An Economic Analysis of Proposed Patent Reform Legislation

Back in September, Dennis Crouch published a good summary of the patent reform legislation.  In an earlier post, I described how the Internet, by reducing the transaction costs associated with identifying valid patented technology, is facilitating an emerging market for ideas.  Patent reform legislation obviously has the potential to either promote or destroy this emerging market.  Here are a few thoughts on how the specific proposals for patent reform would affect the emerging market for ideas.

First to File System

This change would promote the emerging market for ideas by reducing the wasteful costs associated with Interference proceedings, which are an historical artifact of our well-intentioned but ill-executed attempts to reward patent rights only to the first to invent.  In some cases, Interference proceedings do reallocate patent rights to inventors who were first to invent but slower to file.  But are the particular circumstances of these inventors really worth the millions of dollars in government and private money spent on Interference proceedings -- not to mention the negotiating chips we lose in every new IP treaty to keep our idiosyncratic system in place?  Probably not.  And I don't believe the argument that independent inventors and smaller companies will be at a disadvantage because of such a change.  If anything, independent inventors and smaller companies can be more nimble in response to a rule-change that would put a higher priority on getting disclosures filed early.

Damages Apportionment

This change would be disastrous for the emerging market for ideas.  In a free market, price is an extremely compact indicator of underlying, intrinsic economic value.  The asking prices reflect value to current owners.  The bidding prices reflect value to others in society.  Whenever the two can meet, and free exchange occurs, society benefits because both bidder and asker are better off through the trade.

But authorizing judges do damages apportionment gives bidders another option.  Instead of paying the current owner's asking price, bidders can pay legal fees (only some of which they bear -- the rest are borne by taxpayers and the other party) and get the judge's asking price.  In cases where the judge sets the asking price the same or higher than the current owner did before the lawsuit (i.e., when the bidder loses), this won't matter (except for the costs wasted in the lawsuit).  But in cases where the judge sets the asking price lower than the current owner, then society loses even more because resources are being transferred from a higher-valued user of the technology to a lower-valued user.  These costs could far outstrip the costs of the lawsuit.

Some are going to object to this analysis on the grounds that asking prices of some current owners (e.g., patent trolls) are made artifically high, reflecting not the true value of the technology, but rather the opportunity cost to the bidder of designing around a bad patent.  It is true that we need a judicial system to deal with fraud in the form of bad patents.  But damages apportionment is the crudest and most error-prone way to handle bad patents.  Better to focus on the requirements of anticipation, obviousness, enforceability, and 112 than to let a judge hold her thumb up to a market and say, "This part of it is due to this idea."  That's what CEOs are paid (or fired) for.

Search Reports

Probably a minor detriment to the market for ideas.  Ideally, applicants could decide for themselves how much scrutiny they wanted for an application.  For fundamental ideas, applicants should voluntarily submit plenty of prior art to bulletproof their patent.  For minor (but nonobvious) followons that might or might not have commercial value, a serious search might be overkill.

Treble Damages

Probably a minor benefit to the market for ideas because it further limits this remedy.  To an economist, the idea of punishing "willful infringement" would seem strange, since a willful infringer is more likely to be the higher valued user of a technology, and the opportunity cost to the current owner (of selling or licensing to someone else) is a more efficient measure of the value "lost" by the willful infringement.

Post-Grant Review and Open Examination

Probably a minor benefit to the market for ideas because it helps further reduces the costs associated with bad patents (by bringing a larger amount of information to bear on pre-issuance examination), and might help identify the highest-valued users of a technology earlier in the life of the patent.

Tax Methods

Although obviously not applicable to the entire market for ideas, eliminating these patents is probably beneficial to the market as a whole because these patents do not protect new technologies that create value within society.  Rather, they serve only to effect a redistribution from one set of taxpayers to another.  In general, "bad patents" serve only to redistribute wealth.

Venue and Jurisdiction / Patent Trial and Appeal Board

Probably beneficial to the market for ideas.  Forum shopping is inefficient for many reasons.  For one, having a diversity of judges deal with patent cases is beneficial to the patent law for the same reason that having a free market results in a more efficient price.  Why then should only one appellate court handle all patent cases?  The Federal Circuit was (and probably still is) necessary to maintain coherence in patent law doctrine for the same reason that the Supreme Court is necessary to resolve circuit splits in other areas of law.  Charles G. Koch in The Science of Success: How Market Based Management Built the World's Largest Private Company, analogizes the decision rights held by managers at each level of hierarchy within an organization to property rights in a market.  For a system of property rights to work, there must be a mutually agreed upon authority to whom market participants can appeal when disputes arise over their allocation.  Similarly, for decision rights to work, there must be a mutually agreed upon authority to whom decisionmakers can appeal when disutes arise over how decisionmaking rights are allocated.  Having a "free market" in decisionmaking rights benefits organizations (including our judicial branch of the federal government) the same way that a free market for property rights benefits society.  That's why we need a Federal Circuit but we don't need a single patent court of original jurisdiciton.

Interlocutory Appeal

This would benefit the market for ideas.  Since the Supreme Court decided Markman, there's been a problem for district court judges who know that their claims constructions will be reviewed de novo on appeal whereas most of their decisions are given more deference.  Claim construction is a Gordian knot that needs to get cut by someone, somehow.  Best scenario that's the bidder and asker in the market for ideas.  They know the most about the technology.  And unlike the rules of the patent system themselves, which come up over and over again, the facts of a particular case will probably never arise again.  So there is less benefit to an iterative process of decision, appeal, re-decision, re-appeal, then there is for the rules themselves.  If the parties can't decide it on their own, let one judge take a cut at it and then leave it alone.  District court judges should either get deference for or interlocutory review of their claim constructions.

Inequitable Conduct

Weakening this defense would benefit the market for ideas.  Inequitable conduct is necessary for dealing with fraud, but tightening up the rules for when and how it can be asserted would reduce its abuse by infringers that have no legitimate basis for refusing to pay fair value for technology.

PTO Regulatory Power

Too difficult to predict because the benefit or detriment will depend on what rule is being changed and how it is being changed.  In general, it may be detrimental, however, to the extent that large companies have a bigger influence on PTO regulations.

Study of Patent Damages

Very minor detriment.  Instead of giving the PTO the sole ability to do such studies, why not spend the money on making the information that the PTO would use for such studies publicly available to permit anyone who cares enough to do their own study?