There is endless drivel published by charlatans attacking patents.  Professor James Bessen is perhaps the best known standard-bearer for the “patents hurt innovation” camp.   His work is often cited by the popular press (and by the anti-patent clique in Congress). He’s always ready with a pithy quote that obscures the lack of scientific rigor behind his curious views.  The popular press is not really to blame—other than for being lazy and favoring the simple narrative that fits their preconceived notions of reality.

Bessen co-authored a paper titled “The Private and Social Costs of Patent Trolls” in which the authors came up with a jaw-dropping $83 billion cost per year to the economy from “non-practicing entity” (NPE) patent lawsuits. That number, and an equally fictitious $29 billion number, has taken on a life of its own and is extensively quoted. The only problem is the number has no relationship to reality. Ron Katznelson did a great take-down of that figure in his article “Questionable science will misguide patent policy ─ The $83 billion per year fallacy.”

Katznelson points out that the $83 billion figure is a fallacy built on more fallacies. It treats a decline in market capitalization of a company as a cost. It isn’t. It then assumes that changes in stock price after a lawsuit are based on the results of the lawsuit. Ignoring a lot of other factors influence stock price, subsequent stock rebounds, etc., etc. But since the number comes from a professor, lazy journalists will assume it must have intellectual rigor.

On the other hand, there is actual scholarly work done that shows patents ARE in fact important. While some in government like to think they are the ones who create jobs and drive economic activity, credible research strongly supports the view that startups and Small-Medium Enterprises (SMEs) are critical in creating positive job growth and economic activity (see for example, The Importance of Startups in Job Creation and Job Destruction). Since startups and SME’s are critical to jobs and economic growth, it is interesting to explore the way in which patents impact startups and SME’s.

If you believe Professor Bessen’s article on “The Direct Costs from NPE Disputes”, you would conclude that patents stifle startups and SME’s, either as a result of “getting in the way” – that pesky right to exclude – or as a result of SME’s being crushed by patent trolls.

A new paper, Patent Rights, Innovation and Firm Exit, by professors Alberto Galasso of the University of Toronto and Mark Schankerman of the London School of Economics shows the importance of patents to innovation in small/medium sized companies.

The authors built a model to show the relationship between the loss of patent rights and incentives to innovate. They tested a hypothesis that as companies grow and have more patents, there are diminishing returns to any individual patent. It also means the impact on the company of losing patent protection is greater the smaller the company and the smaller its patent portfolio.

The authors didn’t want the data distorted by firms that use an aggressive patent enforcement strategy, litigating widely which can also result in a lot of invalidations. To correct for that problem, the authors chose to look only at patents whose validity was reviewed by the Federal Circuit. This serves to weed out patents of lesser value and importance, and helps to randomize the impact of variation in lower jurisdictions.

The paper shows that small firms that have patents that are core to their business invalidated struggle. Subsequent innovation (as represented by new patent activity) drops by 50%. Losing a core patent substantially increases the likelihood that the small firm will exit the market entirely (as indicated by no new patents at all in the field).

To look at it in a positive light, a small company that has a core patent survive a challenge that makes it to the Federal Circuit – indicating it has a strong, important patent – innovates more and has a better chance of survival than companies that have a patent invalidated.

The paper cites research showing different ways in which patent rights are important to small companies:

  1. Patents shape the nature of competition in both products and technology, especially in markets where small firms are competing with large firms. This makes sense as small firms may only be able to compete effectively in places where they can secure an advantage by protecting technology with patents.
  2. Research suggests that patents are particularly effective in situations where there is a lot of competition.
  3. Patents allow small companies to bring innovation to fields with high barriers to entry by making it possible for them to innovate and license those innovations to big players.
  4. Small firms can use patents to improve access to both debt and venture capital.
  5. Patents are also valuable because they allow the smaller company to enter into cross licensing deals with larger companies. This is presumably important because larger firms are generally older companies that may have older technology that may be foundational and important to new entrants.

Evidence shows that patents are important to innovation in small companies, and that invalidating patents harms those small companies. Therefore, it follows that actions that have weakened the patent system – such as making it easier to challenge patents at the patent office and judicial decisions raising the bar on what’s considered patentable – harm small companies and harm innovation.

The scholarly work done by Professors Galasso and Schankerman is important because it refutes the populist bunk coming from the likes of Bessen. Since Professor Bessen’s work fits the narrative of organizations such as “The Patent Fairness Coalition” (which would better be called the “Patent Destruction Coalition”) and Google, his views are promoted in the popular press and by politicians that are setting the “reform” agenda.

Because Professors Galasso’s and Schankerman’s work actually requires that you have a basic understanding of math and statistics, it is simply not going to be “popular.”  Take the time to read both—and then decide who has more academic credibility. Bessen’s can be read here, and Galasso and Schankerman’s here.

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