Congress will once again take up significant patent reform this week, with the PATENT Act – a version of which passed the Senate Judiciary Committee last Thursday – set for debate on the floor of the House of Representatives.
But some are still litigating the merits of the last significant patent reform Congress passed, 2011’s America Invents Act. Of particular interest, in some quarters of the intellectual property world, are its provisions expanding the inter partes review procedure, which has allowed many more entities to challenge the validity of patents issued by the U.S. Patent and Trademark Office.
Thus far, the results would appear to bear out the claims of those of us concerned that a significant number of patents have been inappropriately granted. Through its first two-and-half years, about 77 percent of the IPR challenges the office has reviewed resulted in invalidating the patent.
But not everyone sees this as a step forward for patent quality. In a guest post at the blog PatentlyO, IP consultant Richard Baker of West Newbury, Mass.-based New England Intellectual Property LLC reviews the results of AIA’s IPR changes, and comes to the bizarre and puzzling conclusion that the law has actually cost the U.S. economy in excess of $1 trillion.(!)
To be sure, there are legitimate economic costs associated with the IPR process that an honest investigator may wish to tally. For instance, the funds expended registering a patent that ought never have been granted would have to count as deadweight losses. But then, so too are the funds spent challenging a patent that ought never have been granted.
But these are not the sorts of costs Baker has in mind. Instead, using data from IPOfferring’s Patent Value Quotient Annual Report of patent sales, Baker calculates that opening a path to challenge inappropriately issued patents has caused the price of U.S. patents to fall by an average of 61 percent. And the patent-holders’ losses, Baker contends, are all of our losses:
Intellectual capital (patents, copyrights, and other forms of economic ideas are worth about $9 Trillion in the United States…So a 61% markdown of patents (and their resulting goodwill when small companies are bought) corresponds to a 61% markdown of a portion of the $9.2 Trillion. Say patents are worth about 25% of the overall value of intellectual capital…, or about $2.3 Trillion, then a 61% loss in value is $1.37 Trillion decrease in the value of the US economy based on the impact of the AIA bill. The American Invents Act bill cost the economy about $1.37 Trillion, or an amount equal to about 7% of the US GDP.
The first and most obvious problem with this analysis is that Baker appears unaware of the distinction between stocks and flows. The current valuation of intellectual property held by U.S. firms is a stock. The nation’s gross domestic product is a flow. The value of the nation’s patents would be included in the total value of all U.S. assets, a figure that is exceedingly hard to estimate, but is certainly many times larger than annual GDP. But it’s the latter we generally refer to when we talk about hits to “the economy.”
There are methods for deriving the former from the latter – that is, for determining a stock’s value by adding up the current and discounted future cash flows it is expected to produce – but there’s certainly no one-to-one correspondence between the two. As an illustration, remember that Americans lost $16.4 trillion of household wealth during the financial crisis of 2007 to 2009. That’s a genuine tragedy. A bigger tragedy still would have been if we’d lost $16.4 trillion of GDP. Mostly, because that would mean the economy would have lost an impossible 113 percent of its value. Instead, peak to trough, GDP declined about 4.3 percent.
A secondary problem is one any Econ 101 student could diagnose. He’s expressing price changes as “losses,” when obviously the net effect of a price change – that is, the effect on “the economy” – is going to be zero. Every dollar lost by someone who holds a stock and wishes to sell it is a dollar gained by someone who covets a stock and intends to buy it. That the valuation of a company or its assets changes does not, in and of itself, tell you much of anything useful about the economy. What would matter to the economy is if the price change was the result of the firm or its sector losing productive capacity, or possibly of some sort of demand shock that would force it to operate at less than productive capacity.
And this is where the whole business of valuing “intellectual capital” as the equivalent of other forms of capital begins to founder. From an accounting perspective, intellectual property would fall under the category of “intangibles,” which also includes things like the skills of the human workforce a firm employs and the relationships it has developed. More specifically, patents are a form of “structural capital,” generally defined as those processes and systems that don’t, strictly speaking, reside in employees’ heads and that remain with the firm even when they leave.
Structural capital is important. Certainly, a securities analyst couldn’t value a firm and a bank officer couldn’t decide whether to lend to it without a good understanding of what its structural capital is and what it’s worth. But if we’re talking about “the economy” here, there are real limits to considering firms’ structural capital in the same terms as other forms of capital.
For example, the structural capital bucket also includes a firm’s reputation. If we were to discover tomorrow that all the pharmaceutical companies have been secretly poisoning our water supply, their structural capital would take a real hit, as would their stock valuations. That doesn’t mean the economically efficient solution would be to suppress the information. There’s still the little matter of the costs those firms are already imposing on the public.
When a refinery explodes, when a tractor breaks down, when a factory gets hit by lightning – those are all genuine capital losses that impede a firm’s ability to continue providing the goods and services consumers want. No similar limitation accompanies the loss of a patent. The firm can keep producing what it always has, albeit in competition with other firms who look to do the same.
Of course, over a longer term, changes in patent law could prove economically troublesome. If the changes were so significant that firms no longer had incentive to invest in research and development, that clearly would be the sort of effect that would show up in GDP. Indeed, this danger counsels a modest and deliberate approach to patent reform.
But Baker makes no effort to quantify or even identify such an effect. To the contrary, what his analysis lacks most is any accounting of the very real benefits that accompany invalidating patents that never should have been granted in the first place. Clearly, the biggest is that the firm holding the patent no longer can extract monopoly rents from consumers. Competition would bring down prices, and those lower prices would mean greater consumer surplus. And creating consumer surplus is actually the purpose of this thing we call “the economy.”
In short, almost everything Baker calls a cost is actually a benefit. Yes, loss of inappropriately granted monopolies would mean write-downs for the firms that hold them, but all of those losses flow back as consumers’ gains. After all, ending slavery also meant mass write-downs of a highly valued form of “property.” It was still the right thing to do.