122 Yale L. J. 1900 Yale Law Journal



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122 YLJ 1900

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122 Yale L.J. 1900




Yale Law Journal

May, 2013


Essay
*1900 THE CONTINUUM OF EXCLUDABILITY AND THE LIMITS OF PATENTS
Amy Kapczynski, Talha Syed [FNa1]
Copyright (c) 2013 Yale Law Journal Company, Inc.; Amy Kapczynski; Talha Syed
ABSTRACT. In IP scholarship, patents are commonly understood as more efficient than other approaches to innovation policy. Their primary ostensible advantage is allocative: as a form of property rights, patents act as a conduit between market signals and potential innovators, ostensibly guiding investment toward inventions with the most social value. Existing accounts recognize that, in practice, signals of social value that patents facilitate may be attenuated because of, for example, transaction costs and limits on the scope and length of patent rights. We show here, however, a different problem with the conventional allocative account. The appropriability mechanism patents rely on, namely excludability, operates in asymmetrical ways for different kinds of information goods. While scholars have noted that patent systems fail to create goods whose value is difficult to appropriate in consumer markets, this fact has not been fully appreciated in the literature, nor have its implications for the standard justification for patents. Through detailed examples in the health context we show that some kinds of information goods will be much more difficult to exclude than others. Importantly, there is no reason to expect that the ease of exclusion will be correlated with social value. The analytic point that emerges is generalizable: patents themselves can have distortive effects, stemming from structural features of exclusion rights. Unlike the problem of attenuation, the problem of asymmetric nonexcludability cannot be resolved by increasing patent scope or length. Because excludability is variable along a continuum, property rights in information, even if formally perfected, and even assuming away conventional transaction costs, will create asymmetrical demand for different kinds of information goods. This argument provides an important new justification for alternatives to patents such as government funding and gives us new insights about how to allocate such funding. It also reinforces the need for a comparative institutional approach to innovation policy, and for incorporating into our debates currently unrecognized implications that patents may have for values such as privacy and free speech.
*1901 ESSAY CONTENTS




      INTRODUCTION

 


      1902

 


      I.

 


       UNDERSTANDING THE CONTINUUM OF EXCLUDABILITY

 


      1908

 





       A. Patents as a Solution to Information Goods' Appropriability Problem

 


      1908

 





       B. The Key Determinants of Excludability

 


      1916

 


      II.

 


       ILLUSTRATING THE THREE INFLUENCES ON EXCLUDABILITY

 


      1921

 





       A. Negative Information About Drugs

 


      1923

 





       B. Lifestyle Interventions

 


      1928

 





       C. Innovations in Healthcare Quality

 


      1937

 


      III.

 


       EXPLANATORY AND POLICY SIGNIFICANCE

 


      1942

 





       A. The Potential Distortions of Patents

 


      1942

 





       B. Specific Policy Prescriptions

 


      1950

 





       C. Broader Theoretical Implications

 


      1957

 





      CONCLUSION

 


      1962

 



*1902 INTRODUCTION
      Each year, nearly 30,000 people in the United States die from infections resulting from central-line catheters used for monitoring in intensive-care units (ICUs) in hospitals. [FN1] These deaths are in part a result of the growing problem of antibiotic-resistant infections in hospitals. [FN2] The intellectual property (IP) literature is replete with proposals to address that problem by incentivizing the creation of new antibiotics-- proposals that sometimes have price tags in the billions of dollars. [FN3] But in 2006, a different kind of breakthrough was reported in the New England Journal of Medicine--a new technology that reduced the number of these infections by about two-thirds. [FN4] The technology was a humble checklist, featuring important and well-known hygienic practices such as hand washing and the use of antiseptic. [FN5] Clinical trials have shown that the intervention works in a range of settings, including in otherwise poor-quality ICUs. [FN6] While the mechanism is still somewhat unclear, it seems to work by giving nurses the authority to enforce the listed practices with doctors and by improving communication in hospitals in other ways. [FN7]
      The checklist intervention is a classic information good: it is immaterial and was much more expensive to create (or to validate, which is often the more pertinent issue with medical interventions, as we will explain) than it is to copy. By any measure of social welfare, it is also a great intervention. It is cheap, has no known side effects, and prevents infections up front rather than simply treating them after the fact. If widely implemented in the United States, *1903 it could save more than 15,000 lives and $1 billion in treatment costs each year. [FN8] These figures are particularly impressive when compared to the billion-dollar figures often attached to proposals for new drug treatments.
      Yet the checklist approach is unlikely to be well rewarded by even a very expansive patent system. Even if we assume that patent law permits a strong and enforceable patent on the intervention, it would be difficult for the creator to use that patent to appropriate any significant proportion of the social value created by the intervention. He would have to track behavior that is routine and to some extent cloaked by privacy norms related to doctor-patient relationships. Thus, the state of technology and of norms place limits on the freedom of our hypothetical patentee to enforce his patent. Of course, we should not overstate the case. An institutional factor would work in the inventor's favor: the existence of hospitals as an organized intermediary. This setup reduces the number of potential infringers and increases the likelihood of tangible evidence of infringing conduct by creating a “paper trail” of written or oral records of established hospital protocols. On balance, though, the checklist will be much less excludable than a drug.
      Recognizing this shortcoming of the patent system draws attention to what we call “the continuum of excludability.” As we elaborate below, excludability is not a binary quality, either “on” or “off” depending on the availability or absence of property rights. Rather, it is highly variable across information goods, and is affected not only by formal legal entitlements, but also by existing technologies for detecting or tracing such uses (and their costs); existing social norms regarding “acceptable” or “reasonable” enforcement efforts (in light of concerns about privacy, freedom of thought and speech, and so forth); and the existing institutions--or social roles, relations, and organizational forms--within which the predominant uses of the good will be made. Once we recognize that excludability is a continuous and not binary variable, an impressive array of information goods that are difficult to exclude even in the presence of patents comes into view. [FN9] Our central aim in this Essay is to develop, with examples in public health, our analytic understanding of the continuum of excludability, and to elucidate its substantial implications for innovation theory and policy.
       *1904 The central justification for patent rights in the United States is economic in nature and is premised on the incentives that they provide to innovators. [FN10] But patents are only one strategy for incentivizing information production. Many others exist, and two in particular are much discussed in the economics literature: public funding (where a government agency either directly carries out research or sponsors others through grants), and financial inducement through prizes (where financial rewards are established, typically by the government, in exchange for specified information goods). [FN11]
      The most influential theoretical account of the advantages of patents over these other institutional approaches can be traced to the influential work of Harold Demsetz. [FN12] In a 1969 article, Demsetz suggested that patents are plausibly superior to more directly government-led strategies for generating innovations because markets utilize dispersed private information more effectively than government actors can. [FN13] Because they link the magnitude and direction of innovation incentives to market prices, in other words, patents may be a better mechanism than reliance on government funding for ensuring that all truly valuable information goods--and only truly valuable information goods--are generated. Demsetz thought that this allocative advantage of patents could outweigh their acknowledged drawbacks, most prominently the fact that patents inefficiently curb the use of protected information. [FN14] Today, this is the most common justification for patents in the legal literature, [FN15] which we will call the “allocative” account.
      External or foundational critiques could be made of the basic logic of the allocative case for patents. For example, one might challenge welfarism as a value, question the relationship between market value and social value, or be skeptical of the positive assumptions of the underlying “homo economicus” model of innovator motivations. We set aside such foundational objections *1905 here, and, for the sake of argument, accept the basic premises invoked by the conventional account. [FN16]
      The main internal criticism of the allocative account in the existing literature points out that patents will systematically underreward research because they yield less than full appropriability (for example, because patents have a limited term and can be designed around, and because transaction costs interfere with market signaling). [FN17] These concerns, however, are not so much a criticism of the allocative case for patents as a worry over obstacles to its full realization. Here we develop an account of a different problem with the allocative case for patents. The link that Demsetz drew between exclusion rights and revenues for creators assumed that exclusion rights do not themselves introduce distortions into the equation between production and social value. But this is not the case.
      We offer a series of detailed examples to show that some kinds of information goods will be much more difficult to exclude (and thus to commodify) than others. Importantly, there is no reason to expect that the ease of exclusion will be correlated with social value. Thus, patents themselves can have distortive effects, stemming from structural features of exclusion rights. Importantly, the problem of nonexcludability cannot be resolved by increasing patent scope or length, and it is asymmetrical with respect to different types of information goods. The continuum of nonexcludability thus means that property rights, even if perfected, and even assuming away conventional transaction costs, will create asymmetrical demand for different kinds of information goods. [FN18]
      Other scholars have pointed out that patent systems fail to create goods whose value is difficult to appropriate in consumer markets. [FN19] But the fact that *1906 excludability operates in asymmetrical ways for different kinds of information goods has not been fully appreciated, nor have its implications for the standard allocative case for patents. Part I illuminates our analytic arguments in more detail, while Part II illustrates the continuum of excludability and its importance with three examples: hospital checklists, negative information about drugs, and information and interventions regarding “lifestyle” risk factors. All three cases identify highly nonexcludable information goods--and position them opposite pharmaceutical products--to show that even though the less excludable innovations may plausibly outperform the pharmaceutical alternatives (in terms of net social benefit provided), a patent system will tend to promote the excludable pharmaceutical approaches over the less excludable alternatives.
       *1907 In Part III, we draw out the central implications that emerge from our analysis. We begin by developing the point that patent rights have the potential to predictably and systematically distort private investment decisions over innovations by overstating the value of highly excludable information goods and understating the value of highly nonexcludable ones. [FN20] As a result, patents will fail to incentivize many significant innovations (even if we were to increase the length or scope of their protection), and indeed may promote the production of less valuable inventions over the production of more valuable ones. The possible first-order distortions that we identify can also become entrenched over time as institutions, training, and cultural habits incline individuals to look for excludable solutions. The continuum of excludability thus opens up new ways of understanding the forces that lie behind important phenomena in our existing institutional environment, such as the widely shared sense that our current healthcare system is “overmedicalized,” or disproportionately focused on technological--and particularly pharmaceutical--interventions. Finally, we show here that our analysis, though illustrated in the context of health innovation, is not limited to that domain. The distortive potential of patents exists across different technological domains, although, for reasons we will describe, it may be easier to identify, and have more consequential effects, in some domains than others.
      We move next to policy implications. Our analysis suggests a new justification for institutional approaches to innovation that do not rely on exclusionary mechanisms (including public funding, prizes, commons-based approaches, and regulatory approaches). Such alternatives can help promote important but highly nonexcludable innovations that would be neglected by the patent system, and also help to counter the distortionary pressures that may be generated by patents. Moreover, our argument gives new support to *1908 the traditional case for public funding of basic research. The conventional case is based on the long-term and uncertain character of the dividends of such research. [FN21] We add a further consideration--namely, the highly nonexcludable character of many outputs of basic research. At the same time, our argument suggests that the traditional case for publicly funded research is too narrow, because it focuses on “upstream” research. Where information goods are highly nonexcludable, markets will undersupply them, suggesting that governments should be involved in not just basic research, but a range of applied research targeting nonexcludable interventions.
      Finally, we discuss a set of broader theoretical implications. First, our analysis highlights a previously unnoticed means by which patents and the pursuit of efficiency through patent law can generate conflict with non-welfarist values such as privacy and free speech. Recognizing this potential conflict has important implications, particularly for arguments about the proper scope of patent law. Second, our analysis suggests that reasoning about the most cost-effective way to produce information should be understood as a process of rough judgment rather than optimization. What is needed is a comparative institutional approach to information policy, one that incorporates an understanding of the continuum of excludability and, moreover, factors in both efficiency and non-efficiency values.
I. UNDERSTANDING THE CONTINUUM OF EXCLUDABILITY
A. Patents as a Solution to Information Goods' Appropriability Problem
      Patents are intended to allow market-driven innovation by permitting inventors to exclude others from the results of their investment, and thereby to appropriate its returns.
      Given our focus on excludability here, it makes sense to say a bit more about the relationship between exclusion and appropriation in the context of information goods. Conventional economic actors will only produce a good when they can appropriate sufficient returns to recoup the capitalized costs of providing the good. (We use the term “appropriate” here in its broadest sense, to simply mean obtain or secure.) One way to appropriate returns from producing information is by selling the information itself, or by selling an information-embedded good. This is a commodity strategy, and it typically requires exclusion of others from the information in question. (If no one is excluded from the information, then the first attempt at exchange may *1909 undermine all others.) One way to exclude others from information is to use simple secrecy. [FN22] Such secrecy does not work when you are selling information itself (absent IP rights), since you must reveal it to sell it. But secrecy can work as an exclusionary strategy if the information is embedded in a good and is difficult to obtain from reverse engineering that good. [FN23] By contrast, secrecy is not an option if the valuable information may be easily obtained by reverse engineering. [FN24] The difficulty of the secrecy strategy in the context of information goods is one key component of the economic argument for intellectual property rights, which offer creators the possibility of exclusion without secrecy.
      There are also many nonexclusionary ways to appropriate returns from information. Most importantly for our purposes, a creator can produce information in exchange for a government reward, such as a prize or a government grant. Here, the creator appropriates returns, but no one is excluded from the information produced. There are also market-based nonexclusion strategies to appropriate returns from information production. For example, first-mover advantages may be the basis for returns, [FN25] as may *1910 ancillary rights such as trademark. [FN26] Think here of the fashion industry, where designs are easily reverse engineered and no IP right directly covers fashion design, but where first-mover advantages and trademarks allow designers to appropriate some of the returns from their creations. [FN27] Creators can also profit by selling the customization of information goods as a service, but not excluding anyone from the information goods themselves, as the Linux-based firm Red Hat does when it customizes open-source software for clients, or as a lawyer might do when she writes a customized brief for a client. [FN28] Crowdsourcing strategies may also allow a creator to appropriate returns from an informational work without exercising exclusionary control over it. [FN29]
      The conventional economic debate is primarily between a subset of these strategies-typically, IP rights, prizes, and ex ante public funding. That is because that debate is premised upon a set of assumptions, including that the information in question is relatively expensive to produce (so that first-mover advantages and trademark are an inadequate reward), and inexpensive to reproduce or difficult to keep secret (so that secrecy is not viable). [FN30] In the pages that follow, we work from these same assumptions in order to address the implications of patents in their most favorable context.
      In the debate between patents, prizes, and public funding, the patent approach has some well-known drawbacks. Because information is nonrival, meaning that its use by one person does not detract from its simultaneous use by others, the grant of exclusion rights threatens to produce an inefficient underuse of said information. Due to transaction costs and other barriers to perfectly tailored price discrimination and licensing agreements, the price(s) *1911 charged by the patentee will price out some consumers and follow-on innovators who are willing and able to pay the marginal cost of distributing the information good, but not the patentee's markup, resulting in what economists refer to as “deadweight loss.” [FN31]
      It was these drawbacks that long ago led Kenneth Arrow to argue that government funding was preferable to patents as a mode of innovation policy. He emphasized that government funding can provide the benefit of incentivizing information production without the static and dynamic costs from foregone uses of the information so generated. [FN32] Demsetz provided the canonical reply: while Arrow emphasized the benefits of marginal-cost pricing of information, Demsetz focused instead on “the production of knowledge at efficient rates.” [FN33] A system of private market rights would, Demsetz suggested, be superior to government in one important allocative sense: it would produce superior “information on the desired directions of investment and on the quantities of resources that should be committed to invention.” [FN34]
      Demsetz's argument here owes much to Hayek's ideas about the informational advantages of disaggregated private actors over centralized government decisionmakers. [FN35] In this account, property rights are said to have a fundamental advantage in guiding the efficient production of information because they harness price signals to provide creators with information about how to direct and allocate the resources that they invest in producing information. The argument for patents is thus premised on a posited relationship between rights to exclude and the use of private information about
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