Intellectual Property, Innovation, and Decision Architectures

Tim Wu has an interesting new draft paper on how public policy in areas like intellectual property affects which innovations are pursued. It’s often hard to tell in advance which innovations will succeed. Organizational economists distinguish centralized decision structures, in which one party decides whether to proceed with a proposed innovation, from decentralized structures, in which any one of several parties can decide to proceed.

This distinction gives us a new perspective on when intellectual property rights should be assigned, and what their optimal scope is. In general, economists favor decentralized decision structures in economic systems, based on the observation that free market economies perform better than planned centralized economies. This suggests – even accepting the useful incentives created by intellectual property – at least one reason to be cautious about the assignment of broad rights. The danger is that centralization of investment decision-making may block the best or most innovative ideas from coming to market. This concern must be weighed against the desirable ex ante incentives created by an intellectual property grant.

This is an interesting observation that opens up a whole series of questions, which Wu discusses briefly. I can’t do his discussion justice here, so I’ll just extract two issue he raises.

The first issue is whether the problems with centralized management can be overcome by licensing. Suppose Alice owns a patent that is needed to build useful widgets. Alice has centralized control over any widget innovation, and she might make bad decisions about which innovations to invest in. Suppose Bob believes that quabbling widgets will be a big hit, but Alice doesn’t like them and decides not to invest in them. If Bob can pay Alice for the right to build quabbling widgets, then perhaps Bob’s good sense (in this case) can overcome Alice’s doubts. Alice is happy to take Bob’s money in exchange for letting him sell a product that she thinks will fail; and quabbling widgets get built. If the story works out this way, then the centralization of decisionmaking by Alice isn’t much of a problem, because anyone who has a better idea (or thinks they do) can just cut a deal with Alice.

But exclusive rights won’t always be licensed efficiently. The economic literature considers the conditions under which efficient licensing will occur. Suffice it to say that this is a complicated question, and that one should not simply assume that efficient licensing is a given. Disruptive technologies are especially likely to go unlicensed.

Wu also discusses, based on his analysis, which kinds of industries are the best candidates for strong grants of exclusive rights.

An intellectual property regime is most clearly desirable for mature industries, by definition technologically stable, and with low or negative economic growth…. [I]f by definition profit margins are thin in a declining industry, it will be better to have only the very best projects come to market…. By the same logic, the case for strong intellectual property protections may be at its weakest in new industries, which can be described as industries that are expanding rapidly and where technologies are changing quickly…. A [decentralized] decision structure may be necessary to uncover the innovative ideas that are the most valuable, at the costs of multiple failures.

As they say in the blogosphere, read the whole thing.