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Entrepreneurship and Public Policy

Lecture 10: Fostering Innovation

A Framework For Thinking About the Role of

Innovation in Entrepreneurship

Public R&D investment

Public R&D investment

Patents

Existing Firms

Basic Science

Research

Private R&D investment

Applied

Research

Anti-trust

Commercialization

New Firms

Private R&D investment

EPP_Lecture 6-2 Spring 2009

Lecture Overview

Public policy to foster basic and applied science research

Public policy to encourage the commercialization of basic and applied research

EPP_Lecture 6-3 Spring 2009

Government Involvement in Basic Research is Often

Justified on the Grounds of “Market Failure”

Basic argument is that private firms under-invest in basic research

Many reasons for this are put forth

Social returns to private R&D are often higher than the private returns

Economies of scale in R&D

Focus on short-term profit objectives

EPP_Lecture 6-4 Spring 2009

Federal Government has Several Policy

Instruments To Promote R&D

Federal R&D grants to universities and private sectors

Often through programs offered by the National

Science Foundation, the National Institute of

Health and the Department of Defense

A variety of tax and subsidy measures

Encouraging private firms to undertake R&D projects at their own expense

Government procurement and contracts

Directing private firm to undertake R&D they would not otherwise take

Small business set-asides exist

EPP_Lecture 6-5 Spring 2009

Federal Government has Several Policy

Instruments To Promote R&D

Federal R&D grants to universities and private sectors

Often through programs offered by the National

Science Foundation, the National Institute of

Health and the Department of Defense

A variety of tax and subsidy measures

Encouraging private firms to undertake R&D projects at their own expense

Government procurement and contracts

Directing private firm to undertake R&D they would not otherwise take

Small business set-asides exist

EPP_Lecture 6-6 Spring 2009

Tax Incentives vs. Direct Subsidies and Contracts

Tax incentives reduce the marginal cost of R&D

Take government out of the decision process and let the market to choose projects

Do not have a “crowding out” effect

Do affect the composition of R&D activities

Subsidy incentives raise the marginal rate of return of R&D

Allow public resources to be targeted toward preferred areas and projects

May lead to “crowding out” effect

EPP_Lecture 6-7 Spring 2009

Where Is U.S. R&D Occurring? (2004)

10%

11%

16%

8%

Industry

Federal

Government

Colleges &

Universities

All FFRDCs

Other Non-profis

55%

National R&D expenditures in 2004 were approximately $313 billion

Source: National Science Foundation, 2006

EPP_Lecture 6-8 Spring 2009

The Effect of Federal R&D Spending on Private

R&D Spending is Debated

It is theoretically ambiguous whether public and private investment are substitutes or complements

Public R&D may crowd out private R&D

Public R&D may also support private R&D directly or indirectly through knowledge spillovers

Many empirical studies show a positive correlation between public and private R&D investment at the firm level

EPP_Lecture 6-9 Spring 2009

Existing Studies Are Subject to Biases

Hall et at. (1999) warn that existing research handicapped by data and research design problems

Most research are ex-post statistical studies that are subject to selection biases

It cannot determine whether public investment cause the private firms to do more R&D or whether firms that do more R&D receive more investment

EPP_Lecture 6-10 Spring 2009

Programs to Promote Innovative Small

Businesses in the Department of Defense

Small Business Innovation Research Program

In DoD, SBIR budget was $1.7 billion in FY2007

Phase I Awards (merit/feasibility): up to

$100,000

Phase II Contracts (prototyping/demonstraion): up to $750,000

Phase III: product development, funded outside the SBIR program

Mentor-protegee program

Information on program effectiveness is limited

EPP_Lecture 6-11 Spring 2009

Programs to Promote Innovative Small

Businesses in the Department of Defense

Small Business Innovation Research Program

In DoD, SBIR budget was $1.7 billion in FY2007

Phase I Awards (merit/feasibility): up to

$100,000

Phase II Contracts (prototyping/demonstraion): up to $750,000

Phase III: product development, funded outside the SBIR program

Mentor-protegee program

Information on program effectiveness is limited

EPP_Lecture 6-12 Spring 2009

Lecture Overview

Public policy to foster basic and applied science research

Public policy to encourage the commercialization of basic and applied research

EPP_Lecture 6-13 Spring 2009

A Framework For Thinking About the Role of

Innovation in Entrepreneurship

Public R&D investment

Public R&D investment

Patents

Existing Firms

Basic Science

Research

Private R&D investment

Applied

Research

Anti-trust

Commercialization

New Firms

Private R&D investment

EPP_Lecture 6-14 Spring 2009

Public Policy to Facilitate the Commercialization of

Applied Research

Patent law and policy

Providing economic incentives to innovation

Policy designed to encourage the commercialization of university-based research

Realizing economic potential of universitybased research

Anti-trust law

Preventing monopoly while acknowledging the proper role of cooperation

EPP_Lecture 6-15 Spring 2009

Goal of the Patent System is to Encourage Innovation

Patent system is designed to provide economic incentives for innovation that increases societal welfare

Innovators are granted temporary monopoly to reap the economic benefits of their innovation

It is well known that monopoly can reduce social welfare

Monopoly distorts price thus reduces consumer welfare

Monopoly discourages further innovation

Patent system therefore aims to strike a reasonable balance between incentives for innovation and consumer welfare

EPP_Lecture 6-16 Spring 2009

Policy Levers of a Patent System

Ease of patenting

Criteria for determining what is patentable

Novel

Non-Obvious

Required disclosures, procedures and examination

Turnaround time

– PTO employee incentives

Patent enforcement

Ruling standards adopted by the patent granting agency

Dispute resolution mechanisms

Court system

EPP_Lecture 6-17 Spring 2009

Policy Levers of a Patent System

Ease of patenting

Criteria for determining what is patentable

Novel

Non-Obvious

Required disclosures, procedures and examination

Turnaround time

– PTO employee incentives

Patent enforcement

Ruling standards adopted by the patent granting agency

Dispute resolution mechanisms

Court system

EPP_Lecture 6-18 Spring 2009

Some Point to Critical Flaws in the Current U.S.

Patent System

System is too generous in granting patents (Jaffe & Lerner, the National Research Council and the FTC , 2006)

The U.S grants a significantly larger fraction of the applications it receives than Europe and Japan

Concern about patenting of research tools and life forms

Specialized federal appeals court for patent cases (created in

1982) is believed to favor patent holders

Patentee win rate has increased after 1982

EPP_Lecture 6-19 Spring 2009

Some Argue that These Flaws Lead to Inefficient

Outcomes

The “accidental” combination of greater legal value of patents and less rigorous patent examination has damaged the system

Encouraging frivolous applications

Encouraging excessive patent litigation

Patent system is being used in an opportunistic

(unproductive) way, thereby increasing the cost and risk of innovation

EPP_Lecture 6-20 Spring 2009

Policy Proposals to Reform the Patent System

Reducing the likelihood that undeserving applications will be approved

Improve information sharing between parties and the PTO so that undeserving applications are less likely to be approved

Implementing multiple levels of review of patent applications

Providing better protection to worthy innovation

Improve the patent court system to protect patent holders with legitimate patents and allow parties threatened by invalid patents to have a reasonable opportunity to make their case

Learning from the Japanese experience of encouraging crosslicensing

Source: Jaffe and Lerner (2006)

EPP_Lecture 6-21 Spring 2009

Reducing the Likelihood that Undeserving

Applications Will Be Approved

PTO could create a system of escalating examinations

Most patents would receive only the basic review

For those patents that matter, interested parties would have both the incentive and the opportunity to bring information forward

Introducing third party, pre-grant opposition

Giving stronger teeth to any post-grant administrative review

Need to limit firms’ ability to use this process strategically

EPP_Lecture 6-22 Spring 2009

Reducing the Likelihood that Undeserving

Applications Will Be Approved

PTO could create a system of escalating examinations

Most patents would receive only the basic review

For those patents that matter, interested parties would have both the incentive and the opportunity to bring information forward

Introducing third party, pre-grant opposition

Giving stronger teeth to any post-grant administrative review

Need to limit firms’ ability to use this process strategically

EPP_Lecture 6-23 Spring 2009

Providing Better Protection to Worthy Innovation

Improve patent quality

Conducting more rigorous examination

Reduce uncertainty

Granting patents to real innovative inventions and discoveries

Enhancing the ability of judges or special masters

(rather than lay person juries) to decide technical issues in patent disputes

Allow all evidence in patent suit disputes

EPP_Lecture 6-24 Spring 2009

Encourage Cross-Licensing

Increases cooperation among competitors which may improve innovations

Collusion and anti-trust implications as well

Potential to reduce excessive patent infringement litigation

EPP_Lecture 6-25 Spring 2009

Public Policy to Facilitate the Commercialization of

Applied Research

Patent law and policy

Providing economic incentives to innovation

Policy designed to encourage the commercialization of university-based research

Realizing economic potential of universitybased research

Anti-trust law

Preventing monopoly while acknowledging the proper role of cooperation

EPP_Lecture 6-26 Spring 2009

The Commercialization of University-based Research:

Policy Background

Policy seeks to balance two objectives

Ensuring that large firms have broad access to university-based research

Encouraging entrepreneurs start new businesses out of university-based research

The 1980 Bayh-Dole Act of 1980 sought to promote commercialization of Federal-funded R&D

Allowed universities to claim legal rights to innovations by their faculty using federal funding

Focus on patents, not copyrights

Many universities have focused on creating a centralized

Technology Trade Office (TTO) as a gateway to facilitate the flow of innovation

EPP_Lecture 6-27 Spring 2009

Some Observers Argue that TTOs are Inefficient

Many believe TTOs have become gatekeepers rather than gateways

Universities structure their TTO operations only to maximize revenues in the short term

TTO officers focus their limited time and resources on the technologies that appear to promise the biggest and fastest payback

EPP_Lecture 6-28 Spring 2009

Policy Proposals to Revise the Role of University

Technology Trade Offices (TTO)

Change the objective of technology transfers from maximizing profits to maximizing volume

Standardize licensing agreements by including royalty applied to sales

Experiment with giving faculty the choice of going through TTOs or acting on their own

Combine resources to share a single technology trade office among universities in the same region

Abandon TTOs and rely on innovators’ give-back for financial support

EPP_Lecture 6-29 Spring 2009

The Role of Federal Government in Encouraging the

Commercialization of University-based Research

The federal government could play a constructive role by encouraging the leadership of universities to pay more attention to commercialization of innovations

Making commercialization performance one criterion for granting further federal funding

Educating universities regarding the importance of commercialization

EPP_Lecture 6-30 Spring 2009

Public Policy to Facilitate the Commercialization of

Applied Research

Policy designed to encourage the commercialization of university-based research

Realizing economic potential of universitybased research

Patent law and policy

Providing economic incentives to innovation

Anti-trust law

Preventing monopoly while acknowledging the proper role of cooperation

EPP_Lecture 6-31 Spring 2009

Anti-trust Law and Innovation

The goal of anti-trust law is to prevent monopolies and improve economic welfare

There are benefits to cooperation which must be weighed in

Cross-licensing

Commercialization

EPP_Lecture 6-32 Spring 2009

Discussion Questions

In this lecture, we discussed some of the criticisms with the current patent system. Do you think these issues affect new businesses differently from established businesses?

Ease of getting a patent => race to file

Ease of defending a patent of questionable merit

What are the potential implications for VC funding?

For IPO investment?

How would you study this issue?

EPP_Lecture 6-33 Spring 2009

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