Intellectual property rights and markets

Generally speaking, law and economics theory treats all the above-mentioned rights as being neutral in their effects on the markets of ideas: given the economic context, the rights have the sole function of favouring an efficient equilibrium, without significantly altering the nature of the markets.

This representation has long been associated with a related view, namely that market success coincides with optimality of ideas, that is, that the market always causes the best ideas to emerge, so that the mechanism described above is efficient from every perspective. But this idea, too, has been discred­ited by the literature of the past decade, which points out how the short-run profit-maximization goals of firms and the uncertainty of creative activities are fundamentally at odds with the long-run welfare-maximization goal, thereby penalizing and crowding out certain types of creative activities such as, for example, basic research (Dasgupta and David, 1994; Arora and Gambardella, 1997; Scotchmer, 1998).

None the less, the mainstream approach continues to rely on the assump­tion that the legal framework does not stifle - but on the contrary enhances - the competitiveness of the market,²⁵ neglecting to note that the specific incen­tive mechanisms have the effect of significantly altering the payoffs and the maximizing behaviours of economic agents. Such effect emerges clearly from surveys on specific industries, which indicate that the market structure of the investigated sectors is significantly altered with respect to both the competitive and the Schumpeterian structures.²⁶

Having said that, the primary aim of intellectual property rights is, by definition, to give the owner a certain amount of market power, and this has clear-cut effects on the competitive structure. This is a key point for the economic analysis, and must be properly understood. In effect, there is a widely held belief that the legal monopoly conferred by exclusive rights does not necessarily confer market power on the owner, or translate into an eco­nomic monopoly (see Anderson, 1998). Now, this is an acceptable assertion in general terms, but subject to misinterpretation.²⁷ It is effectively true that intellectual property right-protected information, if not successful, will not allow the legal monopoly to translate into an economic monopoly: a trade­mark that means nothing to consumers will not differentiate a product from its competitors. A drug that is ineffective, even though it is patented, will not confer any kind of market power. A CD that nobody is interested in buying can by no means be considered an economic monopoly, even though its copyright protection does make it a legal monopoly. Ultimately, the legal monopoly will translate into an economic monopoly only when consumers perceive the information good protected by intellectual property right as being poorly substitutable for other information goods.²⁸ Only then does exclusive control over the non-substitutable resource confer market power to the owner, in inverse proportion to the substitutability of the good.

In some cases, when this market power is at a maximum, the legal mon­opoly becomes an economic monopoly; in other cases this is only partially achieved, but still allows the owner of the right to enjoy a certain profit margin. In any case, it is the prospect of securing supraprofits (and therefore market power) that constitutes the incentive to create, since a perfectly com­petitive market would deliver no extra profits and therefore zero incentive. The logic behind intellectual property rights is thus to reward successful ideas with market power: providing a monopoly, to a greater or lesser extent, as a private benefit in exchange for the creative effort/investment.

We have discussed how trademark increases the amount of information associated with a given product, thereby benefiting consumers, but that in so doing it also serves to differentiate the product from competing ones, that is, attributes market power, thereby benefiting the company that owns the right. A similar dynamic can be observed in other markets where the reward mecha­nism likewise hinges on the erection of de jure entry barriers that effectively confer market power.

Summarizing these arguments, therefore: a systematically competitive sce­nario implies a high level of substitutability between products; in this scenario, though, a complex apparatus such as intellectual property rights is not eco­nomically efficient, because it would be enough to directly finance the production of just a few ideas (as they are perfectly interchangeable) thereby sidestepping the social costs of intellectual property and the duplication of expense incurred in the production of equivalent ideas.²⁹ Now, according to the economic rationality hypothesis it can reasonably be expected that those in possession of market power will not stop at its temporary enjoyment but, as rational actors, will strive to maintain it over time. This is borne out by the comparison of intellectual property industries affected by pockets of mon­opoly (Shapiro, 2000).

Then the result is an intractable economic dilemma, which has thus far received very little attention: on the one hand, intellectual property rights can have the beneficial effect of stimulating the production of new ideas and competition, through the promise of temporary supraprofits; but on the other hand, because they introduce a monopolistic slant to the markets - to a greater or lesser extent depending on the conditions - they also foster the emergence of rent-seeking behaviours which gradually skew the competitive scenario, degrading its overall efficiency. To date, this drift has only been acknowledged in a few sporadic cases, where it was found that intellectual property rights can sometimes be manipulated for anticompetitive purposes.

The first precedent-setting case was probably US v United Shoe Machin­ery³⁰ in the United States, where both the antitrust authority and academics determined that an accumulation of intellectual property rights, albeit in respect of the law, could be used to restrict competition (Anderson, 1998).³¹ Since then, similar cases have been described in the scientific and legal literature without, however, leading to a definitive and comprehensive theor­etical paradigm. Some examples are the ‘brand proliferation’ strategy described by Schmalensee (1978), in which the ownership - and exploitation - of multiple trademarks within a given product category in reality conceals a strategy of foreclosing the market to potential competitors. In like manner, it has been shown that ownership of a large number of unexploited patents (commonly termed ‘sleeping patents’) has the real purpose of restricting the scope of competition open to newcomers (Gilbert and Newbery, 1982). By the same token, an incumbent might work around a principal patent - a practice known as ‘inventing around’ - with the sole purpose of producing sleeping patents and thereby locking out the competition.

Many sectors that produce intellectual property-protected goods are char­acterized, even today, by strategies such as these, which are open to conflicting interpretations.

This ambiguity of interpretation crops up frequently in the literature and in practical cases, as a consequence of the fact that intellectual property is ab origine a monopoly space (albeit only potentially, and not always in practice) granted to creators as a reward for their activity. Hence, the anticompetitive behaviours of owners are to some degree consistent with the legal incentives provided to them, that is, rational and competitive within the altered eco­nomic framework.

Recent European and US legislation has repeatedly brought to light the tensions that exist on this matter. The European NDC Health/IMS Health³² (National Data Corporation Health Information Services and Intercontinental Marketing Services Health Inc.) case, for example, clearly showed how ex­ploitation of the legal monopoly granted by the right treads a fine line between legitimacy (under the intellectual property right laws) and illegitimacy (under the antitrust regulations). But even in the controversial US Microsoft case, where an abundance of disparate elements revealed a well-developed anticompetitive strategy, intellectual property rights were invoked to support the legitimacy of these behaviours.³³

In general, therefore, the existence of market imperfections (Williamson, 1977), of complex economic strategies relating, for example, to intercon­nected markets and/or multiproduct firms (see De Vany and Walls, 1999 for the extended video sector), of rent-seeking inertia arising from pockets of monopoly power, all have the combined effect of gradually altering the structure of the competitive scenario, causing it to drift away from the Schumpeterian model, progressively eroding the competitiveness and effic­iency of the markets.

This dynamic effect therefore alters the overall balance of welfare, and so must be taken into account in the economic analysis of intellectual property.