0:36 Intro. [Recording date: May 7, 2009] Standard argument: Invention, ideas need to be protected by copyright and patent to give people incentives to produce them. Existence of intellectual property: property rights should be clearly defined and protected, but this particular one is inefficient. Neither theoretical nor practical reason. Standard argument: come up with new idea, work hard, invest; if no exclusive rights to concept, new competitors can quickly come in and use that hard work, so no incentive. Seems logical. Two different points of view. First, practical: new idea--open pizza parlor, sell jeans in a particular street, making this gadget rather than that gadget, cell phone that is a little computer. We would not like the idea that the first person to open a jeans shop in that area to have exclusive rights. We want competition, lower cost, better quality. Sounds like it works--we want to have imitation. Imitation is price-taking in mathematical model; in reality, we look at what others do and see if it is good and try to do the good things and not the bad things; price equalization to extent things are similar. Do again: Very high fixed costs, so if you don't allow person to have some rents over and above the opportunity costs, people would not be willing to afford the initial fixed costs. Idea is not new--dates to Alfred Marshall, late 1800s. Market for shoes with laces: sets up factory, implies fixed cost, with constant returns to scale up to that capacity, certain marginal cost. Below that capacity, he is earning a rent, because this initially has low capacity and high demand as a new product. The rent will cover the fixed cost and more, per Marshall. Somebody looks and imitates, sets up another factory for shoes with laces; capacity goes up, quantity sold goes up, price goes down along demand curve, till eventually the price goes the point where the extra rents over the marginal cost covers just right the fixed cost of the last plant built. Long run competitive equilibrium, no further entry. Why doesn't this work for most innovation? Patents are subset. So maybe patents aren't really needed.

9:02 Many innovations take place without patents. Innovator has a choice. Patent has cost: out of pocket cost and risk that by patenting the idea that you open the opportunity for competitors to work around it. In back of our minds, patents are the seed that lead to the potential and then the fruit; but historically, patents come in after the fact to keep out competitors after the innovation has taken place. Look at all of the innovation of the 20th century. Origin of the industry, flurry of small innovators competing, with very little patenting. Bill Gates, PC and the internet; his words: if we had had patents and copyright in the 1970s there would be no software industry. When a new industry comes around, like cellphones, all copy each other like crazy. Exactly what Marshall was describing. Possibilities to improve is large. Opportunity cost of wasting time fighting legally is great when instead can be improving the new product. Sufficient profits in the early days. Technical work that led to the conclusions of the book is that it does allow for patents to be useful in special circumstances. If cost of innovating is gigantic and it is really easy to imitate, really easy to expand capacity very easily, then argument fails. Empirical argument. Book available online free or at Amazon. Historical case studies.

15:01 Two things come to mind about it being an empirical question. Economists look for proofs: high fixed costs justify patents. But lots of cases where fixed costs are not particularly large or where so much opportunity for innovation and profits that the fixed-cost issue isn't important; and then you have to look at the incentives. Turn to the government to keep out competitors even if there is no good economic case. But economists have given people the cover. Socially productive: while it may be true that imitation can quickly lower the returns to all the effort and hurt profits and reduce incentives, what that does it is encourages inventors to compete on things other than just price. So, find firms looking for ways to make their products more useful, more customized. Should I turn efforts to rent-seeking and the government or to the consumer to make product more valuable? Only when the industry matures that innovating becomes harder, rate of return has gone down, that having patents available becomes a way of making money. Presence of patents is huge incentive to put efforts into rent seeking. Empirical part: externality new discovery of last 25 years in economics. One way of justifying patents is through externalities--big externality of imitation. I'm copying you and you know that so you under-invest. Good argument; how relevant in practice. Singapore colleague. Travel Pro example: first company to come up with the rolling suitcase. Quickly imitated, anyone can see carry-ons. Took a while to see that even four wheels could be better. Didn't patent the idea, but still in business, making profits. Had some lead time. Copyright: completely confused. argument is that if the musician doesn't make tens of millions of dollars, he won't sing any more. Become a ditch-digger; we'll lose Beethoven, Paul Simon, etc. Do we encourage it too much? Could be too little. Copyright in music is late, second half of 19th century; son of Bach complains to Parliament. In that short period, extended. Market size multiplied greatly. Now, superstar musicians make so much compared to Frank Sinatra that there is no comparison. Should lead us to pause. Is opportunity cost to Britney Spears so large that she has to make ten times as much as Frank Sinatra? Beatles had low opportunity costs, good at nothing; but some stars today would be doing derivatives, quantitative finance. Compensate them to keep them in the music world. Obviously the profits will go down if you cut copyright to ten years. But would open doors to many more musicians.

24:17 Friends who are intellectual property lawyers; like the artists, self-interested. Have to concede that profits will go down. Worry is that they'll go to zero. Napster came along, was thriving. Listeners wanted Napster to thrive; artists not so happy; what should economists on the outside argue? Napster certainly dented CD sales. If it was legal, would the profits be sufficient, or is that an empirical question we don't have the answer to? We did at the time. "Why Napster is Right"--webpage. Napster was legal given the laws at the time. Showed what current technology allowed. Useful provocation. But in 1999-2000 couldn't tell what final outcome would have been; but now we can tell. Check what's online. Pirate for scientific permission; university was blocking it. Time-consuming to use it. Everything available, but not a big dent in CD market. Time-consuming to find things, sometimes don't find it or it is incomplete, quality not good. Invention of digital distribution of music has not been exploited by the industry because there are no incentives because of the copyright. Fat and happy. In the ten years, music industry has made only small steps toward doing what Napster was doing. Proof that badly allocated intellectual property creates bad incentives for innovation. Two arguments about that kind of example. Quality not as high, but quality is really quite good, good enough for a lot of people; save the $10 from iTunes to get free copy from elsewhere. Russ's article on Napster. It ignored the potential for private solutions to emerge to make those distribution methods useful to consumers. Minimum example: maybe you won't make money on recorded music, but on concerts. Maybe find ways to make your music more usable--come with the lyric sheet, video, who knows what people would come up with. Video tape--Larry Lessig story--movie industry initially afraid that it would destroy their industry. Worried people would crowd into the room, private neighborhood theaters. But movie theaters have gotten better. Round-table discussion: in music industry, technological progress. Nothing to do with the pirates. Those hurt will try to fight it. Same in other industries: GM, Chrysler; steel. Some losers, want to spread around the extra butter, but legal defense of the monopoly position won't hold water. Can still have to pay $20 for a CD for music that you could pay on the internet only a couple of bucks. Surprised iTunes is still $9.99 for a CD. Policy statement. Pay for one tune and share with 9 buddies. Buy about 10-15% of what is on an iPod. Close to the marginal cost. If you could download it for $5, lots of people would refrain from doing the free downloading. Ethical things: it costs so little so why risk it. Distribution system is providing something of value.

35:34 Going to get to pharmaceuticals, but first: Who disagrees? Some would be lawyers; some people who currently have monopoly power; any in economics profession? What is counter-argument? One area from the start for warm reception was actually the academic legal side. Legal scholars who work on intellectual are painfully aware that it is problematic. Mark Lemly, copyright so out of control that it has to be scaled back, pure rent seeking. Practicing lawyers don't react very well. In economic profession, most negative reaction from new growth, endogenous growth literature, Paul Romer: argument was that fixed costs play a role in spurring growth. Paul's argument (Boldrin was a student of Romer and Roberts while at Rochester): innovation technology, "blueprints" in a production function, are public goods and as such they are non-rivalrous and without legal protection non-excludable. Hence there is increasing return. Increasing return comes from the externality and the externality from the blueprint. Productive ideas, once discovered, can be used by everybody at essentially zero cost. We want a lot of those because they are productive; since profitability is tough to sell, we want to protect them temporarily with monopoly. That is wrong at the start: confuses abstract ideas with actual productive ideas. Productive ideas, that have social value, are completely rivalrous and excludable. How do Russ and Michele earn a living? Complete mystery. Give away tons of stuff--podcast, blog, express themselves, teaching strange activity, why do people pay as much as they do for it? Undergrads are paying for Russ and other economists to explain demand curves, which have been around for a century and can be read about for free. Students irrational? Because it's not true that the idea once discovered can be used by everyone. There are a lot of potential ideas. 2 + 2 = 4 is nonrivalrous. Copy in my brain and your brain, but it's the copy in my brain that is useful and that is totally rivalrous. Non-rivalrous means that more people can enjoy it at the same time than just the owner.

43:43 History of economic thought; told Ken Arrow ten years ago. Paper, 1962, Nelson, Arrow, on information. Talks briefly about innovation: ideas of innovation are public goods and as such should be financed by the public purse. Ken is making a mistake: confusing abstract ideas with actual ideas that are the opposite. New growth theory in the 1980s. Ken Arrow was pushing the National Science Foundation (NSF). Government support of research argued to be crucial because of externalities; but in fact it's been very useful for the economists who got the checks but benefits that spilled over to others are limited, some maybe negative. Have cake and eat it. Case of medicine, pharmaceuticals: publicly funded research, patentable ideas turned into private monopoly. Most of the benefits captured by the monopoly. Bhide podcast: distinction between most public ideas and how they are implemented. Camera in a phone. In 1970, would have been laughable. Someone has that idea; once produced, can't be hidden. But the whole value of that is the implementation--how it's put into the phone, what you do with the phone, can you email it, put it on a website, what's the quality? Much less public than the idea itself. One-click button. Patenting of everything no matter how small can block thousands of other products. Political process favors existing competitor at expense of would-be competitor. Wouldn't abolish patents and copyright overnight. Shortening, not lengthening, the term would be a good experiment.

50:49 Pharmaceuticals. Standard argument is that the fixed costs are extremely high; research is very uncertain; so return is very uncertain; so without patent protection people would not seek out new products. True answer is that we don't know enough about it. Companies are very secretive about it. Both true and false. Most of the cost has nothing to do with the process of invention, but with clinical trials. About 80% is clinical trials, necessary to get FDA approval. Second point: look at where in recent two decades at where the effective active components come from, they come from small labs. University labs mostly financed by public money and licensed to large company, NIH, NSF. Create a small company, one-product company, patent it, develop it, then call big pharmaceutical to sell it to do the legal work and marketing. Brilliant researcher in small lab--what would he be doing in absence of this patent process? Don't have an answer, not enough data. Bayh-Dole Act. Pharmaceutical profits have gone up. Others look at that and "blame" pharmaceutical companies. Legal side. Swiss chemical pharmaceutical industry most amazing--thrived without patents until 1978. No patents because of the constitution, French-speaking part of Switzerland. Huge lobbying pressure mostly from Anglo-Saxons all over Europe. Italy. Germany--big chemical industry origin, we took technology after WWII. Natural product can't be patented, but processes can be. Led to German industry becoming the dominant one at end of the 19th century.

59:47 Pharmaceuticals: clinical trials. Public money if anything should be there. We want the tests as a public concern, afraid of principal/agent problem: they have an interest in saying it's safe. Also could argue that private testing agencies with reputations would emerge. Two approaches: let's redesign old mechanism, or don't trust market, political reality, public monitoring. NIH money produces private goods; should go to clinical tests on competitive basis instead. Licensing model, mandatory license, price is the cost. Indian case: Ron Jones. Jury is out. India had thriving pharmaceutical industry. Experiment is being carried out.