The paper, which can be found here, provides an overview of the economics of innovation and IP protection, licensing, and compulsory licensing, with specific applications to standards development and standard-essential patents. The authors also propose principles based on their economic analysis that courts and antitrust agencies can apply at each stage of an antitrust inquiry. The paper concludes with a summary of the approach to IP applied in China, the European Union, India, Japan, Korea, and the United States.
The paper covers a lot of ground (and is quite long). I will try to summarise the argument as much as possible, but, to make it easier to read, I will also attempt to flag the specific topics addressed at each point, so that you may focus on those matters of greater interest to you.
The paper is structured as follows:
Section II summarises the relevant economic literature.
While consumers gain from increases in static efficiency in the short run, economics teaches us that dynamic efficiency, including societal gains from innovation, are an even greater driver of consumer welfare. Policies and laws that encourage investment and innovation are welfare increasing and thus optimal, while interventions that risk thwarting incentives to innovate are not. There is a wide consensus in economics that profits are the key driver of innovation. Firms and investors are generally willing to incur the large costs needed to obtain meaningful innovations only because they expect to obtain a significant return on those investments. Innovation is also used to mitigate the rigors of head-to-head competition; but unlike other ways of softening competition, such as collusion, innovation enhances social welfare.
By increasing the return on costly investments in research and development (R&D), intellectual property rights (IPRs) lead to increased innovation. An IPR, like any other property right, gives its holder the ability to exclude others from using that property, and thereby enables the holder to appropriate some of its value. Society generally allows successful innovators to enjoy some market power because it provides them with a reward for their risky and costly investments which incentivises them to invest. Another reason the rewards obtained for successful projects must be large is that most innovation efforts fail. A last underpinning of IPRs right to exclude is that, without it, people would tend to wait for others to incur the costs and risks of innovation and then free ride on the resulting creations – leading to economic stagnation.
There is an exception to the IPR’s holder right to exclude being optimal: when the innovator chooses to enable non-innovators to produce products or services that become possible as a result of its innovation. In other words, it may be optimal for IPR holders to license their IPR. Since licensing will take place only when licensing revenues exceed the profits the IP owner could obtain by excluding rivals, the option to license ex post unambiguously increases the incentive to invest ex ante. Therefore, licensing contracts will generally be procompetitive, fostering both competition ex post and innovation ex ante. But a decision not to license should not be presumed to be anticompetitive: the IP right holder may think it is in the best position to commercialise a product, or may have limited bargaining power vis-à-vis potential licensees.
However, for the technology market to allow IP owners to license their innovations profitably requires them to be able to enforce their IPRs against an infringer, i.e. against someone that uses the innovation without paying for it.
An important question related to this is whether compulsory licensing is justified. In short, governments and societies have struck a balance between the incentives for innovation (dynamic efficiency) and the inefficiencies stemming from the exercise of market power (static efficiency). The pragmatic resolution of this trade-off is the subject of IP law, and IP law’s content reflects society’s conclusions in this regard. In order to ensure consistency with the balancing decision struck by IP law, there should in principle be no obligation to license IPRs during the limited period of exclusivity granted by IP laws.
This raises an obvious question: when is compulsory licensing likely to increase long-run consumer welfare? In practice, it is close to impossible accurately to balance the welfare-increasing and welfare-decreasing effects of compulsory licensing. Nonetheless, the authors believe that compulsory licensing is likely to have an overall negative effect on welfare. Compulsory licensing is likely to depress innovation from levels that are already inefficiently low, without providing countervailing benefits. It follows that compulsory licensing is likely to increase long-run consumer welfare only in exceptional circumstances.
Standards are particularly important in the IP field. At this point, the authors develop an argument that standard essential patents do not derive any form of market power from being included in a standard. I do not think this is particularly interesting – and I have discussed it at length elsewhere – so I will not look at it here.
Section III seeks to provide a blueprint for antitrust agencies and courts to apply when dealing with a number of IP-related matters.
The authors deal with this by outlining a number of basic principles.
- They first identify four basic general principles: (i) conduct involving IP will be analysed under the same antitrust analysis applied to conduct involving other forms of property, taking into consideration the special characteristics of IPRs. (ii) IP licensing is generally procompetitive. It should therefore be analysed under an effects-based approach, so that licensing restraints will only be condemned when anticompetitive effects are not outweighed by procompetitive effects. This is subject to an exception in the case of naked restraints to competition, such as price fixing. (iii) When considering whether specific conduct has anticompetitive effects, the analysis will include a determination of what would have happened in the absence of a licence (the “but for world”). (iv) The key antitrust inquiry is whether it foreclosed a rival from competing for minimum efficient scale.
- They then outline a number of principles for market definition and dominance: (i) monopoly power is a necessary but not sufficient condition for monopolization or abuse of dominance. The analysis should be focused on competitive effects. Therefore, it is not necessary to determine a relevant market and conduct an analysis of monopoly power if there is not sufficient evidence of net anticompetitive effects. (ii) There is no presumption that IP confers monopoly power or market dominance. Instead, a case-by-case analysis must be conducted to determine whether an IP holder has market power. (iii) Markets should be defined in order to capture as accurately as possible the competitive constraints a firm faces.
- As regards refusals to license, unilateral, unconditional refusals to license are generally per se lawful. An exception may be allowed in unusual circumstances.
- As regards tying and bundling, they are ubiquitous and widely used in a variety of industries and for a variety of reasons. The potential to harm competition and generate anticompetitive effects arises only when tying or bundling is practised by a firm with monopoly power in either the tying good or one of the goods included in a bundle. For tying or bundling to harm competition, there needs to be an exclusionary effect on another seller because tying or bundling thwarts the buyers’ desire to purchase substitutes for one or more of the goods in the bundle from another sellers to an extent that harms competition in the markets for these products.
- As regards grant-backs and cross-licenses, both are usually procompetitive. In both cases, the identification of anticompetitive effects should be required on a case-by-case basis, absent naked restraints.
- As regards excessive pricing, it is not actionable as regards IP rights.
Section IV surveys a number of jurisdictions, to understand how closely each follows the economic principles and the proposed blueprint outlined in the earlier sections.
This is dealt with in an appendix that contains a table reviewing the situation in China, India, Japan, Korea, UE and US. The authors do not really evaluate each jurisdiction as much as describe them. This provides a valuable source of data on these jurisdictions.
This is a very George Mason piece1. I do not mean this in any depreciative sense. It is merely to say that the paper aligns with the main tenets of scholarship coming out of this university – which usually argues in favour of protecting innovation, thinks that antitrust should not interfere with IP rights or standard-setting arrangements, and ultimately proposes careful (minimalistic?) antitrust enforcement.
Long-term readers of my reviews will be aware that I have some concerns about the integrity and effectiveness of IP systems, even as I perceive competition law to be a second-best solution in this area. Nonetheless, we live in an imperfect world where institutional frameworks vary across the world and second-best solutions can be the best option available. With this, I do not mean to criticise this piece – but merely to indicate that its authors share a number of priors that are both well-known, sincerely held and potentially controversial.
Having said that, the article provides an interesting overview of the economics of IP law, and of the interaction of IP and competition law in various areas of the world which is rather easy to follow. It is an interesting paper that can be useful even for those who may not share the authors’ preferred approach to these matters.
1 Of course, Jorge Padilla is in no way affiliated with this school, unlike the two other authors.