The Deterioration of Appropriate Remedies in Patent Disputes

Abstract

Property rights are an essential economic institution. As the great UCLA economist Harold Demsetz famously argued, property rights spur specialization, investment, and competition, which in turn increase productivity, innovation, and wealth throughout the economy.

The same holds true for intellectual property rights, including patents, which are no less important than their traditional counterparts in facilitating innovation and the efficient organization of productive economic activity, particularly in the modern, high-tech economy. A wealth of literature indicates that much, if not most, of the value of innovation is passed on to consumers in the form of lower prices and higher quality goods and services. Indeed, as Nobel Laureate William Nordhaus finds, even in the presence of patents to facilitate the appropriability of the value of innovation by inventors, “only a miniscule fraction of the social returns from technological advances over the 1948- 2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.” Thus, although measurement problems plague such research, there is strong evidence that nations with greater levels of patent protection have historically achieved significantly higher innovative output than those with lower levels of patent protection.

Nevertheless, a significant body of academic and policy work has argued—with very real policy success—that patent rights in the U.S. have been too strong. The past two decades have witnessed a significant weakening of patent protection in the U.S. as courts, legislators, and several private organizations have progressively chipped away at some of the key features of patent protection. This includes the availability of injunctions, the amount of damages awarded to victims of patent infringement, and other, more subtle changes, such as curbs on fee-shifting between parties to patent litigation.

Behind many of these changes lies a powerful intellectual movement, alleging that excessive patent protection is holding back western economies. These critics chiefly fear that the owners of the standard essential patents (“SEPs”) crucial to much of modern technology are charging their commercial partners too much for the rights to use their patents—referred to as patent holdup and royalty stacking—and that so-called patent trolls (“patent-assertion entities” or “PAEs”) are deterring innovation by small startups by employing “extortionate” litigation tactics. Oversimplifying, the argument is that, by selecting certain winning technologies, standardization artificially weakens implementers’ bargaining position vis à vis patent holders. Accordingly, critics argue that the royalties charged by SEP holders should not exceed those that they could have obtained before their technology was included in a standard. However, there is little evidence beyond occasional anecdotes to support the first of these concerns, and a growing body of empirical research points in the opposite direction. And the latter concern, while real, is complex, and the optimal policy response should address these complexities more than typical proposals do. Yet despite the limited evidence and complexities, policymakers have been quick to act on them.

It may even be the case that the policy changes that have been made are impeding the ability of owners of SEPs to enforce their rights to such an extent that they are now being under-rewarded. Most notably, there is at least some evidence to suggest that the looser enforcement of IP rights is resulting in holdout behavior (i.e., situations where would-be licensees avoid concluding a license agreement because they know that they are shielded from legal repercussions for infringement).

While this does not appear to have resulted in a marked decrease in innovative output so far, there is certainly a risk of that happening, especially if lawmakers continue to alter the legal regime in ways that systematically disadvantage patent holders. Indeed, although the causes are unclear, already there are concerns about secular stagnation and the slowdown in productivity growth. In that context, policies that weaken incentives to innovate seem like the height of folly. Moreover, since many important innovations bear fruit only many years after the initial investment in research and development, any subsequent change of course may have few short-term benefits and might even have short-term costs, making it politically difficult if not impossible to change course once more significant adverse effects on innovation start to appear.

Against this backdrop, this article uses the analytical framework of law and economics to offer insights into what policies can help reduce unnecessarily burdensome patent litigation and thereby accelerate the pace of technological progress. Among other things, law and economics enables us to better understand the incentive effects of different rules regarding the enforceability of patents and the optimal balance of remedies to produce the greatest social welfare. The article begins by discussing the critical role that patents play in fostering dynamic technology markets (Section I). It then reviews recent legal and policy developments concerning the availability of injunctions (Section II) and the size of damage awards (Section III). It then considers other legal rules and procedures that may affect innovation incentives (Section IV). We conclude by discussing the policy implications of these developments (Section V).