Responding to a new draft policy statement from the U.S. Patent & Trademark Office (USPTO), the National Institute of Standards and Technology (NIST), and the U.S. Department of Justice, Antitrust Division (DOJ) regarding remedies for infringement of standard-essential patents (SEPs), a group of 19 distinguished law, economics, and business scholars convened by the International Center for Law & Economics (ICLE) submitted comments arguing that the guidance would improperly tilt the balance of power between implementers and inventors, and could undermine incentives for innovation.
As explained in the scholars’ comments, the draft policy statement misunderstands many aspects of patent and antitrust policy. The draft notably underestimates the value of injunctions and the circumstances in which they are a necessary remedy. It also overlooks important features of the standardization process that make opportunistic behavior much less likely than policymakers typically recognize. These points are discussed in even more detail in previous work by ICLE scholars, including here and here.
These first-order considerations are only the tip of the iceberg, however. Patent policy has a huge range of second-order effects that the draft policy statement and policymakers more generally tend to overlook. Indeed, reducing patent protection has more detrimental effects on economic welfare than the conventional wisdom typically assumes.
The comments highlight three important areas affected by SEP policy that would be undermined by the draft statement.
- First, SEPs are established through an industry-wide, collaborative process that develops and protects innovations considered essential to an industry’s core functioning. This process enables firms to specialize in various functions throughout an industry, rather than vertically integrate to ensure compatibility.
- Second, strong patent protection, especially of SEPs, boosts startup creation via a broader set of mechanisms than is typically recognized.
- Finally, strong SEP protection is essential to safeguard U.S. technology leadership and sovereignty.
As explained in the scholars’ comments, the draft policy statement would be detrimental on all three of these dimensions.
To be clear, the comments do not argue that addressing these secondary effects should be a central focus of patent and antitrust policy. Instead, the point is that policymakers must deal with a far more complex set of issues than is commonly recognized; the effects of SEP policy aren’t limited to the allocation of rents among inventors and implementers (as they are sometimes framed in policy debates). Accordingly, policymakers should proceed with caution and resist the temptation to alter by fiat terms that have emerged through careful negotiation among inventors and implementers, and which have been governed for centuries by the common law of contract.
Collaborative Standard-Setting and Specialization as Substitutes for Proprietary Standards and Vertical Integration
Intellectual property in general—and patents, more specifically—is often described as a means to increase the monetary returns from the creation and distribution of innovations. While this is undeniably the case, this framing overlooks the essential role that IP also plays in promoting specialization throughout the economy.
As Ronald Coase famously showed in his Nobel-winning work, firms must constantly decide whether to perform functions in-house (by vertically integrating), or contract them out to third parties (via the market mechanism). Coase concluded that these decisions hinge on whether the transaction costs associated with the market mechanism outweigh the cost of organizing production internally. Decades later, Oliver Williamson added a key finding to this insight. He found that among the most important transaction costs that firms encounter are those that stem from incomplete contracts and the scope for opportunistic behavior they entail.
This leads to a simple rule of thumb: as the scope for opportunistic behavior increases, firms are less likely to use the market mechanism and will instead perform tasks in-house, leading to increased vertical integration.
IP plays a key role in this process. Patents drastically reduce the transaction costs associated with the transfer of knowledge. This gives firms the opportunity to develop innovations collaboratively and without fear that trading partners might opportunistically appropriate their inventions. In turn, this leads to increased specialization. As Robert Merges observes:
Patents facilitate arms-length trade of a technology-intensive input, leading to entry and specialization.
More specifically, it is worth noting that the development and commercialization of inventions can lead to two important sources of opportunistic behavior: patent holdup and patent holdout. As the assembled scholars explain in their comments, while patent holdup has drawn the lion’s share of policymaker attention, empirical and anecdotal evidence suggest that holdout is the more salient problem.
Policies that reduce these costs—especially patent holdout—in a cost-effective manner are worthwhile, with the immediate result that technologies are more widely distributed than would otherwise be the case. Inventors also see more intense and extensive incentives to produce those technologies in the first place.
The Importance of Intellectual Property Rights for Startup Activity
Strong patent rights are essential to monetize innovation, thus enabling new firms to gain a foothold in the marketplace. As the scholars’ comments explain, this is even more true for startup companies. There are three main reasons for this:
- Patent rights protected by injunctions prevent established companies from simply copying innovative startups, with the expectation that they will be able to afford court-set royalties;
- Patent rights can be the basis for securitization, facilitating access to startup funding; and
- Patent rights drive venture capital (VC) investment.
While point (1) is widely acknowledged, many fail to recognize it is particularly important for startup companies. There is abundant literature on firms’ appropriability mechanisms (these are essentially the strategies firms employ to prevent rivals from copying their inventions). The literature tells us that patent protection is far from the only strategy firms use to protect their inventions (see. e.g., here, here and here).
The alternative appropriability mechanisms identified by these studies tend to be easier to implement for well-established firms. For instance, many firms earn returns on their inventions by incorporating them into physical products that cannot be reverse engineered. This is much easier for firms that already have a large industry presence and advanced manufacturing capabilities. In contrast, startup companies—almost by definition—must outsource production.
Second, property rights could drive startup activity through the collateralization of IP. By offering security interests in patents, trademarks, and copyrights, startups with little or no tangible assets can obtain funding without surrendering significant equity. As Gaétan de Rassenfosse puts it:
SMEs can leverage their IP to facilitate R&D financing…. [P]atents materialize the value of knowledge stock: they codify the knowledge and make it tradable, such that they can be used as collaterals. Recent theoretical evidence by Amable et al. (2010) suggests that a systematic use of patents as collateral would allow a high growth rate of innovations despite financial constraints.
Finally, there is reason to believe intellectual-property protection is an important driver of venture capital activity. Beyond simply enabling firms to earn returns on their investments, patents might signal to potential investors that a company is successful and/or valuable. Empirical research by Hsu and Ziedonis, for instance, supports this hypothesis:
[W]e find a statistically significant and economically large effect of patent filings on investor estimates of start-up value…. A doubling in the patent application stock of a new venture [in] this sector is associated with a 28 percent increase in valuation, representing an upward funding-round adjustment of approximately $16.8 million for the average start-up in our sample.
In short, intellectual property can stimulate startup activity through various mechanisms. There is thus a sense that, at the margin, weakening patent protection will make it harder for entrepreneurs to embark on new business ventures.
The Role of Strong SEP Rights in Guarding Against China’s ‘Cyber Great Power’ Ambitions
The United States, due in large measure to its strong intellectual-property protections, is a nation of innovators, and its production of IP is one of its most important comparative advantages.
IP and its legal protections become even more important, however, when dealing with international jurisdictions, like China, that don’t offer similar levels of legal protection. By making it harder for patent holders to obtain injunctions, licensees and implementers gain the advantage in the short term, because they are able to use patented technology without having to engage in negotiations to pay the full market price.
In the case of many SEPs—particularly those in the telecommunications sector—a great many patent holders are U.S.-based, while the lion’s share of implementers are Chinese. The anti-injunction policy espoused in the draft policy statement thus amounts to a subsidy to Chinese infringers of U.S. technology.
At the same time, China routinely undermines U.S. intellectual property protections through its industrial policy. The government’s stated goal is to promote “fair and reasonable” international rules, but it is clear that China stretches its power over intellectual property around the world by granting “anti-suit injunctions” on behalf of Chinese smartphone makers, designed to curtail enforcement of foreign companies’ patent rights.
This is part of the Chinese government’s larger approach to industrial policy, which seeks to expand Chinese power in international trade negotiations and in global standards bodies. As one Chinese Communist Party official put it:
Standards are the commanding heights, the right to speak, and the right to control. Therefore, the one who obtains the standards gains the world.
Insufficient protections for intellectual property will hasten China’s objective of dominating collaborative standard development in the medium to long term. Simultaneously, this will engender a switch to greater reliance on proprietary, closed standards rather than collaborative, open standards. These harmful consequences are magnified in the context of the global technology landscape, and in light of China’s strategic effort to shape international technology standards. Chinese companies, directed by their government authorities, will gain significant control of the technologies that will underpin tomorrow’s digital goods and services.
The scholars convened by ICLE were not alone in voicing these fears. David Teece (also a signatory to the ICLE-convened comments), for example, surmises in his comments that:
The US government, in reviewing competition policy issues that might impact standards, therefore needs to be aware that the issues at hand have tremendous geopolitical consequences and cannot be looked at in isolation…. Success in this regard will promote competition and is our best chance to maintain technological leadership—and, along with it, long-term economic growth and consumer welfare and national security.
Similarly, comments from the Center for Strategic and International Studies (signed by, among others, former USPTO Director Anrei Iancu, former NIST Director Walter Copan, and former Deputy Secretary of Defense John Hamre) argue that the draft policy statement would benefit Chinese firms at U.S. firms’ expense:
What is more, the largest short-term and long-term beneficiaries of the 2021 Draft Policy Statement are firms based in China. Currently, China is the world’s largest consumer of SEP-based technology, so weakening protection of American owned patents directly benefits Chinese manufacturers. The unintended effect of the 2021 Draft Policy Statement will be to support Chinese efforts to dominate critical technology standards and other advanced technologies, such as 5G. Put simply, devaluing U.S. patents is akin to a subsidized tech transfer to China.
With Chinese authorities joining standardization bodies and increasingly claiming jurisdiction over F/RAND disputes, there should be careful reevaluation of the ways the draft policy statement would further weaken the United States’ comparative advantage in IP-dependent technological innovation.
In short, weakening patent protection could have detrimental ramifications that are routinely overlooked by policymakers. These include increasing inventors’ incentives to vertically integrate rather than develop innovations collaboratively; reducing startup activity (especially when combined with antitrust enforcers’ newfound proclivity to challenge startup acquisitions); and eroding America’s global technology leadership, particularly with respect to China.
For these reasons (and others), the text of the draft policy statement should be reconsidered and either revised substantially to better reflect these concerns or withdrawn entirely.
The signatories to the comments are:
|Alden F. Abbott
|Senior Research Fellow, Mercatus Center
George Mason University
Former General Counsel, U.S. Federal Trade Commission
|Torrey H. Webb Professor of Law
University of Southern California
|Ronald A. Cass
|Dean Emeritus, School of Law
Former Commissioner and Vice-Chairman, U.S. International Trade Commission
|Jean Monnet Chair in European Innovation Policy and Associate Professor of Competition Law & Economics
University of Basilicata and LUISS (Italy)
|Richard A. Epstein
|Laurence A. Tisch Professor of Law
New York University
|Executive Director, Tusher Initiative at the Haas School of Business
University of California, Berkeley
|Justin (Gus) Hurwitz
|Professor of Law
University of Nebraska
|Thomas A. Lambert
|Wall Chair in Corporate Law and Governance
University of Missouri
|Stan J. Liebowitz
|Ashbel Smith Professor of Economics
University of Texas at Dallas
|John E. Lopatka
|A. Robert Noll Distinguished Professor of Law
Penn State University
|Founder and Managing Partner
|Geoffrey A. Manne
|President and Founder
International Center for Law & Economics
|Professor of Law
George Mason University
|Austin E. Owen Research Scholar and Professor of Law
University of Richmond
|Vernon L. Smith
|George L. Argyros Endowed Chair in Finance and Economics
Nobel Laureate in Economics (2002)
|Daniel F. Spulber
|Elinor Hobbs Distinguished Professor of International Business
|David J. Teece
|Thomas W. Tusher Professor in Global Business
University of California, Berkeley
|Joshua D. Wright
|University Professor of Law
George Mason University
Former Commissioner, U.S. Federal Trade Commission
|John M. Yun
|Associate Professor of Law
George Mason University
Former Acting Deputy Assistant Director, Bureau of Economics, U.S. Federal Trade Commission