Above all we are grateful to our families, Emanuela, Niccolò, Joyce, and Milena for putting up with us while we wrote this not to speak of reading - PDF

Above all we are grateful to our families, Emanuela, Niccolò, Joyce, and Milena for putting up with us while we wrote this not to speak of reading and criticizing parts of it. A great many people contributed

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Above all we are grateful to our families, Emanuela, Niccolò, Joyce, and Milena for putting up with us while we wrote this not to speak of reading and criticizing parts of it. A great many people contributed to our ideas and knowledge of intellectual property expressed in this book although many of them no doubt would disagree with our sentiments and some of our conclusions. We are particularly grateful to Nicholas Gruen, Doug Clement, Jim Schmitz, Tim Sullivan and especially to our editor Scott Parris for their continued support and advice. Many people advised us about particular issues. We are grateful for Preston McAfee s analyis of the Rambus case, Alessandro Nuvolari s advice, especially about steam power, Ivan P ng s example of the wheeled suitcase, Eric Rasumussen s analysis of marketing and copyright, Jean-Laurent Rosenthal s leads on the history of copyright, and George Selgin and John Turner s corrections to our story of James Watt. Many people contributed examples, comments and references, especially Tim Erickson, Jack Hirshleifer, Bronwyn Hall, Andrea Moro, G. Moschini, Ed Prescott, Paul Seabright, Malik Shukayev, Robert Solow, William Stepp, and Edward Welbourne. We learned an immense amount from our fellow bloggers at John Bennett, Andrea Moro, Michael Perelman, Sheldon Richman, and William Stepp. We are grateful also to the Slashdot website and its many contributors for a set of detailed comments on an early version of some of the chapters. Many other people contributed thoughts, ideas, examples and discussion: Larry Ausubel, David Backus, Kyle Bagwell, Sandip Baliga, Gary Becker, Robert Becker, James Bessen, Andres Bucio, Jorge Capapey, V.V. Chari, Pierre-Andre Chiappori, Eddie Dekel, Drew Fudenberg, Clara Graziano, William Brock, Juan Urrutia Elejalde, John Gallup, Richard Gilbert, Mike Golosov, Dan Hite, Hugo Hopenhayn, Chad Jones, Larry E. Jones, Boyan Jovanovic, Nobu Kiyotaki, Lennart Krantz, Timothy Lee, Jay Lepreau, Bob Lucas, Mike Masnick, Salvatore Modica, Enrico Moretti, Paul Romer, Roger Myerson, Mark Sattherwaite, Rob Shimer, Nancy Stokey, Ivan Werning, Freddy Williams, Asher Wolinsky, Curtis Yarvin, and Alejandro Zentne. Our student and research assistant, Fanchang Huang, read the whole manuscript and corrected an endless list of mistakes, poorly assembled references, and other kinds of mishaps. He did a great job and we are most grateful to him. We are sure some errors will still be there, and it is all our fault. The Chinese University of Hong Kong and The University of Pennsylvania IER/Laurence Klein Lecture provided opportunities to present our work to broad audiences, and for this and the many comments that resulted we are grateful. A great many conferences and seminars listened patiently to variations on our analyis: American Economic Association Meetings, Atlanta; Arizona State University, Economics Department; Beijing University, Economics Department; Brown University, macroeconomics and theory workshops; Carlos III, Theory Workshop; Carnegie Rochester Conference; City University of Hong Kong, Theory Workshop; Columbia, Theory Workshop; Cornell, Theory Workshop; Federal Reserve Bank of Dallas, conference on Globalization; Federal Reserve Bank of Richmond, seminar; Fundacion Urrutia Conference, Madrid; Harvard,Theory Workshop; Humbolt University of Berlin, Theory Workshop; IGER, Bocconi, Milano; Indiana University, Theory Workshop; Iowa State, Theory Workshop; ITAM, Mexico D.F.; IUE, Florence, Economics Department; London School of Economics, Theory Workshop; Loyola University, Chicago; Northwestern, Theory Workshop; NYU, Economics Department; Oxford, Economics Department; Pompeu Fabra, Theory Workshop; Purdue University, Economics Department; Rochester University, Theory Seminar; Rochester University, Wegmans conference; SED Conference, Paris; Stanford, macroeconomics workshop; SUNY Buffalo, Economics Department; Toulouse Theory Workshop; UCLA, Economics Department; UC Berkeley, Macroeconomics Workshop; University of Alabama, Theory Workshop; University of Chicago, Theory Workshop; University of Kansas, Theory Workshop; Universidad Autonoma, Madrid, Economics Department; Venice International University, Economics Department; Wisconsin Madison, Economics Department; World Bank - Pompeu Fabra conference; Wuhan University, Economics Department; and Yale, Cowles Commission. Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 Chapter 1: Introduction In late 1764, while repairing a small Newcomen steam engine, the idea of allowing steam to expand and condense in separate containers sprang into the mind of James Watt. He spent the next few months in unceasing labor building a model of the new engine. In 1768, after a series of improvements and substantial borrowing, he applied for a patent on the idea, requiring him to travel to London in August. He spent the next six months working hard to obtain his patent. It was finally awarded in January of the following year. Nothing much happened by way of production until Then, with a major effort supported by his business partner, the rich industrialist Matthew Boulton, Watt secured an Act of Parliament extending his patent until the year The great statesman Edmund Burke spoke eloquently in Parliament in the name of economic freedom and against the creation of unnecessary monopoly but to no avail. 1 The connections of Watt s partner Boulton were too solid to be defeated by simple principle. Once Watt s patents were secured and production started, a substantial portion of his energy was devoted to fending off rival inventors. In 1782, Watt secured an additional patent, made necessary in consequence of... having been so unfairly anticipated, by [Matthew] Wasborough in the crank motion. 2 More dramatically, in the 1790s, when the superior Hornblower engine was put into production, Boulton and Watt went after him with the full force of the legal system. 3 During the period of Watt s patents the U.K. added about 750 horsepower of steam engines per year. In the thirty years following Watt s patents, additional horsepower was added at a rate of more than 4,000 per year. Moreover, the fuel efficiency of steam engines changed little during the period of Watt s patent; while between 1810 and 1835 it is estimated to have increased by a factor of five. 4 After the expiration of Watt s patents, not only was there an explosion in the production and efficiency of engines, but steam power came into its own as the driving force of the industrial revolution. Over a thirty year period steam engines were modified and improved as crucial innovations such as the steam train, the steamboat and the steam jenny came into wide usage. The key innovation was the high-pressure steam engine development of which had been blocked by Watt s strategic use of his patent. 1 Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 Many new improvements to the steam engine, such as those of William Bull, Richard Trevithick, and Arthur Woolf, became available by 1804: although developed earlier these innovations were kept idle until the Boulton and Watt patent expired. None of these innovators wished to incur the same fate as Jonathan Hornblower. 5 Ironically, not only did Watt use the patent system as a legal cudgel with which to smash competition, but his own efforts at developing a superior steam engine were hindered by the very same patent system he used to keep competitors at bay. An important limitation of the original Newcomen engine was its inability to deliver a steady rotary motion. The most convenient solution, involving the combined use of the crank and a flywheel, relied on a method patented by James Pickard, which prevented Watt from using it. Watt also made various attempts at efficiently transforming reciprocating into rotary motion, reaching, apparently, the same solution as Pickard. But the existence of a patent forced him to contrive an alternative less efficient mechanical device, the sun and planet gear. It was only in 1794, after the expiration of Pickard s patent that Boulton and Watt adopted the economically and technically superior crank. 6 The impact of the expiration of his patents on Watt s empire may come as a surprise. As might be expected, when the patents expired many establishments for making steam-engines of Mr. Watt's principle were then commenced. However, Watt s competitors principally aimed at...cheapness rather than excellence. As a result, we find that far from being driven out of business Boulton and Watt for many years afterwards kept up their price and had increased orders. 7 In fact, it is only after their patents expired that Boulton and Watt really started to manufacture steam engines. Before then their activity consisted primarily of extracting hefty monopolistic royalties through licensing. Independent contractors produced most of the parts, and Boulton and Watt merely oversaw the assembly of the components by the purchasers. In most histories, James Watt is a heroic inventor, responsible for the beginning of the industrial revolution. The facts suggest an alternative interpretation. Watt is one of many clever inventors working to improve steam power in the second half of the eighteenth century. After getting one step ahead of the pack, he remained ahead not by superior innovation, but by superior exploitation of the legal system. The fact that his business partner 2 Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 was a wealthy man with strong connections in Parliament, was not a minor help. Was Watt s patent a crucial incentive needed to trigger his inventive genius, as the traditional history suggests? Or did his use of the legal system to inhibit competition set back the industrial revolution by a decade or two? More broadly, are the two essential components of our current system of intellectual property patents and copyrights with all of their many faults, a necessary evil we must put up with to enjoy the fruits of invention and creativity? Or are they just unnecessary evils, the relics of an earlier time when governments routinely granted monopolies to favored courtiers? That is the question we seek to answer. In the specific case of Watt, the granting of the 1769 and especially of the 1775 patents likely delayed the mass adoption of the steam engine: innovation was stifled until his patents expired; and few steam engines were built during the period of Watt s legal monopoly. From the number of innovations that occurred immediately after the expiration of the patent, it appears that Watt s competitors simply waited until then before releasing their own innovations. This should not surprise us: new steam engines, no matter how much better than Watt s, had to use the idea of a separate condenser. Because the 1775 patent provided Boulton and Watt with a monopoly over that idea, plentiful other improvements of great social and economic value could not be implemented. By the same token, until 1794 Boulton and Watt s engines were less efficient they could have been because the Pickard s patent prevented anyone else from using, and improving, the idea of combining a crank with a flywheel. Also, we see that Watt s inventive skills were badly allocated: we find him spending more time engaged in legal action to establish and preserve his monopoly than he did in the actual improvement and production of his engine. From a strictly economic point of view Watt did not need such a long lasting patent it is estimated that by 1783 seventeen years before his patent expired his enterprise had already broken even. Indeed, even after their patent expired, Boulton and Watt were able to maintain a substantial premium over the market by virtue of having been first, despite the fact that their competitors had had thirty years to learn how to make steam engines. The wasteful effort to suppress competition and obtain special privileges is referred to by economists as rent-seeking behavior. History and common sense show it to be a poisoned fruit of legal monopoly. Watt s attempt to extend the duration of his 3 Boldrin & Levine: Against Intellectual Monopoly, Chapter patent is an especially egregious example of rent seeking: the patent extension was clearly unnecessary to provide incentive for the original invention, which had already taken place. On top of this, we see Watt using patents as a tool to suppress innovation by his competitors, such as Hornblower, Wasborough and others. Hornblower s engine is a perfect case in point: it was a substantial improvement over Watt s as it introduced the new concept of the compound engine with more than one cyclinder. This, and not the Boulton and Watt design, was the basis for further steam engine development after their patents expired. However, because Hornblower built on the earlier work of Watt, making use of his separate condenser Boulton and Watt were able to block him in court and effectively put an end to steam engine development. The monopoly over the separate condenser, a useful innovation, blocked the development of another equally useful innovation, the compound engine, thereby retarding economic growth. This retardation of innovation is a classical case of what we shall refer to as Intellectual Property-inefficiency, or IP inefficiency for short. Finally, there is the slow rate at which the steam engine was adopted before the expiration of Watt s patent. By keeping prices high and preventing others from producing cheaper or better steam engines, Boulton and Watt hampered capital accumulation and slowed economic growth. The story of James Watt is a damaging case for the benefits of a patent system, but we shall see that it is not an unusual story. A new idea accrues almost by chance to the innovator while he is carrying out a routine activity aimed at a completely different end. The patent comes many years after that and it is due more to a mixture of legal acumen and abundant resources available to oil the gears of fortune than anything else. Finally, after the patent protection is obtained, it is primarily used as a tool to prevent economic progress and hurt competitors. While this view of Watt s role in the industrial revolution may appear iconoclastic, it is neither new nor particularly original. Frederic Scherer, a prestigious academic supporter of the patent system, after going through the details of the Boulton and Watt story, concluded his 1986 examination of their story with the following illuminating words Had there been no patent protection at all, Boulton and Watt certainly would have been forced to follow a business policy quite different from that which they actually 4 Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 followed. Most of the firm s profits were derived from royalties on the use of engines rather than from the sale of manufactured engine components, and without patent protection the firm plainly could not have collected royalties. The alternative would have been to emphasize manufacturing and service activities as the principal source of profits, which in fact was the policy adopted when the expiration date of the patent for the separate condenser drew near in the late 1790s. It is possible to conclude more definitely that the patent litigation activities of Boulton & Watt during the 1790s did not directly incite further technological progress. Boulton and Watt s refusal to issue licenses allowing other engine makers to employ the separate-condenser principle clearly retarded the development and introduction of improvements. 8 * * * The industrial revolution was long ago. But the issue of intellectual property is a contemporary one. At the time we wrote this, U.S. District Judge James Spencer had been threatening for three years to shut down the widely used Blackberry messaging network over a patent dispute. 9 And Blackberry itself is not without sin: in 2001 Blackberry sued Glenayre Electronics for infringing on its patent for pushing information from a host system to a mobile data communication device. 10 A similar war is taking place over copyright the Napster network was shut down by a federal judge in July of 2000 in a dispute over the sharing of copyrighted files. 11 Emotions run high on both sides. We have the anti-copyright slogan information just wants to be free promoted by some civil libertarians. On the other extreme, large music and software companies argue that a world without intellectual property would be a world without new ideas. Some of the bitterness of the copyright debate is reflected in Stephen Manes attack on Lawrence Lessig According to Stanford law professor and media darling Lawrence Lessig, a movement must begin in the streets to fight a corrupt Congress, overconcentrated media and an overpriced legal system...contrary to Lessig's rants... Fair use exceptions in existing copyright law...are so expansive that just about the only thing cut-and-pasters 5 Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 clearly can't do legally with a copyrighted work is directly copy a sizable portion of it. 12 Certainly Lessig is no friend of current copyright law. Yet, despite Stephen Manes assertions to the contrary, he does believe in balancing the rights of producers with the rights of users: his book Free Culture speaks repeatedly of this balance and how it has been lost in modern law. 13 Like Lessig, many economists are skeptical of current law seventeen prominent economists, including several Nobel Prize winners, filed a brief with the U.S. Supreme Court in support of Lessig s lawsuit challenging the extension of the length of copyright. Also like Lessig, economists recognize a role for intellectual property: where lawyers speak of balancing rights, economists speak of incentives. To quote from a textbook by two prominent economists Robert Barro and Xavier Sala-i-Martin It would be [good] to make the existing discoveries freely available to all producers, but this practice fails to provide the...incentives for further inventions. A tradeoff arises between restrictions on the use of existing ideas and the rewards to inventive activity. 14 Indeed, while many of us enjoy the benefits of being able to freely download music from the internet, we worry as well how the musician is to make a living if her music is immediately given away for free. While a furious debate rages over copyrights and patents, there is general agreement that some protection is needed to secure for inventors and creators the fruits of their labors. The rhetoric that information just wants to be free suggests that no one should be allowed to profit from her ideas. Despite this, there does not seem to be a strong lobby arguing that while it is ok for the rest of us to benefit from the fruits of our labors, inventors and creators should have to subsist on the charity of others. For all the emotion, it seems both sides agree that intellectual property laws need to strike a balance between providing sufficient incentive for creation and the freedom to make use of existing ideas. Put it differently, both sides agree that intellectual property rights are a necessary evil that fosters innovation, and disagreement is over where the line should be drawn. For the supporters of intellectual property, current 6 Boldrin & Levine: Against Intellectual Monopoly, Chapter 1 monopoly profits are barely enough; for its enemies currently monopoly profits are too high. Our analysis leads to conclusions that are at variance with both sides. Our reasoning proceeds along the following lines. Everyone wants a monopoly. No one wants to compete against his own customers, or against imitators. Currently patents and copyrights grant producers of certain ideas a monopoly. Certainly few people do something in exchange for nothing. Creators of new goods are not different from producers of old ones: they want to be compensated for their effort. However, it is a long and dangerous jump f
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