About the author: D.J. Nordquist is executive vice president of the Economic Innovation Group and the former chief of staff of the White House Council of Economic Advisers.
The U.S. has always been a nation of inventors. New ideas and the jobs they create are fundamental to the strength and dynamism of our economy. The first patent was signed by President George Washington in 1790 for potash, an ingredient used to improve the productivity of fertilizer. Eleven million patents later, our country’s entrepreneurial engine has been greased with patent protections to ensure those willing to take chances are rewarded with safeguards for their intellectual property.
However, innovation and economic dynamism have been declining across numerous measures since the 1980s, a trend that has been accelerating since around the year 2000. A new paper by University of Chicago and Federal Reserve economists finds that patent litigation may be a partial culprit, negatively impacting U.S. innovation and knowledge diffusion.
The authors focus on the imprecision of the current patent regime. They note nonpracticing entities have been able to take advantage of holes in the legal system. NPEs are companies that own or invest in patents but don’t use the patents themselves. Billions are spent annually on third-party funded litigation, some of which backs bad-faith NPEs or “patent trolls” who exploit unclear patent definitions to extract settlement payments from U.S. businesses.
The U.S. has become the world’s largest market for such financing, accounting for over half of the global total. While much of this activity may simply be opportunistic—an investor sees a chance to generate returns—not all of it is benign. Other motivations can include intentionally inflicting costs on firms, distracting a target company with protracted litigation, or causing reputational harm that in turn impacts investor sentiment. Research has found that trolls are more likely to sue firms with large cash balances and on the eve of significant events like mergers or initial public offerings. Annual legal losses to patent trolls totaled $29 billion in 2011 according to one study, a full tenth of total private sector R&D investment that year.
Furthermore, a lawsuit loss to an NPE caused firm R&D investment to drop by an average of $160 million over the following two years, according to a Harvard Business School study. Many of these lawsuits occur thanks to continuation patents—incremental innovations that bear no real resemblance to the original patents, depress innovation, and can later be exploited by trolls.
Another issue in the steep rise of patent litigation is the litigant itself, which may have national security implications. Sunshine may be the best disinfectant, as Supreme Court Justice Louis Brandeis once said, but few jurisdictions require disclosure of the litigant’s funders. That lack of disclosure not only stresses firms with uncertainty, but also opens up the U.S. to potentially adversarial foreign governments such as China or Russia taking advantage of the U.S. legal system for either malign military or national security purposes, or to steal IP.
In either case, the goal may not be financial; the legal discovery process often provides unencumbered access to IP, giving any opening to those who may want to attack key sectors of the U.S. economy. A foreign ally could even use an NPE to protect or advance its own national champions. For example, during the discovery process, some federal courts mandate disclosure of source code within 45 days of lawsuit service so the patent can be examined. So instead of having to bother stealing code, an adversary like China can simply file a lawsuit and be given the data in broad daylight.
Trolls have also been able to exploit another legal loophole: an enterprising federal judge who actively marketed his courtroom as effectively troll-friendly. And it worked: his district in Waco, Texas, rapidly came to hear one-quarter of all patent cases in the U.S. The forum shopping was so egregious that even Congress took notice in a bipartisan fashion, as did Chief Justice John Roberts. The U.S. District Court chief judge for the Western District of Texas finally spread the patent cases to all 12 judges in the district. It’s difficult to say how that 4-year period under one bold judge affected economic dynamism nationally. But states that passed laws to minimize patent troll suits spurred job creation, experiencing a 4.4% increase in employment at high-tech startups, a frequent target of NPEs.
A good fix would be to clarify patent-right boundaries, put tighter limits on continuation patents for derivative inventions that are not particularly inventive, and to increase the speed and efficiency of dispute-resolution mechanisms. Sadly, many of the lawsuits, funded either by investors or bad actors, are simply spending money in the hopes of making a profit in a settlement. They add no value to the economy and in fact do damage to it.
Our Founding Fathers explicitly recognized the importance of entrepreneurship, writing in the Constitution about the importance of “promot[ing] the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” We need policy makers to focus on reforms to ensure the U.S. innovation engine keeps running.
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