For the most part, advocates of free markets contend that competition and innovation go hand-in-hand, as individuals and companies compete to find optimal solutions that will bring them financial success. There's a glaring exception to that, however: the patent system, which has a lottery-like, winner-takes-all reward structure. Anyone who successfully patents an innovation is granted a monopoly for its use, a trade-off that is considered a necessary reward to spur innovation.

The current patent system, however, is beginning to show signs of stress, and there have been a number of questions regarding its basic assumptions. Although it's not part of the changes being considered in the current patent reform efforts, the use of temporary monopolies as a reward for innovation has been challenged in academic circles. That debate has now reached the pages of Science, where a new paper spells out the alternative right in its title: "Promoting Intellectual Discovery: Patents Versus Markets."

The paper spells out a number of reasons why patent monopolies may not be the spur for innovation that they're intended to be: partial solutions don't get any reward, fragmented ownership of innovations can inhibit their use, downstream licensing can inhibit markets well outside of the scope of the innovation, etc. The problems are tied together by the fact that intellectual property is hard to define, meaning all of these issues will almost certainly require repeated trips to the legal system to sort out.

The authors argue that there have been some cases where a period of patent-free innovation took place in a way that ensured that the innovators were still rewarded. Their prime example is the case of the mining industry in Cornwall, England, where the expiration of several patents on steam engines spurred a period of openly shared innovations that led to rapid improvements in steam engine design. (You can read an academic examination of this period if you're so inclined.) The lack of intellectual property allowed multiple improvements to be incorporated in a single design, while the innovators benefited from having their mines operate more efficiently ahead of their competition.

This being a Science paper, the authors engaged in an experiment to see how well these open innovation systems worked in a model market. To do this, they turned to what's called the knapsack problem. Students were given a list of 10 items, each with different weights and values. Given limits to the number of items they could choose and the total weight of the items, the students were asked to maximize the total value.

The authors set up two different types of experiments. In one, there was a winner-take-all monetary prize for the first optimal solution. In the other, the students were assigned shares in each of the objects, and given the opportunity to trade the shares on an open exchange; when the trial was over, rewards would be given based on the number of shares people held in items that were used in the optimal solution.

For all but the most difficult case, where only the market system arrived at a solution, both systems resulted in the discovery of an optimal system. The key difference seems to be that, in the market system, more of the participants finished with an optimized system. The authors present evidence that suggests that prices of the items acted to communicate information on the solution among the market's participants.

Although it would be nice to think that open innovation could lead to efficient solutions, the authors seem to be overselling their (somewhat weak) evidence by claiming their experiment shows the "superiority" of the market system.

In any case, even they recognize that the controlled experimental environment may not provide an accurate reflection of a real environment. Basically, for this system to reward innovators, they must not only have something required for their solution to invest in, but also the capital to do the investing. One thing the authors neglected to note is that the price of the item being invested in actually has to respond some way to the solution. Since many process innovations involve switching to cheap and abundant raw materials, it's hard to see this system working at all in these cases.

In short, this appears to be a case where a proposed solution—market-based innovation rewards, in this case—may work in a subset of cases, but identifying that subset and implementing this solution in it may exact more of a cost than simply continuing with the existing system does.

Science, 2009. DOI: 10.1126/science.1158624