CONSIDERING EX ANTE DISINCENTIVES IN COMPULSORY LICENSING: HOW TO SOLVE THE TRADEOFF BETWEEN OBLIGATIONS TO DEAL AND THE SCOPE OF INTELLECTUAL PROPERTY
Clara Beatrice Calini (*)
Arnold & Porter LLP (Brussels)
SUMMARY: 1. INTRODUCTION. 2. THE ECONOMIC EFFECTS OF COMPULSORY LICENSING ON THE INCENTIVES TO INVEST IN R&D. 2.1. Efficiencies in intellectual property protection.
2.1.1. The «second enclosure movement»: the propertization of ‘expensive’ knowledge as a way of rewarding investments. 2.1.2. Consumer participation in the benefits and the theory of optimal patent protection. 2.1.3. The existence of spillover effects for second generation innovators: «standing on the shoulders of giants». 2.2. The correlation between innovation, market structure and firm size.
2.2.1. IPRs over drastic or gradual innovation and market power.
2.2.2. Innovation and firm size. 2.3. The economic implications of the tradeoff between IPR protection and compulsory licensing in the short run. 2.3.1. IPR exclusivity vs. competition rules. 2.3.2. Inefficiencies of compulsory licensing in the short-run. 2.4. Inefficiencies of compulsory licensing in the long-run. 2.4.1. The ex ante perspective: the invention is made if the inventor knows he can recoup his investment. 2.4.2. The uncertainty related to potential antitrust interventions. 2.4.3. The «attitudinal change»: the choice
between disclosure through patenting vs. reliance upon keeping inventions secret. 2.4.4. Conclusion. 3. AN ANALYSIS OF EU AND U.S. CASE LAW: ARE INVESTMENTS FULLY CONSIDERED BEFORE OBLIGATIONS TO DEAL ARE IMPOSED? 3.1. The European perspective. 3.1.1. A brief overview of the relevant EU case law. 3.1.2. The limited investment expenditures in Magill and IMS. 3.1.3. The new product condition. 3.1.4. Pros and Cons of the «R&D defence» in the Microsoft case. 3.2. The American perspective.
3.2.1. A brief overview of the relevant U.S. case law. 3.2.2. The R&D objective justification. 3.3. How to draw up a balance. 3.3.1. The insubstantial investments’ assumption as the wrong starting point.
3.3.2. Considering substantial R&D expenditures as a defence: a probatio diabolica?. 3.3.3. A possible solution. 4. TRYING TO BE IN THE INVENTOR’S SHOES: CONSIDERING EX ANTE DISINCENTIVES AS THE KEY IN COMPULSORY LICENSING. 4.1. Capitalist growth process and dynamic efficiencies. 4.2. A more comprehensive methodology: the appraisal of ex ante disincentives.
4.2.1. Clarifying the scope of Article 82 EC: the intricacy created by the ordoliberal influence. 4.2.2. An economic approach for measuring allocative efficiencies. 4.2.3. Considering dynamic efficiencies from an ex ante perspective. 4.2.4. The balancing exercise as a ‘one-stop shop’. 4.2.5. Setting appropriate royalties. 5. Conclusion.
«Capitalism […] is by nature a form or method of economic change and not only never is but never can be stationary1».
«Under capitalism, innovative activity – which in other types of economy is fortuitous and optional – becomes mandatory, a life-and-death matter for the firm»2.
The case law has acknowledged that a dominant company which holds an IPR is not obliged to share this facility with its competitors for the sole reason of being dominant: however, under certain circumstances, a refusal to license may constitute an abuse of a dominant position under Article 82 EC. Since companies will invest only when they expect large returns in terms of monopoly profits, it has been demonstrated that mandatory access may lower the inventor’s incentives to invest in R&D.
This article is intended to provide a critical overview of the case law and examine the effects of compulsory licensing on economic welfare. Section 2 describes how, even if IP protection leads to a short-term loss of consumer surplus associated with monopoly profits, in the long run it may enhance welfare gains related to the creation of the invention. It concludes that it is crucial to take into account that compulsory licensing may lower the IPR holder’s incentives to invest to such a point as to deter him from creating an invention if he knows in advance that he will not be able to recoup his R&D investment.
Section 3 shows that EU and U.S. Courts focus mainly on short term allocative efficiencies (i.e. the negative impact of the monopoly on
(*) LL M in European Legal Studies, College of Europe (Bruges); PhD candidate in Law and Economics, Università Luiss Guido Carli (Rome). This article is based on the author’s thesis submitted for the 2007-2008 Degree of Master at the College of Europe. The author wishes to thank Prof. Mario Siragusa and Jacopo Figus Diaz for their help and advice. Ideas, possible errors and omissions are the author’s exclusive responsibility.
1SCHUMPETER, J. A., Capitalism, Socialism and Democracy, 5th ed., George Allen & Unwin Ltd, London, 1976, p. 82.
2BAUMOL, W. J., The Free-Market Innovation Machine, Analyzing the Growth Miracle of Capitalism, Princeton University Press, Princeton, 2002, p. 1.
consumers), with the result that the jurisprudence not only takes the facility for granted (while it should consider the ex ante option of not creating it) but it also assumes as a starting point that investments have been insubstantial. As a result, the inventor faces a probatio diabolica to reverse these presumptions.
Section 4 concludes that a preferable approach would be to analyse cases involving compulsory licensing of IPRs from the perspective of long-term efficiencies, balancing consumers’ short-term gains against the inventor’s ex ante disincentives to invest, especially when significant R&D expenditure is involved.
If one considers that innovation is not only a key ingredient of capitalism but also its engine3, it is evident that the debate on the inventor’s ex ante disincentives to innovate is not only extremely topical but also deserves both attention and solutions.
2. THE ECONOMIC EFFECTS OF COMPULSORY LICENSING ON THE INCENTIVES TO INVEST IN R&D.
2.1 EFFICIENCIES IN INTELLECTUAL PROPERTY PROTECTION.
2.1.1 The «second enclosure movement»4: the propertization of ‘expensive’ knowledge as a way of rewarding investments.
The essential function of IPRs is said to be the reward, in terms of monopoly profits, to the creator of a socially desirable invention5. In this
3BAUMOL, W. J., The Free-Market Innovation Machine, Analyzing the Growth Miracle of Capitalism, supra, p. 1.
4BOYLE, J., “The Second Enclosure Movement and the Construction of the Public Domain”, Law and Contemporary Problems, vol. 66, Winter/Spring 2003, pp. 33-74, at
5ELHAUGE, E., “Defining Better Monopolization Standards”, Stanford Law Review, vol. 56, November 2003, pp. 253-344, at p. 297.
article, we will evaluate the role of R&D expenditures as a fundamental constituent of IP protection6.
A situation where no IPRs exist has notably been defined as a «tragedy of the Commons»7. In such a situation, everyone may freely use inventions, ignoring the costs borne by the inventors. As a consequence, there is competition in the market which leads to zero profits for all, including the inventor who will be unable to recoup the investment. Historically, the solution was found in the «second enclosure movement»8, leading to the creation of legal monopolies for IPRs. To that extent, it should be stressed from the very start that investing in R&D is quite a ‘risky business’. It is generally considered that the research portfolio of a firm should not only be sufficiently diversified but that it should also be taken into account that «a company can expect somewhere between one and three of every ten R&D projects to be profitable»9. This explains why companies will invest only when they expect large returns in terms of monopoly profits.
6Intellectual property protection includes different types of rights: this research is aimed at signalling general principles, without focusing on the specific characteristics of each category. However, I have focused mainly on patents and copyrights rather than on trademarks, whose protection responds primarily to the different problem of granting quality products to consumers.
7HARDIN, G., “Tragedy of the Commons”, Science, vol. 162, n. 3859 of December 1968, pp. 1243-1248, at p. 1243.
8BOYLE, J., “The Second Enclosure Movement and the Construction of the Public Domain”, supra, p. 37.
9SCHERER, F. M., The Economic Effects of Compulsory Patent Licensing, Monograph Series in Finance and Economics, New York University, New York, 1977, p. 18 which refers to MANSFIELD, E., RAPOPORT, J., SCHNEE, J., WAGNER, S. and HAMBURGER, M., Research and Innovation in the Modern Corporation, Norton, New York, 1971, pp. 41-42. In economic terms, R&D expenditures are defined as sunk costs, i.e. fixed costs which do not depend on the output level, and as assets with no opportunity cost (due to the lack of alternative use).
2.1.2 Consumer participation in the benefits and the theory of optimal patent protection.
The major negative implication of legal monopolies is that not all the consumers who wish to buy the product may do so, since the monopolist restricts output to raise prices. The negative impact of a monopoly on consumers is shown in Figure 1: the monopoly results in higher prices and lower quantity (P*, Q*) than the competitive equilibrium (Pc, Qc). The harm caused by a monopoly on consumer welfare corresponds to the area π (equivalent to the additional profits for the producer) plus the deadweight loss (L).
Figure 1: «The Monopoly Loss Triangle» 10
However, the short-run negative impact of a monopoly might be compensated by substantial gains for consumers in the long run11.
10Figure adopted in AHLBORN, C., EVANS, D. S. and PADILLA, A. J., “The Logic & Limits...