Patent protection is a blunt instrument, applying the same laws to different industries which have unique needs. Discuss.

On the one hand, this statement seems too strong. Patent protection does not apply the same laws to different industries. Two main instruments patent length and breadth- are used to design an optimal patent protection case by case. In general, in order for an invention or innovation to be entitled to a maximum 20-year patent in the US, UK, or Europe, it has to satisfy 3 requirements: novel, nontrivial and useful. However, once patent granted, the allowable breadth and length of claims are determined by patent examiners and the judiciary. Gilbert and Shapiro (1990) and Klemperer (1990) try to determine for a given profit level necessary to stimulate efficient R&D, what is the optimal allocation of breadth and length in terms of minimising the deadweight loss from market power associated with the granting of the patent. However, Gilbert and Shapiro (1990) and Klemperer (1990) have discussed breadth of patent protection in the context of single innovations without focussing on the problem of dividing profit among sequential innovators. In the latter case, it becomes obvious that patent protection is a blunt instrument because it does not take into account the structure of the industry and the strategic incentives faced by first generation and second generation innovators when applying patent law. Scotchmer (1991) argues that patent policy is a very blunt instrument trying to solve a very delicate problem, and that its bluntness derives largely from the narrowness of what patent breadth can depend on. The problem becomes obvious in the case of cumulative research. When an initial innovation facilitates later ones, as is the case with basic research, part of the first innovation's social value is the boost it gives to later innovators. First generation innovators will have correct incentives to invest only if they receive some of the social surplus provided by second generation products. At the same time however, enough profit must be left for the second innovators so that they will invest if investing is efficient. Hence the conclusions about optimal breadth/length trade-off when considering a product alone may not be supported and may even conflict once we look at the industry at the whole, considering incentives to innovate when research is cumulative. The challenge in cumulative research is to reward early innovators fully for the technology foundations they provide to later innovators, but also reward the later innovators adequately for their improvements and new products. Hence, the optimal patent protection should consider the problem of how to divide joint profit among sequential innovators when one innovator's technology builds on another's. In fact, the question of optimal patent breadth cannot be addressed separately from the question of possible integration or cooperation among firms. The latter characteristics are essentially unique to each industry and also depend on whether prior cross-licensing agreements are allowed and the type of bargaining structure between firms. For instance, Klemperer (1990) uses a spatial model where the breadth of the patent its scope corresponds to the distance at which the competing firms are allowed to locate from the innovators product. The larger this distance the broader the patent. Klemperer finds that when consumers have different transport costs but same valuations, it is optimal to have a short lived broad patent. However lets now ignore the length of the patent for simplicity (as Scotchmer does) and consider the case for a broad patent in the context of cumulative research.

The implications not only depend on the type of the patent (broad here) but also the possible cooperation or integration between firms. Outside research firms can integrate with initial patentholders in at least two ways: the firms can form cooperative ventures to research and develop new products, and they can form licensing agreements after products have been developed and patents have been awarded. Suppose prior-agreements and licensing are not allowed for some reason. The broad patent may discourage second generation innovation because it will likely infringe the prior patent. However, anticipating that there wont be enough second generation innovation, the first generation innovator may not have the right incentives to invest efficiently since he knows from the start that he wont be getting much profit from his invention. Even if prior agreements are allowed, incentives may still be inhibited. The surplus generated by the first innovator has to be split somehow between the two generations. However, the second generation may threaten not to invest in R&D if given too small a share. This in turn will lower the incentives to the first generation because it wont be able to collect all the returns from its investment and the whole research line may collapse. So would a narrow patent solve the problem? Indeed, Gilbert and Shapiro (1990) argue that the optimal patent should be as narrow as possible for an infinite number of years. Unfortunately, once again cumulative research leads some difficulties. A narrow patent means that many derivative products and applications can be patented and marketed without infringement and hence prior-agreements and licensing are not essential for second generation firms to invest in R&D. However, narrow patents pose another strategic problem. If the value of the second generation product is much higher than that of the first generation one (as is the case for basic research for example), the first generation innovator will have no incentives to patent his innovation at all because this will disclose his findings and benefit other second generation firms. Instead, the first innovator might want to keep his ideas secret and use them himself to develop the second generation product that has higher market value. However, this essentially contradicts one of the purposes of patent law, which is the disclosure of information that should avoid duplication efforts! Unfortunately, empirical findings support the latter scenario. In the US, 51.4% of the product innovations that are kept secret are considered to be effective, while only 38% of the patented are considered so (Cohen, 2002). The effect is even larger for process innovations, that cannot be embodied and sold in the market and apply to a whole production scale. One more argument in favour of the bluntness of patent protection is that the private value of patent protection is linked to the social value of the technology through market demand, but is not linked to firms' research costs. The optimal rule for the breadth of a patent can only use information that is available to patent examiners and courts. Thus, the patenting rule can depend on observable aspects of discovered technologies, but not on prior expectations regarding technological outcomes and costs of research. This restriction greatly reduces the effectiveness of patent law in protecting incentives. Before investing in a second generation technology, the researcher must evaluate the probability that the new technology will not infringe the prior patent. This probability depends on the breadth of the prior patent and on the distribution of possible outcomes of the second investment. The probability of infringing the first patent is lower if the distribution of outcomes places greater weight on outcomes that lie outside the allowed claims of the first patent. A project with low probability of infringing will look more profitable to the second generation researcher than a project that places greater prior weight on outcomes that infringe the first patent. But both projects could have the same expected social value if the expected costs of one project were sufficiently higher than the other. The

patent policy should equally encourage two projects with the same social value, but that cannot be accomplished with a patent rule that depends only on technological outcomes. In conclusion, whether patent law is a blunt instrument or not depends on the type of the industry to which patent law is applied. If the second generation product is simply an improvement over the first type, then the effective protection of the initial patent will end (whatever the official length assigned) as soon as the better product is patented. In such a case, patent law becomes limited in its instruments: setting the optimal patent life and the breadth of protection may not give the right incentives, which will highly depend on what kind of cooperation, licensing, and integration is possible between rival firms. However, in case the second generation product serves a completely separate set of consumers from that of the first generation one, applying the same laws about optimal patent length and breadth to different industries may still be optimal. The latter case is of course highly unlikely in reality where most new research stands on the shoulders of some previous giants. Large shares of government spending on fundamental research (30 to 60% of all R&D spending in developing countries) testify of the recognition of the bluntness of patent protection.