PublishedJune 14, 2013

Troll Economics: The White House Weighs In

Last week, the White House released its agenda of legislative priorities and executive actions on high-tech patent issues.  It was accompanied by a report, Patent Assertion and U.S. Innovation, that builds on recent research and makes the case for the agenda.  The agenda is attributed to the White House Task Force on High-Tech Patent Issues, while the report is a joint product of the Council of Economic Advisers (CEA), the National Economic Council (NEC), and the Office of Science & Technology Policy (OSTP).  Like the various proposals brewing in Congress, it is directed at patent assertion entities (PAEs), more commonly known as trolls.  But with seven legislative measures, five executive actions, and the report, the White House agenda is distinctly ambitious.

It is quite unusual for the White House to assume leadership on patent reform.  To my memory, the only comparable initiative was the President’s Commission on the Patent System of 1965-1966.  At President Johnson’s request, the Commission took a broad look at the patent system in a time of technological change and issued its report as “‘To Promote the Progress of …Useful Arts’ in an Era of Exploding Technology.”  The report made 35 thoughtful recommendations (including recommending against software patents) but got little political traction beyond the administration.  As noted by Commission member James Birkenstock (IBM):

The commission members were greatly pleased that the Johnson administration accepted all of its recommendations. Regrettably, only a few were enacted into law due to the highly influential Patent Law Bar that opposed most of the recommendations.

The Obama administration’s initiative is narrower, more targeted, and well-documented.  The report not only examines the troll problem in depth but links it to fundamental problems of functional claiming in software, uncertainty in the face of massive patenting, and the overshadowing of R&D by strategic patent acquisition and assertion.  The report recognizes that it is not just a problem of restraining and sanctioning a few bad actors.

As with the run-up to the 2008 financial crisis, the present crisis is the result of inadequate and fragmented understanding of a system that has grown too big, self-interested, and trapped in its own rhetoric.  The patent system has not had to account for its effectiveness for a variety of reasons.  Patent law is highly technical and fact-specific; it is not easy for non-specialists to take a close look.  While government programs are often criticized for mission creep and creating constituencies that fight hard for perpetuation, the patent office has escaped real scrutiny because it is supported by the fees it generates.

 Yet patents are not self-enforcing.  They must be enforced in court, and taxpayers must underwrite the infrastructure and salaries of the judicial system.  When cases are decided in a reasoned public decision, there may be a public benefit, but when trolls use the judicial system to extract settlements, there is a burden but no benefit to taxpayers.

The greater problem is that the real costs of the patent system are simply pushed out to the private sector, where they may or may not exceed the benefits.  The Patent and Trademark Office (PTO) has historically been unengaged with what goes on in commerce beyond its walls.  It does not monitor patent practice, nor the development of patent markets and new business models.  In legal terms, the patent system is one-size-fits-all, and the result is that the pharmaceutical industry has received substantial benefits at modest relative cost.  But high-tech receives benefits diluted by an excess of patents and pays the heavy costs of overpatenting through information failure, nuisance assertions, legal maneuvering, and global portfolio wars.  While trolls threaten all producing companies, large-scale patenting creates winners and relative losers within high-tech.  Companies with the largest patent portfolios gain an advantage over new entrants.  The biggest losers are the individual app developers, startups, and small entities that cannot afford to mount a defense against patent attacks.

The PTO has never had much to say publicly about these issues.  However, in 2010 the PTO created an Office of Chief Economist with what was initially an aggressive economic research program to provide data on the effect of intellectual property on the economy.  Yet its work has focused on fees and internal metrics.  Contrary to what one might think, the PTO’s “quality metrics” are entirely directed to its internal processes, rather than the quality of the patents that go out into the world.  The one externally focused economic study, Intellectual Property and U.S. Economy: Industries in Focus, contributed nothing to the understanding of how patents affect innovation and competition, but simply looked at the absolute size of those industries that were above average in their use of particular forms of intellectual property.  This proved nothing except that half of the U.S. economy is a big number.  One could accomplish the same result by showing half of the economy is more lawyer-intensive than the other – and citing the value of half the economy as an implicit argument for the economic value of lawyers.

Economists have long understood from a series of large-scale surveys that the value and use of patents differs greatly across industries.  As Jim Bessen and Michael Meurer showed in Patent Failure (2008), the cost-benefit calculus varies even more dramatically across industries.  By using “event studies” on stock market valuation they made the case that the costs relative to benefits have grown over time and the benefits now exceed the costs only in a few industries, such as pharmaceuticals and chemicals.  Others, including Richard Posner (a federal judge and one of the fathers of the law and economics movement), argue that industry-specific factors such as long product development cycles and high levels of investment relative to ease of copying justify patents in pharmaceuticals but not in software (where copyright protects against copying).

The problem of imposing a one-size-fits-all legal system on innovative activity is that it leads to disparate, indeed discriminatory results.  Not surprisingly, the system is optimized for the industries that derive the greatest benefits from patents, while it generates conflict and controversy at the other end of the spectrum.  Innovation is too important to leave to lawyers, who have naturally benefited from inflating the scope and scale of the patent system beyond what it does well to where its effects have become divisive and counterproductive.

The real significance of the White House initiative lies in its collective effort to bring economic analysis to bear on patent policy – to achieve the economic results that the patent system was originally designed to provide.  The report is the joint product of all three White House agencies with relevant expertise in economics and innovation.

It is also significant that the PTO does not appear to have been involved in the report – and that the items for executive action would move the PTO away from its applicant-centered mindset.  The PTO is known throughout the government and academia for its insular culture, but the office is now charged with making information available to those who are attacked by trolls.  It is also charged with developing and making public robust data and research on issues related to abusive litigation.  In the long run, this will give the office perspective beyond its walls and insight on how patents operate in the real world.  The next PTO director should be willing to take hard, evidence-based look at the role that patents play in innovation – and not assume the best as a matter of faith.  The answer to the systemic problems of the patent system is not just “more of the same.”

circle 09

Brian Kahin

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