1. Innovation and Human Capital Accumulation

2. Innovation  Endogenous growth imperatives  Technological innovations that increase the productivity of fundamental inputs to production are the drivers of economic growth  Sources of innovation  Basic research  Applied research and development  Diffusion of new knowledge and know-how through education and on-the-job-training

3. Markets for Innovation  Public goods aspect of knowledge  Ideas are intangible but easily copied.  An idea, once it is communicated, cannot be made secret again. Hence, absent secrecy, the originator of an idea cannot exclude others from using the idea.  Ideas are non-rival in the sense that one person’s use of an idea does not diminish the availability of the idea for others’ use.

4. Markets for Innovation  Public goods aspect of knowledge creation means that this activity will suffer from the same economic problems associated with all public goods:  Free riding due to so-called “spillover” externality  Insufficient private production of new knowledge if generating it is costly  Need for public policy action to stimulate production

5. Human Capital  As we saw in our discussion of growth, human capital accumulation encompasses two distinct activities: research for innovation, and education  We will postpone discussing education until later in the course, and focus for now on innovations due to research

6. Research  National Science Foundation definitions: R&D. According to international guidelines for conducting research and development (R&D) surveys, R&D, also called research and experimental development, comprises creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of knowledge to devise new applications. Basic research. The objective of basic research is to gain more comprehensive knowledge or understanding of the subject under study without specific applications in mind. In industry, basic research is defined as research that advances scientific knowledge but does not have specific immediate commercial objectives, although it may be performed in fields of present or potential commercial interest.

7. Research  National Science Foundation definitions: Applied research. The objective of applied research is to gain the knowledge or understanding to meet a specific, recognized need. In industry, applied research includes investigations to discover new scientific knowledge that has specific commercial objectives with respect to products, processes, or services. Development. Development is the systematic use of the knowledge or understanding gained from research directed toward the production of useful materials, devices, systems, or methods, including the design and development of prototypes and processes.

8. Research  Funding sources and institutions

9. Research Incentives  The distinction in the NSF definitions and in the funding sources and institutions involved in basic versus applied research reflect the fundamental differences in incentives for doing each type of research

10. Research Incentives  Basic research  Recognition of peers  Membership in prestigious societies  Professional awards  Nobel prize  Access to resources  Government grants  Laboratory directorships  Priority of discovery  Naming rights  Publication and career recognition  Promotion and tenure  Administrative posts

11. Research Incentives  Fundamental characteristics that drive the incentive structure  Research projects build on previous science, but are not motivated by specific market-oriented goals  Basic research frequently finds answers to unposed questions  Example of invention of the laser  Outcomes are highly uncertain  Substantial risk of failure  Emphasis on priority of discovery severely restricts the value of being second with a new discovery, even though independent discovery occurs frequently  Winner-take-all reward structure

12. Research Incentives  Efficiency aspects of the reward structure  Possibility of independent discovery motivates scientists to exert effort in research  But don’t discount the play dimension of research as a motivator!  Establishing priority mandates revealing the discovery sooner rather than later  Allows for peer review and evaluation of the work  Discourages plagiarism and fraud  Encourages consensus building  Building and maintaining a reputation provides a natural check on shirking or free-riding

13. Research Incentives  Lags in development of applications and costs associated with turning new science into new technology reduce incentives for proprietization  Example of xerography  Process discovered in the 1930’s, but the first functioning copier based on the process didn’t appear until the end of WWII  Current issue of faster cycle of research in computer science and biotech areas have led to pressure to patent or otherwise protect what would normally have been considered basic research

14. Research Incentives  Applied Research and Development  Market-driven  Process innovations that reduce costs of production  Product innovations that bring new and/or better products to market  Rewards are proprietary and are funded from the rents accruing to the innovation  Rents are due to  First-mover advantages  Trade secrecy  Patents or copyrights that confer legal monopoly status on the innovation

15. Research Incentives  Characteristics that drive the incentive structure  Problem-oriented research  Proprietary products/processes as goal  Minimal uncertainty about outcomes  Problems with externalities  Knowledge spillovers that benefit competitors  Free-riding by competitors absent protection

16. Research Incentives  Problems arising from incentive structure for applied R&D  Because of spillover externalities, R&D innovations must either be kept secret, or provided legal protection against copying by competitors, if the innovator is to recover the costs of the innovation  The need for protection gives rise to the notion of intellectual property

17. Intellectual Property  Cost-benefit outline of IP protection  Trade secrecy  Beneficial new techniques don’t propagate through the economy  New innovations based on an existing but secret innovation are slowed

18. Intellectual Property  Cost-benefit outline of IP protection  Patents as an alternative to trade secrecy  Patents allow an innovator a legal monopoly over the innovation for a limited period of time. The monopoly position allows the innovator to earn rents (i.e monopoly profits) that compensate him for the costs that went into the innovation  In exchange for the monopoly position, the innovator is obliged to fully disclose the science and technology behind the innovation.  Other firms or inventors are then free to build on the ideas behind the patented innovation for new innovation

19. Intellectual Property  Cost-benefit outline of IP protection  Patent Law (U.S. version): to receive a patent on an innovation, the patentee must demonstrate that the innovation is  Suitable  Useful  Novel  Non-obvious

20. Intellectual Property  Details of requirements:  Suitability: Not all innovations can be patented U.S. patent laws permits granting patents to >Processes, such as new ways of brewing beer or depositing circuits on silicon >Articles of manufacture (tools or other gadgets) >Compositions of matter >New and useful improvements on any of the above >Plant varieties which are produced asexually >Ornamental designs for articles of manufacture

21. Intellectual Property  Utility: To be patentable, an innovation has to have commercial utility >In practice, this is not a very high hurdle, since it is relatively easy to argue that there will be a market (however small) for any innovation >Example: U.S. patent no. 5,023,850 was granted for a wristwatch for dogs, which runs at 7 times normal speed.  Novelty: Is the innovation actually new? >This aspect is a frequent basis for challenging patents in court >Patents for which there is documented “prior art” can be overturned by the courts

22. Intellectual Property  Non-obviousness: in addition to novelty, the innovation must be such that no one else would have thought of it before >Current dispute over the granting of patents for business practices is based on the non-obviousness requirement >Amazon.com’s patent on “one-click shopping” »Most programmers consider this an obvious improvement to online shopping procedures and do not think it should have been granted a patent >Example of possibly allowing a patent to the New York Times for the idea of laying out copy in columns.

23. Intellectual Property  Patent application process  When an innovator files for a patent, they must provide a detailed description of the innovation which will be made public upon the awarding of the patent  After filing, the patent application is assigned to an examiner at the U.S. Patent and Trademark Office  Examiner reviews patent to determine if it satisfies the criteria for granting a patent  Once the examiner determines that the criteria are met, the patent issues and the innovation is publicized

24. Intellectual Property  Patent Challenges  Challenges to a patent are adjudicated by the Court of Appeals for the Federal Circuit (CAFC) >CAFC was created by Congress in 1982 to centralize the process of deciding on patent challenges >Prior to creation of CAFC, regional appellate courts handled cases, often issuing different opinions on similar cases  Challenges must be based on an assertion that some aspect of the patent criteria was not met

25. Intellectual Property  Challenges to novelty are the most common >Based on the assertion that PTO examiners overlooked “prior art”, either in the form of previous patents for similar innovations, or non-patented but common usage of similar innovations >Under U.S. patent law, priority for an innovation goes to the innovator who can demonstrate earliest actual working use of the innovation. Under European law, priority goes to the innovator who files first for a patent  Challenges to obviousness are also possible, but less frequent  Absent a successful challenge, patent protection for an innovation last 20 years from the date of issue

26. Intellectual Property  Patent Infringement  If a patent is found to be valid, it becomes, in effect, the property of the patent holder  Anyone else who uses the patented innovation without the express permission of the patent holder is then said to be infringing the patent  Patent holders can sue infringers to force them to stop using the innovation, and can also sue for damages if the infringer’s use of innovation took business away from the patent holder

27. Intellectual Property  In addition to patents, the U.S. PTO also grants intellectual property rights to trademarks  Trademarks are language, art or iconography which firms use to identify their products  Trademarks, once granted last forever, except in instances where a brand name becomes generic, and the firm fails to defend its brand against this occurrence >Kleenex, Xerox  U.S. law also makes it a crime to knowingly divulge trade secrets, so that these too have a intellectual property aspect to them  Copyright is the fourth type of intellectual property right granted in the law, and we will discuss this later in the course