“The rational actor model rests on one major economic principle and insight: the success and evolution of institutions (patent litigation in this case) rise and fall with one primary factor—transactional costs.”

In Part I of this article, we discussed the underpinnings of U.S. patent policy today: the fundamental assumption that our patent problems stem from a bad actor (patent troll) that takes advantage of the system. Based on this ideological premise, Congress and the Judiciary have structured patent policy to prevent this bad actor from taking advantage of the system, i.e., increasing enforcement hurdles to deter the bad actor.

Rather than helping, this policy has led to the systemic weakening of U.S. patent rights over the past decade+ – so much so that it has undermined the United States as a viable jurisdiction to enforce patent rights.

Here in Part II, we’ll discuss how the ideology of the bad actor came to be, how a rational actor model provides a more realistic framework, and how we can use economic underpinnings of a rational actor to create an economically rooted patent policy.

Origins of the Bad Actor

Viewing our patent problems through the lens of a bad actor (i.e., patent troll) has its own underpinnings. It stems from a cultural ideology known as the villain archetype.

The villain archetype is found in almost every story, across all cultures and times. Nearly every story told to children features the villain archetype.

The villain is the antagonist, someone people despise. A villainous character is someone that creates fear, is selfish and greedy, and even dangerous.

We fabricate archetypes because they are an important part of storytelling. They stir emotion and create a personal connection.

When we employ archetypes to explain other people’s behavior, we are telling ourselves a story to help us understand the world around us.

To frame their understanding of our patent system, all three levels of our government created a story – the story of the villainous patent troll.

But this story misidentifies the problem with our patent system and is inapposite to sound economic policy.

Rational Actor Model

Rather than framing our understanding of the patent system based on a character archetype used for storytelling, we have another framework in which to establish our understanding: economics.

If we frame the problem from an economic perspective, we can then begin to use economic principles to implement patent policy.

The economic principles we can use originate from the work of Douglass C. North, winner of the 1993 Nobel Memorial Prize in Economic Sciences, due in part to his 1992 paper “Transaction Costs, Institutions, and Economic Performance.”

Using North’s Nobel Prize analysis, we can use a rational actor model to frame our understanding of our patent system and approach to patent policy.

The rational actor model rests on one major economic principle and insight: the success and evolution of institutions (patent litigation in this case) rise and fall with one primary factor—transactional costs.

Transactional costs are all costs incurred in the operation of an economic system. In the case of patent litigation, it is all costs involved in a patent holder obtaining a reasonable royalty or settlement from an alleged infringer.

In his work, North cites numerous examples of institutions throughout history that either succeeded or failed based on transactional costs. He observed that “economies with high transaction (and production) costs . . . prevent[] economic growth.”

The table below gives an overview of the transactional costs North identifies and how they relate to patent litigation:

(see here for a more in-depth analysis of North’s economic framework applied to patent litigation).

From North’s economic framework, patent litigation is a grossly unproductive institution. In it, enforcement costs both swallow and drive informational and bargaining costs. Enforcement and its threat are prerequisites to determine the scope and value of a patent and for parties to reach an agreement. Moreover, it costs millions of dollars and years of litigation to determine basic attributes of a patent—its scope and value. Due to this prohibitive transactional-cost structure, North would likely conclude that patent litigation fosters an extremely unproductive and backwards patent system.

Next, North recognized the existence of rational actors, namely entrepreneurs. In a system with high transactional costs, rational actors adapt to market conditions by engaging in exchanges that reduce transactional costs, to create an ideally zero-cost exchange.

In patent litigation, these rational actors are the ones that recognize its prohibitive transactional-cost structure and mitigate such costs by approximating a zero-cost exchange, which is represented by early settlements. These early settlements reduce uncertainty of patent infringement, reduce invalidity risk, and lower enforcement and defensive costs.

Put another way, early settlements in patent litigation are an economic phenomenon to increase transactional efficiency in a highly inefficient patent litigation-institution.

Foundation for Policy

At the heart of it, North recognizes a rational actor acts predictably in response to economic factors. As opposed to a bad actor archetype who is irrationally evil, a rational actor’s behavior can be influenced through changes in economic conditions (i.e., changes to transactional-cost structures). Hence, we have an opportunity to structure patent policy around the rational actor, by creating favorable economic policy.

It is impossible, on the other hand, to structure policy around a bad actor, because a bad actor is a one-dimensional, character archetype. They are selfish, greedy, and incapable of redemption. The only policy for a bad actor is one of deterrence and punishment at any cost, even at the cost of the patent system itself.

Application

Let’s see how the bad actor archetype and rational actor model play out using North’s economic analysis to patent policy:

If we frame our understanding of patent law using a bad actor archetype, we would characterize early settlements as “nuisance litigation” which is perpetuated by the villainous patent trolls. Following this framework, the remedy is to deter and punish the bad actor and prevent it from taking advantage of the system, i.e., by increasing enforcement costs.

This isn’t a solution at all. From Nobel-acclaimed economic principles, it’s a step in the entirely wrong direction, one that increases transactional costs. This approach serves to undermine the effectiveness and utility of our patent system.

The current outcry against 101 jurisprudence is the manifestation of a decade+ long, systemic patent policy driven to increase enforcement costs. This policy has resulted in an abomination that has undermined the integrity of the U.S. patent system, creating more unpredictability and confusion (see Finnavations Case Study and IBM’s comments on 101 law).

If we instead use a model rooted in economics, we would understand early settlements as an economic response to reduce transactional costs within the context of patent litigation, not nefarious conduct perpetuated by evil doers.

Using North’s economic principles, we would recognize the problem to be high transactional costs in patent litigation. Most importantly, we can frame a policy-based solution: reduce such transactional costs.

Namely, the solution rests in lowering informational costs. Instead of costing millions of dollars and taking years to determine whether a patent is infringed and its value, can we create a cheaper alternative? Can we create a reliable method for determining basic, informational attributes of a patent without needing to spend years and millions of dollars in patent litigation?

These are the questions we need to be asking ourselves. This should form the foundation of our U.S. patent policy.

Beyond the Villain

Culturally, we have a bias to create the villainous archetype. It gives us someone to despise and blame for all the problems. Psychologically, demonizing the villain fuels us with passion and emotion.

But if we continue to use stories centered around character archetypes to frame patent policy, what hope does the U.S. patent system have? We need to refine our understanding beyond the bad actor story we have been telling ourselves.

Even if Congress fixes 101 law, if we continue to believe a villainous character is the root cause of our patent problems, we will continue down a self-destructive path that increasingly cripples our patent system.

But if we instead use economic principles to frame our understanding of patent policy, we can help create a solution based on sound economic principles.

North set forth a simple, yet profound observation: “The success stories of economic history describe institutional innovations that have lowered the costs of transacting and allowed more of the gains from trade to be captured, thereby permitting the expansion of markets.”

To improve our patent system, we need to think in terms of transactional costs, and its improvement stems from lowering transactional costs, not demonizing and obstructing archetypal characters that we fabricate.

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