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November 27, 2007

Coase, the Internet, and a Market for Ideas

Palazzo_Ducale.jpg The Internet is changing the economic costs and benefits of many activities in our society. The economics of innovation are changing too. The result could be the emergence, for the first time in history, of an efficient market for ideas.

Before the Internet, we lived in a world in which the transaction costs of reaching an agreement over who, how, and when an idea would be used for profit were usually expensive relative to the benefits of coordinating the commercialization of that idea. Even after a system of property rights was established through patent law, many companies found the cost of obtaining and enforcing patents -- not to mention the cost of avoiding or paying for other companies' patent rights -- high relative to the benefit of exclusive rights to a market for a limited period of time. Inventors have generally chosen to assign by contract the rights in their ideas to an employer in exchange for a paycheck. Companies have often chosen to maintain their ideas a secret, opting out of the costs of procurement and assuming the risk of unmitigated competition. Only companies from a select group of industries -- industries that can generally be characterized as extreme in both capital requirements and vigorous competition -- have chosen to obtain and enforce property rights in ideas.

The Internet is now causing a massive shift in the balance of the costs and benefits of our system of property rights in ideas. Ronald Coase is famous for advancing the hypothesis that in a world in which there are no transaction costs, an efficient outcome will obtain regardless of the initial allocation of property rights. Transaction costs, of course, are never zero in the real world. But Coase's Theorem is useful because it tells us to expect markets to emerge as transaction costs become small relative to the gains from trade.

The transaction costs of our system of property rights in ideas has hardly vanished because of the Internet. Yet the Internet is dramatically diminishing these transactions costs. The costs of searching for prior art, freedom to operate, and ownership information may have dropped the most because of the public availability of search algorithms, and databases of patent disclosures and assignments. But even the costs of communicating ideas has dropped as the Internet has enabled us to send a mindboggling array of media around the world in an instant.

Imagine how this shift in economics could aid our government in "promoting the progress of science and the useful arts" if, instead of narrowing the scope of property rights in ideas, we were to broaden and strengthen the system by tailoring these property rights to correspond to the economic value that inventors contribute to our economy. The emergence of a market for ideas would level the playing field for independent inventors and startup companies in their attempt to compete with big business. Whatever else we see emerge from patent reform, here's to the hope that our reforms will promote the emerging market for ideas.

The image is of the Palazzo Ducale in Venice, where the first patent system was implemented in the late 15th century. It is interesting to note that the Venetians were able to implement unprecedented divisions of labor by assigning exclusive rights to artisans during this period. Following the analysis here, the Venetians' success with their patent system (which spread from Venice throughout Europe to England, and eventually the new world) could be attributed to the relatively modest transaction costs of identifying and negotiating with artisans. This was a time and place in world history in which pretty much every important merchant knew every important artisan personally.

Posted by Michael Martin at November 27, 2007 10:36 AM | The Patent System

Comments

Of course this theorem would appear to assume that the cost of a transactions should approach zero because the benefits of patent protection are significantly outweighed by the costs of the protection itself. Although this may be true in some industries this may not be a safe assumption for all industries. For example products that are more the result of art than science have an inherently lower probability of discovery and therefore not warrant the benefit/cost of protection. This theorem also ignores the truth that patents aren't meant solely to initiate transactions (ie licensing revenue) but also to protect markets where the cost to enter would either be high or the ability to enter non-existent.

In a nutshell this theorem may like many other theorems be too abstract to be applied to the real world.

Posted by: David at November 28, 2007 9:11 AM

I'd like to see a deeper analysis of why 15th Century Venetians were able to use their budding patent system to great economic value, and how we've falled off the path that they started to carve out of the wild woods of intellectual property.

Thanks for the insights and I'd be interested to read any other thoughts you have on IP protection.

Anthony

Posted by: Anthony Kuhn at November 28, 2007 10:32 AM

transaction costs are never zero (you gonna work for free?) :: neither is there perfect competition (else, no profits) ...

what is more likely is a serious shift in defining what people do and what they should be paid for ... a re-evaluation of "value-creation" ... trust and recognition will be the currencies that replace size and location ... until then lots of political and socio-economic issues (immigration, entitlements, china, etc.) will whittle away at traditional economics.

the economics of scarcity will meet the economics of abundance ... a time deficit economy that focuses on grabbing attention ...

as for mr. kuhn's comments, how exactly do you characterize what the venetians did with what we do now?

they lived maybe 40 years and actually had to work (something most of us would not likely be able to identify let alone do every day -- ) ... many of the folks receiving patronage died penniless and the true genius was rarely if ever initially identified :: although much later, think antonio stradivari

btw, why do i have to type "patent" (why is it required?) i wanted to type "thumb tack"

Posted by: ironicslip at November 30, 2007 11:34 AM

transaction costs are never zero (you gonna work for free?) :: neither is there perfect competition (else, no profits) ...

what is more likely is a serious shift in defining what people do and what they should be paid for ... a re-evaluation of "value-creation" ... trust and recognition will be the currencies that replace size and location ... until then lots of political and socio-economic issues (immigration, entitlements, china, etc.) will whittle away at traditional economics.

the economics of scarcity will meet the economics of abundance ... a time deficit economy that focuses on grabbing attention ...

as for mr. kuhn's comments, how exactly do you characterize what the venetians did with what we do now?

they lived maybe 40 years and actually had to work (something most of us would not likely be able to identify let alone do every day -- ) ... many of the folks receiving patronage died penniless and the true genius was rarely if ever initially identified :: although much later, think antonio stradivari

btw, why do i have to type "patent" (do i include the parentheses?) i wanted to type "thumb tack"

Posted by: ironicslip at November 30, 2007 11:35 AM

ooohhh ... sorry, double post for half a response ... should've included the parentheses!

Posted by: ironicslip at November 30, 2007 11:37 AM