Do patents help or hinder innovation?

The patent system is one of the main instruments governments use to increase research and development incentives, while at the same time promoting follow-on innovation. However, there is growing concern among academic scholars and policy makers that patent rights are themselves becoming an impediment, rather than an incentive, to innovation. The increasing proliferation of patents and the fragmentation of ownership rights among firms are believed to raise transaction costs, constrain the freedom of action to conduct research and development, and expose firms to ex-post holdup through patent litigation (Heller and Eisenberg 1998). In the extreme case where bargaining failure in patent licensing occurs, follow-on innovation can be blocked entirely.

These dangers have been prominently voiced in public debates on patent policy in the US (National Research Council 2004, Federal Trade Commission 2011) and recent decisions by the Supreme Court (e.g. eBay Inc. v. MercExchange, LLC, 547 US 338, 2006). Similar concerns have also been raised in European policy discussions on the implementation of a unitary European Patent and European Patent Court (European Commission 2011).

In order to design government policies that effectively address this problem, it is first important to quantify the extent to which patent rights do in fact impede follow-on innovation, and to identify whether their impact differs across technology fields and firms. Broad reforms of the patent system may be required if this blocking effect is pervasive and has a substantial impact on firms across different technology areas. On the other end, more targeted policies may be preferable if patents appear to block follow-on innovation only in very specific environments.

Removal of patent rights through judicial decisions

In recent research, we estimate the impact of patent rights on cumulative innovation (Galasso and Schankerman 2013). To study this relationship empirically is challenging for two reasons. The first problem is that we need to identify comparable technologies with and without patent protection. The second is that follow-on innovation is difficult to measure.

In our analysis, we exploit patent invalidation decisions by the US Court of Appeal for the Federal Circuit, which has exclusive jurisdiction in appellate cases involving patents.  We use comprehensive data on 1357 Federal Circuit decisions from 1983 to 2008, and record whether each patent was invalidated. About 40% of the decisions in our sample lead to a loss of patent protection for the technology. To measure cumulative innovation, we follow the large empirical literature in economics which exploits citations by later patents as a way to trace knowledge spillovers (for a good survey, see Griliches 1992).

To estimate the effect of patent rights on follow-on innovation, we compare the number of citations received by patents that are invalidated to those that are upheld by the Federal Circuit Court, in a five year window following the decision. A fundamental challenge with this approach is that invalidated patents may differ from those that are upheld in a variety of dimensions that may affect patent citations. For example, patents covering technologies with greater commercial potential are both more likely to be an attractive target for follow-on innovation and to induce the patentee to invest heavily in the case to avoid invalidation. It is crucial to address this ‘endogeneity’ issue in order to estimate the true causal impact of patent protection on cumulative innovation.

Our empirical strategy exploits the fact that judges are assigned to patent cases through a computer program that randomly generates three-judge panels, with decisions governed by majority rule. This random allocation of judges, and variation in their propensity to invalidate patents, allows us to identify the causal impact of removing patent protection. Essentially, we compare the citations received after Federal Circuit decisions by patents that are invalidated because they were randomly assigned to judge panels with high propensity to invalidate with the citations received by similar patents that are not invalidated because they were randomly assigned to judge panels with low propensity to invalidate. In conducting this exercise, we control for a number of confounding factors such as the age of the patent, the technology field and the number of citations received before the Federal Circuit decision.

Blocking future innovation

We find that the loss of patent protection leads to about a 50% increase in subsequent citations to the focal patent, on average. This evidence shows that, at least on average, patents block cumulative innovation. One may be concerned that this is a publicity effect from the court’s decision. However, we show that this impact begins only after about two years following the court decision, which is consistent with the onset on follow-on innovation rather than simply being a ‘media effect’ from press coverage associated with the court decision.

We also find that the impact of patent invalidation on subsequent innovation is highly heterogeneous. There is substantial variation across broad technology areas. As illustrated by the figure below, patent invalidation has a large and statistically significant impact on cumulative innovation in the fields of computers and communications, electronics, and medical instruments (including biotechnology). However, we find only a small and statistically insignificant effect in the chemical, pharmaceutical, or mechanical technology field.

We investigate the source of this heterogeneous effect and find that the technology fields where the impact of patent invalidation is strongest are characterised by two features: complex technology (where new products rely on numerous patentable elements) and high fragmentation of patent ownership among diverse firms. This finding is consistent with predictions of the economic theories that emphasise bargaining failure in licensing as the source of blockage.

Figure 1. Impact of patent invalidation on follow-on innovation

Lastly, to uncover the mechanisms that lead to these licensing failures, we examine whether the blocking effect is stronger for certain kinds of patentees or downstream innovators. We split patentees and citing innovators in three size groups: ‘small’ with patent portfolios with less than 5 patents, ‘medium’ (6 to 101 patents), and ‘large’ (more than 102 patents). We find no statistically significant effect of patent rights on later citations when the invalidated patents are owned by small or medium sized firms. The impact is entirely driven by the invalidation of patents owned by large firms, which increases the number of small innovators subsequently citing the focal patent. This finding suggests that patent rights held by large firms may block the ‘democratisation’ of innovation among small innovating firms.

Targeted solutions

Overall, our findings show that patent rights block cumulative innovation only in very specific environments, and this suggests that remedial government policies should be targeted. A ‘broad based’ scaling back of patent rights is unlikely to be the most appropriate policy. It is preferable to design policies and institutions that facilitate more efficient licensing, and thereby promote cumulative innovation without diluting the innovation incentives that patent rights provide. One interesting example of such institutions are the biological resource centers in the US studied by Furman and Stern (2011), which reduce the ‘transactional’ costs of accessing knowledge inputs.

This article was first published on VoxEU.org. You can see the original version, including references, here.