• 20 Dec 2004
  • Research & Ideas

The U.S. Patent Game: How to Change It

Innovators and society are paying too high a price in the current patent system, says a new book by Adam B. Jaffe and Harvard Business School’s Josh Lerner. A book excerpt and Q&A with Lerner.
by Ann Cullen

When lawyers fare better than inventors and entrepreneurs where U.S. patents are concerned, you know injustice is being done. The current system makes patents easier to acquire, sure, but renders them less prestigious as well, and less likely to attract valuable financing. In addition, older firms that are feeling threatened have learned how to bully younger upstarts by wielding licenses and patent law like a weapon. It certainly doesn't encourage the spirit of innovation, does it?

However, it isn't just the inventors and fledgling businesses that suffer. The economy as a whole does too, in ways that are often invisible.

A provocative new book by economists Adam B. Jaffe and Josh Lerner describes what's wrong, but shines a light on ways to fix the system, too. Their book, Innovation and Its Discontents: How Our Broken Patent System is Endangering Innovation and Progress, was published in November 2004 by Princeton University Press. Jaffe is professor of economics and dean of Arts and Sciences at Brandeis University. Lerner is the Jacob H. Schiff Professor of Investment Banking at Harvard Business School.

In Innovation and Its Discontents, Jaffe and Lerner say the patent system is the product of three elements that are required to interact: technology, people, and government. The interaction, which they describe in detail, "ultimately affects us all, and so should concern us all," they write.

In the following interview for HBS Working Knowledge, Lerner explains what's wrong and how to fix it.

Ann Cullen: How did you come to write this book with Adam B. Jaffe? What sparked your interest in this research?

Josh Lerner: Adam and I have done research, together and separately, over the past decade on issues related to patent policy. While this work explored a variety of interesting issues, the limited circulation of the periodicals in which the works appeared and the necessarily technical nature of the articles meant their impact was limited. Meanwhile, in many settings—from panel discussions to consulting projects to congressional hearings—we were hearing about the increasing severity of the patent system's problems, and the negative effects that they were having on firms.

While these issues had been widely recognized by practitioners, and had been the subject of weighty, footnote-laden reports by such bodies as the Federal Trade Commission and the National Academy of Sciences, there had been little popular attention to this issue. (The only trade books on the topic seemed to either be "war stories" about memorable patent disputes or exhortations to executives to get rich by exploiting the patent system's weaknesses!) These circumstances led us to decide to write this book. We sought to write a volume that would be readily accessible for business and government practitioners, and which conveyed clearly the system's problems and some steps to solving them.

Q: What are the current barriers to fixing the patent system? What reforms to this system do you suggest?

A: Why is reform of the patent system so hard? An extensive body of work, often described as "political economy," provides an answer to this question, at least at a broad-brush level. These writings have emphasized the danger of "capture" of government programs. [Editor's note: In a nutshell, regulatory capture refers to the tendency of regulators to favor, in effect, the interest of the industry they are supposed to be regulating rather than the public interest.] Any program that assigns subsidies or assigns property rights is prone to the distortions that may result as interest groups or politicians seek to direct the public programs in a manner that benefits them.

While the most dramatic effects are seen in the U.S., this is a global problem.

The patent system has many features that make the problem of capture likely. The most important of these relate to the complexity of these laws. The set of lawyers who understand these issues is unlikely to be large. While probably few are inclined to intentionally perpetuate an inefficient system, the substantial gains that they enjoy from the current system's complexity—e.g., lengthy and lucrative assignments—is likely to have a subtle effect on many practitioners' reactions to proposals for radical change.

Moreover, the negative effects of bad patent policy are very diffuse, and very difficult to see and understand. Consumers are unlikely to get excited about the extent to which subtle shifts in abstract judicial doctrine will affect the amount they pay for new products. Even CEOs are not apt to give these arcane issues the same kind of attention as something like tax policy, which affects a corporation's bottom line in a direct and transparent way.

Q: How have the changes in the patent process you document affected entrepreneurial finance?

A: Young, innovative firms are hurt in two ways by a poorly-operating patent system. First, as patents become easier to get, their value for the truly innovative firms—such as those backed by venture capitalists—decreases. Just as excellent students no longer can stand out if "grade inflation" at a college leads to almost all students getting A's, so too, innovative companies find it increasingly difficult to get the visibility and recognition they deserve if the patent system does not work efficiently.

Second, young firms are frequently targets of patent litigation. In many cases, an established firm, frequently one whose competitive position and innovative activity are declining, realizes it has a valuable stockpile of issued patents. This firm then approaches rivals, demanding that they take out licenses to its patents. In many cases, they will target smaller and young firms who do not have extensive financial resources to engage in protracted patent litigation. The small, young firms are often forced to capitulate.

Q: Given the changes you document to the U.S. patent process, do you think that if the current system is not fixed, more innovation will move overseas?

A: While the most dramatic effects are seen in the U.S., this is a global problem. As Dominique Guellec, the chief economist at the European Patent Office in Munich, observes, "patent offices are under incredible pressure" worldwide. Many offices have had to grapple with an influx of patents, and many nations are strengthening patents—often in response to pressure by American politicians. So this is not a uniquely American problem.

Nonetheless, to the extent that the problems are most severe in the U.S., I agree that this will tend to depress the share of the U.S. in innovation.

Q: Your book talks about the "pauperization of the patent system." Can you elaborate on what you mean by this?

A: Beginning in the early 1990s, Congress converted the United States Patent and Trademark Office from an agency funded by tax revenues, which collected nominal fees for patent applications, into one funded by the fees it collects. Indeed, the patent office has become a profit center for the government, collecting more in application fees than it costs to run the agency! In some years, as much as $200 million, or about 15 percent of total revenues, have been diverted from the patent office to the U.S. Treasury.

This change has had important consequences. Increasingly, the patent office views itself as an organization whose mission is to serve patent applicants. And, of course, what applicants want is for their applications to be granted! Furthermore, the new orientation creates strong incentives for the patent office to process applications as quickly as possible, and at the lowest possible cost. As a result, there has been a widely perceived decline in the rigor with which patent applications are reviewed. This, in turn, encourages more people to apply for dubious patents.

About the Author

Ann Cullen is a business information librarian at Baker Library, Harvard Business School, with a specialty in finance.