Economic Principals

Every generation receives an overwhelming lesson or two in economics from the real world. In the '70s, it had to do with the superior performance of trade-oriented economies -- Japan and the Asian "tigers" in particular -- and the dismal record of the command economies of the socialist nations. In the '80s, it had to do with the vulnerability of the oil cartel to the forces of supply and demand -- and a demonstration of just how much central banking policy mattered.

The lesson of the '90s is that strong intellectual property rights are not required to build a great new technological system. The Internet proves that.

Indeed, such strong rights may not even be desirable. The dominance of Microsoft's inflexible and failure-prone Windows computer operating system demonstrates why that may be so.

The usual argument for strong intellectual property rights is that they spur innovation and economic growth that otherwise might not occur. Everyone benefits as a result -- not just those immediately connected to the industry. And few doubt the benefits of growth itself.

Yet the Internet was patched together by thousands of software architects ordinarily earning nothing more than their good livings, loosely coordinated by an anonymous user group known as the Internet Engineering Task Force and funded for many years entirely by the government. Together they produced a miraculously user-friendly system that costs very little to use.

Meanwhile, Bill Gates' monopoly on the Windows operating system for personal computers has made him the richest man in the world. He has demonstrated the same deep intelligence with which he built his fortune in giving some of it away.

But the need to control the use and distribution of his software in order to keep the profits flowing has rendered it difficult to use. Unlike Internet software, it is all but impossible to modify and adapt. It still breaks down too often. And unlike the machines themselves, where aggressive competition is the rule, its price has remained artificially high.

Recently Gates rammed through a substantial price increase by opting to charge users for the copies of his software they make for personal use on other computers in their homes. And he's attempting to use his monopoly position to impose the same top-down control on the Internet itself. Talk about contagious greed!

Now, a new generation of economists has begun questioning the conventional wisdom that a patent is the only good way of rewarding someone for coming up with a new idea. And if the arguments are not yet fully persuasive, they have indisputable promise. That is, they bid fair to illuminate the world we live now in by showing how it could be otherwise.

In a paper called "The Case Against Intellectual Property" in the May issue of the American Economic Review, Michele Boldrin of the University of Minnesota and David Levine of the University of California at Los Angeles argue that intellectual property doctrines have been over-extended.

"It is a long jump from the assertion that inventors deserve the fruits of their efforts to rthe conclusion that current patent and copyright protection are the best way of providing such reward," they write.

And now in a recent working paper called "24/7 Competitive Innovation" Danny Quah of the London School of Economics takes the argument a step further.

If market participants are free to act "24/7," he says -- that is, if new technology permits them to copy, buying and selling previously high-priced "property" with increasing ease -- then normal market forces in the aftermarket may be counted on to automatically restore something like perfect competition for intellectual assets. In that case, he says, the appropriate way to go may be in the direction of weaker rather than stronger intellectual property rights.

"The Boldrin-Levine analysis is an important and profound development," asserts Quah. "It seeks to overturn nearly half a century of formal economic thinking on intellectual property, suggesting instead that perfectly competitive markets in intellectual assets function in the usual …way and therefore lead to socially efficient markets," he says.

The Boldrin-Levine journal article is protected by copyright, of course. You must have a subscription to the journal to read it. A technical version is available, however, and the flavor of their work may be had from Boldrin's and Levine's Web pages. Quah's paper can be found at http://econ.lse.ac.uk/staff/dquah/currmnu1.html#247).

Boldrin and Levine begin their argument by stipulating that productive activity of any sort ordinarily is undertaken only in expectation of a reward. If strong property rights are required to insure the production of, say, potatoes, they must provide good incentives for the production of ideas, too. Stealing potatoes is a bad idea, they say. So is the theft of ideas.

But "intellectual property" has come to signify something much more than the right to offer instantiated ideas for sale, say Boldrin and Levine. It now includes the right to regulate their subsequent use. "When you buy a potato, you can eat it, throw it away, plant it or make it into a sculpture. When you buy a potato you can use the 'idea' of a potato embodied in it to make better potatoes or to invent french fries. Current law allows producers of computer software or medical drugs to take this freedom away from you."

"It is against this distorted extension of intellectual property that we argue." Better it should be called "intellectual monopoly," they say. "As far as we know there is no organized movement to provide producers of potatoes, or any other commodity involving sunk costs, with a government monopoly."

What is different about creative activity, according to the authors, is what economists call the "indivisibility" involved in producing the first unit of a new idea -- a song, say, or a software program or a new drug. "Two half-baked ideas do not equal one fully-baked idea," they say. Or even a baked potato.

Leaving aside whether indivisibility really is the crucial dimension, the conventional wisdom is that it is the specter of cheap copying which makes it impossible for innovators to earn back their production costs. Intellectual assets are described as "non-rival" goods -- that is, an indefinite number of copies can be made and used simultaneously by any number of users.

Hence the need to control the product's use downstream. If a royalty cannot be collected, the argument goes, the good won't be invented and society will be the poorer.

But does it really work that way? Boldrine, Levine and Quah are economists and therefore concerned with the concise and inclusive mathematical models that permit economists to do their work. The conviction that markets produce optimal quantities of most goods but routinely fail to supply enough of some is taken with the utmost seriousness. The details of their new arguments -- the concepts themselves -- are so unfamiliar that they are hard to understand, even for other economists.

But a cursory examination of the real world turns up plenty of examples of markets in which intellectual assets are supplied for not much more than the price of the very first copy of their work.

Take painters, for example. They possess no claim on the value of their work once it leaves their hand. The price their new paintings fetch is determined entirely by the value of their paintings in the aftermarket. A few painters get rich, a few do reasonably well, gallery owners and collectors make money too, plenty of people think the system is some grouse about the system, but no one argues that art is generally undersupplied for lack of strong intellectual property rights.

Musicians, on the other hand, have a well-established claim to a penny or so each time a recording of their music is played or a performance given. But suppose that right evaporated -- as well it might if the copying technology represented by Napster gained the upper hand. Would that be the end of rock and roll as we know it?

Of course not. Professional music would evolve in the direction of cheaper copies and more expensive live performances -- with audiences presumably free to bring their tape recorders along. The most popular artists no longer would reap great fortunes -- but, given the public's willingness to pay high ticket prices, neither would they fail to perform.

Aren't undertakings like software and pharmaceutical design entirely too complicated to trust to the kind of cottage industry system that characterizes the provision of the arts? Yet and no. It's true that the fixed costs of, say, sequencing the human genome are enormous. But that's why governments were bearing it in a large collaborative effort, until a consortium of equipment manufacturers fomented a race with a private company.

Who gained from the heavy spending on a race? Disease sufferers who might otherwise have died if the quest has proceeded at the government scientists' somewhat stately pace -- or so the argument went. So did the equipment makers and the scientists on both teams. Were the lives, theoretically saved, worth the welfare losses from the extra competition? It's a question that economists will debate for years to come.

Likewise, the success of the Open Source software movement has demonstrated that there's more than one way to build a successful operating system for personal computers. The starter code originally supplied by software architect Linus Torvalds -- freely down-loadable on the Internet and subject to continual improvement by its users has broadened out into an large and growing industry. Consumers are better off; so are Open Source software developers. Only the shrink-wrapped set is opposed.

The questions that Boldrin, Levine and Quah have raised about our system of stimulating innovation may be far from answered, but they are important to pursue. What was once an essentially American system is become a global system with every passing day.

Yet overextended monopoly property rights may be damaging to social welfare in at least two ways. They may restrict consumption and distribution of some of life's best bargains, by keeping prices unnaturally high. They may stimulate excessive innovation and increase the sense of churn as well.

Suppose the valuation that we place on the creation and possession of intellectual property is the real bubble of our times? That's a good deal more unsettling possibility than an 8000 Dow.