INSTITUTIONAL DESIGN FOR CHINA’S INNOVATION SYSTEM: Implications for Intellectual Property Rights China March, 2007 Joseph E. Stiglitz

The role of intellectual property Part of society’s innovation system To provide incentives to innovate –By allowing innovator to restrict use of that knowledge –Thereby obtaining a return on his investment in knowledge There are other parts of society’s innovation system There are other ways of financing and producing research –Universities, government supported research labs –Open source movement –Financial returns are only part of incentive system of scientists –In many areas of research (basic science) patents play small role There are other ways of providing returns on knowledge than patents –Trade secrets, first mover advantage There could be still other ways of providing incentives –Prizes

Key question The role of the patent system within this broader innovation system The design of the patent/ipr regime –What can be patented, breadth of patent, standard of novelty, etc. –Procedures for granting patents/challenging patents –Rules for patent enforcement –Responsibilities as well as rights—requirements for disclosure –Restrictions—not to engage in abusive anti-competitive behavior; compulsory licenses How these questions are answered can affect the efficiency of the economy and its innovativeness –There are large costs to the current patent system –Are there reforms which would improve its efficiency?

China’s Innovation System These questions are especially important for China today One of China’s main challenges is closing the knowledge gap, that separates it from more advanced industrial countries –In spite of huge progress, gap remains large –The wrong IPR regime could make it more difficult to close the knowledge gap

One of central elements in 11th five year plan is the design of institutions for China’s distinctive market economy Western system has been highly productive –Based on strong government support of basic research –But also highly distorted Expenditures on marketing/advertising vs. research; direction of research (me-too drugs and life style drugs vs. life-saving drugs; life-saving drugs for rich vs. life-saving drugs for poor) Monopoly system associated with patents means knowledge is not used efficiently –And in some cases has actually retarded innovation

–What is needed is a development oriented intellectual property regime, designed for China’s stage of development As in other areas, one size fits all policies don’t work America’s IP system is not good for America And is even more poorly suited for China China needs an innovation system that focuses on economizing on resources –Innovation system in West focuses on economizing on labor –Can result in high levels of unemployment –Part of broader institutional infrastructure for the innovation system

Innovation system illustrates several general themes Institutional structures that are appropriate for one country may not be the best for another –One size fits all doesn’t work –Differences in circumstances, history –Differences in objectives This is true of property rights system (including intellectual property rights) –Even formulation needs to be changed –Responsibilities as well as rights –Key role of restrictions –These are social constructions that need to be adapted to the circumstances, history, and objectives of each country

Knowledge as a public good Fundamental problem is that knowledge is a public good –In fact, it’s a global public good no marginal cost associated with use intellectual property circumscribes its use and thus necessarily causes an inefficiency

But not only does IP create a distortion by restricting the use of knowledge They create an even worse distortion—a (temporary) monopoly power –Social costs of distortion especially high in the case of life-saving drugs –IPR is often used to leverage (further) monopoly power (Microsoft) Long history--automobile Ordinarily, property rights are argued for as a means of achieving economic efficiency –Intellectual property rights, by contrast, result in a static inefficiency, justified by the dynamic incentives –Any method of raising funds has a social cost, but patent system is not “optimal” way of raising money (not optimal tax)

Recent advances in industrial organization suggest that costs may be far higher than previously thought –Schumpeter was wrong about temporary nature of monopoly –Monopoly power once established can easily be perpetuated –Particularly evident in case of network externalities, switching costs (including “learning”) And that benefits may be lower than previously thought –Incentives for R & D may be less –Distortions in the direction of research

Further costs High administrative costs (patent suits) High levels of uncertainty –Intrinsic uncertainty of research –Compounded by risk of patent infringement Risk of litigation

Losses of dynamic efficiency Question—can one obtain dynamic benefits at lower static costs? Worry: The patent system may even be slowing down the pace of innovation Fundamental problem: rewards do not correspond to marginal social returns –Marginal social return is having the innovation available earlier than it otherwise would have been Contrast clear in case of human genome project –Further distortions arise from monopoly rents –Much of returns can arise from “enclosing commons” In this case there is a cost, but no benefit Evident in controversy over bio-piracy

Why patents may slow innovation Knowledge is the most important input into the production of knowledge –Especially of concern when patents involve ‘enclosing the commons’ –Intellectual property rights restrict access to knowledge Incentives for innovation with monopoly less than in more competitive market place –Monopolist can increase profits by discouraging innovation by rivals and raising rivals costs (Microsoft) Patent conflict (patent thickets) can impede innovation –Development of the commercial airplane Much of R &D activity directed at circumventing or strengthening monopoly –Not at creating new products and lowering costs which enhance welfare IMPLICATION: STRONGER INTELLECTUAL PROPERTY RIGHTS MAY NOT LEAD EVEN TO FASTER PACE OF INNOVATION

Key tasks facing Innovation system Selection of projects and researchers Financing –Knowledge is not costless, so there has to be some way of financing it Risk absorption Incentivizing Dissemination

Key attributes in evaluating different parts of innovation system How well they perform these roles Costs they impose on the economic system –Patent system’s high transactions costs –Transactions costs Well designed innovation system will be a mixed system –But are we relying to heavily on the patent system? –And is the patent system well designed for achieving the objectives?

Critique of patent system Besides large static and dynamic distortions Finance –REVENUES FOR RESEARCH PROVIDED BY MONOPOLY PROFITS –DIFFERENCE BETWEEN PRICE AND MARGINAL COST CAN BE VIEWED AS A ‘TAX’ ONE DESIRABLE PROPERTY: ‘BENEFIT TAX’ BUT IN MOST OTHER ARENAS, ONLY LIMITED RELIANCE ON BENEFIT TAXES –INEFFICIENCY AND INEQUALITY

Bias towards excessive patenting Fighting a patent creates a public good (open access) While patenting knowledge makes a public good private There will be underinvestment in fighting bad patents Problem can be exacerbated by bad procedures

INEQUITIES ASSOCIATED WITH IPR KNOWLEDGE AS A GLOBAL PUBLIC GOOD SHOULD BE FINANCED BY THOSE MOST ABLE TO PAY IPR DOES NOT RECOGNIZE DIFFERENCES IN CIRCUMSTANCES— OTHER THAN EXTENT TO WHICH PROFITS CAN BE EXTRACTED

LEGAL SYSTEM CAN LEAD TO UNFAIR OUTCOMES HIGH COSTS OF IMPLEMENTING IPR INCLUDING HIGH COSTS OF CHALLENGING PATENTS –PUTS DEVELOPING COUNTRIES AT A DISADVANTAGE –EXACERBATING RISKS OF BIO-PIRACY PRESSURE NOT TO ISSUE COMPULSORY LICENSES AND TO HAVE STRONG IPR REGIMES REINFORCED BY INTERNATIONAL ECONOMIC INSTITUTIONS AND ‘MARKET’

Concerns of developing countries KNOWLEDGE AS A GLOBAL PUBLIC GOOD –SHOULD BE FINANCED BY THOSE MOST ABLE TO PAY –IPR DOES NOT RECOGNIZE DIFFERENCES IN CIRCUMSTANCES—OTHER THAN EXTENT TO WHICH PROFITS CAN BE EXTRACTED CURRENT SYSTEM PROVIDES LITTLE INCENTIVES FOR R & D ON DISEASES THAT AFFLICT THEM –PART OF PROBLEM OF BEING POOR IS THAT YOU CAN’T PAY MUCH WHAT SEPARATES DEVELOPING AND DEVELOPED COUNTRIES IS GAP IN KNOWLEDGE –TRIPS HAS MADE IT MORE DIFFICULT TO CLOSE THAT GAP –TRIPS should never have been part of WTO AT THE SAME TIME, PROVIDES LITTLE PROTECTION FOR THEIR INTELLECTUAL PROPERTY (BIO-PIRACY, PROTECTION OF BIODIVERSITY) DEVELOPING COUNTRIES HAVE CALLED FOR A DEVELOPMENT ORIENTED INTELLECTUAL PROPERTY REGIME –There is no reason to expect that the design of an IPR system which balances costs and benefits which is optimal for the U.S. would be optimal for a developing country

PRIZE SYSTEM AS AN ALTERNATIVE Current system is a prize system –Prize is monopoly power –Monopoly power means that there are incentives to restrict use of knowledge Prize associated with actuarial value of the social benefits, with licensing –Competitive market would ensure more efficient dissemination –Without waste on advertising, other anti-competitive behaviors design to enhance monopoly profits –Prize could be “contingent”—related to sales –Contingent purchase funds preserve monopoly system

Comparing alternative systems patentprizeGovernment funded selectionDecentralized, self-selection Lacks coordination Decentralized, self-selection Lacks coordination “bureaucratic” But can be more coordinated Finance (tax)Highly distortionary and inequitable Can be less distortionary and more equitable Most efficient riskLitigation riskLess riskLeast risk Innovation incentives Strong but distorted Strong, less distorted Cannot work when objective is not well-defined Dissemination incentive Limited-- monopoly Strong—using competitive mkts Strong Transaction costshigh

Conclusions The importance of IPR has been exaggerated IPR needs to be seen as port of a portfolio of instruments We need to strengthen the other elements of this portfolio And to redesign IPR to increase its benefits, reduce its costs