A Weak Patent System Increases Inequality, Protects Incumbent Monopolies

EDITORIAL NOTE: What follows is part III of Neal’s series on the transformation of the American patent system. To start reading from the beginning please see: The Disintegration of the American Patent System. For those who would like a PDF download of Neal Solomon’s series please see: Transformation of the American Patent System: 2006 to 2016.

The weakening of patent rights is coupled with a weakening of antitrust enforcement that limits control of market leaders. This combination of weaker patent rights for market entrants and limited antitrust enforcement has uniformly benefited large technology corporations and has served to distort market efficiencies.

The consequences of a weakened patent system are increased inequality, a higher competitive bar for market entrants, protection of incumbent monopoly profits, decreased competition, disincentive to invest in innovation by both small entities that have higher costs and large companies that can free ride, declining productivity growth, slower employment and wage growth and economic malaise.

Economic Consequences of Judicial Decisions

While patentability restrictions, patent validity reviews, reduction of remedies, compulsory licensing and perpetuating PAEs are logical consequences of recent judicial actions, there are numerous additional adverse consequences as well.

A weak patent regime promotes free riding by infringers, particularly technology incumbents and Asian manufacturers that use patented inventions. It is now far easier to steal patented inventions than to actually invent.

Given limited remedies, the voluntary licensing market has been effectively eliminated. Why negotiate when one can steal another’s technologies and most likely only pay a small fee that would have negotiated anyway?

For the most part, in a weak patent regime, it is logical for infringers to refuse to deal with patent holders. This patent hold out is promulgated by the easy choice to asymmetrically challenge patent validity in a PTAB IPR at considerable expense, time and risk to the patent holder. This makes efficient infringement the dominant choice: infringers are practically invited to steal.

With high barriers to enforce patents, there are reduced incentives to invent or invest in risky innovation. In fact, there are disincentives to invent, in a distorted system in which patents are actually a high-cost liability with limited rewards. Recent data show a clear trend in the last decade of reduced investment in innovation manifest in the worst productivity growth data in several generations precisely because of the misplaced incentives from a weak patent regime.

The trend of the last decade in patent law has thus been to help infringers and to hurt innovators and market entrants, precisely the opposite of a healthy patent system.

In addition to market incumbents, who are the winners in the weak patent regime? China. Manufacturers are beneficiaries and since much manufacturing has shifted to China, large state owned manufacturing companies are big winners. In fact, start-ups are beginning to shift to other nations since there are limited benefits of American entrepreneurship in a weak patent regime.

Like the Japanese patent system, the U.S. patent system has shifted towards benefiting companies that pool large patent portfolios. The trend towards large patent portfolios to capture value is capital resource intensive, which locks out small entities from the patent system and the economy.

Anticompetitive Features of a Weak Patent System

Attacking the patent system is a low cost way for technology incumbents to free ride, with courts as unreflective and unwitting accomplices. But attacking the patent system is also anticompetitive.

Patents are critical tools enabling companies to compete. Not only do patents supply an incentive to invest in research to solve complex problems to develop novel and useful technologies, patents are crucial to market entrants to enable them to compete with established incumbents. In a weak patent regime, an oligopoly of incumbents and manufacturers tend to benefit at the expense of market entrants. The courts have thus effectively protected infringers at the expense of innovators.

Market competition is disrupted since innovation costs and enforcement costs are increased. In effect, weak patents harm competition as they drive up costs. Since all matters are driven to the courts in an efficient infringement paradigm, transaction costs increase disproportionately for small entities.

Because patents have been politicized in the courts, with higher costs to defend patent validity in IPRs and for enforcement, along with reduced remedies, incumbents now typically refuse to deal with patent holders. This hold out by incumbents makes patent enforcement the only option for many patent holders.

However, the collective refusal to deal by a group of technology incumbents is clearly anticompetitive. When all incumbents hold out, free ride and engage in efficient infringement, there is an implication that they fix prices in a concerted effort to manipulate patent input prices for incumbents’ goods. In the aggregate, these anticompetitive behaviors benefit from a weak patent system that rewards incumbents at the expense of market entrants. With higher barriers to entry, there are fewer market entrants and these entrants supply subsequently less market competition. With less market competition, there are fewer jobs created in smaller companies, prolongation of market competition asymmetry, perpetuation of incumbent monopoly profits, disincentives for incumbents to invest in R&D and slower aggregate economic growth. The last decade has witnessed all of these dysfunctional economic phenomena in an historically weak economic recovery.

Long-term price fixing results from the implicit cooperation by buyers of technology to ignore seller’s rights. As there appears to be a concerted effort to drive down prices of patented inventions, along with the higher transaction costs, there is a squeeze on sellers of IP.

We have seen this movie before. In the 19^th century, railroads moved into a region and hired mercenaries to swindle settlers that worked the land. How is configuring a weak patent system to enable systematic infringement of small entities innovation to benefit large incumbents any different?

Efficient infringement and compulsory licensing are amplified by these collusive behaviors. It is not controversial that large technology incumbents cooperate to ignore patent rights since they happily advertise their disdain for the patent system and the illegitimacy of patent holders (other than themselves).

When the weak patent regime in which efficient infringement thrives is combined with weak federal government or judicial antitrust enforcement, harms to patent holders are further enhanced. Weak antitrust enforcement eliminates the competition in an efficient market when incumbents are able to cooperate to ignore patents and voluntary licensing, suggesting secondary anticompetitive effects of weak patent and antitrust enforcement.

Market Entrants Require Patents

The biggest shift in the last decade has been the requirement of capital-intensive resources to invest in technology research and patent enforcement. The U.S. patent system has thus become de-democratized. Whereas in the period before 2006, anyone could receive a patent for their hard work and ingenuity, now the system has been locked out for all but the most resource rich. This is particularly ironic since patents are critical tools for market entrants that, by definition, tend to lack capital resources.

One upshot of the changes in patent law has been the effective addition of regulations and taxes to the patent system, which unduly burdens market entrants least able to function with these high taxes.

There has been a clear shift towards investors in technology sectors that require patent rights. With more risk, investors have a higher cost of capital and require higher returns. These factors reduce rewards for patent holders relative to investors and reduce inventions on the margins to unfundable ideas that cannot be monetized.

The dramatic one-way changes to patent law in the last decade have tended to completely ignore competition law. While strong patents help market entrants to compete against larger rivals, weak patents only help market incumbents and China. We have thus witnessed in the last decade the rapid destruction of competitive markets, the rise of China as the world’s main manufacturer and the preservation of incumbent monopoly profits at the expense of market entrants. Furthermore, the incentive to invest in innovation has been badly disrupted, with business starts at their lowest rates ever recorded. The changes in patent law have distorted free markets, misplaced incentives for innovators and enabled perverse disincentives for incumbents to invest in innovation.

Furthermore, rather than invest in technology innovation, in a weak patent regime, venture capitalists now focus on short-term business models that avoid risky innovation. For example, the average number of patents of the top 75 U.S. “unicorns” [i.e., companies with a market valuation of $1B or more] in 2015 stood at eight. Start-ups themselves become un-innovative since they have incentives to steal others’ technologies, to complain about the inflexibility of patent system when caught infringing and to invest in neither R&D nor patent enforcement. We can call start-ups that are discouraged to invest in innovation and would rather steal others’ innovation “little free riders.” Free riding becomes the norm, with small ventures becoming revenue-free service- focused levitation acts with no new technology.

With less incentive to invent or invest in innovation, it should be no surprise that in a weak patent regime, productivity growth has declined precipitously and economic growth is substantially reduced.

Constructive Remedies

There is a need to restore balance, moderation and responsibility to the patent system. There are several things that should be done.

First, the Supreme Court needs to review eligibility for injunctions in patent infringement cases. In some ways, eBay was an unfinished work. The Court needs to craft a narrow injunction to protect a property right and promote exclusion without necessarily harming an infringer’s products. The courts need to stop attacking the identity of the patent holder, particularly the original inventor, for justification of instituting an injunction.

Since incumbent hold out is promulgated with weak remedies, it is necessary to apply enhanced damaged to serial infringers. Enhanced damages provide an incentive to negotiate fair patent licenses in good faith. Similarly, fee shifting should be applied to serial infringers to remove the high transaction cost bar to patent holders.

IPRs should only be instituted with a high (clear and convincing) bar to preserve the presumption of patent validity. Third parties should not be allowed to challenge a patent. Only a judge should be allowed to request a patent validity review, typically in egregious cases. The same standards need to be applied to the patent review process in the PTAB and the federal district courts. Moreover, patents in IPRs must be amendable, as originally provided in the statute. In addition, patent obviousness must be narrowed in patent reviews, as an adjunct to novelty, so as to maintain a common sense approach to patent examinations. In sum, due process should apply to patent validity reviews in the PTO as they would in the courts.

Courts need to find logical ways to preserve software and medical diagnostic patents.

Damages need to be fair, reasonable and predictable. There is a need to restore balance to the system. Perhaps FRAND damages are a good start.

The Court in i4i and Halo upheld two hundred years of patent law, suggesting that at its best the court is able to muster some common sense.

When the patent system is strengthened, there is a responsible licensing regime, with clear boundaries for patent rights and fair prices. One goal of the patent system should be to reconstitute the voluntary licensing market. This keeps things out of the courts altogether, something that all sides should agree on.

Further Reading

Solomon, Neal, Lost Profits Analysis for Patent Infringement Damages, 2010, SSRN.

Solomon, Neal, What is a Reasonable Royalty? A Comparative Assessment of Patent Damages Methodologies, 2010, SSRN.

Solomon, Neal, Analysis of the ‘Four-Factor Test’ in Patent Cases Post-eBay, 2010, SSRN.

Solomon, Neal, Three Dogmas of Intellectual Property Jurisprudence, 2010, SSRN.

Solomon, Neal, A Review of Patent Validity Jurisprudence, 2010, SSRN.

Solomon, Neal, Adverse Effects of Moving from Property Rules to Liability Rules in Intellectual Property: A New View of the Cathedral Without the Disintegration of Property Rights in Patent Law, 2010, SSRN.

Solomon, Neal, The Problem of Willfulness in Patent Infringement Litigation, 2010, SSRN.

Solomon, Neal, The Problem of Oligopsonistic Collusion in a Weak Patent Regime, 2010, SSRN.

Solomon, Neal, Policy Solutions to the Productivity Growth Crisis, 2016, SSRN.