An Economic Analysis of Patent Law Exemption for Research on a Patented Invention Reiko Aoki (Kyushu University, Hitotsubashi University, RIETI) Sadao Nagaoka (Hitotsubashi University. RIETI) 2 nd ATE Symposium 15 December 2014 UNSW Business School

2 Research Exemptions Research use of patented inventions Whether and how research use of patented inventions should be exempted? Alternative views: -No exemptions (except for private individual use) -“Research on the subject matter ” be exempted but “research with the subject matter” should not be exempted Integra vs Merck -“Research for non-commercial (academic) use ” be exempted. Duke vs Madey

3 Research on the subject matter and its exemptions Verification, evaluation, improvement (but infringing) and inventing-around or leap-frogging (non-infringing) Two types of innovation process and model Pioneer and follower research model – Scotchmer (2004) → “research exemption harms follower” Perpetual R&D competition model –Each firm is both a pioneer and a follower.

4 Pioneer and Follower Research Model (extending the Scotchmer (2004) )

5 License choices and timing with and without Research Exemption NO research exemption: Ex-ante License is forced on a licensee –A licensor will give a license before undertaking research (investing), since, if not, no research will take place Research exemption (research is not infringing): Ex-ante license is an option –If no ex-ante license, the licensee will get an ex- post license at production stage only if there is successful improvement

6 Failure Improvement Leap-frog

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12 Perpetual R&D Competition Model Perpetual stochastic R&D innovation process, where each firm is leap-frogged by a drastic innovation by another firm continuously. Each innovation uses the past innovations as its knowledge basis and it in turn contributes to future innovations

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Incumbent and Entrant 14 Innovation Supply Curve Innovation Benefit Curve

Supply and Benefit Curves 15

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Effect of Research Exemption 17 Segal and Whinston 2007 Research Exemption Transaction cost & license payment decreases IB shifts upward Investment increases

R.E. vs Shorter Leading Breadth Both weaken forward protection (shifts profit from pioneer to follower) Shorter leading breadth changes both size and distribution of profit –Shorter time for pioneer to collect profit –Leading breath can be too short or too long R.E. only changes distribution –All firms are pioneer and follower – same profit –Makes marginal profit larger → more incentive 18

19 Conclusion on the exemption of research on subject matter Economic effects depend critically on innovation process. Eliminates transaction cost and double marginalization in perpetual competition and enhances the innovation by increasing the gain from becoming the incumbent Can reduce economic welfare by discouraging efficient ex- ante contracting in the context of a pioneer and follower research context. The best approach might be to provide broad research exemption on the research on subject matter, while stronger protection is provided for pioneer invention in terms of the breadth of claims.