Lecture 10: Fostering Innovation

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

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Public policy to foster basic and applied science research
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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”
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Basic argument is that private firms under-invest in basic research
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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

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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
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A variety of tax and subsidy measures
– Encouraging private firms to undertake R&D projects at their own expense
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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

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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
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A variety of tax and subsidy measures
– Encouraging private firms to undertake R&D projects at their own expense
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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
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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
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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

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

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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
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Many empirical studies show a positive correlation between public and private R&D investment at the firm level
EPP_Lecture 6-9 Spring 2009

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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

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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
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Mentor-protegee program
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Information on program effectiveness is limited
EPP_Lecture 6-11 Spring 2009

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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
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Mentor-protegee program
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Information on program effectiveness is limited
EPP_Lecture 6-12 Spring 2009

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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

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
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Patent law and policy
– Providing economic incentives to innovation
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Policy designed to encourage the commercialization of university-based research
– Realizing economic potential of universitybased research
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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
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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
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It is well known that monopoly can reduce social welfare
– Monopoly distorts price thus reduces consumer welfare
– Monopoly discourages further innovation
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Patent system therefore aims to strike a reasonable balance between incentives for innovation and consumer welfare
EPP_Lecture 6-16 Spring 2009

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Ease of patenting
– Criteria for determining what is patentable
• Novel
• Non-Obvious
– Required disclosures, procedures and examination
– Turnaround time – PTO employee incentives
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Patent enforcement
– Ruling standards adopted by the patent granting agency
– Dispute resolution mechanisms
– Court system
EPP_Lecture 6-17 Spring 2009

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Ease of patenting
– Criteria for determining what is patentable
• Novel
• Non-Obvious
– Required disclosures, procedures and examination
– Turnaround time – PTO employee incentives
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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
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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
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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
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Patent system is being used in an opportunistic
(unproductive) way, thereby increasing the cost and risk of innovation
EPP_Lecture 6-20 Spring 2009

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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
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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
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Learning from the Japanese experience of encouraging crosslicensing
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Source: Jaffe and Lerner (2006)
EPP_Lecture 6-21 Spring 2009

Reducing the Likelihood that Undeserving
Applications Will Be Approved
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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
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Introducing third party, pre-grant opposition
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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
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Introducing third party, pre-grant opposition
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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
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Improve patent quality
– Conducting more rigorous examination
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Reduce uncertainty
– Granting patents to real innovative inventions and discoveries
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Enhancing the ability of judges or special masters
(rather than lay person juries) to decide technical issues in patent disputes
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Allow all evidence in patent suit disputes
EPP_Lecture 6-24 Spring 2009

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Increases cooperation among competitors which may improve innovations
– Collusion and anti-trust implications as well
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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
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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
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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
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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
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Many believe TTOs have become gatekeepers rather than gateways
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Universities structure their TTO operations only to maximize revenues in the short term
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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)
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Change the objective of technology transfers from maximizing profits to maximizing volume
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Standardize licensing agreements by including royalty applied to sales
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Experiment with giving faculty the choice of going through TTOs or acting on their own
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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
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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

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The goal of anti-trust law is to prevent monopolies and improve economic welfare
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There are benefits to cooperation which must be weighed in
– Cross-licensing
– Commercialization
EPP_Lecture 6-32 Spring 2009

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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
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What are the potential implications for VC funding?
For IPO investment?
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How would you study this issue?
EPP_Lecture 6-33 Spring 2009