Robert Litan is an economist and attorney with decades of experience as an executive in both the private, public and government sectors. He is currently a non-resident Senior Fellow at the Brookings Institution, and he also serves on the research advisory boards of the Smith Richardson Foundation and the Committee for Economic Development. 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. In short, Litan is extraordinarily accomplished and has seen the world from many different vantage points.
Litan is also a prolific author, having authored or co-authored over 25 books and numerous articles in professional and popular publications. His latest books include The Trillion Dollar Economists (Wiley Press, 2013), The Need for Speed (Brookings Institution Press, 2013, co-authored with Hal Singer); Better Capitalism (Yale University Press, 2012, co-authored with Carl Schramm), and Good Capitalism, Bad Capitalism (Yale University Press, 2009, co-authored with William Baumol and Carl Schramm). Thanks to his writings and Congressional testimony Litan has become a widely recognized national expert in regulation, antitrust, finance, and a variety of other policy subjects.
Most recently, however, Litan co-authored a study that concluded that modestly increasing the number of patents under license could generate social benefits ranging between $100 and $200 billion per year. See $200 Billion Could Be Added to Economic Output Annually by Unlocking Patents. It is through his work on this study that I met Litan. I asked if he would be interested in doing an interview and he graciously accepted.
Without further ado, what follows is part 1 of my two part interview with Litan, which took place on December 1, 2014. We discuss a wide range of topics, including the economics of innovation, the importance of properly incentivizing innovation, licensing of patents and how a streamlined, thoughtful approach to patents licensing could dramatically and positively impact the U.S. economy.
QUINN: Thanks, Bob, for taking the time to chat with me today. I know you just published a study with Hal Singer titled Unlocking Patents that has gotten an awful lot of publicity, but before jumping into a discussion about the study I thought maybe we could start more generally with an open-ended question about patents being critical to incentivizing innovation, which I know is the first line of the abstract of this study. But so many people argue that it just isn’t true. So I wonder if you could give us a little bit of a primer on incentivizing innovation from an economic perspective and then we can go from there.
LITAN: Well, innovation is like any other good or service in the economy. There has to be rewards from it for those who undertake it to spend the money to achieve it. Especially because such a large share of innovations spill over or are not captured by those doing the innovating. Or to put it another way the game has to be worth the candle in order for you to go ahead and make the candle. This principle was recognized as early as the founding of our Constitution. In fact, patents have been part of culture since they were used in Europe I think dating from as early as the 15th Century.
QUINN: Now I’m sure you’ve heard the critics say that you just don’t need patent rights in order to incentivize innovation and innovation is just going to happen naturally and that patents get in the way. I’ve tried to do the best I can to explain why one needs patents, but from an economic standpoint what is your response to the people who say that or level that charge?
LITAN: In a world without patents you would have a sub optimal level of innovation. If people could not earn at least some temporary rents from their innovation then they will do less innovating. What’s not widely appreciated is that patents represent a bargain that society strikes with innovators. The government says it will give you a temporary monopoly or temporary exclusivity in return for your full public disclosure of what it is that you invented. Without patents we would not get the kind of full disclosure that is now routine with patents. Now, I think later we may get into a conversation about how some of that disclosure is convoluted and is wrapped in excessive legalese which is a separate issue. But nonetheless under the current and long standing patent system in the United States inventors have to tell other people how it is that they came up with their invention and what their invention actually amounts to.
If we didn’t have patents then companies or individuals attempting to commercialize what it is they invent would keep everything as a trade secret. It is true there is a well-recognized body of common law protecting trade secrets, and which says that as long as you don’t affirmably disclose your idea to other people you have a right to keep it a secret. Coca-Cola’s secret formula is a prime example. Nobody knows how to replicate Coke.
A lot of companies have trade secrets. I believe that many of them resort to trade secrets in part because patents now have become too expensive or too risky to commercially exploit. From a social point of view this is bad outcome: if all we had were trade secrets it would mean that any time anyone wanted to invent something new that seemed to build on something that had gone before the inventor would have to reinvent the wheel because he or she wouldn’t have access to the secret information that is being protected by trade secret law. So one huge virtue of the patent system is that it avoids having inventors and firms in aggregate spending billions if not tens of billions of dollars constantly reinventing wheels. This would be especially problematic in the pharmaceuticals and chemical industries, which are now heavily dependent on patents.
QUINN: It seems self-evident to me that all of what you just said is true. Some of the critics will question, however, whether the drug companies are making up just how expensive it is to take drug to market. The estimates that they come up with seem like pennies on the dollar compared to the actual costs. Others will say that software doesn’t take a whole lot of money to make. I know that is not true, at least for any software that will work, be updated, takes into account security and does what it’s supposed to do. Real software costs a lot of money to create, but people just don’t see that, they don’t seem to understand. And then we get into this sound bite cycle where they say information wants to be free, et cetera, et cetera.
QUINN: How do you combat that? It strikes me that the argument about patents, which I agree with everything you’ve said so far, is not a sound bite argument.
LITAN: It can be a sound bite argument, namely that “you don’t get anything for nothing.” If we as society want more innovation we have to pay for it, which means that inventors get paid. Period. So that’s the sound byte version.
Now it is true that there is huge variation across industries in their use of patents. So in the case of computers or any other industry in which there’s a very short product cycle, patents may not be all that important to firms. In those cases, it may make sense commercially to protect one’s IP with either copyright or trade secret law. But in industries like pharmaceuticals and maybe to a lesser extent chemicals where there is no short product lifecycle, patent protection is much more critical.
In any event, cross industry variation in the use of patents shouldn’t mean that we should just junk the patent system. As I said, the alternatives to go to a system of trade secrets which has very, I think, suboptimal social implications relative to patents. Indeed I think when people object to patents they don’t think about well what else would firms rely on for protecting their hard-earned IP. Indeed, even companies that are heavily involved in the open source world are using patents as a “currency” through which they can achieve collaboration with other firms. That’s why you see big firms like Microsoft and IBM cross license. They do it not only to insulate themselves from infringements against them but because patents are the tickets through which can collaborate with other parties to innovate, make better products and so on.
QUINN: I’m glad you raise that point. To me we want to have patent thickets because every time we’ve ever experienced a true patent thicket throughout history that’s been the moment in time when the industry players have gotten together and trade their rights and agreed on a platform so everybody can move forward. A real patent thicket causes innovation to leap forward. But right now I don’t see a patent thicket. People point to the smartphone industry but exactly what innovation has been stopped in the smartphone industry? Every version of the smartphone is lighter, the battery lasts longer, the screen is stronger, the processor is faster, et cetera, et cetera. I just don’t see any patent thicket problems.
LITAN: The patent thicket idea is bumper sticker or sound byte, and historically has often had negative connotations. But in general our economy is characterized by lots of cross licensing arrangements, and without patents there would much less cross-firm collaboration. This important in our increasingly complicated economy, where many pieces of machinery or consumer items have countless numbers of parts and things wouldn’t work well together unless the firms making them are able to cross license their innovations.
QUINN: I don’t know what the critics really are thinking. It strikes me that they really haven’t thought it all the way through. I suppose on some level they are right at this point to say that it doesn’t make a lot of sense to seek software patents with respect to a lot of inventions because the law has swung so dramatically against innovators, which means many are probably are racing toward trade secrets. That being the case, what do you expect to see happen in the software area where there’s such upheaval? Or in certain biotech sectors where the Supreme Court seems to just not want to recognize certain classes of invention as being patent eligible? What kind of impact do you suppose that that’s going to have on innovation and the economy more broadly?
LITAN: You’re not going to like this answer. It’s difficult to generalize. Let me put it this way. I think too much attention is paid by lawyers and maybe even economists and policymakers to the exact standards for patenting and whether or not a patent should issue or not, and not enough attention is paid to how do we encourage all the existing patent holders and any new patent holders from commercializing what patents have already been issued. So, for example, in our study we point out that of over 2 million patents that have been issued only about 5% of them have license fees associated with them. That indicates that only the tip of the iceberg is being licensed or commercially exploited and the vast preponderance of patents are not being commercially used. To be sure, some portion of that vast proportion is probably commercially useless. But there have to be a significant number of patents, whether it’s tens of thousands or hundreds of thousands, which are not being now commercially exploited because of the legal disincentives to do so. That is because is if I license a patent today I run the risk of being sued by other parties that want a share of my royalties. Other parties will claim that the idea is not novel, and if they are more well-heeled than I then, I lose even though I may be the one that really did come up with this new this innovation.
Society loses when lots of patents are not commercially exploited that could be. One of the objectives of the paper that we wrote was to try to change the national conversation towards ways in which we can have more commercialization. Ironically one of the conclusions we’ve come to is that legislation or regulation may be unnecessary to advance this cause. That in fact there are now some emerging market solutions that are now being tested in the market, albeit in very early stages, that will make it worthwhile for parties to license and also for other parties to gain royalties. I’m hopeful that over time we may see the marketplace help solve this problem.
QUINN: Now I want to go back to something that you just said — society loses if this doesn’t happen. I think there’s a popular belief that society has gained because all this information has been put into the public domain via disclosure in a patent and if there’s not a lot of licensing going on and there’s no commercial activity going on those patents are going to fall into the public domain usually at either four years or eight years after issue because the owners are not going to make the first or second maintenance fee payment. So society gets all this knowledge that then can be used for free without having to pay anybody. That is the quid pro quo that you alluded to earlier. But what I’ve seen throughout my career is you’ll get an inventor come to you who’s come up with a really interesting solution to a problem that they face. They’ve tried to find something that they could purchase to address that problem and there was nothing available. So they invented a solution. It worked for them so now they want to get a patent search done to see whether it makes sense to move forward with a patent application. And many times we’ll find nearly exactly what they have come up with. The inventor then will ask me how is that possible? How could something this useful that addresses this problem that I would pay for and I know other people would pay for has been patented but is nowhere in the marketplace? The answer I think is that with a lot of different inventions if there can be no exclusive rights then the party who goes in and creates that market runs the risk of the free rider problem. People can come in and larger entities can come in and steal their market right out from under them. So there’s no incentive to invest, to bring those things to market. So I do think in a system without exclusive rights and the ability for innovators to trade those rights, whether it’s by sale or licensing, society does lose in the end.
LITAN: All the points you make are right. An additional point just to kind of pile on to what you said is that a disadvantage of the current system is that while some parties may actively engage in patent searches to see if they can more easily license rather than invent themselves, others may be discouraged from doing a search out of a fear of being charged with willful infringement. That is, if someone later comes along and says your doohickey doesn’t really differ that much from mine, your damages could be greater in an infringement if you did the search, so why take the risk?
QUINN: I’ve always thought that that was idiotic for many different reasons. I just heard Jay Walker give a keynote speech in New York at the IP Dealmaker’s Forum several weeks ago. And he alluded to at one point in time at Microsoft the only immediately fireable offense you could commit was reading a patent that was owned by somebody else.
LITAN: Right. That’s in Marshall Phelps’s book, Burning the Ships.
QUINN: That is unbelievable. The reality is willful damages are incredibly difficult to get. Maybe it will be easier to get now after some recent Supreme Court decisions, but they are incredibly difficult to get, number one. And number two is how can you possibly hope to innovate without knowing what else has come before you? And I think that this leads to a big problem in the discussion about patents and innovation and innovation policy in general. I don’t think we know any longer what it means to innovate. It seems that that word has gotten hijacked to become synonymous with, well, it’s a new product offering from me therefore it’s innovation. And, no, that just means you never sold it before. To innovate is to do something new and different. In the words of Abraham Lincoln — I’m going to paraphrase here— in order to get inventors to do that you have to stoke the fire of their creative genius and that’s done with the patent system.
LITAN: All true. But I do want to go back to the issue of willful infringement. It was Phelps two told the story in his book about Microsoft making it a fireable offense to engage in a patent search, I don’t think we should dismiss that notion. Now, I’m not saying that happens in every case. But you know, when you have the head of the IP licensing for a major company saying that I think we should take it seriously.
QUINN: Oh, I didn’t mean to sound like I wasn’t taking Marshal seriously. I know people do that. I hear it all the time. It just strikes me as a little bit odd. If your goal is really to innovate how could you not know what others are doing? I mean you would never hear a researcher trying to get their PhD say, well, you know, I’ve decided that I’m just going to do this and I’m not going to take any time to see whether anybody else has researched it and I’m going to look at this for three or four years and base my thesis and professional future on this only to later realize, oh, it’s already been done.
QUINN: To somebody who is really engaging in research and development and innovation that way of thinking just strikes me as ridiculous.
LITAN: Well, of course it’s ridiculous. We agree on that. Let’s stipulate that it makes no sense to have a system in place that runs the risk of discouraging people from engaging in prior searches.
LITAN: Or searches of prior art. By the way, as an aside I was advised when I was in graduate school (economics) that one way to ensure creativity is not to look at what other people have done because it’ll hamstring your thinking. So there are people out there who purposely will not go out and look at prior art because it does constrain your thinking. But there are also many other people out there, certainly in corporate America, who will want to search prior art, if they didn’t incur excessive legal risks for doing so, as a way of saving time and money so that they’re not reinventing the wheel. So I don’t want to make this argument willful infringement applicable totally across the board. I’m just simply saying the current system does run the risk of discouraging some people from engaging in search of prior art and that’s unfortunate. That’s all.