Americans have long celebrated many things, but one of them has been our incredible ability to continue innovating. Much of what it means to be a modern society is due to innovations made or commercialized most successfully first in this country. The telephone, the automobile, the airplane, computers (mainframe and personal) and software to operate them, air conditioning, and the Internet (with retailing and search) were all commercialized by entrepreneurs in the United States.
Patents have been and remain critical to incentivizing innovation, which in turn is key to sustaining economic growth and increasing living standards. Public officials, academic scholars and other commentators continue to debate whether and how to improve the legal standards and procedures for granting patents and challenging them. As important as these subjects are, they do not address the central economic problem with the current patent system in the United States.
The real challenge is that today the legally oriented patent system imposes significant transactions costs on licensing inventions: Most patent owners and users cannot bear the costs or risks associated with enforcing and licensing their patents. As a result, a substantial portion of the two million-plus patents granted, and thus the knowledge and technology they embody, is not commercialized or used to benefit others. The potential cost of this waste to the American economy has been estimated to be as large as $1 trillion annually, representing a five percent reduction in potential GDP.
Our study released today provides an illustrative calculation suggesting that modestly increasing the number of patents under license, using conservative assumptions of the impact on the economy of increased innovation, could generate social benefits ranging between $100 and $200 billion per year. This estimated range easily could be surpassed if the U.S. can achieve enhanced licensing of existing patents, and if any market solutions also enable the dissemination of more knowledge that could increase the numbers of patented innovations themselves.
A vigorous debate is under way about the pace of future growth. While some are optimistic that the compounding effects of information technology (driven by Moore’s law) will continue, broaden to sectors outside of IT, and conceivably even accelerate, others worry the U.S. economy has run out of good ideas and is condemned to a future of “secular stagnation,” or even worse. Official government forecasts of future productivity growth (a good proxy for innovation) lie somewhere in the middle of these extremes, but at roughly 1.5 percent per year, even these forecasts have a pessimistic tone: During the 1990s, productivity grew at about double this rate.
The magic of compound interest underscores the huge differences in average living standards implied by different growth rates, and thus different rates of innovation. For example, it takes almost 50 years for an economy growing at 1.5 percent (on a per capita basis) to double in size. At three percent, the doubling time is halved to about 24 years. In dollar terms, this means that average family income, currently about $45,000, will take almost two generations to hit $100,000 in the slow-growth scenario. At the more rapid three percent growth rate, average family income would be closer to $200,000 at the end of same time frame.
Solutions that encourage the commercialization of innovations and the knowledge they embody can help address America’s productivity challenge. Unfortunately, these innovations are impeded rather than facilitated by the current patent system. The reason is that the current patent licensing system does not scale—that is, the transactions costs associated with consummating the tenth (or hundredth) licensing deal is no less than the transactions costs associated with consummating the first. Licensing is critical because that is an important way, in addition to direct use of patents by their inventors, that patented innovations actually get used and commercialized, to the benefit of consumers. In addition, because patents require disclosure of the new knowledge embodied in the innovations they cover, patents are more valuable to other producers, entrepreneurs and established firms than trade secrets, which by definition, are kept hidden from others.
Yet, independent of the controversy over patent infringement suits filed by non-practicing patent owners (NPPOs), most patent owners and users— including individual inventors, small to medium-sized businesses, and even universities— cannot afford the cost or complexity of licensing patents under current legal arrangements. These costs favor large companies that have the resources to build up large patent portfolios to use offensively or even defensively against infringement claims of other large competitors. As a result, only the patents that companies guess will be most immediately highly profitable, and therefore can hurdle the high risks or costs of infringement lawsuits, will be used and licensed. It is as if the economy were playing a game of baseball in which the only hits that counted were home runs by players on very well-financed teams.
In such an economy, vast numbers of other valuable or “run-producing” innovations —triples, doubles, singles, or even sacrifice flies—generated by many other firms, universities or individual inventors cannot be economically licensed given the potential risks or costs of litigation. Extending the baseball analogy, the current patent system is like a reconfigured Baseball Hall of Fame that accepts only long-ball hitters, and leaves out all those great players—like Ty Cobb, Rob Carew, Tony Gwynn, and Honus Wagner (among many others)—who were great singles and doubles hitters, and who were of great value to their teams.
In addition, the fear of being held as a “willful infringer” (and thus having to pay much larger damages than might otherwise be the case) discourages potential users, including firms and entrepreneurs, from searching for and using the knowledge embodied in many patents. As a result, the U.S. economy has a lot of “dead” intellectual capital and knowledge that could come alive if only the transactions costs were surmountable.
Although legal reforms to the patent system might help improve “patent quality” (ensuring that patents are granted only for truly novel inventions) and cut down wasteful patent litigation, the real key to improving the patent system and enhancing economy-wide innovation is to unlock the potential economic value of hundreds of thousands of ostensibly “dead” patents—that is, those having commercial value but not being licensed because of the costs and risks of litigation to owners and users of patents. This outcome can be achieved by several market-based solutions, which are not mutually exclusive, and do not require any legal reform.
These underemployed assets can be too easily overlooked even though it is well recognized that intellectual property already has become hugely important to the U.S. economy. By one recent estimate, intellectual capital in some form, including patents, accounts for 55 percent of gross domestic product (GDP), and “intangible assets” (such as corporate intellectual property, goodwill, and brand recognition) account for 80 percent of the value of U.S. public companies today. Yet as hugely significant as the intangible asset figures are, they could be even larger (raising GDP further) under a well-functioning patent-licensing regime. Indeed, given the centrality of IP to our economy, it is essential for firms of all sizes and ages to have an IP strategy, and often specifically a patent strategy— one laying out how firms are going to commercially use or license their innovations, minimizing the likelihood of infringing patents owned by others, or minimizing the financial risks if those owners assert patent rights against them.
This is simply common sense given the $1.5 trillion dollars that companies and governments spend globally on research and development (R&D) each year. Leading companies know they have to rely on ideas from others as much, if not more so, than ideas generated within. Much, if not most, of that outside knowledge can be found in patent disclosures, the quid pro quo for granting patent holders a time-limited right to exclude, although interpreting the disclosed information is complicated by the legal language in which it is stated. Nonetheless, a 2006 study concluded that 88 percent of U.S., European, and Japanese businesses say they rely upon the technical knowledge disclosed in patents to keep up with industry advances and to direct their own R&D.
All of this matters not just now, but indefinitely into the future. The former head of the United States Patent and Trademark Office (USPTO), David Kappos, has aptly analogized the U.S. patent system to a national 401(k) plan; a generator of income- producing assets whose value will only grow over time, to the benefit of both current and future generations. Yet, as we demonstrate below, America’s 401(k) plan is under- performing, delivering far less return than it could. If markets could develop ways to commercialize a substantially greater number of assets now impaired by a cumbersome patent-licensing system, productivity and living standards would advance at a more rapid pace.
About the Authors
Robert Litan is a non-resident Senior Fellow at the Brookings Institution and a Consulting Economist with Economists, Inc. During his professional career, he has headed economic research at the Brookings Institution, the Kauffman Foundation, and Bloomberg Government. Litan has also served as Deputy Assistant Attorney General in the Antitrust Division of the Justice Department and as Associate Director of the Office of Management and Budget. Hal Singer is a Principal at Economists, Inc., a Senior Fellow at Progressive Policy Institute and an Adjunct Professor at Georgetown University’s McDonoug