Designed for Innovation: The Structure of IPR regimes and the Evolution of Information Technologies Elad Harison, Presentation for the 2 nd EPIP Conference Maastricht, November 2003

The Economic Rationale of IPRs: Patents and copyrights are the main mechanisms of IPRs. Both were established when physical goods, and not intangible commodities, had prevailed. Economic rationale: Intellectual property rights (IPR) aim to guarantee economic incentives for innovation by legal provisions of monopoly over invention. IPR assist formation of new inventions: legislation supplies “monopoly over technology” for elongated terms in return to disclosure of technical know-how to a public domain (David, 1993). Since the inclusion of information technologies and goods in the scope of IPR protection (1981), the appropriability of patents and copyrights to protect software technologies and yet to preserve the pace of innovation has continuously been questioned from legal and economic standpoints.

Are Software IPRs Over-Protective?  Restrictive systems of IPR may hinder innovation by granting relatively broad monopolistic dominance over technological advances.  Patent literature implies reduction in the level of social welfare as a result of under-utilization of resources and inefficiencies in firms’ R&D, which results from patent races and monopolistic competition (Reinganum, 1982; Gilbert and Newbery, 1982).  Patenting (in) earlier phase of technological path guarantees dominance over applications in advanced stages of its evolution.  An overlap between patents and copyrights forms an over-protective regime (Samuelson et. al., 1994; Reichman, 1994).

Are Software IPRs Under-Protective?  High piracy rates in industrialised nations and in less-developed countries.  Higher incentives to innovate (Clapes, 1993).  Protecting software SMEs from predatory imitation by large firms (Heckel, 1992). Efficient allocation of R&D resources by agreed standards for development: compatibility and interfaces as a source of economic inefficiencies (Cohen, 1999). Accelerating the pace of innovation: Firms are encouraged to achieve advantages as “first-movers” in the market.

Aims:  To identify the desirable structure of the patent regime, in terms of length and inventive step, that generates maximal degree of technological progress.  To reveal the relationships between different degrees of IPR protection and market dynamics and firms’ decisions.  To assess how efficient is the present regime in furthering innovation in information technologies.

Basic Properties of Software Technologies: Cumulative Innovation: Innovation in software and information technologies is characterized by a sequential process in which “technical advance is cumulative, in the sense that today’s advances build on and interact with many other features of existing technology” (Merges and Nelson, 1990). Creative Destruction: Improved product versions are continuously released to the market by firms. Users diminish technological predecessors in favour of advanced products. Zero-marginal cost.

The Model: Heterogeneity: Firm i develops and competes with a software application with j features. The scales of technical quality (performance) of the product features are denoted: Q i (t) = {Q 1, …, Q j } User n embraces j (unchanging) preferences for the technology, denoted:  n = {  1n, …,  jn }

The Model: Innovation vs. Imitation: Every period, each firm selects one technical feature, J i (t), for development: J i (t) = { j  J Ⅰ U i (t) j i (t) =Max(  j -Q ij (t)), ∀  j >Q ij (t) } Firms devote a fixed share of their revenues to R&D / to reverse- engineering of unprotected, superior products (Abi-Saad et. al., 2001): RD i (t) =  ·R i (t-1) ;  i (t) = (1-  )· R i (t-1) Following Klette and Griliches (1998) and Arora et. al. (2003), the technological progress is positively correlated with R&D: q ij (t) = q ij (t-1)+  ij (t) ;  ij (t) ~ N(ƒ a (RD(t)  ),  ) Firm invests in R&D if the sum of accumulated technical know-how and the expectancy of the technical progress (E  ij (t)) exceeds the maximal quality of unprotected features.

The Model: Patenting and release of new products: The patent regime is defined by length L and inventive step s, which are exogenously determined. Patents are represented as a vector:  j = { l j, H j, Q jp } Firm patents technical advances if: Q ij (t-1)+q ij (t) > Q jp +s Firm releases new product version without infringing existent patents, i.e. Q ij (t) = Q ij (t-1)+q ij (t), if: (a) It owns recent patents: i = H j. (b) Patents expired: t > l j +L (c) Inventions are sufficiently novel: Q ij (t-1)+q ij (t) > Q jp +s Pricing: P i (t) = P i (t), if i n (t)≠i n (t-1) (User changes technology) P i (t), if i n (t)=i n (t-1) (User upgrades technology)

The Model: 123

Adoption of Technology: Every period, users select which technology to implement on the basis of technical quality and price. The “distance” between user n’s preferences and the technical qualities of product i is: d in (t) =  [  j -q ij (t)],  j > q ij (t) The chosen product i minimizes the following target function: V in (t) =  ·d in (t) +  ·p i (t), ( ,  > 0) No infringements of IPRs by users or by firms. j

Results: Average Quality (after 50 periods):

Results: Average Quality (after 50 periods):

Results: Quality Variance (after 50 periods): 1 2

Results: Quality Variance (after 50 periods): 1 2

Results: The share of imitators: INNOVATE IMITATE

Results: Technical quality decreases when patent lifetime increases, ceteris paribus. Technical quality increases with the minimal inventive step under short and medium patent terms. The propensity of firms to imitate (to innovate) increases (decreases) with the minimal inventive step. The propensity of firms to imitate (to innovate) decreases (increases) with patent duration. Shorter duration of patents fosters competitiveness in software markets and, on average, superior level of technology. Removal of IPRs for software technologies produces quasi-optimal degrees of technical quality. However, those scales of performance are higher than the measures achieved under the conditions of the present regime.

Extensions of the model: Network externalities. Open Source development, hybrids vs. proprietary products. How IPR policies may change at the presence of skilled/unskilled users who can contribute to software development?