Podcast: What Happens to the Economy When Patent Protections Are Weakened, With Jonathan Barnett

Robust intellectual property rights provide the incentives necessary to drive innovation by allowing markets to form for tangible and intangible assets. Without them, incentives get distorted and innovation slows. Rob and Jackie sat down with Jonathan Barnett, director of the Media, Entertainment and Technology Law Program at USC’s Gould School of Law, to discuss the recent history, current political dynamics, and economic stakes associated with patent protections.

Mentioned

• Jonathan Barnett, “The Great Patent Grab” (August 20, 2021). In The Battle over Patents: History and Politics of Innovation (eds. Stephen H. Haber and Naomi R. Lamoreaux, Oxford University Press 2021), USC CLASS Research Paper No. CLASS21-48, USC Law Legal Studies Paper No. 21-48.
• Robert D. Atkinson and Michael Lind, Big Is Beautiful: Debunking the Myth of Small Business (The MIT Press, 2019).
• Stephen Ezell, “TRIPS Waiver on COVID-19 IP Rights Wouldn’t Help Vaccine Access; It Would Just Harm Innovation,” ITIF Innovation Files, March 19, 2021.
• Stephen Ezell, “The Bayh-Dole Act’s Vital Importance to the U.S. Life-Sciences Innovation System” (ITIF, March 2019).

Auto-Transcript

Rob Atkinson: Welcome to Innovation Files. I’m Rob Atkinson, founder, and president of the Information Technology and Innovation Foundation.

Jackie Whisman: And I’m Jackie Whisman. I head development at ITIF, which I’m proud to say is the world’s top ranked think tank for science and technology policy.

Rob Atkinson: This podcast is what the kinds of issues we cover at ITIF from the broad economics of innovation to specific policy and regulatory questions about new technologies. And today we’re going to talk about intellectual property and e-trust and how that all can work together to either maximize or frankly limit innovation.

Jackie Whisman: Our guest is Jonathan Barnett, who is director of USC law school’s media entertainment and technology law program, and the author of Innovators, Firms, and Markets, The Organizational Logic of Intellectual Property. He specializes in IP contracts, antitrust and corporate law. Welcome Jonathan. Thanks for being here.

Jonathan Barnett: Well, thanks for very much for the opportunity to appear on your podcast.

Jackie Whisman: You write in a fascinating chapter titled The Great Patent Grab, in the forthcoming book that stated “Starting in the late new deal, the effective strength of patent protection declined substantially driven by weak patent and strong antitrust enforcement. This patent hostile environment, persisted for several decades, culminating in the antitrust litigation and compulsory licensing order against Xerox in 1975”. What led you to write this? And can you say more about your findings in the chapter?

Jonathan Barnett: Sure. What I tried to do in this project was use history to inform current policy debates. We’ve had a very vigorous policy debate going on in this country for at least the past 15 years about how strong patent protection should be. And the argument that’s been winning the day and has resulted in significant policy actions is that patent protection should be weakened. And it has been weakened considerably. Why is this period in US history of importance to this policy debate? Because it provides us with roughly four decades of a natural experiment to see what happens to the US innovation economy. When you significantly reduce the availability and the strength, the patent protection during this period of time, they went further, significantly further than we have done so far. And we can learn from that period to see what might happen. If we continue to go down the road, we’ve been going for roughly the past 15 years of progressively reducing the protections that are available to inventors and the investors in inventors.

Rob Atkinson: John, I just want to add one other point, which I thought was really interesting from your article or your chapter. And it was also something that I wrote about with my colleague, Michael Lind in our book, Big Is Beautiful. It was a weakening of patent protection. A lot of it, not all of it, but a lot of it also through the guise of antitrust, it was like, “Well, we’ll weaken their patents and then somehow we’ll get this magical more competition. And that will be beneficial”. Can you say a little bit more about that avenue?

Jonathan Barnett: Sure. There are basically three policy actions going on that were affecting the strength of patents during this postwar period. The first was in the courts, very difficult to enforce a patent and some courts less than 20% of patent owners were able to uphold the validity of their patents, on average. The second as you refer to as the use of antitrust and what happened there was over 130 compulsory licensing orders were issued against US corporations, including some of the largest corporations of the day. This would be as if the FDC or DOJ antitrust today, forced companies like Google or Qualcomm or Facebook or Merck to open up their patent portfolios and license them to any interested party. That’s what happens during this period.

The third policy step was the infusion of public R and D money, which was a gift with strings attached. Those strings, essentially either prohibited or strictly limited the recipients of that money from ever patenting or being able to exclusively license out the inventions that they developed using that money. So essentially what happened during this period of time is that the US innovation system was socialized to a great extent. It was largely supported by public money and it was difficult to monetize R and D through the patent system. And as you mentioned, that happened both through the vehicle patent law and through the vehicle of the antitrust laws.

Jackie Whisman: In figure one is fascinating where you list all the compulsory licenses by firm and by year, what were some of the more prominent cases that you would call out?

Jonathan Barnett: Yeah, there’s a lot of big ones. You have Alcoa at the beginning, you’ve got GE, RCA, Kodak, DuPont, mostly in the fifties, late fifties, early sixties, and then rounding up the lineup. It ends with Xerox in 1975. The one I would like to focus on is Alcoa. One of the earliest targets and they were embroiled in an antitrust litigation with the government and the compulsory licensing order was part of a remedy by which Alcoa essentially negotiated its way out of a breakup of the company. Now what I did, I did a before and after on Alcoa, what did Alcoa’s innovation activity look like before the order? And after the compulsory licensing order. In the compulsory licensing order that Alcoa was subject to was particularly stringent because it applied to all of its future patents. It also required Alcoa not only to license anyone who was interested in the patents, but to transfer knowhow to those licensees, to show them how to use those patents.

Well, what I wanted to see is did this discourage Alcoa from investing in innovation and did it change the way Alcoa monetized its innovation. And in fact, what I found using indirect measures is Alcoa continue to invest significantly in innovation about the same amount in terms of the number of employees that were devoted to it. But two important changes I observed the first is that their patenting rate plunged, which makes perfect sense. Why are you going to invest in patents that you would have to transfer over to competitors? But the second, which should raise great concern is that they shifted the type of innovation they were doing. They shifted towards process innovation. Now, why would you do that? Because process innovation is hard for competitors to observe. And so what the late new deal inspired and post-war patent policy achieved, did it compel, did it induce companies like Alcoa to spread their knowledge through the market?

No, it did not. It caused them to shift over to a different way to monetize innovation, which can be summed up in one word secrecy. And so what we get, is we get in terms of output, perhaps roughly the same amount of innovation, but we lose in two respects as a matter of public policy. One, the information is not circulating as much through the market. And the second is that we were shifting towards innovation that is essentially taking the technology we have and learning how to make it just a little bit better, a little bit more efficient. What we’re losing are radical innovations, transformative innovations that disrupt industries. And that’s ultimately, I think the big loss in this policy loss in this postwar, weak patent period.

Rob Atkinson: You know, Jonathan, you mentioned, I mean, just to remind the listeners to get a patent, you must publish, you must make it open to what you’re doing, what your invention is, but then you have the rights to keep that to yourself for 20 years. And so it has the best of both worlds. If you will. You know, one of the things you mentioned when you were describing that, it made me think of China because that’s really what China does with foreign companies. They say you want to come into our market. You not only for many of these companies and industries like telecom equipment, you not only had to basically give your knowledge away, but you had to train your competitors. For example, when some of the major foreign American and other telecom equipment companies went in there, they actually helped Huawei and ZTE because they had to, one of the things that struck me with your piece is you noted RCA.

And for people who don’t remember RCA extends for Radio Corporation of America, which was established in world war I, and to pay for, by the way, the Marconi patents because the Navy, we needed our own radio system. And then it became the world’s leading, a consumer electronics company. It was the pioneer of television, color television and the justice department didn’t like them. And there was a study at the time that later that showed that they’re quote, “monopoly” or oligopoly or whatever market leadership role raised the price of color televisions by about two and a half percent. But it was also one of the most innovative companies in the world. And also they not only did product innovation, but process innovation. And there’s a very good study by a scholar at Rensselaer Polytech who showed that, just taking the benefits of their process innovations that leaked out because engineers would know each other, drove down the price of televisions, way more than the 3%.

And yet what RCA had to do because of the government was they could no longer make money licensing. So they used to license their patent portfolio quite extensively to American firms. They had to give it now for free. So then they instead licensed it to companies like Sony and [Matsushutsu 00:10:01] of Japan so much so that the head of RCA was given some big Japanese award because he single handedly helped the Japanese. So it was one of those weird things or it didn’t really, maybe it lowered prices by letting Japanese television happen. So it seems like policy makers just weren’t... It wasn’t even on their radar screen to think about those kinds of second order effects.

Jonathan Barnett: Yeah, of course. When you have a compulsory license in the very short term, we’re going to see a price reduction in our existing technologies. But I think it is widely acknowledged that over the medium to the long term society is going to do far better off by having the incandescent light bulb invented and replacing the kerosene lamp rather than sticking with the kerosene lamp and making that a little bit cheaper. And other example is the Xerox compulsory licensing order in 1975. Again, a very stringent order applied to all future patents required the provision of knowhow. That company was essentially destroyed as a result of that compulsory licensing order because its technology was freely imitated by competitors. Now did the US consumer get a cheaper photocopying machine in the immediate short term? Yes they undoubtedly did. But what was the damage done to the innovation incentives in the US economy?

I think they may have been quite significant, especially, especially when we look at the timeline of Xerox. Xerox launched its first photocopier in 1959. Right? So that means it only had 16 years in which to enjoy its patent base franchise it’s spent in excess of 15 years perfecting that technology. That doesn’t sound like a very good trade off that you spend so much time being the pioneer of a new technology to have it expropriated relatively shortly after that. And we do see in the 1970s we see for the first time, if you look from the end of world war II through the present, the 1970s, our national R and D intensity, which is the percentage of total GDP devoted to R and D. We see a significant decline during that time, we see a lot of policy discussion about the decline, the downfall of US innovation.

We see many of these fortune 100 companies that were targeted by these compulsory licensing orders. Companies like Alcoa or RCA who were once called innovation leaders. And in fact they were, became innovation laggers. It is these types of observations. I think this is forgotten today that led up to the two signature events that launched the strong patent regime that was initiated in the early eighties. That was the enactment of the Bayh-Dole act in 1980 and the establishment of the federal circuit in 1982. These two acts were not conspiracies in order just to divert monopoly rents over US big business. They were a good faith attempt to restore a property rights baseline to re incentivize US innovation. And if we have time on the podcast, I can talk about some other evidence that’s not in this paper, but which I’ve written about afterwards, which shows you how quickly, how beautifully, the US market reacted to that bolstering of property rights for the innovation sectors.

Rob Atkinson: Yeah. I’d love to segue way over to Bayh-Dole and that era because it relates to, Bayh-Dole. One of the key reasons why the US went in that direction in part was because we saw, basically the old regime, we saw that it had gone too far, that it was well intentioned, but it really failed. And so, “Okay, well we better recalibrate”. But the second reason was, and it was related to the first failure was the fries of foreign competition. That was a big motivator behind senator Bayh and senator Dole doing Bayh-Dole. But you know, one of the things with the Xerox case is at the time the chief economist at the FTC, he said, “We won’t be happy unless Xerox market share is cut in half within the next three years or so”. It was cut in half in the next three years with virtually all of that market share, being taken by Japanese companies. Well maybe the FTC said that was fine. Maybe they didn’t care about shipping jobs over to Japan. But I think most Americans would say, “Why are we robbing a major American leader and then letting Japanese companies have that technology without even paying for it?” What are your thoughts on that?

Jonathan Barnett: Yeah, I think one of the contributions when the Chicago school revolutionize antitrust is that we don’t want to aim for any particular industry structure. Different industry structures can give us different positive or adverse economic effects or effects as a matter of innovation policy. What we want to do is we want to look at outcomes. So for certain types of innovation, large firms can be very conducive for certain other types, small firms. Most of the time, what we see in healthy innovation ecosystems is we see a symbiosis between large firms that have the scale economies in production and distribution and small firms that tend to be very good at innovation. That was one of the downfalls of the weak pattern regime during the post-war period, because it created an innovation environment that was only conducive for large firms. And that probably explains in part why the US started falling behind in terms of innovation leadership during that time.

Rob Atkinson: Although to be fair, giving away IP to foreign companies. I mean the same thing happened with regard to Bell Labs, where they were essentially forced by the justice department to license the transistor at way way below market costs. And the Japanese were able to buy it because the Japanese had almost no foreign exchange reserves or you know, money. So Bell Labs never would’ve done that. They would’ve licensed in a different way. So in a way it’s market distortions also that are forcing these strange things to happen.

Jonathan Barnett: Well sure. Whenever we move away from robust property rights protection, whether it’s tangible goods, where there would be no disagreement, but the same logic applies with intangible goods. What you’re doing is you’re not allowing markets to form around these intangible assets. You’re not allowing the market to price out these assets and you’re not allowing the market pricing signaling and resource allocation function. And so everything gets distorted. That’s why, let’s go back to the Alcoa case. They could have always had a secrecy based strategy. They could have always focused on process technology under a more complete property rights regime. They didn’t choose to do that. So the fact that they reacted that way only once property rights were pulled out from under them, suggest that they were adopting a second best strategy.

Rob Atkinson: Yeah, I’d also I’ve read, although I’m not an expert on this, that one of the problems with the Alcoa case, was Alcoa was so productive that even though they may have had some pricing power that pricing power is essentially offset by the fact that because of the economies of scale and others, that they’re able to lower the price of aluminum so much. So it was like, we didn’t like the monopoly part, but we didn’t recognize the low cost just from their efficiencies.

Jonathan Barnett: Oh sure. You know, absolutely. Alcoa is one of the best studied antitrust litigations because they were pursued both in the twenties and again in the forties, by the government. This is almost your classic example of economic efficiency, the reward being government persecution. And you’re absolutely right. In a nutshell, what the studies about Alcoa have found is that they were so efficient through the economies of scale that they benefited every economic segment that they touched in bringing down the price of that essential input that they were supplying. And in fact, the only monopoly rents that they accrued were attributable almost entirely to the tariffs that were imposed on foreign producer. So otherwise would’ve been able to answer the market at competitive pricing level. So they produced tremendous efficiencies and they passed on most of those efficiencies to the intermediate and the end users.

Rob Atkinson: Interesting. That’s fascinating.

Jonathan Barnett: Yeah.

Jackie Whisman: One issue that has been front and center since the COVID 19 pandemic began, is compulsory licensing with some arguing that government should force vaccine companies to give up their licenses, especially to developing nations. Stephen Ezell at ITIF has written a ton on why we oppose that, but I’d like to hear your take and why.

Jonathan Barnett: I think there’s two main reasons why that would be misguided. Although I understand it is well intentioned than I agree fully with the policy objective of maximizing access to necessary drugs. And at the same time incentivizing innovation of new and improved therapeutics. The first reason why I think that does not have a sound policy basis is that there is almost no industry that provides a better empirical case for the patent system than pharmaceuticals. And the reason is that the cost of developing a pharmaceutical drug all the way from the very first day in the lab, all the way until it’s released in the market with FDA approval is currently in excess of $3 billion, including the costs on projects that fail, which are most of them. And the cost of imitating those drugs through generics are far, far lower.

And so there’s really no empirical case that I’m aware of that a privately funded pharmaceutical market could sustain itself without robust patent protection. The second reason that I think that this is misguided is that we had talked earlier about the patent disclosing information through the fact that it’s published once it’s issued. But there’s another way in which a pattern discloses information, which is that what a pattern does, is it essentially it takes my pharmaceutical innovation and puts it inside. What I like to call a property envelope. That property envelope is very useful because now we can transact over it. Let’s say I’m a company called BioNTech and I’ve come up with a new mRNA based vaccine technology. But I do not have the capacities to produce and distribute on a mass scale.

Since I can take my technology and put it in the property envelope we call patent, I can then talk to companies like Merck or Pfizer. Maybe I’ll settle on Pfizer and we can enter into a partnership that is a policy win on every way you look, it’s a policy win for innovation. It’s a policy win for getting that product out into the market faster and more cheaply than would otherwise be possible. And so I completely agree with the objective of those who are seeking things like compulsory licensing and IP waiver, but I feel that the means that are being recommended to do that will be counterproductive to a very great extent.

Rob Atkinson: Well Jonathan, the other thing about that, again, I think most of the people who want weak IP, I would call them... And if you remember Baba Ram Dass, but you know, he was that guy and he had this thing “Be here now” that was his thing. You know, we’re supposed to meditate and chant “Be here now” that’s those folks Be Here Now. So if we can get compulsory licensing for the next year, we’re in good shape. And they don’t think about be here in 20 years, the next big pandemic, and we want to have incentives. So your point about reducing the incentives a hundred percent agree. But the other point which we had talked about before, when we were just chatting, there’s a massive overproduction, not overproduction, certainly this global capacity now to produce vaccines. We’re not running out of vaccines. If anything, we have almost too much capacity. So it’s one of those things that’s trying to solve a problem that doesn’t really appear to exist.

Jonathan Barnett: Yeah. That seems to be what the evidence suggests. And even on the Be Here Now points to use your phrase. You know, I think a lot of... some of the economic literature on patent and policy sort of has what I call a Eureka model of innovation where there’s that Eureka moment of innovation. And then in the next sequence it’s already in the store. Okay. But that’s not at all how innovation works. In fact, what most of innovation about is commercialization is about figuring out the production process and the distribution. That’s also part of Be Here Now. And the pattern is going to facilitate that because it’s going to allow a pharmaceutical company to work with partners in developing countries to set up manufacturing facilities, set up distribution facilities. The patent in and of itself is not going to facilitate doing that. And a patent that is compulsory license is obviously going to dis incentivize the patent owner from deploying personnel and investing resources in facilitating the dissemination of that technology.

Rob Atkinson: No, that’s a good point.

Jackie Whisman: And this brings us back to Bayh-Dole anti IP advocates claim, the government can use so-called March-In rights to lower drug prices under Bayh-Dole. Can you explain maybe quickly, because this is our last question. Can you explain what March-In rights are and whether the Bayh-Dole act actually allows this sort of thing?

Jonathan Barnett: Sure. March-In rights under the Bayh-Dole act are triggered under four scenarios and I will not discuss all four. I will only discuss the one that is being relied upon as the purported basis for the government to intervene, to essentially impact the prices at which drugs that can be traced back to federal R and D funding that those prices could be regulated through that provision. All that particular exception refers to is this scenario in which the patent owner is not making efforts to technically complete and execute the patent. It makes no mention of prices. And beyond that, the legislative history, everything that we know about why the act was enacted, and I would be surprised if you would find anything to the contrary in the committee reports. Bayh-Dole was explicitly designed to cure what was a patchwork of policies across different federal agencies, about the extent to which recipients of federal R and D funding could then assert legal exclusivity through the pattern or any other means.

Why did this patchwork arise? Because at the beginning of the postwar period, there had been a general federal policy that the taxpayer had paid for this R and D and therefore, it should not be patented, or if it is patented, it should be made exclusively available to everyone. There were multiple commissions and reports issued throughout the postwar years and a common theme recurs over and over, the knowledge is available for everyone to use and no one wants to use it. And the reason for that is very simple. Why would a business invest tens or hundreds of millions of dollars in cultivating an intangible asset and at the end of which they are not going to have exclusivity over that product, as a result of that different federal agencies, the DOD in particular had to continuously attenuate and create limitations to give some exclusivity to contractors.

The beauty of the Bayh-Dole statute was that it just wiped all that away. And it said, you take federal money for R and D. We want you to take that off the shelf, and we want you to invest in creating commercially viable products and services. And if we had more time, we could talk about the biotech sector and how the biotech sector flowered, especially through startups on the basis of that firm assurance, there are limited exceptions in the statute. The legislative history makes clear it has nothing to do with price controls. And the legislative history makes clear that any exception that we see in the statute should be read exceedingly narrowly because the statute was explicitly enacted in order to provide assurance to investors that 99% of the time, the government is not going to use those March-In rights and guess what? To this day they never ever have.

Rob Atkinson: It’s a great story. I actually used to work for the guy who was a chief of staff for senator Bayh or not chief staff, he was the main person in that bill. You know, one of the other things about that is Stephen Ezell has done some great work, looking at the rate of innovations from federally funded research pre Bayh-Dole and post. And it’s really night and day. Jonathan, I feel like we could go on, this is such a fascinating set of issues. And we only really just touch the surface of your paper, which I guess will be coming out in a forthcoming book. Is that right?

Jonathan Barnett: Yes, that’s true. Actually I believe it might be up on Amazon already, so.

Rob Atkinson: Oh, good. Well, we’ll link to it. Wonderful. So anyway, thank you so much. It was really great.

Jonathan Barnett: Okay, great. Thank you.

Jackie Whisman: And that’s it for this week. If you liked it, please be sure to rate us and subscribe, feel free to email show ideas or questions to podcast at ITIF.org. You can find the show notes and sign up for our weekly email newsletter on our website. ITIF.org and follow us on Twitter, Facebook and LinkedIn at ITIF DC.

Rob Atkinson: We have more episodes and great guests lined up. New episodes will drop every other Monday. So we hope you’ll continue to tune in.