Falling in the emotional wake of the terrorist attacks on the World
Trade Center and Pentagon, this year's Grammy awards ceremony had a
solemn tone. More than a dozen moving performances recognized the mood
of a nation seeking to heal its wounds. Tony Bennett crooned "New
York State of Mind" in a duet with Billy Joel. Nelly Furtado soared
with "I'm Like a Bird." The Rev. Al Green and CeCe Winans
gave a powerful gospel finale.
The most forceful performance of the evening, however, was the speech
delivered by Michael Greene. As president of the National Academy of
Recording Arts & Sciences, he spoke gravely of "serious risk"
and warned of worldwide threat. "Embrace this life and death issue,"
he implored the audience. The menace is "pervasive, out of control
and oh so criminal."
But Greene was not referring to the events of Sept. 11. The sinister
threat he spoke of was neither Al Qaeda nor anthrax. "The most
insidious virus in our midst," said Greene, with a very stern face,
"is the illegal downloading of music on the Net."
If it seems just a bit overwrought to imply that pulling a Britney Spears
song off the Web is the greatest threat since international terrorism,
the tenor of Greene's sermon was a clear indication of the music world's
fear. New technology has loosened the industry's hold over product replication
and distribution. Their profits, their business model, their very existence
is under siege.
And the music business is not alone in this worry. Over the past decade,
the captains of many other industriesmovies, publishing, software,
pharmaceuticalshave railed against "piracy" that they
feel afflicts their profits. The copyright and patent protection conferred
by government to protect their intellectual property has been breached
by new technologies that easily and quickly copy and distribute their
products to mass markets. And as quickly as a producer figures a way
to encrypt a DVD or software program to prevent duplication, some hacker
in Seattle, Reykjavik or Manila figures a way around it.
So if Greene's tirade was tone-deaf, his concern was understandable.
His industry and others feel threatened because they can no longer control
their product. The music industry has tried to squelch the threat, most
conspicuously by suing Napster, the wildly popular Internet service
that matched up patrons with the songs they wanted, allowing them to
download digital music files without charge. Napster, of course, lost
the lawsuit and, as this goes to press, is heading toward liquidation.
But the struggle between Napster and the music industry has given high
profile to a much broader question: How does an economy best promote
innovation? Do patents and copyrights stifle innovation rather than
nurture it? Have we gone too far in protecting intellectual property?
Is a society served better by the unfettered exchange of ideas and information
than by granting creators and inventors the right to control the distribution
and future uses of their products? More succinctly: Was Napster right?
In a paper that has gained wide attentionand caught serious flakbecause
it challenges conventional wisdom on the matter, economists Michele
Boldrin and David Levine* have begun to answer that question in the affirmative.
Copyrights, patents and similar government-granted rights over ideas
and innovations serve only to reinforce monopoly control, with its attendant
damages of inefficiently high prices, low quantities and stifled future
innovation, said Boldrin and Levine in "Perfectly
Competitive Innovation," a Minneapolis Fed staff report. And
more to the point, they argued, economic theory shows that perfectly
competitive markets are entirely capable of rewarding (and thereby stimulating)
innovation, making copyrights and patents superfluous and wasteful.
Reactions to the paper have been predictably disparate. Robert
Solow, the Massachusetts Institute of Technology economist who won
a Nobel in 1987 for his pioneering work on growth theory, wrote them
a letter calling the paper "an eye-opener" and making suggestions
for further refinements. Danny Quah, a professor of economics at the
London School of Economics, called their analysis "an important
and profound development" that "seeks to overturn nearly half
a century of formal economic thinking on intellectual property. ..."
But UCLA economist Benjamin Klein finds their work "unrealistic,"
and Paul Romer, a Stanford University economist whose pathbreaking development
of new growth theory is the focus of much of Boldrin and Levine's critique,
considers their logic flawed and their assumptions implausible.
It is a measure of the depth and ambition of the paper that the authors
absorb these criticisms and continue to consider their work sound and
its implications far-reaching. "To avoid being humble when it is
not needed," joked Boldrin in an e-mail from Madrid, where he is
currently on sabbatical, "we are actually challenging IO [industrial
organization] and IT [international trade] theories, beside NGT [new
growth theory]." Yet he also noted in an earlier interview, "We're
not claiming to have invented anything new, really. We're recognizing
something that we think has been around ever since there has been innovation.
In fact, patents and copyrights are a very recent distortion."
But even if that's true, Boldrin and Levine are working against a well-established
conventional wisdom that has sanctioned if not embraced intellectual
property rights, and theirs is a decidedly uphill battle.
A long heritage
So, what is that conventional wisdom? In the 1950s, Solow showed that
technological change was a primary source of economic growth, but his
growth models viewed that change as exogenous, a given determined by
elements beyond pure economic forces. In the 1960s, Kenneth Arrow, Karl
Shell and William Nordhaus delved further into this source of economic
growth, analyzing the relationship between free markets and technological
change. They concluded that free markets might fail to bring about optimal
levels of innovation.
"[T]hree of the classical reasons for the possible failure of perfect
competition to achieve optimality in resources allocation: indivisibilities,
inappropriability, and uncertainty ... all ... hold in the case of invention,"
wrote Arrow in a landmark 1962 article. "We expect a free enterprise
economy to underinvest in invention and research (as compared with an
ideal) because it is risky, because the product can be appropriated
only to a limited extent, and because of increasing returns in use."
The uncertainty associated with creation and invention seems a clear
roadblock to investment in technological change: Will all the hours
and dollars spent on research and development result in a profitable
product? Is the payoff worth the risk? The uncertainty of success diminishes
the desire to try. Much of Arrow's article examined economic means of
dealing with uncertainty, none of them completely successful.
The second problem, what economists call inappropriability, is the divergence
between social and private benefitin this case, the difference
between the benefit reaped by society from an invention, and the benefit
reaped by the inventor. Will I try to invent the wheel if all humankind
would benefit immeasurably from my invention, but I'd only get $1,000?
Maybe not. Property rights, well defined, help address this issue.
And the third obstacle to innovation, indivisibility, is the concept
that the act of invention involves a substantial upfront expenditure
(of time or money) before a single unit of the song, the formula or
the book exists. But thereafter, copies can be made at a fraction of
the cost. Such indivisibilities result in dramatically increasing returns
to scale: If a $1 million investment results in just one unit of an
invention, the prototype, a $2 million expenditure could result in the
prototype plus thousands or millions of duplicates.
This is a great problem to have, but perfect competition doesn't deal
well with increasing returns to scale. With free markets and no barriers
to entry, products are priced at their marginal cost (the cost of the
latest copy), and that price simply won't cover the huge initial outlay.
Inventors will have no financial incentive for bringing their inventions
to reality, and society will be denied the benefits.
Increasing returns therefore seem to argue for some form of monopoly,
and in the late 1970s, Joseph Stiglitz and Avinash Dixit developed a
growth model of monopolistic competitionthat is, limited competition
with increasing returns to scale. It's a model in which many firms compete
in a given market but none is strictly a price-taker. It's a growth
model, in other words, without perfect competition. The
Dixit-Stiglitz model is widely used today, with the underlying assumption
that economic growth requires technological change, which implies increasing
returns, which means imperfect competition.
New (endogenous) growth theory
Much of this work was formalized in the 1980s and 1990s by Romer in
what he called a theory of endogenous growth. It was the idea that technological
change-innovation-should be modeled as part of an economy, not external
to it as Solow had done. And the policy implication was that economic
variables like interest and tax rates, as well as subsidies for research
and technical education, could influence the rate of innovation.
Romer refined the ideas of Arrow and others, developing new terms, integrating
the economics of innovation and extending the Dixit-Stiglitz growth
model into what he called "new growth theory." In a parallel
track, Robert Lucas, Nobel laureate at the University of Chicago, elucidated
the importance of human capital to economic growth. And just prior to
all this growth theory work, Paul Krugman, Elhanan Helpman and others
integrated increasing returns theory with international trade economics,
creating "new trade theory." Similar theories became the bedrock
of industrial organization economics.
Central to Romer's theory is the idea of nonrivalry, a property he considers
inherent to invention, designs and other forms of intellectual creation.
"A purely nonrival good," wrote Romer, "has the property
that its use by one firm or person in no way limits its use by another."
A formula, for example, can be used simultaneously and equally by a
hundred people, whereas a wrench cannot. The formula is a nonrival good,
the wrench is rivalrous.
Nonrivalrous goods are inherently subject to increasing returns to scale,
said Romer. "Developing new and better instructions is equivalent
to incurring a fixed cost," he wrote. "Once the cost of creating
a new set of instructions has been incurred, the instructions can be
used over and over again at no additional cost." But if this is
true, then "it follows directly that an equilibrium with price
taking cannot be supported." In other words, economic growthand
the technological innovation that it requiresisn't possible under
perfect competition; it requires some degree of monopoly power.
Economists prize economic growth but distrust monopoly, and to accept
the latter to obtain the former is a Faustian bargain at best. With
"Perfectly Competitive Innovation," Boldrin and Levine vigorously
reject the contract. "It may not be an exaggeration to assert that
a meaningful treatment of endogenous innovation and growth is commonly
believed to be impossible under competitive conditions," they wrote.
"We aim at disproving this belief."
They point to the historical record. Innovation, they argue, has occurred
in the past without substantial protection of intellectual property.
"Historically, people have been inventing and writing books and
music when copyright did not exist," noted Boldrin. "Mozart
wrote a lot of very beautiful things without any copyright protection."
(The publishers of music and books, on the other hand, sometimes did
have copyrights to the materials they bought from their creators. But
as University of London economist Arnold Plant argued in a classic 1934
review of the copyright history, "The copyright monopoly, like
patent monopoly" isn't necessary to remunerate authors and inventors,
it restricts supply, and it doesn't produce better products than those
"which [emerge] ... from the competitive bidding of the open market.")
Contemporary examples, said Boldrin and Levine, are also plentiful.
The fashion worldhighly competitive, with designs largely unprotectedinnovates
constantly and profitably. True also in modern art. The financial securities
industry makes millions by developing and selling complex securities
and options without benefit of intellectual property protection. Competitors
are free to copy a firm's security package, but doing so takes time.
The initial developer's first-mover advantage secures enough profit
to justify "inventing" the security.
As for software, Boldrin refers to a Massachusetts Institute of Technology
working paper by economists Eric Maskin and James Bessen. Maskin and
Bessen wrote that "some of the most innovative industries todaysoftware,
computers and semiconductorshave historically had weak patent
protection and have experienced rapid imitation of their products."
Moreover, U.S. court decisions in the 1980s that strengthened patent
protection for software led to less innovation. "Far from unleashing
a flurry of new innovative activity," wrote Maskin and Bessen,
"these stronger property rights ushered in a period of stagnant,
if not declining R & D among those industries and firms that patented
most." Industries that depend on sequential product development,
they argued, are likely to be stifled by stronger intellectual property
regimes. "So examples abound," said Boldrin. "That's the empirical
point: Evidence shows that innovators have enough of an incentive to
innovate." But he and Levine are not, by nature or training, empiricists.
They build mathematical models to describe economic theory. And in the
case of intellectual property, they contend, evidence contradicts theory:
Current theory says innovation won't happen unless innovators receive
monopoly rights, but the evidence says otherwise. "So what we do
is to develop the theoretical point to explain the evidence," said
Rivalry over nonrivalry
Central to their argument is a closer look at nonrivalry. A fundamental
tenet of current conventional wisdom is that knowledge-based innovations
are subject to increasing returns because ideas are nonrivalrous: One
person's use of an idea (or song, movie, book, software, etc.) doesn't
diminish anyone else's. As Thomas Jefferson put the same concept (more
eloquently): "He who receives an idea from me, receives instruction
himself without lessening mine; as he who lights his taper at mine,
receives light without darkening me."
But Boldrin and Levine argue that in an economy, this has no relevance.
While pure ideas can be shared without rivalry in theory, the economic
application of ideas is inherently rivalrous because ideas "have
economic value only to the extent that they are embodied into either
something or someone." What is relevant in the economic realm is
not an abstract concept or formulano matter how beautifulbut
its physical embodiment. Calculus is economically valuable only insofar
as engineers and economists know and apply it. "Only ideas embodied
in people, machines or goods have economic value," they wrote.
And because of their physical embodiment, "valuable ideas ... are
as rivalrous as commodities containing no ideas at all, if such exist."
A novel is valuable only to the extent that it is written down (if then).
A song can be sold only if it is sung, played or written by its creator.
A software programonce writtenmight seem costless, but "the
prototype [of a program] does not sit on thin air," wrote Boldrin
and Levine. "To be used by others it needs to be copied, which
requires resources of various kinds, including time. To be usable it
needs to reside on some portion of the memory of your computer. ...
When you are using that specific copy of the software, other people
cannot simultaneously do the same. ... Once again, there is no free
In each instance, development of the initial prototype is far more costly
than production of all subsequent copies, admit Boldrin and Levine.
But because copying takes timea limited commodityand materials
(e.g., paper, ink, hard disk space), it is not entirely costless. "Consider
the paradigmatic example of the wheel," they wrote. "Once
the first wheel was produced, imitation could take place at a cost orders
of magnitude smaller. But even imitation cannot generate free goods:
to make a new wheel, one needs to spend some time looking at the first
one and learning how to carve it."
The first wheel is far more valuable than all others, of course, but
that "does not imply that the wheel, first or last that it be,
is a nonrivalrous good. It only implies that, for some goods, replication
costs are very small."
Economic theorists have generally assumed that the dramatic difference
between development and replication costs can be modeled as a single
process with increasing returns to scale: a huge fixed cost (the initial
investment) followed by costless duplication.
Boldrin and Levine said this misrepresents reality: There are two distinct
processes with very different technologies. Development is one production
process involving long hours, gallons of coffee, sweaty genius and black,
tempestuous moods. At the end of this initial process (hopefully), the
prototype exists and the effort and money that produced it are a sunk
cost, an expense in the past.
Thereafter, a very different production process governs replication:
Replicators study the original, gather flat stones, round off corners,
bore center holes and prune tree limbs into axles. Stone wheels roll
off the antediluvian assembly line. In this second process, the economics
of production are the same as for any other commodity, usually with
constant returns to scale.
The candle's flicker
As Boldrin and Levine develop the mathematical model that describes
this, they assume only that "as in reality," copying takes
time and there is a limit (less than infinity) on the number of copies
that can be produced per unit of time. These "twin assumptions"
introduce a slim element of rivalry. After it's created, the prototype
can be either consumed or used for copying in the initial time period.
(Technically, it could be used for both, but not as easily as if it
were used for just one or the other.)
While others have simply assumed, with Romer, that the prototype of
an intellectual product is nonrivalrous, Boldrin and Levine argue that
this tiny amount of cost undermines the conventional model. It's as
if Jefferson's candle flickered when it was used to light another: The
wax, wick and air that embody the flame are production factors, and
sharing the flame actually does incur a drop of wax, a bit of wick and
a wisp of oxygen. And when this is the case, find Boldrin and Levine,
production is not subject to increasing returns and competitive markets
can work. "Even a minuscule amount of rivalry," they wrote,
"can turn standard results upside down."
Still, the central question is whether innovators will have enough
incentive to go through the arduous, expensive invention process. Since
the 1400s, when the first patent systems emerged in Venice, governments
have tried to provide incentive by granting inventors sole rights to
their creations for limited periods. The U.S. Constitution, for example,
gives Congress the power "to promote the Progress of Science and
useful Arts, by securing for limited Times to Authors and Inventors
the exclusive Right to their respective Writings and Discoveries."
Economists have long recognized that those exclusive rights give creators
limited monopolies, allowing them to set prices and quantities that
may not be socially optimal. But conventional thinking has said these
costs are the necessary trade-off for bringing forth creative genius,
for lighting the candle. "Modern economic literature reflects our
reality," wrote Steven Shavell of Harvard Law School and Tanguy
van Ypersele of the University of Namur, in a recent article, "and
takes the general optimality of intellectual property rights largely
as a given." Today, the legal realities and economic conventions
have assumed the air of incontrovertible fact: If inventors can be "ripped
off"copied as soon as they createwhy would they bother?
We must grant them rights.
In arguing for competitive innovation, rather than the monopolistic
variety, Boldrin and Levine emphasize that they are not saying creators
don't have property rights. On the contrary, they stress that innovators
should be given "a well defined right of first sale." (Or
more technically, "we assume full appropriability of privately
produced commodities.") And creators should be paid the full market
value of their invention, the first unit of the new product. That value
is "the net discounted value of the future stream of consumption
services" generated by that first unit, which is an economist's
way of saying it's worth the current value of everything it's going
to earn in the future.
Britney gets her due
So, if Britney Spears records a new song, she should be able to sell
the initial recording for the sum total of whatever music distributors
think her fans will pay for copies of the music over the next century
or so. Distributors know her songs are in demand, and she knows she
can command a high price. As in any other market, the buyer and seller
negotiate a deal. The same for a novelist who writes a book, a software
programmer who generates code or a physicist who develops a useful formula.
They get to sell the invention in a competitive market. They're paid
whatever the market will bear, and if the market values copies of their
song, book, code or formula, the initial prototype will be quite precious,
and they'll be well paid.
In fact, said Boldrin, "in a competitive market, the very first
few copies are very valuable because those are the instruments which
the imitatorsthe other people who will publish your stuffwill
use to make copies. They're more capital goods than consumption goods.
So the initial copies will be sold at a very high price, but then very
rapidly they will go down in price."
But what creators won't get, in Boldrin and Levine's world, is the right
to "rent" their intellectual propertythat is, the legal
right to impose downstream licensing agreements that prevent customers
from reproducing the product or modifying it or using it as a stepping
stone to the next innovation. They can't, in brief, prevent their customers
from competing with them.
"Britney will get her dues the same way Monteverdi, Mozart, Vivaldi
and Co. did," wrote Boldrin in an e-mail. "Same for writers.
All they have to do is follow in the footsteps of Homer and Shakespeare."
Boldrin isn't proposing that Spears approach the King of Prussia for
patronage, but he is saying that the market will take care of her; monopolies
But will the market pay enough? That depends on the opportunity costs
of the inventor. If the price likely to be paid for an invention's first
sale exceeds the opportunity costs of the inventor, then yes, the inventor
will create. If a writer spends a year on a book, and could have earned
$30,000 during that year doing something else, then her opportunity
cost is $30,000. Only if she guesses she can sell her book for at least
that much is she likely to sit down and write.
"What we show in the technical paper is that the amount [a book
publisher] gives me is positive, and in fact, it can be large,"
said Boldrin. "Then it's up to me to figure out if what society
is paying me is enough to compensate for my year of work."
But more startling is the next implication of the Boldrin and Levine
model. What happens as reproduction technologies improve, as printing
presses get faster or as software and the Internet allow teenagers to
share music files faster and fartherthe scenario that so horrified
Michael Greene at the Grammy ceremony? Won't that drive authors and
musicians into utter poverty by ripping them off even more quickly?
In fact, the opposite should occur. Increasing rates of reproduction
will drop marginal production costs and, therefore, prices. If demand
for the good is elastic (if demand rises disproportionately when prices
drop), then total revenue will increase. And since creators with strong
rights of first sale are paid the current value of future revenue, their
pay will climb. "The point we're making is the invention of things
like the Napster or electronic publishing and so on, are actually creating
more opportunities for writers, musicians, for people in general to
produce intellectual value, to sell their stuff and actually make money,"
said Boldrin. "The costs I suffer to write down one of my books
or songs have not changed, so overall we actually have a bigger incentive,
not smaller incentive."
Static efficiency vs. dynamic growth
Part of the conventional wisdom about economic growth and monopoly
protection for innovation is that monopoly rights do impose short-term
costs on an economy. They give an undue share of the economic pie to
those who own copyrights and patents; they misallocate resources toward
some uses by allowing innovators to command too high a price; and they
allow innovators to produce less than the societally optimal level of
the new invention. But these costs are all considered reasonable because
innovation creates economic growth: The static costs are eclipsed by
dynamic development. The pie grows. It is part of the Schumpeterian
concept of "creative destruction," that future growth demands
a sacrifice of static efficiency.
But again, Boldrin and Levine say this is a false dilemma. Monopoly
rights are not only unnecessary for innovation, they may stifle it,
particularly when an innovation reduces the cost of expanding production.
"Monopolists as a rule do not like to produce much output,"
they wrote. "Insofar as the benefit of an innovation is that it
reduces the cost of producing additional units of output but not the
cost of producing at the current level, it is not of great use to a
monopolist." Monopolists, after all, can set prices and quantities
to maximize their profits; they have no incentive to find faster reproduction
technologies if they won't enhance profits.
More broadly, producers are likely to engage in what economists call
"rent-seeking behavior"efforts to protect or expand
turf (and profits) by fighting for government-granted monopoly protectionand
that behavior is likely to stifle innovation. Expensive patent races,
defensive patenting (in which firms create a wall of patents to prevent
competitors from coming up with anything remotely resembling their product)
and costly patent infringement battles are common functions of corporate
law departments. Many observers say this kind of activity chokes off
creative efforts by others, particularly small and middle-sized firms that are typically more innovative. "Rent-seeking
behaviors induced through government grants of monopoly," wrote
Boldrin and Levine, "are likely to hinder rather than promote innovation."
Like any radical innovation, Boldrin and Levine's argument seems to
have shocked many mainstream economists, at least initially. There's
"a lot of 'that can't possibly be true' followed later by 'that
actually seems to make some sense,'" said Levine. "We've been
presenting it in quite a few key places, and I have to admit that every
time there was a riot," said Boldrin. "There was a riot at
Stanford last Thursday. It was a huge riot at Chicago two weeks ago.
I know it was a riot at Toulouse when David presented it."
A "riot" among economists might not call for crowd control,
but the paper does evoke strong reactions. Klein at UCLA said the paper
is "unrealistic modeling with little to do with the real world."
Specifically (in a paper with Kevin Murphy of the University of Chicago
and Andres Lerner of Economic Analysis LLC), Klein wrote that Boldrin
and Levine's model works only under the "arbitrary demand assumption"
that demand for copies is elastic, so that as price falls over time
output increases more than proportionately and profit rises. In the
case of Napster and the music industry (the focus of the Klein-Murphy-Lerner
paper) this "clearly conflicts with record company pricing. That
is, if Boldrin and Levine were correct, why are record companies not
pricing CDs as low as possible?"
Romer has a broader set of objections. As a co-author and graduate school
classmate of Levine's and a former teacher of Boldrin's at the University
of Rochester, Romer has no desire to brawl with his respected colleagues.
Moreover, he agrees that property rights for intellectual goods are
sometimes too strong; in some cases, society might benefit from weaker
restrictions. Music file-sharing, for example, might increase social
welfare even if it hurts the current music industry. And he stresses
that alternative mechanisms for bringing forth innovation might well
be superior to copyrights and patents: government support for technology
education, for example, reward systems or public funding for research
and development. Nonetheless, Romer does have serious problems with
the theory that Boldrin and Levine espouse.
First of all, the property rights Boldrin and Levine would assign to
innovators "would truly be an empty promise," said Romer.
In their model, if a pharmaceutical firm discovers a new compound, it
can sell the first pills but not restrict their downstream use. A generic
drug manufacturer could then buy one pill, analyze it and start stamping
"So what Boldrin and Levine call 'no downstream licensing' is instant
generic status for drugs" and while they argue that the inventor
"can sell a few pills for millions of dollars" this conclusion
is unrealistic if everyone who buys a pill can copy it. "You can
make a set of mathematical assumptions so that this is all logically
consistent," said Romer, "but those assumptions are wildly
at odds with the underlying facts in the pharmaceutical industry."
If Boldrin and Levine are unrealistic about appropriability, they are
even more at sea regarding rivalry, said Romer. While it's true that
ideas must be embodied to be economically useful, it's false to say
that there is no distinction between the idea and its physical instantiation.
A formula must be written down, but the formula is far more valuable
than the piece of paper on which it's written. In a large market, the
formula could be so valuable that "the cost of the extra paper
is trivialso small that it is a reasonable approximation to neglect
If Romer's approximation is rightif it truly is reasonable to
neglect that "trivial" costthen the slim element of
rivalry that Boldrin and Levine use to overturn conventional wisdom
Romer also objects to Boldrin and Levine's contention that competition
can deal well with sunk costs. "This claim is simply false,"
he said. And he suggests that Boldrin and Levine are wrong to object
to copyright restriction of downstream use of products, since perfect
competition optimally allows sellers and buyers to enter contracts that
limit downstream use. "What justification is there," said
Romer, "for preventing consenting adults from writing contracts
that limit subsequent or downstream uses of a good?"
Boldrin's quick e-mail response: "We never say anything like that!!
Patents and copyrights are NOT private contracts; they are monopoly
rights given by governments."
And Romer countered: "The legal system creates an opportunity for
an owner to write contracts that limit how a valuable good can be used.
... The proposal from Boldrin and Levine would deprive a pharmaceutical
company or the owner of a song of the chance to write this kind of contract
with a buyer."
What to believe?
The discussion thickens rapidly. Even a master of abstruse theory like
Lucas confesses in response to an onerous Region query about
the Boldrin and Levine paper, "If the questions get too abstract
(as in some of your questions and some of their paper!) I get lost."
Still, says Lucas, "there is no question that Boldrin and Levine
have their theory worked out correctly. The issue is where it applies
and where it doesn't." The strongest examples for Boldrin and Levine,
according to Lucas, are Napster and the music industry. "If we
do not enforce copyrights to music, will people stop writing and recording
songs?" he asks rhetorically. "Not likely, I agree. If so,
then protection against musical 'piracy' just comes down to protecting
monopoly positions: something economists usually oppose, and with reason."
But Lucas cautions that their theory may not apply everywhere. "What
about pharmaceuticals?" he says, in an echo of Romer. "Here
millions are spent on developing new drugs. Why do this if the good
ideas can be quickly copied?"
Solow suggests that Boldrin and Levine should enrich their "very
nice paper" by testing its robustness. What happens if the time
interval between invention and copying is shrunk? "It would be
interesting to look at the limiting behavior," he wrote. And "does
anything special happen if you introduce some uncertainty about the
outcome of an investment in innovation?" Solow is raising here
one of the key obstacles to competitive innovation that Arrow pointed
out in 1962, an obstacle Boldrin and Levine "ruled out by considering
a deterministic environment."
Replicating the past
Curiously, much of this debate parallels an extensive controversy in
Europe a century and a half ago. European critics of the patent system
in the mid-1800s said it hindered further innovation and harmed consumers
through unduly high prices. Other opponents said inventors themselves
received little of the profit generatedthe companies to which
they sold rights made the big moneywhich implied that patents
weren't necessary. Being first to market was often enough incentive,
said other observers, as was the prestige associated with invention.
"Many economists disapproved of the patent system," wrote
Shavell and van Ypersele. Indeed, in 1863, the Congress of German Economists
noted that "patents hinder rather than further the progress of
invention, ... hamper [their] prompt general utilization ... [and] cause
more harm than benefit to the inventors themselves."
The Dutch repealed their patent system in 1869. Switzerland rejected
legislation to adopt a patent system in 1863. Bismarck called for its
abolition in Prussia in 1868. The British established three commissions
between 1850 and 1870 to investigate and reform their system and several
members of Parliament proposed total abolition. But the depression of
the 1870s created a backlash against the era's free-trade movement and
patents again gained favor. "Europe ultimately embraced patent,"
wrote Shavell and van Ypersele, "but for reasons that may perhaps
be regarded as more politically accidental than indicative of a substantive
policy judgment favoring that system."
If the current debate repeats history, the controversy won't soon be
resolved, but at least policymakers have begun again to discuss the
issues. Announcing an extensive series of hearings held between February
and May 2002 on antitrust policy and intellectual property rights, Timothy
Muris, chairman of the Federal Trade Commission, noted that during the
1970s, antitrust lawyers tended not to appreciate the importance of
intellectual property. Now, he said, the pendulum has swung, and some
observers say "perhaps it is intellectual property doctrine that
is not showing a proper appreciation for the innovation that competition
Refining the theory
For their part, Boldrin and Levine recognize that work remains to be
done to strengthen their theory. They have begun to look at the effect
of uncertainty on their model, as Solow suggests, and they say the results
still broadly obtain. The difference is that a large monopolist may
be able to self-insure against risk, whereas competitors will need to
create securities that allow them, said Boldrin, "to sell away
some of the risk and buy some insurance."
As for pharmaceutical research development, Boldrin and Levine contend
that it's largely a straw-man argument, a misrepresentation of the industry's
economics. Much of the high cost of pharmaceutical development, said
Boldrin, is due to the inflated values placed on pharmaceutical researchers'
time because they are employed by monopolists. Researchers are paid
far less in the more competitive European drug industry.
In addition, pharmaceuticals aren't sold into a competitive market,
said Levine. "They are generally purchased by large organizations
such as governments and HMOs." If inflated drug prices are viewed
more realistically, they argue, if pharmaceutical markets were truly
competitive rather than protected by monopoly rights, the development
costs of new drugs would not be nearly as insurmountable as commonly
Moreover, copying a drug takes time and money, providing the innovative
drug company with a substantial first-mover advantage. "It's not
obvious that the other guys can imitate me overnight," said Boldrin.
"The fact that you are the first ... and know how to do it better
than the other people ... it may be a huge protection."
Still, they admit, there are cases of indivisibility where the initial
investment may simply be too large for a perfectly competitive market.
"We have argued that the competitive mechanism is a viable one,
capable of producing sustained innovation," they wrote. "This
is not to argue that competition is the best mechanism in all circumstances."
If indivisibility constraints bind, some socially desirable innovations
may not be produced; the problem is similar to a public goods problem.
The authors suggest that contingent contracts and lotteries could be
used in such cases, but "a theory of general equilibrium with production
indivisibility remains to be fully worked out."
"All we have made ..."
Some economists have already begun work on the next stages. Quah at
the London School of Economics has taken their basic model, confirmed
it and then pushed it in a number of directions to test its robustness
and applicability. In one paper, he finds their model works well if
he tweaks assumptions about consumption and production of the intellectual
assets, but it falters if he changes time constraints.
In another paper, Quah contends that Boldrin and Levine's potential
solutions to indivisibility constraints (through innovation lotteries,
contingent contracts or entrepreneur coalitions) may not actually resolve
the constraint. "What is needed," he wrote, "is the capability
to continuously adjust the level of an intellectual asset's instantiation
quantity." Which translates roughly to coming up with half an idea,
more or less. So, that might be a problem. (Boldrin and Levine are already
working on it.)
More studies like Quah's will be needed to poke, prod, refine, refute
and extend Boldrin and Levine's theory. And empirical work will be needed
to see whether it is, indeed, a more apt description of innovation.
The theory is part of an intellectual thicket, and economists who work
that thicket tend to render it impenetrable by adopting different terms
or defining identical terms differently.
What is clear, though, is that Boldrin and Levine have mounted a formidable
assault on the conventional wisdom about innovation and the need to
protect intellectual property. That it has met with opposition or incredulity
is to be expected. What matters are the next steps.
"The reaction for now is surprise and disbelief," reflected
Boldrin. "We'll see. In these kinds of things, the relevance is
always if people find the suggestion interesting enough that it's worth
pushing farther the research. All we have made is a simple theoretical
See also: Perfectly Competitive Superstars