Former UF University Economics Society President Vivek Rajasekhar, currently on assignment promoting liberty at the Cato Institute, shared a post with some other UES luminaries recently called “What kind of innovation do patents encourage?” Apparently, people are learning a little bit more about the economics of intellectual property, probably due to several new books being published on the subject, and the promulgation of illuminating blogs.

Many persons are loathe to consider reforming intellectual property, unless it is to strengthen IP rights. Through college, we never really challenge this assumption. But long before Professor Lessig‘s outstanding works on the subject, several notable economists tackled government’s efforts to promote IP. For example, Milton Friedman writes:

…intellectual property is different from physical property: in both cases, you have a monopoly but the monopoly on intellectual property is wholly different because duplicating the property comes generally at a very low or zero marginal cost. You are enforcing a monopoly pricing, as it were, that limits output to lower than the optimum social level.

Friedman is not alone. The most persuasive and eloquent critic of intellectual property rights is the late Sir Arnold Plant. Amongst many other broadsides, he argued “intellectual property protection might result in too much intellectual property being produced rather than too little (or perhaps both, for different types of intellectual property).” This is a fundamental point. Intellectual property protections simultaneously encourage and discourage certain types of IP. Economist and philosopher Murray Rothbard concurred in the case of patents, arguing that whether or not patent rights increase the amount of research expenditures, they certainly distort the type of research expenditures. He argued this on two grounds. First, that expenditures are “overstimulated” in the early stages during patent races until the race is over, after which point they are “unduly restricted” as all competitors may be excluded from benefit. Second, that because only certain types of inventions are patentable, research is overstimulated in those areas and by corollary relatively understimulated in others due to financial incentives being diverted to the overstimulated areas. Rothbard continues from his magnum opus Man, Economy, and State:

The most popular argument for patents among economists is the utilitarian one that a patent for a certain number of years is necessary to encourage a sufficient amount of research expenditure for inventions and innovations in processes and products. This is a curious argument, because the question immediately arises: By what standard do you judge that research expenditures are “too much,” “too little,” or just about enough? This is a problem faced by every governmental intervention in the market’s production. Resources—the better lands, laborers, capital goods, time—in society are limited, and they may be used for countless alternative ends. By what standard does someone assert that certain uses are “excessive,” that certain uses are “insufficient,” etc.? […] The market does have a rational standard: the highest money incomes and highest profits, for these can be achieved only through maximum service of consumer desires. This principle of maximum service to consumers and producers alike—i.e., to everybody—governs the seemingly mysterious market allocation of resources…. But the observer who criticizes this allocation can have no rational standards for decision; he has only his arbitrary whim.

Just where do the distortions and misallocations occur? A very interesting perspective by “Renegade Division” makes use of a distinction apparently created by noted libertarian Stephen Kinsella:

Vertical Innovation is when a new product is innovated based on merely a small amount of added new technology, for example adding the facility of watching videos on an MP3 player, or adding a new metal on an alloy best suited for making railway tracks which now reduces its ability to expand and contract in heat and in cold, or creating an AIDS vaccination by using the results, effects, and formulas of 10 different immunity vaccines.

Horizontal Innovation is when a new product is developed which provides same functionality as a previously existing product but it tries to achieve that in a different manner. For example a new motorcycle is developed which uses fluids load-balancing(just making it up) for more stability because a motorcycle is already developed and it is patented, or a new type of Fan is developed which is embedded in a box because the regular fan is already developed and patented.

We give up vertical innovation in order to foster horizontal innovation. Absent IP, however, the system would reach an equilibrium that fosters more vertical innovation and still gives us some horizontal innovation, but now protected by contract. In the absence of intellectual property rights, that is to say, government-created rights to intangible assets, the free market would allocate intangible assets as prices and consumers deem fit. Suddenly, the value of these assets will be assigned by contracts between persons who can negotiate the price in order to best allocate risk, as opposed to the government-granted right of artificial scarcity that detaches intellectual property transactions from reality. To put this more simply, contracts would take the place of intellectual property and not a whole heck of a lot would change except for more efficient allocation of scarce resources, including time.

As long as people are educated as to what a circle-c symbol means in a book, and they buy it subject to that, we would a seamless transition in copyright. For trademark, we would not need to rely on the strictures of the Lanham Act, which arguably entrench the rich and powerful at the expense of those who would develop similar goods or services and thereby please consumers. Rather, we would expect the common law concept of “fraud” to rule again. It would no longer be enough to be similar, as the small Victor’s Secret store was in Tennessee. It would have to be really attempting to pass itself off as Victoria’s Secret leading to bona fide customer confusion. Patents are a more difficult case and the strongest one could be made for pharmaceuticals. We like their innovations. Speaking as an economist, I don’t think we would necessarily see much less innovation or drug development. I think we would see fewer competitors and a consolidated industry that still seeks to buy the smaller companies with promising drugs.

How am I so confident? Well, the sad truth, long unheralded by an education system stuck in the 1960s preparing people for 1950s jobs, is that contracts can fill the role of IP very well. You can have all manner of contracts: small ones, long ones, ones in shrinkwrap, ones reduced to a symbol, written in Chinese, English, or Binary. At root, contractual agreements represent a meeting of the minds and the consent of the parties. At root, intellectual property creates incentives for certain types of production at the expense of others. It’s an academic point, since it’s so strongly tied to an almost inconceivable counterfactual, but an important one nonetheless.

Don’t believe me? Fashion has worked for a very long time without strong IP. Fashion changes significantly year to year and countless billions in profits are still made. Additionally, the Open Source movement, which is very much based in the power of contract contra the limitations of IP, has eviscerated profits for operating systems, encyclopedias, and many other products. The gains we all receive are significantly greater than the jobs lost and no protection is necessary. In support of this point, Donald Bordeaux, Chairman of the George Mason Economics Department, writes in today’s “Costs are not benefits; Reducing costs is not harmful“:

How can a nation be hurt in this way if it gains greater access to lower-cost inputs? Suppose, for example, that a genius invents a low-cost machine (much like the one in Star Trek) that can safely and comfortably transport human beings from point A to point B — from our home to the local supermarket, or from our home to Tahiti — instantaneously and for only pennies per transport. This machine is soon sold for $1.99 and becomes, say, an app on a cell-phone or is clipped on to one’s belt.

The great majority of Americans who now work in the transportation and travel industries would lose their jobs. The demand for automobiles would plummet, as would the demand for airplanes and for airline services. Even the demand for hotels and motels would fall dramatically, as many business travelers would just beam themselves back home for the night rather than sleep in a far-away, strange bed. But would America be made poorer by this marvelous invention? Of course not. We’d be made materially much richer.

So, folks, let’s reform the system and go with freedom: it has worked before, it can work again. Put IP lawyers out of work and make them transactional attorneys.

UPDATE: After publication of this post, I noticed another blog post alluding to the possible demise of international IP at the hands of ever-growing contractual agreements here. Contracts govern rights between parties and will always be there. They are not mutually exclusive with IP, though they are more flexible and market disciplined.