Intellectual Property and Economics -

Richard Posner
What has Richard Posner dealt with in brief
● Introduction: The author discusses the economic analysis of intellectual property
rights, focusing on the trade-off between incentives and access, and the differences
between intellectual and physical property. He also introduces the law and economics
approach, which examines the legal rules and institutions that govern intellectual
property.
● The Optimal Term: The author analyzes the optimal length of protection for
intellectual property rights, especially patents and copyrights. He compares the reward
system and the property rights system, and considers the effects of discounting, public
choice, heterogeneity and retroactivity. He also explains why trademarks and trade
secrets do not have fixed terms.
● Transactions Costs, Fair Use and Piracy: The author explores the role of
transaction costs in limiting the scope of intellectual property rights. He illustrates the
concept of fair use, which allows some unauthorized copying of copyrighted materials,
and its applications in various cases. He also discusses the impact of piracy on the value
and incentives of intellectual property owners.
● Protecting Expression But Not Ideas: The author examines the distinction between
expression and ideas in intellectual property law, and the reasons for excluding ideas
from protection. He argues that allowing appropriation of ideas would impose high
transaction costs, induce rent-seeking behavior and retard technological progress. He
also compares copyright and patent law in terms of independent discovery and
infringement.
● Other Alternatives for Covering the Fixed Costs of Innovation: The author
reviews some alternative methods of providing incentives for the creation of intellectual
property, such as public financing, head start, control of complementary goods and
trademark. He evaluates the advantages and disadvantages of each method, and suggests
some possible reforms.
● The Ongoing Expansion of Intellectual Property Rights: The author comments
on the recent trends of expanding intellectual property rights, and the economic factors
behind them. He points out the effects of digitization, globalization and network
externalities on the value and costs of intellectual property. He also considers some
challenges and opportunities for the future of intellectual property law and policy.
Some Basic Terms explanation
Creation of Intellectual Property (IP): Making things like inventions, music, or books can
be expensive upfront (fixed costs). Once it's created, however, the extra cost of making
copies or sharing it with more people (variable costs) is usually very low.

Challenge - Incentives vs. Access: There's a challenge in figuring out how to balance two
things:

1. Incentives to Create: If we don't reward creators enough, they might not bother making
new things.
2. Access for Everyone: But if we make it super easy for everyone to use or get the
intellectual property, the creators might not make enough money to justify creating it in
the first place.

Two Main Solutions:

1. Financial Rewards (like subsidies): Give money to creators to encourage them. This
helps with both creating stuff and making it available. But if everyone can access it freely,
the creator might not make much profit.
2. Limited Property Rights (like patents and copyrights): Give creators exclusive rights for a
while, so they can control who gets to use their creation. This gives them a chance to
make more money, but it limits access for others during that time.

Risk Factor: Creators might be scared to make new things because they might not make
enough money or even lose money. However, spreading the risk (diversification) can help
reduce this fear.

Calculating Rewards: We can decide how much to reward creators based on how well their
creation does in the real world. However, waiting to see how successful something is before
rewarding the creator can make it tough for them to finance their projects.

Public vs. Private System:

1. Public systems (like government-funded rewards) might work, but they could also be
influenced by politics.
2. Private systems (like patents) tie the reward to the success of the creation but might end
up giving creators more money than they spent, even considering the risk.

In short, it's a tricky balance. We want to reward creators enough to encourage them but not
make it too hard for others to access what they've created.
The Optimal Term
People who study the economic side of law look at how to regulate things like intellectual
property (like copyrights for books, music, etc.). They're interested in encouraging innovation,
treating creations like public goods, and figuring out the best pricing.

Imagine you write a book. The law says you have the exclusive right to control who can use it for
a certain period - this is the copyright term. The question is: how long should this period be? In
order to arrive at the answer one has to ensure that they strike a balance between incentives and
access. The optimal length of the copyright term is decided by looking at the balance between
the benefits of motivating creators and the costs of limiting access. Specifically, they aim to set
the term where the expected revenue (money made from the creation) equals the total costs
(including opportunity costs, which means considering what else could have been done with the
time or resources).

They use a fancy term - discounting to present value. This means they take into account that
money gained or spent in the future is not as valuable as money today. So, they adjust future
revenues and costs to see what they are worth in today's terms.

The goal is for the creator to make enough money to cover all costs, and the term should be just
right to achieve this balance.
If a copyright term is already quite long, making it even longer might not change this balance
much. So, the idea is to find the sweet spot where creators are motivated, and access for the
public is not overly restricted. In a nutshell, it's about finding the right balance in how long
creators have exclusive rights to their work, considering both their incentives and the public's
ability to access and use creative works.

The Sonny Bono Copyright Term Extension Act of 1998 increased the length of the copyright
term from the life of the creator plus 50 years to the creator's life plus 70 years. This change
would have only a trivial effect on the present value of the expected revenues of creators of
expressive works. However, an increase in the copyright term is made retroactive,
meaning that access costs rise from the date on which the copyrights on existing
works would have expired had it not been for the extension.

Comparing with the law of physical property provides richer explanations than conventional
economic analysis for why some types of intellectual property rights, such as patents and
copyrights, are time-limited rather than perpetual, while other types of intellectual property
rights, such as trademarks and trade secrets, do not have any definite term. The temporal
limitation of patents and copyrights augments the public domain, as once the patent or
copyright expires, the patented or copyrighted work cannot be reappropriated; it is forever a
part of the public domain.

The concept of copyright is a complex and multifaceted issue, with the public domain providing
inputs that can be obtained without transaction costs. However, long copyright terms also have
economic benefits, such as preventing congestion and maintaining market value. A longer term
can prevent the overexposure of a work, which could lead to a decline in total utility.
Additionally, the cost of creating an expressive work can be overstated, as it requires continued
expenditures on advertising and promotion.

The optimal copyright term is an unresolved empirical issue, and assuming that the same term
for all expressive works is optimal is another complication. A fixed term may overreward
some producers and underreward others, causing a misallocation of resources.
Trade secrets, on the other hand, do not have fixed terms but may be copyrightable as derivative
works. Trademarks serve as a method of economizing on consumer search costs by providing a
compact identifier of a producer's brand. Competitors are not harmed by using generic terms or
symbols associated with the entire product, as they are not allowed to pick a term or symbol
associated with the entire product.

Trade secrets have no fixed term, as the only legal protection trade secret provides is protection
against unlawful appropriation of confidential information. A competitor can appropriate a
trade secret through reverse engineering or independent discovery, or because the firm that
possessed the trade secret failed through negligence or inadvertence to keep it secret.

Transaction Costs, Fair Use and Piracy

The optimal term for protecting intellectual property may have received disproportionate
attention from economists. By examining the legal rules governing intellectual property, law and
economics analysis can suggest desirable reforms. One reform would require copyright
owners to re register old copyrights in a form that makes it easy for creators of
new expressive works to identify the current copyright owner. Failure to re register
would be treated as abandonment, and the work would go into the public domain and could be
freely copied. The cost to copyright owners would be trivial, as very few copyrights old enough
to be affected by the suggested reform have any commercial value.

The proposed reform would also allow copying that had not been specifically
authorized by the creator of the intellectual property. This is a common feature of
intellectual property law and differentiates it from the law governing physical
property. The copyright doctrine of "fair use" already allows a considerable amount of
unauthorized copying of copyrighted materials, and Congress and courts could expand "fair use"
to solve problems created by long copyright terms.

The fair use privilege allows book reviewers to quote without the copyright owner's
authorization from the book being reviewed. This is another situation where even creators of
intellectual property would likely prefer that free copying be allowed, as it makes book reviews
more credible to the reading public and valuable to the publishing industry as a whole.

Fair use is a doctrine in intellectual property law that differs from

non-intellectual property law due to its economic nature. In the physical domain, only
one person can use a piece of tangible property at a time, making borrowing a cost on the owner.
However, intellectual property is a public good, and one person's use does not prevent
simultaneous use by another. If a work is copied, the original owner is not prevented from
making and selling copies. The existence of cheap copies may inflict economic harm on the
original owner, but it may not if the copying is limited to excerpts.

The public good character of intellectual property alters the economics of

misappropriation, as seen in the widespread piracy of copyrighted operating system
software. While theft of physical property deprives the property's owner of its use, intellectual
property theft does not. If the software pirate or those who purchase the pirated software cannot
or would not pay the price charged by the owner, piracy does not cost the owner any lost sales.
However, if piracy reaches a level where pirates are making copies of their pirated copies and
selling the new copies to people who would otherwise buy the copyrighted product, the
copyright owner may be hurt.

The public good character of intellectual property and the higher transaction
costs of exploiting such property predict that property rights in intellectual
property will be less extensive than in the case of physical property.

Protecting Expression but not Ideas

Fair use is a limitation on the scope of copyright, as it only protects expression, not ideas, from
unauthorized copying. In the copyright domain, "ideas" are generally literary and artistic
techniques and genres, stock characters in fiction, and basic plot lines. Allowing these
building blocks of creative expression to be appropriated would impose
enormous transaction costs, and even creators of intellectual property might
prefer that protection be limited. Granting exclusive rights to fundamental aesthetic
concepts or approaches would induce rent-seeking expenditures on being the first to claim
ownership of the new idea.

This objection applies to generous patent protection, as it may spark patent races that may cost
more than the benefits of a slight acceleration in the rate of invention. Alright, let's simplify this:

Patents are like special rights given to inventors. They allow inventors to control who can use
their invention and charge a price for it. The issue is that inventors can set a price for using their
invention that is higher than what it costs to make a copy of it. This is because inventions are
often just information, and copying them is usually cheap unless it's not allowed. However,
when we give inventors too many rights over their inventions (like making those rights too
broad), it can lead to them setting prices way above the actual cost. This, in turn, might
encourage too many people to enter the market. Excessive entry means too many people trying
to get into the market to make and sell the same thing. This can be a problem because it might
lead to too much competition, which can be bad for both the inventors and consumers.
In simpler terms, patents can make things expensive by letting inventors charge a lot for their
inventions. If we give inventors too many rights, it can attract too many competitors, making
things a bit messy for everyone. So, it's a balance between letting inventors earn
money for their ideas and making sure people can still access and afford those
inventions.

The ideas that patent law refuses to protect tend to be ones generated by basic research, which
are not considered "useful" within the meaning of patent law. One objection to creating property
rights in such ideas is that it would often be difficult to trace an idea into a particular process or
product. Another objection is that patents are a poor method of encouraging basic research, as it
does not have immediate commercial application and is not attractive to private investors due to
high discount rates.

Other Alternatives for covering Fixed costs of

Innovation
Public financing of basic research is a crucial method for providing incentives to engage in
socially valuable activities like basic research. This aligns with property law's preference for
reward rather than property, as it may overreward finders and induce excessive expenditures on
finding and not losing. In cases where the benefits of basic research are too remote to interest a
firm, public financing may still be justifiable in economic terms if the social discount rate of such
investments is lower than the private rate.

Public subsidies for creating intellectual property rights are only one alternative
to intellectual property rights. Another option is for the government to do nothing because
the market will exclude copiers without the aid of the law. Copyright was not an issue before the
invention of the printing press, because of the high cost of copying books by hand.

Sometimes, the costs of copying can be high, leading inventors to forgo seeking a patent. A
patent is limited in duration, requires incurring legal and other fees, and may contain
information that allows competitors to "invent around" the patented process. The social and
private costs of secrecy may be great, but they are to an extent self-limiting.

Other alternatives to property-right protection through patent or copyright include a first

inventor's head start, control of a complementary good, and trademarks.
Trademark protection is forfeited if the trademark is sold "in gross," separate from the assets
used to produce the product. Additionally, trademarks lose protection when they become
generic, designating the product rather than the brand, making it difficult for competitors to
communicate effectively with consumers.

Economists once believed that trademarks were anticompetitive because they were sold at
higher prices than generic equivalents. However, this belief is based on the difference between
the nominal price and the full price of a consumer good. The full price is the sum of the nominal
price and the consumer's search costs, which are lower for branded goods. A trademark is
forfeited if the producer fails to maintain the quality of its trademarked good, as it no longer
provides the consumer with useful information.

Though not an intellectual property right, trademarks can be a method of creating or

extending such a right. For example, high prices of branded pharmaceutical
drugs tend to remain high even after the patent expires, and consumers may
become skeptical of the generic substitutes. This attitude may cause some consumers to
continue buying the branded product even though cheaper generics are now available.

Heavy investments in trademarks create a hostage situation where the producer is strongly
motivated to maintain quality to protect consumer confidence. The consumer incurs lower
search costs and has a reasonable assurance of the quality of the nominally higher-priced good.

Given trade secrecy, the learning curve, trademarks, and other means of recovering fixed costs of
invention, the question arises whether patents confer net social benefits. Some degree of
patent protection is socially beneficial due to the heavy social costs of trade
secrecy, which would be an even more popular method of internalizing the
benefits of invention without patents.

Patents have a limited duration of 20 years for most types, which is much shorter than the
copyright term. This is due to the lack of defense of independent discovery in patent law and the
legal requirement that patent applications disclose the best means of practicing the patent.
Failure to disclose the best means invalidates the patent, reducing the patentee's power over
price by reducing the costs of competitors.

However, patent law also allows unauthorized exploitation of someone else's intellectual
property. A legal monopoly is not necessarily an economic monopoly, as close substitutes exist
for a patented product, and a patent may confer little power over price. A common fallacy is that
a patent can be used as a lever to obtain power over the price of unpatented products that are
complements of the patented product.

The current scope of patent protection is uncertain due to concerns and tradeoffs. Narrowly
interpreting patents would create unequivocal benefits, such as prices closer to
marginal cost and a larger public domain, lowering input costs of later
inventors. The narrower a patent, the greater the aggregate costs of the patent system and the
more patentees a new inventor may have to obtain licenses from to create a technology using a
broad range of patented knowledge. Conversely, a broader patent creates greater
incentives for the development of truly novel technologies.

Derivative Works and Improvement Patents

The treatment of derivative works in copyright law and patent law differs significantly. A
derivative work cannot be copyrighted by anyone other than the owner of the original without
the owner's authorization, but it can only be patented if it differs significantly from the original.
This highlights the sensitivity of intellectual property law to the costs of operating the legal
system. If works indistinguishable from the original were copyrightable, it would be extremely
difficult to determine infringement.

An alternative to giving the owner of the copyright on the original work the exclusive right to
copyright derivative works, the law could allow the creator of a derivative work to copyright it
even though they would not be able to sell it without a license from the original owner.
Copyright law would then be aligned with patent law, which permits the unauthorized improver
of a patented good to patent the improved version, although the improver will not be able to sell
it without a license from the original patentee.

The different treatment in copyright and patent law may be due to the economic justification for
the law's different treatment. Technological improvement is typically a continuous,
collaborative process, and allowing unauthorized improvers to patent their
improvements encourages maximum participation in efforts to improve the
originally patented process or product. This distinction may also explain the different
treatment in copyright and patent law of joint ownership.

The patentability of unauthorized improvement patents is supported by the "Darwinian" theory

of technological progress, which suggests that firms should encourage research and
development on technologies dominated by a patent or patents held by another firm.

The legal status of derivative works and improvement patents is influenced by the
institutional difference between copyright and patent law. Copyright is asserted
without a preliminary administrative screening, while patent applications are screened by the
Patent and Trademark Office. This results in the likelihood of an improvement patent being
issued if the work does not represent a genuine improvement. This could lead to a proliferation
of separately owned derivative works, increasing transaction costs for creators.

Independent discovery infringes patents, but not copyrights. Independent discovery of useful
ideas is common, but independent creation of expressive works is uncommon. Copyright
protection is limited to the precise expressive form of a copyrighted work, and the invention of
new products and processes is more costly. Inventors may be reluctant to invest large sums into
creating new products due to concerns about illusory protection.

Copyright does enable artists to obtain additional income from derivative works, which may
increase their incomes and supply of art. However, centralizing the inventive process may retard
technological progress. The prospect theory aims to reduce rent seeking by increasing benefits to
being the original prospector, but it may encourage wasteful races to be the prospector. In
conclusion, copyright law cannot be justified on the grounds that it increases the income of
copyright owners, unless the supply of copyrighted works is deemed suboptimal.
The Ongoing expansion of Intellectual Property
Rights
Intellectual property rights protection has expanded in recent decades due to the dramatic fall in
the quality-adjusted cost of copying, as well as the growing wealth of consumers worldwide. The
social value of a work that involves a heavy upfront investment increases due to the slight
incremental cost of providing the work to additional customers. The social loss from
undermining intellectual property rights is greater if the incentives to create such works are
diminished.

Reductions in the cost of copying help and hurt copyrighted work owners by reducing their
marginal costs. The access of intellectual property owners to a global market is greater the lower
the costs of disseminating their work. Technological changes that facilitate the direct sale of
intellectual property to the ultimate consumer enable owners of intellectual property to bypass
intellectual property law by relying on contracts, encryption, or both to prevent copying by the
consumer.

The asymmetry of interests between owners of intellectual property rights and would-be copiers
is crucial in explaining the expansion of intellectual property rights. Owners have a large stake in
extending their rights, while would-be copiers have less incentive to challenge intellectual
property rights in the legislature. This asymmetry of interests is probably the reason for
extending copyright and patent terms retroactively, despite offering almost no incentive for
creating additional intellectual property.