H.H. Chartrand

April 2002

The Economics of Biotechnology & Intellectual Property Rights

Ultimately the biotechnology sector rests on the legal foundation of intellectual property rights (IPRs). It is ‘fueled’ by new knowledge generated, for example, by biotech ‘star’ innovators (Zucker et al 1998) that then becomes economic property through the agency of IPRs and thereby provides the legal foundation for the industrial organization of the sector.

Economics Helps

Economics illuminates the matter by recognizing that IPRs ‘commodify’ knowledge allowing it to be bought and sold in spite of its nature as a non-rivalrous and non-exclusionary good. Such rights are created by the State as a protection of, and incentive to, creativity which otherwise could be used freely by others. In economic terms, without legislation, knowledge suffers the free-rider problem. In return, the State expects creators to make their work available and that a market will be created in which such work can be bought and sold. But while the State wishes to encourage creativity, it does not want to foster harmful market or ‘monopoly’ power. Accordingly, the State builds in limitations embracing both time and space. Rights are granted for a fixed period of time, and protect only the fixation of creativity in material form. Eventually, therefore, intellectual property enters the public domain where it may be used by everyone without charge or limitation.

Economics Fails

Currently, economics does not provide an adequate or holistic explanation of the complex nature, formulation, optimal application and exchange of IPRs. Partially this reflects that, as with microeconomic data (Part I, para 2.02), economics relies on other disciplines, specifically law and political studies, to create, monitor and mutate these rights and thereby determine what is actually bought and sold in economic exchange. In effect, mainstream economic thought reifies the legal complexity and economic richness of IPRs into ‘goods and services’. This, in turn, reflects a more general failure to ‘root’ in economic theory (i.e., married to, or otherwise associated with, utility and marginal revenue), the evolutionary nature of property rights. The closest the mainstream has come to the legal foundations of capitalism is “New Institutional” or the ‘transaction cost’ school of thought (Coase 1937; 1974, 1978, 1992, 1998).

Only two schools of thought, both long ‘dead’, raised the elemental question of what is actually bought and sold in an economic transaction. A third touched a related chord. A fourth rang the bell of innovation or ‘creative destruction’ but in the legal stratosphere of Capitalism, Socialism & Democracy (Schumpeter 1950), i.e., corporate vs. public property rights - democratically defined.

The first was the Physiocrats (Part IV). To quote Samuels:

Thus did the Physiocrats implicitly recognize that the basic economic institutions (the organization of economy) are legal in character; that law is an instrument for the attainment of economic objectives and that economy is an object of legal control. (Samuels 1962, 162)

The second was the ‘Old Institutionalism’ of John R. Commons (Commons 1924). In addition to the legal implications of economic futurity (Commons 1950), Commons characterized the evolutionary nature of property rights as the trend towards increasing command over the future actions of economic agents. Both the Physiocrats and Commons became marooned in the backwaters of economic thought.

The third was the Austrian school in general but specifically the ‘economy of knowledge’ or ‘price system’ school of F.A. von Hayek (Hayek 1945; 1989) that struck a related chord. Like the price system, the legal system has a life of its own which, particularly in the Anglo-American Common Law tradition, is not fully subject to conscious centralized control. In law, the legislature responds to changing political tides leaving resulting uncertainty to the courts wherein ‘precedent’ is set on which future disputes will be settled. The court is the fifth wheel of a ‘transaction’ in ‘Old Institutionalist’ terms (Commons 1931). The other four are: actual and ‘next-best’ buyers and sellers.

The Problem

Taking the microeconomic term ‘minimax’ to stand for the economic criterion of minimizing cost and maximizing revenue:

To minimax one must know what is being minimaxed! Thus, as I understand it, in the past, and on “the Continent” (as the British would say), one first became a lawyer then an economist;
Each of the major forms of intellectual property (copyrights, patents, registered designs and trademarks) are, in law, ‘bundles of rights’ (Samuels 1962)
most of the economic literature has focused on knowledge spillovers (Audretsh and Stephan 1999) and appropriation due to the inadequacy of IPRs; little has dealt with manipulation of these ‘bundles” to efficiently direct the innovation process, e.g., in the way the Physiocrats wanted to direct the laissez faire, laissez passer marketplace

The Physiocratic theory of economic policy is fundamentally related to a theory of property: state relations in which private property is the dominant institutional form but wherein the public interest is manifest in the continuing modification or reconstitution of the bundle of rights that comprise private property at any given time. (Samuels 1962, 161)

A BUNDLE OF RIGHTS APPROACH TO IPRs

Drawing on Adler – a lawyer (1984), a bundle of IPRs could include:

Statutory Requirements

Alternatively, if one were to imagine each major class of IPRs (copyrights, patents, registered designs and trademarks) as different and distinct types of ‘gears’ with many blades or teeth of varying thicknesses and lengths then each State (subject to international convention) may sharpen, lengthen, thicken or otherwise vary a bundle of generic rights to fashion the national motor of innovation. Such rights include, among others, (Exhibit 1):

Adaptation

Assignment

Breadth

Duration

Eligibility

Licensing

National Treatment

Scope

Subject Matter

Transfer

Translation

An elementary demonstration of the explanatory and policy potential of a ‘bundle of rights’ approach can be drawn from Eswaran and Gallini (1996). In essence, they propose that after a pioneering innovation there follows two alternative patent development paths:

process innovation – the vertical improvement of the now existing product; and/or,
product innovation – the horizontal addition to the market of a new product exhibiting product differentiation reflecting different tastes or needs of ‘consumers’ rather than a new or ‘superior’ product per se.

Development of an ‘optimum’ public patent policy involves varying:

product breadth: proximity of an imitator product to infringement; and/or,
process breadth: proximity of an imitator process to infringement; that is,
the legal definition (legislature and court) of what constitutes defense against infringement, e.g., better, cheaper or novel, and under what circumstances and in what industries.

Optimum public patent policy would foster, according to Eswaran and Gallini:

more efficient entry if it favoured broad process but narrow product patents when a pioneer’s R&D costs are low; and/or,
greater product differentiation if it favoured broad product but narrow process patents when a pioneer’s R&D costs are high.

Conclusion

Economics aids understanding of IPRs by ‘commodifying’ them. In the process, however, mainstream economics has lost sight of what John R. Commons and the Physiocrats saw: the foundation of the economy is property rights whose definition evolves and mutates creating or foreclosing new market opportunities. In the case of biotechnology and intellectual property it is fitting to end with the recent ‘hybrid vigour’ proposal to ‘translate’ DNA sequences into music, so-called “DNA Ditties” to gain not just patent but also copyright protection for new biotech knowledge (Fountain 2002).

References

Adler, R. G., Biotechnology as an Intellectual Property, Science, 224 4647, 1984/04/27, 357-363.

Audretsch, D. B and Stephan P. E., “Knowledge spillovers in biotechnology: sources and incentives”, Journal of Evolutionary Economics, 1999, 9 97-107.

Coase, R. H. "Evolution, Selection and the Economic Principle - Discussion." American Economic Review, May 1978, 68 (2), 244-245.

Coase, R. H. "The Institutional Structure of Production." American Economic Review, September 1992, 82 ( 4), 713-719.

Coase, R. H. "The Market for Goods and the Market for Ideas." American Economic Review, May 1974, 64 ( 2), 384-391.

Coase, R. H. "The Nature of the Firm." Economica, November 1937, 4 (16), 396-405.

Coase, R. H. "The New Institutional Economics." American Economic Review, May 1998, 88 ( 2), 72-74.

Commons, "Institutional Economics", American Economic Review, vol. 21 (1931), pp.648-657.

Eswaran, M. and Gallini N., Patent Policy and the Direction of Technological Change, RAND Journal of Economics, 27 4, 1996/Winter, 722-746. [product/process optimality]

Fountain, H., DNA Ditties: Song of Myself, New York Times, March 31, 2002.

Hayek, F.A., "The Use of Knowledge in Society", American Economic Review, Vol. 35, No. 4, Sept, 1945, pp. 519-530.

Hayek, F.A., "The Pretence of Knowledge", American Economic Review, Vol. 79, No. 6, Dec. 1989, pp. 3-7.

Samuels,W.J., "The Physiocratic Theory of Property and State", Quarterly Journal of Economics, 75(1), Feb. 1961, pp. 96-111.

Samuels, W.J., "The Physiocratic Theory of Economic Policy", Quarterly Journal of Economics, 76(1), Feb. 1962, pp. 145-162.

Schumpeter, J.A., Capitalism, Socialism and Democracy, 3rd Ed., - Chapter VII - The Process of Creative Destruction, 1950, Harper Torchbooks, New York, 1962.

Zucker, L. G. et al, “Intellectual Capital and the Birth of U.S. Biotechnology Enterprises”, American Economic Review, March 1998, 88 (1), 290-306.

The Question

Pick one problem/issue/concern related to biotechnology (e.g. growth, location, ownership, distribution of benefits, industrial structure …) and:

1. define the problem clearly and succinctly;

2. using the economic literature from the class (and elsewhere) address:

a. how economics helps to illuminate the problem (it may do so in more than one way); and

b. economics’ limitations in addressing the problem

c. NOTE: you are expected to refer to at least 5 of your specific readings and 5 other readings on the syllabus in your answer.

Your mark will be assigned based on the structure of your talk, the completeness of the answer and the appropriateness of the references you cite.