Patents are supposed to encourage innovation. But a new study shows that when it comes to information technologies, litigation—abetted by dysfunctional aspects of the patent system—is slowing rather than enhancing inventiveness.

Boston University legal scholars James Bessen, Jennifer Ford, and Michael Meurer focus in their article in the current issue of Regulation, "The Private and Social Costs of Patent Trolls," [PDF] on “non-practicing entities” (NPEs) that buy up dubious “vaguely worded patents" that can be interpreted as covering established technologies. They then "use them opportunistically to extract licensing fees from the real innovators.” Critics liken NPEs to mythical trolls that lurk under bridges built by others demanding tolls from travelers.

The recent bidding wars for patent portfolios held by ailing tech companies are a good indication of just how dysfunctional the information technology patent mess has become. For example, Kodak, the bankrupt photo film company, is now suing Samsung, Apple Computers, and HTC for allegedly infringing its digital photography patents. The floundering Kodak is pursuing these patent lawsuits in the hope of shoring up its patent portfolio with the aim of selling it for up to $2.6 billion.

Kodak is following the path of bankrupt telephone manufacturer Nortel Networks, which auctioned its portfolio of 6,000 patents in June 2011 to a consortium including Microsoft and Apple for $4.5 billion. Last summer, search giant Google spent $12.5 billion purchasing Motorola Mobility chiefly to obtain its portfolio of 25,000 patents. As a platform to bolster innovation? Hardly. As Google CEO Larry Page explained, “Our acquisition of Motorola will increase competition by strengthening Google’s patent portfolio, which will enable us to better protect Android from anti-competitive threats from Microsoft, Apple and other companies.”

Note that Page said that Google needed the Motorola’s patents, not its inventions. Why? To defend against its competitors’ patent lawsuits. In other words, these tech titans are wielding patent portfolios in a legal game of reciprocal deterrence not too unlike the old nuclear standoff of mutually assured destruction between the U.S. and the Soviet Union, and it’s just about as economically productive.

In their research, Bessen and his colleagues focus on a segment of the software and related patents muddle, the patent lawsuits filed by NPEs. The researchers find that NPE lawsuits “are associated with half a trillion dollars of lost wealth to defendants from 1990 through 2010.” And the losses from this sector of the patent wars are intensifying: The last four year have seen average lost wealth of more than $80 billion annually. The majority of NPE patent litigation involves software and related technologies. 

The Boston University researchers calculate patent litigation losses by looking at how the more than 4,000 lawsuits filed against publicly traded firms affected their stock prices and their research and development efforts over the short and the long run. The researchers report that business divisions of companies affected by the lawsuits typically saw their revenues decline by a third and that they delayed releasing new products for two years as the lawsuits hung fire.

The lawsuits do not simply transfer wealth between the defendant firms and NPEs and the inventors whose patents they hold. Looking at the losses incurred by patent defendants from the nearly 600 lawsuits filed by publicly listed NPEs, the scholars find that the defendant companies lost nearly $88 billion in wealth between 2000 and 2010. On the other hand, the NPEs gained only about $8 billion from the lawsuits and resulting licensing fees, of which $1.7 billion was paid to independent inventors whose patents were the bases of the NPE lawsuits. As a consequence, this litigation resulted in an overall loss to the economy of $80 billion with precious little money actually paid to independent inventors.

Nathan Myhrvold, head of the prominent NPE Intellectual Ventures, rejects this harsh characterization of his industry. His company, asserts Myhrvold, “is misunderstood. We have been reviled as a patent troll—a renegade outfit that buys up patents and then uses them to hold up innocent companies.” Instead, Myhrvold insists that by buying up patents his company is trying to “create a capital market for inventions” which will “turbo-charge technological progress, create many more new businesses, and change the world for the better.” In other words, Myhrvold argues that he and his ilk function much more like beneficent fairy godmothers than trolls.

Bessen and his colleagues find little evidence to support this fairy godmother interpretation of the role of NPEs. They cogently point out that since NPEs generally sue after defendant firms are already using a technology, what is chiefly transferred between defendants and NPEs is not technology, but money. The patents deployed in the lawsuits cover technologies that have likely been developed independently by a number of companies. Imagine Cinderella figured out for herself how to turn a pumpkin into a coach, only to be confronted at midnight by a fairy godmother demanding a fee for the unauthorized use of pumpkin transformation spells.

Instead of a capital market for inventions, information technology companies in the U.S. find themselves enmeshed in a growing capital market for litigation. The result is reduced incentives to innovate, slower introduction of new advanced products to consumers, and reduced earnings for shareholders.

Ronald Bailey is Reason's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.