Brussels, 25 August 2003
The present document, written jointly by scholars specializing in the economics of innovation and intellectual property, critiques and corrects misleading impressions conveyed by the Explanatory Statement that appears in the JURI report to the European Parliament, especially those pertaining to the interpretation of the existing economic research evidence on patents' role in stimulating software innovations.
Inasmuch as the rapporteur's explanatory statement in the JURI report is the document that will introduce the directive to many members of the Parliament who are unfamiliar with the subject, the imbalance and incompleteness of the analysis it offers is extremely unfortunate.
Because the proposed directive's terms are treated as matters of political compromise, economic issues that deserve careful consideration are glossed over, and the many problematic aspects of software patents that are now becoming manifest in the United States are entirely ignored. Indeed, a number of these problems were raised in the economics section of the study conducted for the Commission by the Intellectual Property Institute and, after the publication of the proposed directive, in the Parliament's own commissioned study, "The Patentability of Computer Programs," prepared by the Institute for Information Law at the University of Amsterdam.
The explanatory statement opens by reciting the large number of patents granted for computer-related inventions (not limited to computer programs) as evidence of the demand for patents. This is dangerously misleading without a proper understanding of the context, as is the suggestion later in the document that companies with substantial software-related research may be expected to spend 5-10% of R&D on patenting. Both higher numbers of patents and high expenditures on patents may be symptomatic of strategic portfolio building. As the CEO of an SME testified at the FTC/DOJ hearings:
"I have no idea whether my product infringes on upwards of 120 different patents, all of which are held by large companies who could sue me without thinking about it. The end result, much like Borland, I have now issued a directive that we reallocate roughly 20 to 35 percent of our developers' resources and sign on two separate law firms to increase our patent portfolio to be able to engage in the patent spew conflict."
In the same hearings, Robert Barr, Vice President of Cisco, said
"Where the patent system enables true innovation, true progress, where it enables companies to bring new products to consumers in circumstances where they otherwise would not do it, or where it disseminates knowledge that others need and want, then it's working. There are certainly examples of industries where it serves these purposes, and these benefits must be preserved. But in my experience at Cisco and my prior experience representing a variety of companies, the negative effects of stockpiling patents, the consequences of innocent infringement through independent development, the cost of proving non-infringement or invalidity through patent litigation and the exploitation of the patent system as a revenue generating tool in its own right have hindered true innovation and outweighed the benefits."
Both executives are responding to the fact that the patenting increase in the computing and communications technology area in the United States has been driven by the strategic motive of piling up patents for defensive use and use in cross-licensing negotiations and not by the need to secure returns to innovation. It is noteworthy that the majority of U.S. patents in software technology are not taken out by package software publishers, but by hardware manufacturers plus IBM (which is classified as a computing service provider). The growth in patenting in this areas is disproportionately driven by large U.S. firms involved in the manufacture of semiconductors, computers, and communications equipment, who are amassing patents specifically for defensive purposes as described by both the speakers quoted above. While cross-licensing is commonplace among the large companies, many are now using their portfolios to extract offset fees from companies that bring smaller portfolios to the table.
The SCO actions against Linux should remind policymakers that exploitation of intellectual property is not limited to the protection of going businesses. As a weapon, intellectual property is used most effectively by companies that have no going business and therefore little to lose from uninhibited aggression. They wield the most power when their property claims have been inadvertently embedded in the systems of millions of business so as to cause widespread uncertainty among sectors that are mere users of technology. This prospect of economy-wide liability argues strongly for a strict interpretation of the technicity requirement that limits patents to the scope of the technical contribution. This would limit speculation in software patents by largely confining their application to technical fields where there is more likely to be awareness of relevant patents and less temptation to assert patents against unknowing and unsophisticated users. Ideally, this would eliminate the risk of inadvertent infringement in the basic information processing functionality of operating systems and common applications such as word processors.
More generally, the rapporteur's statement fails to address the potential negative economic effects of large portfolios on the competitive structure of an industry characterized by strong economies of scale and network effects. Software patents readily may multiply instances of monopoly control over compatibility interfaces in computer code, thereby opening the way for the abuse of market power over "essential facilities" – and expanding the problems with which the competition authorities would have to contend. We appreciate the JURI committee's efforts to address this by amending Article 6 to ensure that patents (like copyright) cannot be used to block interoperability by complements, but note that this does not preclude the use of patents to pre-empt critical functions within a general-purpose information infrastructure.
The most serious error in interpreting the economic evidence is perhaps that in section 5, where the rapporteur's statement asserts that "academic studies have shown a link between R&D spending, patent applications, and productivity." No documentation for this claim is provided. In fact, what is known via academic research is that although a firm's R&D spending is clearly related to its productivity, profitability, or market value, there is little evidence that patents contribute separately to performance, that is, above and beyond R&D spending. Direct survey evidence for the United States and Europe has found that patents are only considered important for securing returns to innovation in the specialty chemicals industry including pharmaceuticals, medical instruments, and specialized machinery.
In the study already cited that explicitly focused on software patents, Bessen and Hunt found that the correlation between R&D and patenting in the U.S. over time has been significantly negative. In other words, as software patenting rates have risen, R&D investment in sectors using information technologies has declined. Whether there is an underlying causal relationship remains unestablished, but the U.S. experience warrants scepticism regarding claims that software patenting would contribute to the goal of raising the software R&D investment rate in the European Research Area.
We appreciate the rapporteur's and the Parliament committees' concerns for monitoring the impact of software patents in Europe and the U.S. This should be done in a scientifically sound manner in which the methodology and conclusions are publicly debated. It must begin with a proper empirical baseline before the directive is implemented in order to understand the effects of the directive. Indeed, it should be done before the directive is enacted to ensure that the baseline is not prejudiced by business behaviour that anticipates implementation. As the Institute for Information Law study notes, there is grossly inadequate information about the functioning of patents in practice and a need for disinterested independent oversight, such as the proposed European Patent Observatory.
Despite the promise implicit in its title, the small contract for the study was not awarded to one of Europe's many research institutes specializing in the economics of innovation, but to the legally oriented Intellectual Property Institute in London, which has no economists on staff and at best a limited record of conducting economic research. The economist brought in on the study did a respectable review of the literature in 11 pages, a minor fraction of the report, which as a whole dwelt extensively on legal issues. As noted, there were discrepancies between the economics section and the summary, yet the Commission did not provide for peer review, either in writing or through a public event. Nevertheless, the analysis in the memo that accompanies the Commission's draft directive is largely based on selected statements from the study and basically justifies the direction indicated in the 1997 and 1999 documents.
Most regrettably, Internal Market as the lead DG on intellectual property has failed to address the larger economic and institutional problems inherent in the patent system, even as it moves Europe toward the laudable goal of a community patent. Indeed, instead of making an effort to better understand how the system affects competition and innovation, it has invested resources in unabashedly promoting greater use of the system. In effect, this urges Europe into the kind of strategic portfolio building that operates as a limitation and barrier to small businesses in the U.S. To this end, the Commission jeopardized its reputation for objectivity by awarding a large contract to IBM, a company with a uniquely voluminous portfolio and a famously aggressive licensing program, to make recommendations on how national patent offices should promote patenting.
In the same vein, the Commission has pursued planning for insurance to support patent enforcement through litigation, since it is known to be costly for SME. This, however, was premised on another misunderstanding of the U.S. situation. As the contracted study concluded: "The tacitly assumed successful and wide use of insurance in the USA proved to be illusory." The investigation showed that the principal insurance market in the U.S. was for defensive insurance and that the insurers themselves were fearful of the risks involved. Their concerns were remarkably consistent with the picture of patent minefields and attendant risk and uncertainty painted in the FTC/DOJ hearings.