I just read your article in Reason on competitive innovation [reprint of "Was Napster Right?" September 2002 Region.] It is well done.
I have been thinking about this problem for several decades. My conclusion has been that copying from earlier sales or learning from previous learners works to internalize the social surplus from an innovation, but not always completely. I also concluded this process works better when the transmission occurs through human capital learning rather than reproduction of a product because the transmission through human capital is slower.
In my 1971 textbook Economic Theory I wrote about the transmission through products or human capital:
"Some caution is prudent, however, in accepting the basic supposition that R and D expenditures by one firm reduce the costs of other firms. Firms introducing innovations are alleged to be forced to share their knowledge with competitors through the bidding away of employees who are privy to their secrets. This may well be a common practice, but if employees benefit from access to salable information about secrets,* they would be willing to work more cheaply than otherwise. If so, innovating firms would be able to hire labor more cheaply than other firms, and this would at least partly offset the loss from having to disclose one's knowledge to competitors. For example, research assistants work for the National Bureau of Economic Research more cheaply because the knowledge they acquire about empirical techniques can be used later to obtain better paying jobs elsewhere. Similarly, top fashion designers (perhaps inadvertently) sell many of their most expensive designs to firms planning to copy them; the high prices paid partly measure the gains from copying and mass producing these designs."
* Employees might not benefit from access to secrets because competition between them could reduce the market price of their information to zero.
Gary S. Becker
University Professor of Economics and Sociology
University of Chicago