Patent Failure: How Judges, Bureaucrats, and Lawyers Put Innovators at Risk

Zimbabwe, a country once considered the "breadbasket of Africa," now suffers widespread starvation. Much of this decline can be attributed to the tyrannical policies of President Robert Mugabe-in particular, his disregard for property. In 2000, Mugabe's followers seized land on over one thousand farms owned by white farmers. But when Zimbabwe's Supreme Court ordered the squatters evicted, Mugabe forced the chief justice to resign and physically threatened the remaining justices, who relented. Owners abandoned their property, severely disrupting agricultural production, and within a few years Zimbabwe was wracked by famine.

Even with the rule of law, property systems can fail. A successful property system also requires supportive institutions, and the technical details of property law must make sense. Consider one particular country where many property owners had a hard time enforcing their rights and were often forced to resort to expensive litigation. In one notorious case, a property owner had to assert its rights against more than one hundred parties, an ordeal that involved forty-three separate lawsuits. With so many ostensible trespassers, one might assume the property owner's claim was weak, but as the courts found, this was notthe case. Only one suit was dismissed on summary judgment, the owner's claims were largely upheld on appeal, and almost all the defendants settled.

This example does not come from a failed state or a "tinhorn dictatorship." The country in question is the United States; the property is U.S. Patent No. 4,528,643, granted in 1985; the owner who initiated the lawsuits was a company called E-Data; and the alleged violators included a roster of technology companies as well as thousands of small businesses and individuals operating e-commerce websites. This failure of property rights cannot be attributed to a breakdown of the rule of law. Rather it was caused by the failure of patent-related institutions and patent law generally to get the details right. This widespread pattern of alleged violation and litigation would surely be unusual in real estate or personal property in the United States.

Such a rickety system of property rights seems unlikely to be an engine of growth. Burdensome means of enforcement lessen the value of property to its owners. Moreover, property disputes impose costs on other parties. Even though few are sympathetic to trespassers, squatters, and others who seek unjust enrichment, there is good reason to worry about costs imposed on innocent violators. In the case above, many of the defendants believed that they were not infringing upon the owner's rights, and they innocently made investments that turned out to be in violation. Those investments were exposed to unnecessary risk because of unclear property boundaries. A defective property system discourages trade and investment not just by property owners, but also by those who inadvertently face the threat of property related lawsuits.

This book considers patents as a form of property right. If patents work as property, they should reward innovators and encourage investment in innovation. Below, we explore how the laws and institutions of property, including patents, succeed and how they fail. The E-Data example suggests that even in an advanced society with well-developed legal institutions and strong respect for the law, property can fail. Yet this one example might not be entirely representative. We need to go further and ask whether patents work well as property overall.

This question is important because innovators have grown frustrated with the failings of the American patent system. Over the past several years, in newspaper articles and at hearings held by the Federal Trade Commission (FTC) and the National Academy of Sciences (NAS), industry executives have complained in growing numbers that the patent system is broken. In response, Congress has held its own hearings and debated reform. Critics argue that changes in patent law have created "a legal frenzy that's diverting scientists from doing science." Some even believe that the patent system should be abolished. Others say that the patent system can be fixed with some modest reforms. Still others maintain that the patent system is not broken at all, and that current efforts to reform it are just an attempt to weaken the rights of small inventors.

It is hard to tell who is right, however, because most evidence offered in support of these positions is anecdote, if not myth:

Defenders of the current system tell stories about the role of patents in protecting small inventors from rapacious corporate giants. But most patents and most litigation do not come from independent inventors, so it is not clear how representative these stories are, or how important small inventors are overall.

Critics of the system cite patents on a peanut-butter-and-jelly sandwich (U.S. Patent No. 6,004,596), a method of using a backyard swing (U.S. Patent No. 6,368,227), and a method of combing hair over a bald spot (U.S. Patent No. 4,022,227) as evidence of poor patent "quality." Standing alone, however, these patents are not evidence that anything is seriously wrong. Silly patents and patents on unworkable inventions, such as perpetual-motion machines, have been around for at least two hundred years.

Critics also raise the issue of lawsuits initiated by "patent trolls"-people who obtain broad patents not for purposes of innovation, but solely to ensnare real innovators who might inadvertently cross the boundaries of the trolls' patent. The label "troll" is potent rhetoric, but only a small percentage of patent litigation can be attributed to the most egregious trolls.

Stories about garage inventors are inspiring, while stories about frivolous patents and frivolous lawsuits are troubling, but better evidence is needed to guide patent reform. Without this evidence, it is hardly surprising that some reform proposals seem to be ad hoc.

This book moves beyond anecdote to provide the first comprehensive empirical evaluation of the patent system's performance. We measure patents against a simple, well-defined yardstick inspired by economic analysis of property rights. Our yardstick weighs the benefit of patents to an innovator against their cost, including the risk of inadvertent infringement. If the estimated costs of the patent system to an innovator exceed the estimated benefits, then patents fail as property.

Some readers might immediately find our objective to be somewhat oddly stated or, perhaps, overreaching. The key limiting qualifier here- the limitation that makes the empirical exercise feasible-is "as property." At the risk of getting a bit pedantic, this phrase requires more careful discussion.

Many readers might think the phrase is redundant in the present context. Some are likely to assume that patents are property. What, then, could it mean to ask if they work "as property"? For example, in a paper comparing different ways of providing incentives to innovate, theoretical economists Gallini and Scotchmer (2004) tell us that patents are "intellectual property," which they define as "an exclusive right to market an invention for a fixed time period." As such, it might seem sensible to call patents "property" because exclusion is a hallmark of property. Property rights in land give a farmer exclusive rights to grow crops and bring them to market. If patents provide exclusive rights to market inventions, how could they not work "as property"?

It is important, however, to distinguish idealized depictions of patents from the actual workings of the patent system. Patents do not actually provide an affirmative right to market an invention; they provide only a right to exclude others from doing so. This might seem an inconsequential difference, but it has practical significance: other patent holders can block even a patented invention from coming to market. The power to block innovation is especially troublesome when property boundaries are not well identified.

Some of the troubling issues raised by the E-Data patent are explained by this difference. E-Data's patent was for a kiosk that produced digital audio tapes and the like in retail stores, but they interpreted this patent to cover a very broad swath of e-commerce. On the other hand, IBM holds hundreds of patents related to e-commerce, but this did not prevent E-Data from threatening to block IBM from marketing its own innovative e-commerce products. To market its own patented technologies, IBM was forced to pay E-Data for a license. Similarly, Research in Motion (RIM) holds patents on its popular BlackBerry personal-communication device, but this did not prevent NTP, a patent licensing company, from famously suing RIM for patent infringement. To avoid being excluded from the market for its own patented invention, RIM paid NTP more than a half-billion dollars.

Gallini and Scotchmer present idealized notions of patents and property that might be useful for some theoretical inquiries. Empirical investigation, however, requires us to be mindful of the ways in which real patents might fall short of such stylized concepts of property. If examples like E-Data and RIM are typical-and this is the kind of empirical question we explore in depth below-then patents will perform quite differently from the property ideal. Below, we estimate just how far actual patents fall short of that ideal. Patents work well as property for some kinds of technology and given the right institutional setting. Patents fail as property for other kinds of technology and given the wrong institutional setting.

Overall, the performance of the patent system has rapidly deteriorated in recent years. By the late 1990s, the costs that patents imposed on public firms outweighed the benefits. This provides clear empirical evidence that the patent system is broken. Both our empirical analysis and our comparative institutional analysis provide clues about the causes of this deterioration-and about what might be done to fix it.

Our focus is on the American patent system, and some of the problems we identify with the American patent system are unique. Nevertheless, there are two reasons that our analysis has relevance to innovation in other countries. First, many other patent systems are under some pressure to become more like the American patent system. For example, Japan and Europe have loosened restrictions against software patents. Second, patent rights and patent litigation are global matters. Important inventions are usually patented in all major markets. This means that patent holders can choose where to litigate. Increasingly, patent disputes are being litigated in the United States, usually resulting in worldwide settlement agreements. Indeed, European inventors file more lawsuits in the United States than they file in any European country other than Germany. This means that the United States patent system directly affects firms and innovators in Europe, Japan, and elsewhere.

Patents as Property

We begin by comparing patents to tangible property. Lawyers and legal scholars-perhaps because they have endured at least a semester of training in property law and are therefore aware that things might not be so neat-tend to speak of patents not as a form of property, but as analogous to other forms of property. Some argue that the analogy might not be appropriate (Lemley 2005), others that the analogy is long-standing (Mosoff 2007), but most recognize that the law and institutions of property systems are complicated and patent law necessarily diverges from the law of tangible property.

We begin our inquiry in chapter 2 by looking at the appropriateness of this analogy, comparing the property-like features of patent law to features of the law of tangible property. We have already noted one important difference: patents do not provide an affirmative right to use an invention. More than one person can use an invention at a time and more than one inventor can claim rights over an invention. Many people can even invent the same technology independently at the same time. In contrast, tangible property is a "rival" good-that is, only one person can use it at a time. This means that the right to exclude others more or less conveys an affirmative right to use tangible property. As we shall see, this difference between inventions and tangible property is important.

In many other ways, however, patent law shares essential doctrinal features with the law of tangible property. Specifically, patents provide partial rights to exclude others from using an invention as well as rights to transfer ownership. Just as property rights provide incentives to invest in the acquisition, development, and maintenance of tangible property, patents potentially provide incentives to conceive a new technology ("invention"), develop it into a commercial product or process ("commercialization"), and put it to use ("innovation"). Such "innovation incentives" are central to the Constitutional mandate to "promote the progress of ... the Useful Arts," which the framers set out when empowering Congress to devise a patent system.

But property and patents only potentially provide these incentives. Our review finds well-known evidence that property systems sometimes fail to provide such incentives efficiently:

Property rights can fail when their validity is uncertain. Such was the case when the transition from Mexican to American rule in California during the nineteenth century clouded the validity of land titles granted under Spanish and Mexican rule. This uncertainty led to squatting and a decline in agricultural productivity.

Property rights can fail when rights are so highly fragmented that the costs of negotiating the rights needed to make an investment become prohibitive. Such was the case with Russian retail establishments in that country's transition to a private economy. Ownership rights to stores were granted to large numbers of parties, making it too difficult for any one group to obtain the required permissions to operate each store. The stores were often shuttered while street vendors conducted a busy trade nearby.

Property can fail when boundary information is not publicly accessible. In many less-developed nations, cumbersome regulations discourage impoverished people from recording property boundaries. This limits their ability to trade that property or to use it as collateral for obtaining loans.

Finally, property rights can fail when the boundaries of the rights are not clear and predictable. This problem sometimes arises with property extracted from nature, such as mineral rights. For example, mineral veins beneath the surface of the earth twist and intersect in unpredictable ways. Such a boundary-related failure in the copper mines of Butte, Montana, led to a violent struggle between rival claimants.

These failures emphasize the importance of implementation in property rights systems. The economic effectiveness of any property system depends not just on what it sets out to do, but also on the laws, regulations, institutions, and norms that implement the system. Consequently, the doctrinal similarity between patent law and the law of tangible property can obscure important differences in economic performance that arise because these doctrines are implemented differently. Patents might not work well as property if patent law is not implemented effectively; the messy details of how patents work matter.

(Continues...)

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Excerpted from Patent Failure by James Bessen Michael J. Meurer
Copyright © 2008 by Princeton University Press. Excerpted by permission.
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