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From Innovation to Rent Seeking

Mises Daily: Wednesday, April 18, 2012 by

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It's often thought that the technology sector is the least regulated and therefore has been the most productive during the past couple of decades. Famously, Bill Gates had no interest in politics. "In the beginning, Microsoft tried to ignore the powerful political forces arrayed against it, hunkering down in Redmond, Washington, to focus on its core businesses," William F. Shugart wrote in the Freeman. Of course, the Department of Justice snapped Mr. Gates to attention.

And while Mark Zuckerberg says he doesn't like to vote, since hiring Sheryl Sandberg, who served in the Clinton administration, Facebook's DC presence has increased, and President Obama himself stopped by the FB office.

The news of AOL's patent sale to Microsoft reminds us that there is plenty of government force channeling money toward the coffers of the big tech companies. It's not all warm and fuzzy corporate slogans, cool workplaces, and upscale company cafeterias in Silicon Valley.

Battalions of intellectual-property (IP) lawyers keep constant watch over the government-erected barriers and monopoly privileges that lock up ideas and create corporate value out of thin air.

AOL is considered so old school, kids snicker if they see someone with an aol.com email address. In 2001, old-school media giant Time Warner consolidated with American Online (AOL), the Internet and email provider of the people, for a whopping $111 billion. However, eight years later, the CEO of Time Warner, Jeff Bewkes, announced that the marriage of AOL and Time Warner was dissolved.

Last year, AOL bought the Huffington Post for $315 million or reportedly five times revenues: the multiple to profits being unknown, as there were none.

But Microsoft had $1 billion burning a hole in its pocket, and AOL had 800 patents it didn't need; a deal was made, and AOL shareholders loved it. However, this is no aberration. Steve Lohr writes for the New York Times,

The lofty price — $1.3 million a patent — reflects the crucial role that patents are increasingly playing in the business and legal strategies of the world's major technology companies, including Microsoft, Apple, Google, Samsung and HTC.

Patents that can be applied to both smartphones and tablet computers, which use much the same technology, are valued assets and feared weapons, as the market for those devices booms. Companies are battling in the marketplace and in courtrooms around the world, where patent claims and counterclaims are filed almost daily.

The AOL-Microsoft deal is just a continuation of the red-hot patent market. Last April, Novell sold 880 patents to a consortium of companies, including Microsoft and Apple, for $450 million.

Two months later Apple, RIM, Sony, and others bought 6,000 patents from Nortel Networks for $4.5 billion.

Last August, Google paid $12.5 billion for Motorola Mobility and its 17,000 patents.

RealNetworks sold 190 patents and 170 patent applications to Intel for $120 million in January of this year.

Last month, Facebook bought 750 patents from IBM for an undisclosed sum, shortly after the social networking giant was hit with a patent lawsuit by Yahoo.

David J. Kappos, director of the United States Patent and Trademark Office tells the NYT these legal battles are nothing new. Whether it was steam engines or automobiles, when big markets open up, patent wars begin.

But this is a lot of money chasing something that, Stephan Kinsella writes,

is not really property at all, and is just an umbrella term linking distinct, mostly artificial, positive rights created by the legislature out of thin air — "legally recognized rights arising from some type of intellectual creativity, or that are otherwise related to ideas."

Most people think of patents as an exclusive right to manufacture, use, or sell an invention, but as Kinsella points out, what patent law really does is exclude others from making, using, or selling that particular invention.

It used to be that specialty patent holders, aka trolls, would buy up patents with the hopes of extracting payment from big tech firms either before, or in, court. But now it's the big companies doing legal battle with each other. "These major companies are using patents to gain competitive advantage rather than just seeing patents as financial assets," Colleen Chien, an assistant professor at the Santa Clara University School of Law tells the NYT.

So is Microsoft for instance, with its 20,000 patents, in the technology business or has it become the world's biggest troll, lurking to opportunistically pummel other tech firms in court and out?

Of course the whole idea behind patent law is that it is supposed to fuel innovation. Who would spend time and talent thinking up any new inventions, if the idea could quickly be stolen and the inventor not assured of a large windfall?

Society is thought to benefit because more inventions mean greater wealth. Kinsella points out that this utilitarian argument falls flat. Societal wealth, even if it could be measured, cannot be justified by aggressing against one group's rights to benefit others.

But studies have not shown any net gain from patent-law-induced innovation. Kinsella suggests,

Perhaps there would even be more innovation if there were no patent laws; maybe more money for research and development (R&D) would be available if it were not being spent on patents and lawsuits. It is possible that companies would have an even greater incentive to innovate if they could not rely on a near twenty-year monopoly.

Instead of spurring innovation, IP appears to be a rat's nest of litigation. For example, Google's chief legal officer, David C. Drummond, estimates that a modern smartphone might be susceptible to as many as 250,000 potential patent claims.

In a study published in 2008, James E. Bessen and a colleague, Michael J. Meurer, professors at the Boston University School of Law, concluded that the costs of litigation were twice the benefits in the areas of software and telecommunications, where "the claims are often so broad and vague that it is completely unpredictable what the patents cover and don't."

Professor Chen admits that the "patent system is making innovation more expensive," but she doesn't think there's been enough focus on the benefits. After all, she says, "In a case like AOL, this patent sale is keeping it alive and giving it a chance to innovate elsewhere."

What were once great companies furiously innovating to generate returns have become rent seekers collecting war chests of state privilege to compete in the court room rather than in the marketplace.

While government force may keep companies like AOL alive, consumers will surely be worse off and ultimately pay the price.