The economics of intellectual property rights

The analysis in section 8.3 showed that overlapping usage rights led to an inefficient overexploitation of a scarce resource. This outcome occurred because the resource was assumed to be rivalrous in consumption: one individual's consumption of the resource reduced the amount that was available for consumption by others. The solution to this is reality of rivalrous consumption was to have a single excluder charge a usage fee, which internalised the externalities flowing between multiple users. Hence the strong link between private property rights and economic efficiency.

In the absence of rivalry in consumption, overlapping usage rights do not create an overuse problem. Since one person's use does not reduce the amount that is available to others, this means that no negative externality is created by multiple usage and so there is nothing for an excluder to price. In fact, in the absence of consumption rivalry, it would be inefficient not to permit multiple users of a good that already exists to exploit it without any restrictions. It also follows that allowing multiple, overlapping excluders would be inappropriate.

Many new inventions, ideas or other forms of intellectual property possess exactly these kinds of characteristics: they are cheap to reproduce, and unlike land and other forms of property, they are not scarce or rivalrous in the short run, once they have been produced.

However, note the important qualification here: we have only talked about the short run, once a good has already been produced. What if the product does not yet exist? It is all too obvious that good ideas are hard to come by. Thus, although many inventions are costless to reproduce, they are certainly costly to produce in the first instance. In other words, the first unit of production may have very large, upfront, sunk cost, with subsequent units having low or zero marginal costs.

What would be the consequence of allowing multiple, overlapping users in this case? If an inventor is not able to exclude, he is not able to charge a price; and if he cannot charge a price, he cannot earn revenue; and if he cannot earn revenue, he cannot make a profit, and will have no incentive to produce in the first place.

In other words, there is a dilemma here: even though it is efficient not to exclude users once the good is produced, the good may not be produced unless exclusion is possible. Therefore, overlapping usage rights, whilst perhaps efficient in this situation in a static sense, are unlikely to be efficient in a broader, dynamic sense. But on the other hand, permanent single exclusion rights cannot be efficient in a broader dynamic sense either - investors will certainly produce many inventions, if they enjoyed permanent exclusion rights, but they would then only be made available to an inefficiently low number of consumers, at a price that is too high.

This is a classic problem of second-best policy analysis. In the absence of the constraint that inventors require adequate compensation to produce new ideas or inventions, the first-best rule is to allow overlapping usage rights. But clearly the constraint cannot be ignored. Once we introduce this important constraint into the analysis, the first best rule is no longer appropriate.

The solution to this problem is to grant the inventor an intellectual property right, which is a hybrid property right of sorts. It is a mix of a rule of a single excluder and a regime of overlapping users. From an efficiency point of view, the idea of an intellectual property right is to allow inventors to temporarily exclude other users (thus ensuring that they will at least be partially compensated for their efforts), but to eventually allow others the right to use the new technology without paying the inventor.

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