Capitalism, Free Markets and Patents: Grounds For A Major Policy Revision

Among the many economic problems of today one important issue has been receiving lesser attention. Of course the credit-crisis is more appealing and necessitating serious attention because of its detrimental impact it has and potentially will have for the world economy in the coming months and years.

However, this article focuses on another major issue: the international patent framework. This article sets out a necessary policy revision, which ultimately provides necessary economic incentives in case of a financial meltdown.

One pervasive misconception on market capitalism is that our economies are driven by free markets. Despite a couple of centuries of economic science and theory, free markets have still not been established. The capitalist markets of today are not synonymous with free markets. The globalization of market capitalism of today is more synonymous with oligopolistic markets and at times even with monopolistic markets. If capitalism can be saved its cure is found with laws and regulations that aim for free markets to emerge. One of these policy revisions enabling this goal, concerns an adjustment in our patent-framework.

Our patent-framework is hopelessly failing. The cause of this failure is quite simple: the manner in which we choose to reward inventions is totally flawed. Ethical and basic human rights are with some regularity violated. One of the ugliest of examples is found with the introduction of the first HIV/AIDS medication in the 1990s. South-Africa, and Brazil were asked to pay the market price of HIV-medication, while millions of people were suffering the consequences of this terrible disease and were in fact dying. These were monopolistic market prices. South-Africa and Brazil violated these absurd regulations. It would have been unethical not to have violated them.

Patents: A Monopolistic Reward

Societies postulate that someone who has made an invention should be rewarded. People want to reward inventors because it constitutes to a form of good behavior. Societies benefit from inventions.

The societal and economic objective is to enable inventions to get commercially successful. We call these successful inventions ‘innovations’. To achieve innovativeness in our economies we reward a patent to the part of the invention which is considered new.

The properties of patents define the extent to which societies find how inventors should be rewarded. In the current framework it is done with an exclusive right to exploit this invention. The inventor is the only one who is allowed to exploit this invention commercially. This is exactly the same as giving away a monopoly.

When a company or person is given a legal position of a monopolist, then that economic actor has a license for any form of behavior, thus also bad behavior. Patent holders can set prices at any level they see fit. Commonly, prices are set such that profits are maximized, as was the case with HIV/AIDS medication.

This is exactly the point where our patent-framework fails. A monopolist does not serve societal objectives. It therefore does not serve the interest of any individual in that society. A society with a maximum number of opportunities is one in which opportunities are spread equal to all. A monopolist prevents this from happening.

Under normal economic circumstances, where patents have no relevance, monopolists are prohibited and dealt with. Monopolistic or oligopolistic behavior are forms that only result in negative economic outcomes. Moreover, it makes capitalism not synonymous with free markets at all.

Adjusting Patent-Regulations

Any adjustment in our patent-framework should satisfy two preconditions. Firstly, good behavior must be rewarded. Secondly, bad behavior must be prevented. In the current framework bad behavior is possible. A solution must be sought to prevent this kind of behavior, to rule it out entirely. The properties of patents must therefore be adjusted.

A very simple solution can accomplish and satisfy these two preconditions: reward an inventor with a tax-exemption according to a specific time-table during which the patent holder is gradually forced back to normal taxation levels. The exclusivity to produce or use the principle underlying the innovation is eliminated such that everybody is able to use this knowledge. As reward for making a great invention the inventor is compensated through a tax-exemption.

The first strand of criticism which will be noted with this proposed adjustment is the only one, and concerns what is of utmost interest: investments. Investments must at all times be earned back. More importantly, it must remain profitable to undertake research and development. Costs therefore must not only be earned back, it must also be more profitable for companies that undertake research and development than for companies who do not.

The incentives of today must therefore be maintained, however, they must be regulated in a different fashion. The simplest of reward structures is to exempt innovative products from value-added taxes. In Europe this would mean a 19% cost-reduction. This 19% tax reduction can be utilized by the patent holders in any manner as they see fit. They can use it as a means of competitive edge, or to utilize it as profit margins. A time table can be settled through international negotiations by major economies. I favor a 1%-1 year thumb-rule to establish a very stable and gradual path to normal taxation levels. But this very well could be a 5%-5 year thumb-rule as well which favors businesses.

A more complex reward structure would be to exempt the entire production of an innovative product from taxation all together. The downside however is that this would open the door for moral hazard. Companies will attempt to benefit more than what is legitimate.

This proposal forces companies to invest in research programs with commercially beneficial prospects, and therefore it creates the incentive to search for more efficient and more effective methods to enable inventions to emerge. This necessitates more cooperation among companies, such that they share their knowledge and research data because it helps them to achieve their objectives.

Illustration

This can be illustrated with an example. Pharmaceutical and biotechnological companies spend substantial sums of money on research and development in order to develop new medicines. They do so because when their research pays off, it enables them to hit the jackpot and receive a monopolistic position.

Scientific literature is quite clear on this matter: these companies spend millions, if not billions on investments in research programs. These research programs are very expensive to undertake. Mostly because of state of the art equipment, and because knowledge is frequently so new it comes with high prices.

The same literature is less clear on another matter and it concerns the upward price-effect on these investments. This upward price-effect is caused, or perhaps more accurately, induced by the monopolistic reward defined by our patent-framework.

A monopolistic reward causes competitive behavior for resources, thus all inputs for production and assets. In other words, all interests in serving and/or controlling markets, such as distribution channels, exclusive cont(r)acts, and exclusivity of patents are rivaled for. Companies will attempt to achieve a leading position over their competitors, and prevent their competitors of competing as much as possible. It kills competition.

Once one of them arrives at finish-line the competition is over. And for the next 15-20 years or so, there is no competition. It is like having an athletics-track becoming the exclusive running ground for a single runner. And as a matter of experience, I do not like to buy a ticket and go to an athletics stadium just to see one single runner sprint towards the finish line. I want to see a competitive race. I want to see competition.

With this patent-framework there are not many examples of cooperating companies to give. It requires exceptional willingness of management teams to cooperate with one another. This remains often an illogical course of action. By choosing for isolated research, thus keeping research in-house, companies do not have to share potential profits. This choice drives investment costs upwards while unnecessary research is done. However, this cannot be empirically backed yet. It has never been researched.

In the literature it has been reported that some companies conduct 50.000 tests with expectations of only 8 possible successful results. That would mean that 49.992 tests do not have satisfactory results. Now, suppose that 10 companies (worldwide) are researching one particular cure for a certain disease, and these 10 companies conduct the same number of tests (n=50.000). This would mean that 500.000 tests are conducted with a theoretical maximum result of 80 tests (8:50.000 success-rate). The interest concerns the overlap of research and test results. In other words, to what extent are tests done double or more and what are the costs involved in relation to successful results?

At the same time, some results might be of interest to companies venturing other research programs on other diseases. It very well could be that a small number of tests could have had a result that allows a major breakthrough for something else.

When research is done on this matter, it can be expected that an upward price-effect exists and that when companies share their data, costs will drop significantly. Cooperation, and thus sharing data, sharing information, and sharing knowledge will serve society at large, exactly the same way as our schools educate our young generations for the better.

However, as long as this is not cleared up it cannot be stated as a matter of fact. It requires scientific research to prove this, to verify this as an actual problem found with our patent-framework. My bet is that if research is done it will point out the extent of possible cost savings, and it will indicate the potential societal gains which ultimately amount to billions of cost savings. Billions that can be spend on other things!

Economic Consequences

A major consequence of the proposed adjustment is that it stimulates innovativeness within an economy. The literature in this respect is quite clear. When knowledge is shared it diffuses among many individuals, it spreads among many firms, enabling all these firms to use this knowledge to develop new insights for their products and services. They can improve production processes and methods, and they all enhance their economic positions. This enables competition to revive and trigger companies to generate prosperity for society at large. While at the same time, these companies will still make substantial profits, because new products give rise to new markets.

As a result of this adjustment, competitive and free markets emerge. This adjustment enables multiple businesses to compete within a renewed context of innovative markets, ensuring competitive market prices.

And still, the inventor is given an unique position because as patent-holder the business has profit advantage over its competitors. It is a societal win-win outcome. It means lower prices, higher employment, a far more rapid diffusion of innovations, healthy competitive markets, and prosperous businesses.

The primary reason and explanation why Silicon Valley has become the most important center for ICT-innovations on this planet is because they shared their knowledge. Luckily for us all, those bright young people did not forbid the use of the mouse cursor-icons simply because they had patented them.

The proposed measure simply prohibits a form of human behavior which at least is questionable. This proposal disallows a form of human and economic behavior that does not help societies to progress. This measure ensures only good forms of competitive behavior.

Inventors are key to our development, and they must be rewarded for their contribution at all times. We must choose to reward them proportionally, and maintain the incentives by allowing them to profit. Not monopolistically, not oligopolistically, but honestly, according to free market principles.

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