Creation Myths

Does innovation require intellectual property rights?

Douglas Clement from the March 2003 issue

(Page 3 of 4)

In each instance, the development of the initial prototype is far more costly than the production of all subsequent copies. But because copying takes time -- a limited commodity -- and materials (paper, ink, disk space), it is not entirely costless. "Consider the paradigmatic example of the wheel," they write. "Once the first wheel was produced, imitation could take place at a cost orders of magnitude smaller. But even imitation cannot generate free goods: to make a new wheel, one needs to spend some time looking at the first one and learning how to carve it."

The first wheel is far more valuable than all others, of course, but that "does not imply that the wheel, first or last that it be, is a nonrivalrous good. It only implies that, for some goods, replication costs are very small."

Economic theorists generally have assumed that the dramatic difference between development and replication costs can be modeled as a single process with increasing returns to scale: a huge fixed cost (the initial investment) followed by costless duplication. Boldrin and Levine say this misrepresents reality: There are two distinct processes with very different technologies. Development is one production process involving long hours, gallons of coffee, sweaty genius, and black, tempestuous moods. At the end of this initial process, the prototype (with any luck) exists and the effort and money that produced it are a sunk cost, an expense in the past.

Thereafter, a very different production process governs: Replicators study the original, gather flat stones, round off corners, bore center holes, and prune tree limbs into axles. Stone wheels roll off the antediluvian assembly line. In this second process, the economics of production are the same as for any other commodity, usually with constant returns to scale.

As Boldrin and Levine develop their mathematical model, they assume only that, "as in reality," copying takes time and there is a limit (less than infinity) on the number of copies that can be produced per unit of time. These "twin assumptions" introduce a slim element of rivalry. After it's created, the prototype can be either consumed or used for copying in the initial time period. (Technically, it could be used for both, but not as easily as if it were used for just one or the other.)

While others simply have assumed, with Romer, that the prototype of an intellectual product is nonrivalrous, Boldrin and Levine argue that the tiny cost of replicating it undermines the conventional model. Production is not subject to increasing returns, they argue, and competitive markets can work. "Even a minuscule amount of rivalry," they write, "can turn standard results upside down."

Britney Gets Her Due

Still, the central question is whether innovators will have enough incentive to go through the arduous, expensive invention process. Since the 1400s, when the first patent systems emerged in Venice, governments have tried to provide incentive by granting inventors sole rights to their creations for limited periods. The U.S. Constitution gives Congress the power "to promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries."

Economists long have recognized that such exclusive rights give creators monopolies, allowing them to set prices and quantities that may not be socially optimal. But conventional thinking says these costs are the necessary tradeoff for bringing forth creative genius. Today, the legal realities and economic conventions have assumed the air of incontrovertible fact: If inventors can be "ripped off" -- copied as soon as they create -- why would they bother?

In arguing for competitive innovation rather than the monopolistic variety, Boldrin and Levine emphasize that they are not saying creators don't have rights. On the contrary, they stress that innovators should be given "a well defined right of first sale." (Or, more technically, "we assume full appropriability of privately produced commodities.") And creators should be paid the full market value of their invention, the first unit of the new product. That value is "the net discounted value of the future stream of consumption services" generated by that first unit, which is an economist's way of saying it's worth the current value of everything it's going to earn in the future.

So if Britney Spears records a new song, she should be able to sell the initial recording for the sum total of whatever music distributors think her fans will pay for copies of the music during the next century or so. Distributors know her songs are in demand, and she knows she can command a high price. As in any other market, the buyer and seller negotiate a deal. The same rules would hold for a novelist who writes a book, a software programmer who generates code, or a physicist who develops a useful formula. They get to sell the invention in a competitive market. They're paid whatever the market will bear, and if the market values copies of their song, book, code, or formula, the initial prototype will be precious and they'll be well paid.

In fact, says Boldrin, "in a competitive market, the very first few copies are very valuable because those are the instruments which the imitators -- the other people who will publish your stuff -- will use to make copies. They're more capital goods than consumption goods. So the initial copies will be sold at a very high price, but then very rapidly they will go down in price."

What creators won't get, in Boldrin and Levine's world, is the right to impose downstream licensing agreements that prevent customers from reproducing the product, modifying it, or using it as a stepping stone to the next innovation. They can't prevent their customers from competing with them.

But will the market pay the creator enough? That depends on the innovator's opportunity costs. If the price likely to be paid for an invention's first sale exceeds the opportunity costs of the inventor, then yes, the inventor will create. If a writer spends a year on a book, and could have earned $30,000 during that year doing something else, then her opportunity cost is $30,000. Only if she guesses she can sell her book for at least that much is she likely to sit down and write.

"What we show in the technical paper is that the amount [a book publisher] gives me is positive, and in fact, it can be large," says Boldrin. "Then it's up to me to figure out if what society is paying me is enough to compensate for my year of work."