Both patents and economics have a long history. Documented economic thought in Western civilization can be dated back to Ancient Greek times when Aristotle (384–322 BC) completed his books ‘Politics’ and ‘Ethics’. In eastern culture, economic thought can be dated even further back to the period of Spring-Autumn and Warring States in China, during which a political-economic book ‘Guanzhi’ was written by Guanzhong (725–645 BC). The history of patents is somewhat shorter. The word ‘patent’ comes from the Latin word ‘litterae patentes’, meaning ‘open letter’. Patents were initially used by medieval European monarchs to sell monopoly rights over the trade of specific commodities. The use of patents to encourage invention can be dated back to 1474, when the Venetian state government established a statute on patents. The principle that patents should be given only to inventors was laid down by Francis Bacon in 1602 and enacted by the British Parliament in 1623.
1.1 Linkage Between Patents and Economics
Patents and economics might seem totally unrelated, but they are linked to each other through innovations or inventions (generally speaking, inventions mean significant innovations. However, since they are of the same nature, we use them interchangeably in this book). Nowadays, most people acknowledge the importance of innovations in an economy, but very few realize that innovations are the ultimate source of economic growth. The increased productivity due to process innovations (innovations improving production processes) has been widely studied and confirmed by economists, but little attention has been paid to the role of product innovations (innovations creating new products) in an economy. The importance of product innovations is related to varieties of commodities and thus to consumption ceilings. These ceilings stem from the fact that, although the desire of a human being is unlimited, one’s ability to consume one specific type of good or service is limited. For example, a person can drink only a limited amount of beer a day and no one can listen to the same music all day every day (even for a teenage!). Hence, without product innovation, the limited varieties of goods and the limit on consumption of each good lead to a consumption ceiling. As household consumption approaches this ceiling and the economy will stagnate (Some economists might disagree on this. We will discuss this later).
Since innovation is vital to economic growth, the question we need to ask is: do we naturally have enough innovation? The answer is negative for two reasons. One is that innovations are extremely costly and have a high chance of failure. Most innovations need funding and time in order to do experiments and research. More importantly, innovations are full of uncertainty. By definition, innovation means trials or attempts in the hope to come up with some new products or solutions. The innovators have no idea if their attempts would work. Since innovation activity is a trial-and-error process, innovations have a high chance of failing, with many useful innovations succeeding only after numerous failures. Edison’s invention of carbon-filament electrical bulb is a good example. The other reason that imitation deters innovation. Generally speaking, innovation takes time and is costly, but imitation of an innovation is generally much easier. This means that innovators spend a lot of their energy and money in creating new products for society, but they get very little reward for their creativity due to imitation. Consequently, people shy away from innovation activities. In short, the high risk of innovation failure and low return on successful innovations greatly deter innovation activity.
There are many ways to encourage innovation and scientific discovery. One is prize money. It is well known that the Nobel Prize has a significant impact on scientific discovery. Other prizes in different countries also have played an important role. For example, the invention of marine clocks was largely the outcome of the Longitude Prize offered by the British government for an invention which could easily determine the longitude of the ship during its long-haul travel at sea. A second way to encourage innovation is for the government to set up or fund research/innovation organizations to conduct innovation activities (i.e. the public produce option). A third method is for the government to provide some funding to private innovation firms in order to reduce their innovation costs. Each method has its own limitations. For example, the prize money can reward only a limited number of innovators (in other words, there is a very low chance for innovators to get the prize, so it is not an incentive for most inventors), the public produce suffers from the shortcoming that government-funded institutes are insensitive to the market potential of their innovation, and the government-subsidized private produce is also inefficient because it is hard (if not impossible) for the government to monitor the performance of the private firms due to information asymmetry.
In summary, these methods have three limitations. First, all methods require extra funding to speed up innovation. Second, all methods need to be carefully administered and thus involve high administrative costs. Last but not least, the outcome of encouraging innovations is not ideal. Since there is no guarantee that these methods reward innovators according to their contribution to the economy, innovation funding may not be used efficiently to achieve the best outcome for society.
Compared with the above methods, patents are an ideal way to stimulate innovation. The method requires no extra funding because the rewards come from the sales of the innovated products or from the patent transactions; it requires minimum administration; it can reward many inventors and can reward them appropriately according to the contribution of their inventions. However, patents also have their downsides. They can cause social welfare losses due to patent monopoly power. Nevertheless, the net social benefit of patents is far greater than the net gains from other methods of stimulating innovation, so patents can and should be used as an ideal and primary tool to stimulate innovation (some might disagree. We will have more discussion on this shortly).
The above is a basic or simplified explanation of the links between patents and economics. Chapters 2–5 are mainly on economics, but they form the fundamental argument that innovations and thus patents are crucial for economic growth. Built on this foundation, Chapters 6 and 7 discuss the patent system in detail, suggest a thorough reform and project the impact of a new patent system. However, the reality is much more complex and this has generated seemingly endless and heated arguments both in economics and in patent studies. To a large extent, this book is a response to these arguments and is an effort to expose the essence of issue and to find a solution.
1.2 Cutting Through Economics Jungle
Economists’ long-lasting arguments on business cycles and economic growth have generated a thick jungle in which the role of innovation is buried. Classical, neoclassical and new classical economists believe that market mechanism works well to achieve supply/demand equilibrium and that the economy is always in full employment excluding the very short periods of disequilibrium. The repeatedly occurring economic recessions lasting many months or even years and the associated large number of unemployed workers are a powerful rejection to the claims by those economists. Now many economists are converted to econometricians or empiricists. They think economic growth (or everything in the world) follows statistical laws, thus they enjoy playing with statistical models and are uninterested in the nature and the real causes of economic issues. From economic recessions and stagnation, heterodox economists see problems in a market economy, but they attribute these problems to various relevant but non-essential factors. Underconsumptionists believe that the shortage of consumption is the cause of economic recessions, so they advocate luxury spending as the way to promote economic growth. Keynesian economists blame the deficiency of effective demand, which stems from uncertainty and the lack of ‘animal spirits’ (according to Keynes and post-Keynesians), from nominal wage rigidity, liquidity trap and inelastic investment demand (according to Keynes and orthodox Keynesians), or from nominal and real wage/price rigidities due to imperfection of markets (according to new Keynesians). Monetarists and Austrian School economists attribute the cause of economic recessions to speculative activities and credit cycles. Marxists, socialists and institutionalists see the capitalist institution as the ultimate source of problems in a market economy. Schumpeterians highlight the importance of innovations but deplore the disappearance of entrepreneurship.
Orthodox economists’ view that economic recessions are short periods of disequilibrium appeals to no one but themselves. However, it seems that econometrics has gained popularity among orthodox and heterodox economists and among policy makers. Although there are only a limited number of published papers criticizing the trend of empiricism, econometricians’ blind faith in statistics was questioned unopenly by many economists through their disbelief of statistical modelling results. In response to orthodox economists’ difficulties in explaining the reality and to econometricians’ downplaying or even discarding logical power, Chapter 2 of this book emphasizes the importance of logic demonstrated in the history of political economy. Chapter 3 discusses statistical theory and practice. It reveals that probability law is only a law of ignorance and contains neither mechanism nor causality. In the case where the condition for random experiments is not satisfied, probability law is not applicable. In this case, the statistical modelling results are, strictly speaking, not valid. At best, these results can be used only as a rough guide for research and other practice.
Heterodox economists reveal various relevant factors causing economic problems, but they have failed to uncover the key factor underpinning economic growth and business cycles. Uncertainty and the lack of animal spirits can explain economic recessions and stagnation, but they also cause difficulties in explaining the existence of long periods of economic growth in economic history. Rigid wages, sticky prices, and other market imperfections may exist in an economy, so new Keynesian economists have provided microeconomic foundations for Keynesian theory. However, these market imperfections should be a minor aspect of a market economy because the market mechanism has been proven to be an efficient way to allocate resources. Any promotion of non-market approaches (e.g. planned or command economy) is rejected by the failure and replacement of non-market economies in recent history. Starting from Kondratiev (1922) and Schumpeter (1939), more and more economists have realized the contribution of innovations to economic development, but very few of them have understood the mechanism by which innovations affect the economy. Chapter 4 and the first half of Chapter 5 of this book review various economic thoughts and discuss their deficiencies.
In rejecting the existing economic theories on business cycles and economic growth, the second half of Chapter 5 aims to establish a new theory which can reveal the key role of innovations in the economy. The new theory starts with three simple axioms: (1) everyone has a satiety point in consuming any type of good or service; (2) saving acts as both precautionary premium and saved resources, so it can bring satisfaction not only in the future when the saved resources are consumed, but also at the current time through the sense of security obtained. (3) the expected future consumption is the key element of profitability and thus is the base for investment decision. Chapter 5 discusses the implications of these axioms and then explains the vital role of...