gorillas have opposable thumbs. Show me a single gorilla with hair but no opposable thumbs and I will agree with you that opposable thumbs do not cause hair. That parallels your argument, and it is just as sound as your argument.
    Lack of a single counter-example does not establish causation. My question does not negate causation. It’s just part of a discussion.

  18. Anon June 13, 2015 12:16 am

    K,

    You quite miss the point that I offered you the chance of showing an example with EITHER cause or correlation.

    Do you want to try again?

  19. K David Crockett June 14, 2015 5:37 pm

    Anon@18
    But I am assuming a perfect correlation, as I pointed out @12. Even perfect correlation does not prove causation: That is just too basic to argue.
    I think you started from a misunderstanding of my original post. You said “The adage “correlation is not causation” is often incorrectly wielded as if to dismiss even a correlation” which suggests that you thought I was dismissing the correlation, when I assumed that the correlation was established. However, as in my gorilla example, I think the proof of a causal relationship requires more than Lybecker has presented.