On Rent-seeking In Innovation

In the pursuit of profits, economic agents, be they large firms or singleindividuals, seek to gain an advantage over direct competitors by introducingnew goods, services, and technologies. This leads to continuous adoption ofinnovations, which are widely recognized as the key to growth and development.Innovating is therefore a socially valuable activity, and a classical example of theway in which the selfish pursuit of the private interest may lead to increasedsocial welfare when channeled through properly organized markets. The privateadvantage, though, is greatly magnified when the innovator is the sole supplier ofthe new good, service, or process; everybody loves to be a monopolist, andinnovators are no exception to this rule. The felicitous coincidence of private andpublic interest breaks down here, as social welfare is generally harmed by thepresence of monopolies.To protect moderate benefit of innovators, IP and patents are granted. But roleof intellectual property-especially patents-in fostering innovations and theiradoption is still far from clear. There are two main arguments in favor ofintellectual property. The first is that without the benefit of a governmentmonopoly, on account of increasing returns to scale, innovations would eithernot be produced at all or too few innovations would be produced. The othercorrectly observes that rent-seeking is possible through the private sector as wellas the public, and that legal grants of monopoly may mitigate the costs of privaterent-seeking. Although these arguments are sensible in theory, they are notjustified by empirical analysis.In cases where it is possible to expend real resources in making the secret lessaccessible, the innovator faces a real trade-off between private and publicrent-seeking. The goal of this paper is to examine that trade-off and establishwhen patents may and may not yield an efficiency gain. This efficiency gain mayhave two sources. First, private rent-seeking may imply a higher social cost thanpublic rent-seeking; in this case social efficiency demands a legal monopoly onaccount of the large social costs induced by private individuals pursuing tradeand industrial secrecy. Second, the pursuit of trade and industrial secrecy maylead the innovator to restrain production of the new good even more than a legalmonopolist would, thereby imposing a larger dead-weight loss upon consumers;in this case the concession of a legal monopoly leads the innovator to safelyexpand capacity and allow for a more rapid adoption of the good. Our analysisshows that both these elements are indeed at play in a fairly simple and naturalmodel of private and public rent-seeking.Our major new finding is that there may be greater secrecy with intellectualproperty than without it. The public rent-seeking option has positive value onlyafter a certain critical level of productive capacity is accumulated. Hence, aninnovator that has purchased the option has an incentive to keep the secrecy untilthat level of capacity is reached, which can be achieved by investingsubstantially in the private rent-seeking effort. We show that thiscomplementarity between public and private rent-seeking may lead to higherexpenditure on private rent-seeking when the public rent-seeking option isavailable than when it is not.Though it is commonly believed that a benevolent social planner-fox example,the government-can set the cost of public rent-seeking low enough to makethings better. But in practice, governments committing to socially efficientmechanisms are less frequent than complete contingent markets. Furthermore, inreality we observe that, through a process of "regulatory capture", governmentseventually become part of the overall rent-seeking system. We examine the latterperspective in our final section where we endogenize the cost of obtaining apatent. The rent-seeking regulator will set the cost of public monopoly near thelevel at which the innovator becomes indifferent between exercising or not thepublic monopoly option. At this level, as we just argued, the level of expenditurein private rent-seeking activities is maximized. So, this paper is organized as follows:The first part examines whether IP or patents can stimulate innovation...