FTC/DOJ Joint Hearings on Washington, D.C. February 6, 2002 Testimony of Richard C. Levin It is a pleasure to participate in the opening session of these important hearings. I am especially honored to share the platform with the distinguished public servants who have shaped and now shape the interpretation and enforcement of the nation's antitrust and intellectual property laws. My involvement today derives from two personal experiences. In the 1980s, with the support of the National Science Foundation, I directed a substantial research program at Yale on the economic impact of intellectual property. Currently, I co-chair a committee on Intellectual Property Rights in the Knowledge-Based Economy under the auspices of the National Academies' Board on Science, Technology and Economic Policy(1) . Both these experiences provide insights relevant to the subject of these joint FTC/DOJ hearings. The centerpiece of our research in the 1980s was a survey of 650 executives responsible for research and development in 130 different industries. The survey -- which I developed in collaboration with Alvin Klevorick, Richard Nelson, and Sidney Winter -- sought to characterize both the opportunities for technological advance and the capacity of firms to appropriate the returns from their investments in research and development. (2) The most striking and most influential finding from the data collected in the mid-1980s was that the role of patents differed across industries and technologies. In most industries, firms reported that being first to market with a new or improved product and supporting their head start with superior marketing and customer service most effectively protected the competitive advantages of their R&D. In these industries, patents were not regarded as highly effective in protecting a firm's competitive advantage. The pharmaceutical and certain other chemical industries were striking exceptions. In these industries, patent protection was deemed to be far and away the most effective means of appropriating the returns from research and development. Despite significant changes in patent law during the ensuing years, a follow-up survey conducted in the late 1990s by Wesley Cohen, Richard Nelson, and John Walsh essentially replicated our findings.(3) The perceived value of pharmaceutical and chemical patents derived in part from the nature of technology. In the 1980s, the valuable and effective patents in these industries gave exclusive rights to a particular chemical compound, a specific molecule. In such cases, patent rights were relatively easily enforced, and the rights to one patented molecule were rarely required to obtain or practice a patent on another molecule. In contrast to the discrete nature of chemical and pharmaceutical innovation, progress in other key technologies -- such as microelectronics, telecommunications, and computers -- was cumulative. Virtually any advance required access to a bundle of prior patents. This circumstance had its roots at the very beginning of the microelectronic era, when access to the Bell Labs' transistor patent was required to develop virtually any new product. It continued through the early years of the integrated circuit era, when industry participants typically needed to license the fundamental product patent from Texas Instruments and the fundamental process patent from Fairchild.(4) By the early 1980s, semiconductor firms already had a well-developed practice of cross-licensing their entire patent portfolios and determining the net flow of royalties by "scoring" the most important patents in each portfolio. Today, with the widespread use of patented research tools and the attendant need for cross-licensing, the pharmaceutical and biotechnology industries are moving closer to the cumulative technology paradigm. The difference between discrete and cumulative technologies is not acknowledged in the granting of patents or in the resolution of patent litigation. But it is a distinction of some value in the antitrust analysis. Put simply, in cumulative technologies, cross-license agreements are a necessary condition of technical progress. They should not ordinarily be regarded as anticompetitive unless they are used in a concerted way, without sufficient justification on grounds of efficiency, to block entry into a relevant product or innovation market. Let me turn now to the ongoing work of our National Academies committee, which is investigating the broad economic impact of changes in patent law and administration over the past quarter century. Over the past two years, the committee has held three conferences and six meetings involving public participation. We have heard from virtually every interested segment of our society with a stake in the effectiveness of the patent system: independent inventors, open source software developers, large companies, lawyers, judges, patent office officials in the United States and Europe, representatives of international organizations, academic economists and lawyers, and antitrust enforcement agencies. The committee expects to present its findings and recommendations in September 2002. At this point, I want to make it very clear that I do not speak for the committee. Instead, I will offer just a few personal observations about two particular areas of concern. First, there is widespread concern about the quality of patents issued in newly emerging areas of technology. In some respects, such concern is inevitable. Almost by definition, new areas of technology lack well-established bodies of prior art in earlier patents and the published literature. This makes it difficult for patent examiners to determine whether a claim meets the required tests of novelty and nonobviousness. Still, even an observer sympathetic to the difficulties faced by patent examiners would find reasonable basis for concluding that many software patents, most notably those describing computer-enabled business methods, do not meet a common sense standard for innovation. There are potentially serious consequences of a low threshold for patenting in emerging technology areas. A patent, after all, grants an exclusive right, and in some cases it can confer power in product and innovation markets. We should be wary of creating unwarranted market power by granting unwarranted patents. The remedy, however, lies not in placing more rigorous antitrust constraints on the behavior of the holders of low-quality patents. The remedy is to improve the process of granting and reviewing patents to ensure that monopoly rights are not conferred on rent-seekers who have not truly achieved "progress" in the "useful arts." The Patent and Trademark Office has already begun taking steps to improve the quality of its prior art data bases and the qualifications of newly-hired examiners in emerging areas of technology. Still more resources may be needed to ensure timely and effective review of patent applications. The courts might also consider returning to a more rigorous application of the standard for nonobviousness articulated in the last major Supreme Court decision on the subject: Graham v. John Deere 383 U.S. 1 (1966). A recent study(5) documents how decisions by the Court of Appeals for the Federal Circuit have tended to substitute "secondary" for "primary" tests of obviousness, resulting in a standard that comes perilously close to "if someone invested money in developing this invention, it must not be obvious." A standard so diluted runs the risk of rewarding pure rent-seeking with rights that should be reserved for socially beneficial innovation. Another idea worthy of consideration would be to institute a system of post-grant review under which third parties could challenge the validity of a patent on grounds other than the narrow ones now permitted under the current re-examination procedures. A low-cost administrative review procedure might reduce the need for costly infringement litigation, and wasteful investments by those later judged to have infringed a valid patent might be avoided. A speedy procedure might also produce great social benefit by clarifying at an early stage the appropriate standard of nonobviousness and the scope of permissible claims in emerging areas of technology. A second area of concern that has come to our committee's attention is one that more properly needs review by the antitrust enforcement agencies. Increasingly, in the computer networking, telecommunications and related technologies, we have come to rely on the work of private standard-setting consortia. The work of these bodies is often indispensable in facilitating progress in cumulative technologies, yet the potential for anticompetitive and exclusionary practices warrants scrutiny. The Antitrust Guidelines for the Licensing of Intellectual Property, which offer intelligent and sensible guidance in the areas of cross-licensing and patent pooling, provide a relevant model for policy in this area. To permit efficiency-enhancing collaborations to move forward and to protect consumers from anticompetitive practices, standard-setting bodies should be subject to appropriately clear, specific and well-crafted antitrust guidelines. These are but two areas of concern that have come to the attention of our committee. Among many others, I would mention the high cost of patent litigation, the inefficient reliance upon subjective determination of intent in such litigation, the drift toward granting patents for discovering facts of nature rather than requiring human invention, and the wasteful duplication caused by the failure to achieve full international harmonization of patent law and full reciprocity for searches and examinations. These concerns, like those involving the standards of patentability, are more directly addressed through statutory, judicial, or administrative changes in the patent system, rather than through changes in antitrust law or enforcement. Despite all the concerns that have been raised in the course of our committee's work and that will be raised in the course of these hearings, we must not lose perspective. Innovation is alive and well in the American economy. For more than a half century, our nation has led the world in the development of new technologies and the creation of new products. Our international competitive advantage rests on the unique encouragement we give to scientific progress through the peer-reviewed public funding of projects located in institutions that combine frontier research with advanced scientific and technological education. Our open, entrepreneurial economy, fueled by vigorous and effective capital markets, translates the results of scientific advance into industrial innovation. Intellectual property rights play a significant role in this process by protecting the returns to innovation, just as antitrust enforcement preserves competition and protects consumers from abuses of market power. There is always room for improvement, and I trust that these hearings will identify such opportunities. But we should remember that intellectual property and antitrust are only small pieces of a larger system that, by historical and international comparative standards, functions very well indeed. Endnotes: 1. For a description of the committee's work, see http://www4.nationalacademies.org/pd/step.nsf. 2. See R.C. Levin, A.K. Klevorick, R.R. Nelson, and S.G. Winter, "Appropriating the Returns from Industrial Research and Development," Brookings Papers on Economic Activity, 1987:3, and Klevorick, Levin, Nelson, and Winter, "On the Sources and Significance of Interindustry Differences in Technological Opportunities," Research Policy, 1995. Additional analyses of the survey data are found in Levin, "A New Look at the Patent System," American Economic Review, May 1986, and Levin, "Appropriability, R&D Spending, and Technological Performance," American Economic Review, May 1988. 3. W.M. Cohen, R.R. Nelson, and J.P. Walsh, "Protecting Their Intellectual Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not)," Working Paper No. 7552, National Bureau of Economic Research, 2000. Although their findings are largely consistent with our previous work, Cohen, Nelson, and Walsh report some increase in the relative effectiveness of trade secrecy as a means of appropriation. 4. See R.C. Levin, "The Semiconductor Industry," in R.R. Nelson, ed., Government and Technical Progress: A Cross-Industry Analysis. Pergamon Press, 1982. 5. G.S. Lunney, Jr., "E-Obviousness," 7 Michigan Telecommunications and Technology Law Review 363 (2001). |