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What are the Costs of the Patent System?

September 27, 2007

I'm trying to find out if there are any recent estimates as to the cost of the patent system--e.g., what the annual dollar cost is in the US that would not be borne if not for the patent system.

As I've noted before (see There's No Such Thing As A Free Patent), the standard utilitarian rationale for the patent system is that patent law encourages extra innovation; this innovation presumably is valuable. And the defenders of patent assume that the value of this extra innovation is clearly greater than the cost of the system.

Yet even if we assume the utilitarian framework for judging the merits of having a patent system--and ignore the economic and moral problems with utilitarianism--it's obvious that the cost of the patent system is not trivial.

For example, I believe about 400,000 patent applications are filed per year in the US, of late. Assuming a ballpark cost of $15k (patent attorney fees, filing fees, prosecution costs for previously filed applications), we have $6 billion right there. However, patent prosecution costs are a little tricky here because many applications are continuing applications and so some of the prosecution cost has already been expended on the parent. So another way to do this (suggested to me by Meurer) is to find a lower bound to these costs by multiplying $15K or maybe $20K by the number issued patents rather than the number applied for. The number of utility patents alone issued in 2006 is about 174,000. Using this method, and $20k as the average cost, we get $3.5 billion. Let's split the difference and call it $4.5 billion.

What other costs are there? I suppose we could count the entire revenue of the PTO, but that would probably be double counting. And patent attorney salaries are already implicitly counted in this cost (patent prosecutors, not litigators).

Next, we have royalties paid for patent licenses. I have no idea what the total amount of royalty payments equals, but given that IBM alone gets about $1.3 billion a year from licensing fees, let's be conservative and halve this (because some of it may be exaggeration; some may be for trade secrets, etc.), and then multiply this by ten (assuming IBM is no more than 1/10 of all patent license fees in the entire US economy); now we have $6.5 billion more. Our subtotal is $11 billion.

Then we have patent litigation costs. It's well known that it can easily cost a million dollars or more to defend a patent lawsuit. Bessen & Meuer, if I read their paper correctly, estimate $16 billion in patent litigation costs in 1999; we can assume comparable costs now (again, conservative estimate, since they are probably higher -- Bessen's view (email to me) is the figure is only for public firms [and in 1992 dollars?] ... since 1999 the rate of litigation has increased substantially, so current number are probably quite a bit higher".) So we'll use $20 billion, conservatively. And that's not counting crazy damage awards, like the $100 or $1billlion awards occasionally handed out. Okay, now we have $20 billion from patent lawsuits. This might double-count licensing fees a bit, so let's knock it to $15 billion to be safe. That's $26 billion so far.

What else. There are lots of other costs, but they are too hard to measure, or even estimate with any certainty, along the lines of what is seen--and not seen. We can never know the value of some innovations that would have been produced if the threat of patents had not dissuaded the potential innovator from entering the field. It's got to be in the billions. Let's say $2 billion, being conservative. Okay, we're up to $28 billion so far. I have a strong sense that this is a radical underestimate, but let's go with it for now.

Julio Cole notes also that "The existence of patents also induces wasteful expenditure of resources by competitors trying to "invent around the patent," i.e., to develop competing products that are sufficiently differentiated so as not to infringe on an existing patent." Let's give this another $5 billion. $31 billion so far.

Also, because the patent system rewards the more practical type of inventions that can be patented, R&D dollars are skewed toward this, and away from other types of research, or other investments or uses of the funds. So if the billions spent on patent filings, royalties, and defense costs were instead invested or spent on more fundamental R&D, surely this would reap valuable dividends. Let's say $10 billion worth as another ballpark (assuming the $31 billion is invested, etc., yielding a decent return). So now we have $41 billion as our cost.

I'm sure there are others, so this is an underestimate, maybe by an order of magnitude.

I'm looking for some studies that ballpark it like this. Anyone aware of any such studies? Anything obvious and big I'm leaving out? My Mises blog post Revisiting Some Problems with Patents lists several studies on the effects of the patent system on innovation, but not sure if any of them look at it from this perspective of come up with any conclusions formatted in this way.

BTW, this cost number would have to be compared to the value of the marginal innovations stimulated by the patent system. Moreover, this number needs to be first discounted. Why? Let's assume the patent system stimulates an extra amount of innovation in a given year that has a value of $20 billion. We can't count all of this as a gain, since most scientific and engineering innovations will happen sooner or later. The patent system merely encourages them to happen sooner. So let's assume that 75% of patent-stimulated innovation would have happened eventually, within 10 years of when it did occur. So we value 75% of the $20 billion only at the time value of that amount for 10 years.

These are all estimates so let me do a quick back of the envelope and say that we have $5 billion plus time value of getting $15 billion of value 10 years earlier. What's this--maybe $5 billion plus another $5 billion, at most? So here we have a grand total of $10 billlion of gain. Compared to $41 billion cost. The patent system loses by $31 billion a year.

And it's possible that there is no gain at all, or even negative gain. Which means the system is pure cost.

Let me note the conclusion of Bessen & Meurer, in the draft ch. 1 of their forthcoming book:

The results ... show that chemical and pharmaceutical firms earn far more from their patents than they lose to litigation. But for other firms, Figure 1.1B tells a simple but dramatic story: during the 1980s, these firms may have, at best, broken even from patents, but beginning in the mid-1990s, litigation costs exploded. By almost any interpretation, the US patent system could not be providing overall positive incentives for these US public firms by the end of the 1990s. The risk of patent litigation that firms faced in their capacity as technology adopters simply outstripped the profits that they made by virtue of owning patents. A firm looking to invest in an innovative technology during the late 1990s, taking this risk into account, would expect the net impact of patents to reduce the profits from innovation rather than to increase them. Moreover, preliminary data for more recent years suggest that this problem has gotten worse since 1999.

Note that patents do provide profits for their owners, so it makes sense for firms to get them. But taking the effect of other owners' patents into account, including the risk of litigation, the average public firm outside the chemical and pharmaceutical industries would be better off if patents did not exist.

Thoughts? Suggestions?

Update: See Michele Boldrin & David K. Levine, Growth and Intellectual Property (draft). In this paper, Boldrin & Levine do a calculation, in the context of a model in which patents are good for innovation (in fact, an extreme version: no innovation at all without at least some patents). From an email by Boldrin to me, 9/28/07: "Then we compute what a 'benevolent dictator' would consider to be the socially optimal degree of patent protection. By assumption all the transaction/legal costs you are looking at are assumed away here. Then we go on and use data to figure out if the current level of IP protection in different industries/countries is too high or too low. We find it is too high, sometimes by orders of magnitude." The paper assumes "a standard model in which IP protection is socially beneficial" (even though they reject the "standard model" and argue elsewhere "that IP is not generally socially beneficial"). Even assuming a world in which IP is "socially beneficial," they conclude that

  • The elasticity of total monopoly revenue is increasing, hence the term of IP protection should decrease over time as the market size increases. Our best estimate, given the historical growth rate of market size, is that IP protection terms should decrease of about two months per year.
  • Current copyright and patent terms are equivalent to complete monopoly protection for the full economic life of new goods, and are dramatically higher than optimal ones, sometime by two orders of magnitude.
  • On the basis of the available evidence, our best estimate of the length of optimal copyright term is about one year, and that of patents is about seven to thirteen years.

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