Tim Lee

Hayekian Insights on Intellectual Property

I just read a fantastic paper by Tim Wu about the implications of Hayek’s insights about decentralized decision making for intellectual property policies. In the standard debate over intellectual property, supporters of stronger protections tout to the ability of IP regimes incentivize creativity, while critics point to the dead-weight losses incurred when the monopolist prices its products above marginal cost.

But Wu argues that this discussion misses an important consideration: in addition to propping up the price of intellectual creations, intellectual property regimes like patent and copyright centralize the decision making processes of creative industries. Take the case of Netflix’s patent on Internet-based video rental. This patent appears to give Netflix the exclusive right to decide who may offer online video rental services, at least those that have interfaces similar to Netflix’s own. That effectively means that anyone who wants to enter the online video rental business (such as Blockbuster) must get a license from Netflix to do so.

In a world of perfect information, that might not be a big problem. Netflix has every incentive to develop the online video rental industry. After all, Netflix wants to maximize its revenues, and a larger, healthier online video rental market means bigger licensing revenues for Netflix. Hence Netflix has every incentive to develop new and better online video rental features, and to license its patent to third parties who have the capability to expand the market. If Netflix were omniscient, giving Netflix a monopoly over online video rental might actually make the market more efficient, as Netflix could reduce wasteful competition.

Wu’s objection precisely mirror’s Hayek’s critique of the 20th Century socialists: if we assume that the central planner (the state in Hayek’s case, Netflix in mine) has perfect information, centralization could conceivably outperform decentralization. But as Hayek says, “that is emphatically not the economic problem which society faces.” Just as the state lacks the information required to determine the best way to develop the whole economy, Netflix lacks the information necessary to determine the best way to develop the online video rental business.

Hence, in the real world of limited information, a better market structure is for no one to have a monopoly. Let anyone who wants to put his capital at risk start up his own video rental service, and let the efforts succeed or fail on their merits. This will, admittedly, lead to a larger number of failed video rental efforts, but it’s also more likely that a decentralized, competitive online video rental market will find new products and techniques that a centralized industry structure would have missed. Ultimately, the decentralized structure is likely to prove more innovative.

Wu does a beautiful job of laying out a Hayekian critique of the centralizing effects of strong intellectual property regimes. He explores the various ways that a monopolist’s lack of information is likely to hamper its ability to drive technological innovation as well as decentralized processes would do. And he closes his paper by pointing some specific areas intellectual property policy choices will lead to either the centralization or decentralization of creative industries. He makes a persuasive case that we should have a bias toward policies that minimize the harmful centralizing effects of overly broad IP regimes.

September 1, 2006 | Comments |

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    Thanks for the pointer, Tim.


    I'm still reading, but I note that on p.118 (p.18 in PDF), Professor Wu observes:

    [A]s our Japanese friends found out, the personal computer did not merely complement the mainframe, but ultimately replaced it.

    This is simply wrong.


    See, for example, just from the first result of a quick Google search, Stephen Shankland's article “IBM's 'T-Rex' bites into server market” (CNET, 27 Feb 2004):

    In the market for servers costing $250,000 and up, IBM's mainframe revenue increased 30 percent to $1.8 billion from the fourth quarter of 2002 to the fourth quarter of 2003, according to Gartner. In contrast, the overall market for servers of that price grew 8 percent to $4.9 billion, the market researcher said.

    Mainframes just keep on rockin'.

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    IP is already decentralized because it enables private actors (rather than a central government or state entity) to hold, prospect, license and commercialize copyrights and patents. See Edmund Kitch, Elementary And Persistent Errors In The Economic Analysis Of Intellectual Property, 53 Vand. L. Rev. 1727, 1727 (2000).

    *** Netflix lacks the information necessary to determine the best way to develop the online video rental business... (Wu) explores the various ways that a monopolist's lack of information is likely to hamper its ability to drive technological innovation***
    Are you implying that by its patents, Netflix (or any other patent holder) controls the entire entry and competition dynamic in its market? This is using the term monopoly a bit broadly:) But, for now I'll just say it doesn't matter whether a patent holder such a Netflix knows how to drive innovation in its industry. Competitors can either "invent around" or seek licensing arrangements with a patent holder. Rarely will a patent confer an absolute monoopoly over a market such that the patent holder stifles innovation by having limited informaiton (and if you're aware of any absolute monopolies, please let me know).

    You sure give Netflix a lot of credit. Somehow, in your review of Professor Wu, you move from saying Netflix has a patent, to Netflix has a monopoly over online video rentals, to arguing that by having a patent, and hence monopoly, Netflix introduces economic inefficiencies consistent with a socialist state. Again, this is the result of very very liberal use of the term monopoly:)

    *** supporters of stronger (IP) protections***
    BTW- Who is in support of "stronger" IP protections? As you may know, many companies and independent organizations considered "supportive" of IP have submitted amicus briefs and offered Congressional testimonials calling for more stringent patenting standards. I'm not aware of anyone trying to make current IP protections "stronger."
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    Tim Wu is the father of net neutrality, a former student of Lessig, and perhaps Lessig's chief disciple. His style of argument is Lessigian, taking arguments from the right and turning them on their heads to support his communitarian program. This essay is a classic of the genre.

    The first question one has to ask is whether Wu is sincere in his invocation of Hayek, or simply employing the name of one of the icons of free markets in a perverse manner. IP conjurs capital out of the woodwork, without which the development of great ideas into products wouldn't happen, so it affects the incentives for innovation.

    And the second is whether he's actually making a case against all IP or simply conflating the consequences of over-broad patents with all IP. The Netflix example, if factual, would be an example of an over-broad patent. Entire service sectors shouldn't be patentable.

    And finally, with Wu one always has to check the facts. His analysis of the Japanese Fifth Generation computer project ignores that effort's prime failing, which was simply that it was too early. Modern Internet services such as Google search depend heavily on parallel processing and natural language processing, for example.

    I suspect Tim Lee is having a bit of fun here and doesn't take Wu seriously.

    The stark polarization of centralized vs. decentralized decision structures doesn't reflect any known feature of the real world. Market dynamics in capital-intensive industry pit multiple centralized decision structures - corporations - against each other, so the reality is polyhierarachy, not something just short of chaos.
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    Noel, centralization and decentralization are on a spectrum. Stronger IP protections push things in the direction of central planning, in the sense that more economic decisions are made by large, hierarchical bureaucracies like Microsoft and the DVD CCA, rather than by individual entrepreneurs. Obviously, it's a lot less central planning than having, say, the entire software industry run by a single government-protected monopoly. But on the margin, more expansive intellectual property rules mean more central planning.

    And yes, liberal licensing mitigates this effect to a large extent. However, licensing still requires some foresight on the part of the licensor. The licensor might become wedded to a particular licensing model that works well with certain uses of a patent but not others. And some companies, for whatever reason, might opt not to license at all.

    Richard, I don't read him as taking any particular position on the desirability of intellectual property in general, for or against. Rather, he's highlighting one factor that people should keep in mind. As for "stark polarization": well yeah, obviously Wu is accentuating differences that are not generally as stark in the real world. But that's by design: he's trying to emphasize a factor that's often overlooked in real-world policy debates. He isn't claiming (nor am I) that this is a knock-out argument against intellectual property in general. Rather, he's pointing out that this is one of the factors that needs to be weighed when evaluating IP policies.
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    Well, yeah, several have pointed out that Google's search patents are a barrier to entry to the search business and therefore have monopolistic effects, for example. That's not really a fresh insight, and I've made it myself on Lessig's blog.
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    Richard:

    Nothing in your post really contradicts or refutes anything in Tim Wu's paper. You're basically just pointing out that you don't trust the guy, which is understandable given your respective views on "net neutrality."

    Regarding the Japanese Fifth Generation projct, I would be interested to find out if any significant amount of R&D; from that project made its way into the architectures of today's large Web companies. Did the Fifth Generation project in any way anticipate the coming dominance of commodity components?
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    First of all, current IP policies actually enable de-centralized industry structure, thus creating the opportunity for small firms to specialize and compete in markets, and for the industry in general to license and thus diffuse innovation through copyrights and patent exchange. See my review of Professor Chesbrough's book on "Open Innovation." http://weblog.ipcentral.info/archives/2006/08/o...

    *** He (Professor Wu) isn't claiming ... that this is a knock-out argument (decentralization) against (IP) ... he's pointing out that this is one of the factors that needs to be weighed when evaluating IP policies.***
    If current IP policies perpetuated the dominance of big tech firms, prevented the viability and entry of new firms, and if the industry thus became stagnant with little innovating activity, Professor Wu's theory may be more important, or at least immediately relevant to tech policy, but this isn't the case.

    ***Noel, centralization and decentralization are on a spectrum. ***
    Despite our disagreement over exactly "what is (de)centralization" lets make sure we call the industry more/less centralized, rather than either centralized or decentralized. Personally, I don't like where this discussion is going. We're heading full speed into a debate on "what is the optimal level of (de)centralization" which will just draw us into a discussion on "whats the optimal level of innovation." Uhh. As long as there is a non-concentrated software industry (see below) that's healthy and productive, abstract debates that don't consider the reality in front of us, are senseless (you don't believe that the tech industry is doing fine, look at the stock market).

    ***Stronger IP protections push things in the direction of central planning, in the sense that more economic decisions are made by large, hierarchical bureaucracies like Microsoft and the DVD CCA, rather than by individual entrepreneurs. Obviously, it's a lot less central planning than having, say, the entire software industry run by a single government-protected monopoly. But on the margin, more expansive (IP) rules mean more central planning.***
    In contrast, the software industry is very NON-CONCENTRATED. That means a significant amount of innovation, and patenting, occurs with small companies; as illustrated by the amount of turn-over in leading firms, and the rapid rate of entry of new industry players. (see some work from Professor Merges http://weblog.ipcentral.info/archives/2006/09/m...). And yes, companies like MSFT and IBM are big, and they hold many patents, but there's a significant software industry beyond them that holds important IP assets, and commands influence in important markets.

    ***... liberal licensing mitigates this effect to a large extent. However, licensing still requires some foresight on the part of the licensor. The licensor might become wedded to a particular licensing model that works well with certain uses of a patent but not others. And some companies, for whatever reason, might opt not to license at all.***
    I keep bringing up the concept of substitutions in my discourse with you. If a company has a patent, even if its "weded to a particular licensing mode," competitors can STILL invent around, or licensing essential technologies from other companies. If these competitors are actually innovative, they might invent something new or find a new approach. These are activities that we consider "market activities."

    ***Richard, I don't read him as taking any particular position on the desirability of intellectual property in general, for or against.***
    Actually, Professor Wu advocates, as you do, the complete elimination of software patents. I hope he takes this idea to some patent reform testimony, as its neither a serious nor viable policy option, and his argument for it is even worse.
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    It's always struck me that the information flow critique of planned economies is weak. Advances in communications technology and computers ultimately render it moot. If we had a planning system that had point-of-sale information on every purchase and all the information on Internet searches, it could certainly allocate resources quite well.

    The issue is the lack of incentives to do the job properly, as the planning bureaucracy would ultimately be run by people, and we all have self-interested motives.

    The patent system actually facilitates the flow of information about inventions, as the bargain you make when you apply for a patent is full disclosure of your methods in return for a limited-time monopoly. You have every incentive to develop your idea in a rational and optimal way because your profits depend on that, and you have access to capital.

    So it seems to me that Wu emphasizes an unimportant aspect of centralization-by-patent and ignores the counteracting influences.
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    A major predicament in reading papers, such as Tim Wu's, is that they tend to be too narrowly focused. While the focus tends to be principally economic based, I would like to see added sociological analysis. Mr. Wu is clearly aware that money is not the sole motivator for innovation (see footnote 51 on page 17 and "The third exception, consistent with our assumptions of human nature, is the effect of pride, laziness, or incompetence. Granted a broad patent or copyright on a popular product, a firm may simply refuse to license decentralized improvement because it wants to retain maximum control and is comfortable with its expected returns." on page 19.)



    I think arguements favoring very limited and narrow patents can be made much stronger by incorporating some sociology (motivational theory) into the analysis. Decision making for an upstart company creating new technology is much different that that of an old established company trying to protect its market (property).

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    Actually, Professor Wu advocates, as you do, the complete elimination of software patents. I hope he takes this idea to some patent reform testimony, as its neither a serious nor viable policy option, and his argument for it is even worse.

    The very notion of a "software patent" is ridiculous. Anything we can do with software we can do with hardware, and more easily now than ever before. With such things as FPGAs and ASICs, hardware design resembles software design to such a degree that can't tell them apart. We even have hardware design languages, such as System C and Concurrent Pascal, derived from pure software languages.
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    > Anything we can do with software we can do with hardware, and more easily now than ever before.

    This is probably true, but if something can be implemented in software or hardware, then it's fundamentally nothing more than an algorithm. Should algorithms be patentable? Donald Knuth doesn't think so:

    http://lpf.ai.mit.edu/Patents/knuth-to-pto.txt
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    Knuth sounds kinda crazy. As long as "methods" and "procedures" are patentable, why shouldn't "algorithms?" Is there really a difference?
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    I'm personally in support of software patents, still I think various critics of these patents have good arguments. Knuth isn't one of them...
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    Knuth talks about

    "aspects of technology that involve
    concrete laws of physics rather than abstract laws of thought."

    There's the difference. A method or procedure should be patentable (according to Knuth) only as applied to a physical system, not as a self-contained piece of mathematics.
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    Patents teach methods, and illustrate them through embodiments, preferred and otherwise. So the distinction he seeks to make isn't sensible.

    You really can't draw a bright line between "software" patents and "hardware" patents.
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    Patents teach methods, and illustrate them through embodiments, preferred and otherwise. So the distinction he seeks to make isn't sensible.

    You really can't draw a bright line between "software" patents and "hardware" patents.
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    > You really can't draw a bright line between "software" patents and "hardware" patents.

    This is true, but can you draw a bright line between patents on software and patents on pure mathematics? No doubt some folks who frequent this board would have no problem with pure mathematics patents, but courts have not generally agreed with this position. Yet there are a great many patents which boil down to pure mathematical algorithm once you strip away details of implementation or embodiment. Which could lead once to believe that patentability has more to do with embodiment than with the underlying core algorithm, method or process.

    It's a tough, somewhat philosophical issue, and I don't pretend to have anything like a bright-line answer. I am convinced, however, that there are far too many bad patents being awarded by the PTO, and many of these bad patents cover software-related "advances."
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    What's up with the comments on this blog? When you press "Post" you're rolling the dice here.
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    Just came across this interesting discussion of my paper.

    A few points. First, the point of the paper, as many have correctly noted, is to begin moving the discussion of the desirability of IP away from the model of monopoly profit versus incentives to create and towards and understanding of its effects on industry structure.

    I wanted to emphasize that the choice of rules and exceptions in IP will centralize and/or decentralize decision-making. For example, as I say in the paper, from a Hayekian viewpoint the derivative work right probably gives the copyright owner power to decide the future of a given work.

    In response to Richard Bennett and a few others, the use of Hayek is of course in good faith. I believe the that centralization of decision-making in industries like the software and, say, music industries is aided by the accumulation of large stores of intellectual property.

    However, on re-reading my paper, I also think that it would have been useful to do more to emphasize some of the ways that IP rights can decentralize decision-making. For example, patents on drugs make it easier to decide to research a drug even if the NIH thinks its a bad idea. That point deserves more exposure.

    Finally, to Noel Le, there are plenty of current efforts to both weaken or strengthen IP protection. For example, a treaty under consideration by the WIPO proposes to create a new 50-year IP right in broadcast signals, for what reasons I have not completely understood.

    Anyhow thanks to those who read the paper,

    Tim Wu

    PS I had understood from the preponderance of articles I read and computer scientists I talked to that Japan's Fifth Generation project hadn't been a great success. However, I suppose dissent from that position is to be expected.
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