Sunday, August 19, 2018

Economic Value of Intellectual Property As a Direct Result of Supply and Demand, Not Labor Inputs: The Shorter Version

Stuart K. Hayashi





The following is a summary of the arguments of my much longer essay “Economic Value of Patents As a Direct Result of Supply and Demand, Not Labor Inputs.”



There is no “scarcity” on impractical, harebrained ideas for products, such as “glow-in-the-dark sunscreen.” Nor is there a “scarcity” on very basic, vague ideas for products that the idea generator has neglected to flesh out. But there is a “scarcity” of fleshed-out practicable designs for products. A “practicable design” is for a detailed, diagrammed, unique design for a product that, if put into production according to the design’s specifications, will result in units that supply the satisfaction of marketplace demand to such an extent that market participants would willingly pay for access to units at a price that exceeds the average cost per unit. A patent is granted for such a practicable original design, not a basic or general or vague idea for a category of product.

Creating such an original practicable design does not come cheap. In order for any vendor to feel confidence in selling units produced from the original design, the original design must work as promised. That consideration necessitates that the inventor run tests to measure the efficacy of units produced from the design. Hence, the inventor invests hours or years of time and labor, as well as invests in equipment, to run the tests needed to arrive at a design that is so practicable that units produced from it will stand a chance at supplying the satisfaction of marketplace demand. The time and labor and resources the inventor invests in the creation of her practicable original design are “scarce,” imposing costs upon her. For that reason, the quantity of practicable original designs for products are “scarce” as well.

While there is no finitude in impractical ideas for products, or in product ideas which remain vague, on account of no one fleshing out such ideas, there is a finite quantity on original designs for products whose units will efficiently supply the satisfaction of marketplace demand. In effect, if there were no intellectual property protection laws at all, there would still be this preexisting “scarcity” on practicable original designs for new products.

Because clients and customers are only willing to purchase product units that are practicable enough to satisfy their marketplace demand, the very nature of this consideration is the source of the fact that there is a finite quantity on the number of practicable original designs that can exist at any given moment. Hence, there is finitude in the supply of practicable original designs for new products. And if inventors are not recompensed for their investment of time and work and resources and equipment into the creation of their practicable original designs, the quantity of new inventions will become scarcer as well.

Not wanting to listen to me, some opponents of patent rights have made the knee-jerk accusation that I am trying to justify patent rights on the basis of the “labor theory of economic value.” That is a straw man on their part. I am not saying that the inventor’s investment of hard work and resources is the direct cause of the economic value of the inventor’s practicable original design. Nor is that investment the direct cause of the price that the inventor expects to be paid for her practicable original design. (When I refer to the “price” of the invention, I do not refer only to the price that the inventor could charge to a firm wishing to possess the patent, but also the royalty the inventor could charge licensees.)

The direct cause of the economic value of the inventor’s practicable original design is that the innovative aspects of the design allow for units produced from the design to supply the satisfaction of marketplace demand to an extent beyond what was capable for all the units that were on the market prior to the inventor having introduced this design of hers.

Here is an example of a patented design making possible the production of units that satisfied marketplace demand more adequately than had similarly-used units that were on the market prior to the invention of this new patented design:

Eventually there was an electrical method of instant communication over miles, coming in the form of telegraphs. But the messages sent through telegraphs could only come in the form of a series of short beeps and elongated beeps. A new esoteric language — Morse Code — had to be devised so that written English messages could be encoded into, and then deciphered from, a sequences of short beeps and elongated beeps. If economic value could be measured in “utility points,” we might imagine that someone with ready access to a telegraph might gain an average 1,000 utility points from it.

Then Alexander Graham Bell introduced the telephone. It could transmit and receive electrical signals from distances comparable to those sent and received by telegraphs, but learning and deciphering a code such as Morse Code was no longer needed. There was the new convenience of simply being able to speak one’s own language and to be understood readily by anyone on the other end of the line who used the same language. Each telephone was a unit produced from a particular design, and it can be said that someone with ready access to a telephone might gain an average 1,500 utility points from it.

If a man who once was able only to use a telegraph obtained 1,000 utility points from that telegraph, and now obtains 1,500 utility points from his telephone, then he has experienced a net gain of 500 utility points. That net gain in 500 utility points per user is the net increase in economic value for which the inventor is responsible.

Once the inventor’s practicable original design is properly recognized as her private property, whatever price she may charge for it — be it the price she might charge a firm to obtain her patent outright, or be it the royalty she tries to negotiate out of firms wishing to license her original design — is rightfully determined by the confluence of marketplace demand with supply.

The fact that patent royalties are rightfully determined by supply and demand is not negated by the simple refusal of many people to acknowledge that the practicable original design should rightfully be considered a form of private property. That is just as the fact that land prices and land rents are rightfully determined by supply and demand is not negated by the simple refusal of many people to acknowledge that a private, improved homestead should be considered a rightful form of private property.

No, that the inventor worked very hard and invested so many “scarce” resources into the creation of her original design is not the direct cause of her original design’s economic value. If she worked really hard and invested a lot on producing an original design that resulted in units that failed to supply the satisfaction of marketplace demand — if she worked hard and invested millions to invent a method for producing glow-in-the-dark sunscreen — the original design would still not be worth much.

When it comes to these practicable original designs that result in units that do superbly supply the satisfaction of marketplace demand, though, the fact that the inventor worked hard and invested time and labor and “scarce” resources into the creation of her original design is not unimportant. It is an important consideration worth my bringing up because the inventor working hard and investing “scarce” resources into the creation of her original design is the direct cause of the fact that such practicable original designs are “scarce” themselves.

This is just as the fact that a homesteader working hard and investing time and labor and “scarce” resources into the improvement of his parcel — converting an inhospitable wilderness into an improved plot capable of supporting human life — is an important consideration even though it is not the direct cause of the homesteader’s homestead possessing economic value. The direct cause of a homestead possessing economic value is that its attributes allow for it to supply the satisfaction of marketplace demand. Yet the very reason why that homestead is capable of supplying the satisfaction of marketplace demand, though, is that in his investing of time and effort and resources into the improvement of his land, the homesteader’s exercised wise enough judgment in his choices on this enterprise that resulted in the improved land possessing the attributes enabling it to supply the satisfaction of marketplace demand.

The reasons why a particular plot of improved land can and should command a high price on the supply side, is twofold. First, a plot of land is rendered inhabitable as a result of human effort and initiative, and only a few humans are willing and able to exert the effort and initiative that is needed. That consideration, by itself, is the source of the “scarcity” of improved plots of land. Secondly, each homesteader must make his own judgments in how to improve his land, resulting in different homesteaders making different choices, with some of these choices being better than others. Hence, although two homesteads may have started out as very similar pieces of geographic terrain, one might be end up more suitable than the other in terms of supplying the satisfaction of marketplace demand, on account of one homesteader making wiser choices than the other.

Likewise, the reason why a particular patented original design can and should command a very high price — be it the royalty charged to licensees or the price a firm must pay for the whole patent itself — is twofold. First, a general idea is fleshed out and converted into a practicable original design as a result of human effort and initiative, and only a few humans are willing and able to exert the effort and initiative that is needed. That consideration, by itself, is a major cause of the “scarcity” of practicable original designs. Secondly, each inventor must make her own judgments. Hence, different inventors trying to solve the same basic problem will approach that problem from different angles and make different choices. Hence, although two patents might approach the same basic problem or even result in similar devices, one might be more suitable than the other in terms of the satisfaction of marketplace demand.

Thus, no, there is no basis to the accusation of those who immediately proclaimed that my explanation was an attempt to apply the “labor theory of economic value” to inventions and patents. I have not said that the hard work and “scarce” resources that the inventor invested in her creation of her practicable original design is the direct cause of the original design’s economic value or the prices that the inventor should be able to charge.

Both (1) the economic value of the practicable original design and (2) the prices that inventor may charge for her services, are the direct result of the practicable original design’s ability to supply the satisfaction of marketplace demand. That the inventor had to invest so much hard work and “scarce” resources in order to create her practicable original design, however, factors into both (a) the “scarcity” of practicable original designs as such, and (b) the particular original design’s ability to supply the satisfaction of marketplace demand.

Yes, the economic value of the inventor’s invention comes from how the invention supplies the satisfaction of marketplace demand, a new supplying of new satisfaction of marketplace demand that had not happened before. And here is why first dibs on rightful private ownership over the invention should go to the inventor herself: any time new economic value is created, first dibs on rightful ownership over that value must goes to the very same party that created that value. When land is made more valuable on account of the homesteader improving it, first dibs on ownership over the value in that land must go to the homesteader himself.

To recognize that is not to deny that the direct source of the improved land’s value is its ability to supply the satisfaction of marketplace demand. It is proper to recognize that the homesteader’s contribution is what made it possible for that improved land to supply any satisfaction of marketplace demand. Likewise, as an efficacious original design for a product generates a net increase in value in the economy, first dibs on ownership over that value must go to the party that created it: the designer herself.