Entrepreneurship and Public Policy Lecture 10 Fostering Innovation

Entrepreneurship and Public Policy Lecture 10: Fostering Innovation

A Framework For Thinking About the Role of Innovation in Entrepreneurship Public R&D investment Existing Firms Patents Basic Science Research Applied Research Commercialization Anti-trust Private R&D investment New Firms EPP_Lecture 6 -2 Spring 2009

Lecture Overview • Public policy to foster basic and applied science research • Public policy to encourage the commercialization of basic and applied research EPP_Lecture 6 -3 Spring 2009

Government Involvement in Basic Research is Often Justified on the Grounds of “Market Failure” • Basic argument is that private firms under-invest in basic research • Many reasons for this are put forth – Social returns to private R&D are often higher than the private returns – Economies of scale in R&D – Focus on short-term profit objectives EPP_Lecture 6 -4 Spring 2009

Federal Government has Several Policy Instruments To Promote R&D • Federal R&D grants to universities and private sectors – Often through programs offered by the National Science Foundation, the National Institute of Health and the Department of Defense • A variety of tax and subsidy measures – Encouraging private firms to undertake R&D projects at their own expense • Government procurement and contracts – Directing private firm to undertake R&D they would not otherwise take – Small business set-asides exist EPP_Lecture 6 -5 Spring 2009

Federal Government has Several Policy Instruments To Promote R&D • Federal R&D grants to universities and private sectors – Often through programs offered by the National Science Foundation, the National Institute of Health and the Department of Defense • A variety of tax and subsidy measures – Encouraging private firms to undertake R&D projects at their own expense • Government procurement and contracts – Directing private firm to undertake R&D they would not otherwise take – Small business set-asides exist EPP_Lecture 6 -6 Spring 2009

Tax Incentives vs. Direct Subsidies and Contracts • Tax incentives reduce the marginal cost of R&D – Take government out of the decision process and let the market to choose projects – Do not have a “crowding out” effect – Do affect the composition of R&D activities • Subsidy incentives raise the marginal rate of return of R&D – Allow public resources to be targeted toward preferred areas and projects – May lead to “crowding out” effect EPP_Lecture 6 -7 Spring 2009

Where Is U. S. R&D Occurring? (2004) National R&D expenditures in 2004 were approximately $313 billion Source: National Science Foundation, 2006 EPP_Lecture 6 -8 Spring 2009

The Effect of Federal R&D Spending on Private R&D Spending is Debated • It is theoretically ambiguous whether public and private investment are substitutes or complements – Public R&D may crowd out private R&D – Public R&D may also support private R&D directly or indirectly through knowledge spillovers • Many empirical studies show a positive correlation between public and private R&D investment at the firm level EPP_Lecture 6 -9 Spring 2009

Existing Studies Are Subject to Biases • Hall et at. (1999) warn that existing research handicapped by data and research design problems – Most research are ex-post statistical studies that are subject to selection biases – It cannot determine whether public investment cause the private firms to do more R&D or whether firms that do more R&D receive more investment EPP_Lecture 6 -10 Spring 2009

Programs to Promote Innovative Small Businesses in the Department of Defense • Small Business Innovation Research Program – In Do. D, SBIR budget was $1. 7 billion in FY 2007 – Phase I Awards (merit/feasibility): up to $100, 000 – Phase II Contracts (prototyping/demonstraion): up to $750, 000 – Phase III: product development, funded outside the SBIR program • Mentor-protegee program • Information on program effectiveness is limited EPP_Lecture 6 -11 Spring 2009

Programs to Promote Innovative Small Businesses in the Department of Defense • Small Business Innovation Research Program – In Do. D, SBIR budget was $1. 7 billion in FY 2007 – Phase I Awards (merit/feasibility): up to $100, 000 – Phase II Contracts (prototyping/demonstraion): up to $750, 000 – Phase III: product development, funded outside the SBIR program • Mentor-protegee program • Information on program effectiveness is limited EPP_Lecture 6 -12 Spring 2009

Lecture Overview • Public policy to foster basic and applied science research Public policy to encourage the commercialization of basic and applied research EPP_Lecture 6 -13 Spring 2009

A Framework For Thinking About the Role of Innovation in Entrepreneurship Public R&D investment Existing Firms Patents Basic Science Research Applied Research Commercialization Anti-trust Private R&D investment New Firms EPP_Lecture 6 -14 Spring 2009

Public Policy to Facilitate the Commercialization of Applied Research • Patent law and policy – Providing economic incentives to innovation • Policy designed to encourage the commercialization of university-based research – Realizing economic potential of universitybased research • Anti-trust law – Preventing monopoly while acknowledging the proper role of cooperation EPP_Lecture 6 -15 Spring 2009

Goal of the Patent System is to Encourage Innovation • Patent system is designed to provide economic incentives for innovation that increases societal welfare – Innovators are granted temporary monopoly to reap the economic benefits of their innovation • It is well known that monopoly can reduce social welfare – Monopoly distorts price thus reduces consumer welfare – Monopoly discourages further innovation • Patent system therefore aims to strike a reasonable balance between incentives for innovation and consumer welfare EPP_Lecture 6 -16 Spring 2009

Policy Levers of a Patent System • Ease of patenting – Criteria for determining what is patentable • Novel • Non-Obvious – Required disclosures, procedures and examination – Turnaround time – PTO employee incentives • Patent enforcement – Ruling standards adopted by the patent granting agency – Dispute resolution mechanisms – Court system EPP_Lecture 6 -17 Spring 2009

Policy Levers of a Patent System • Ease of patenting – Criteria for determining what is patentable • Novel • Non-Obvious – Required disclosures, procedures and examination – Turnaround time – PTO employee incentives • Patent enforcement – Ruling standards adopted by the patent granting agency – Dispute resolution mechanisms – Court system EPP_Lecture 6 -18 Spring 2009

Some Point to Critical Flaws in the Current U. S. Patent System • System is too generous in granting patents (Jaffe & Lerner, the National Research Council and the FTC , 2006) – The U. S grants a significantly larger fraction of the applications it receives than Europe and Japan – Concern about patenting of research tools and life forms • Specialized federal appeals court for patent cases (created in 1982) is believed to favor patent holders – Patentee win rate has increased after 1982 EPP_Lecture 6 -19 Spring 2009

Some Argue that These Flaws Lead to Inefficient Outcomes • The “accidental” combination of greater legal value of patents and less rigorous patent examination has damaged the system – Encouraging frivolous applications – Encouraging excessive patent litigation • Patent system is being used in an opportunistic (unproductive) way, thereby increasing the cost and risk of innovation EPP_Lecture 6 -20 Spring 2009

Policy Proposals to Reform the Patent System • Reducing the likelihood that undeserving applications will be approved – Improve information sharing between parties and the PTO so that undeserving applications are less likely to be approved – Implementing multiple levels of review of patent applications • Providing better protection to worthy innovation – Improve the patent court system to protect patent holders with legitimate patents and allow parties threatened by invalid patents to have a reasonable opportunity to make their case • Learning from the Japanese experience of encouraging crosslicensing • Source: Jaffe and Lerner (2006) EPP_Lecture 6 -21 Spring 2009

Reducing the Likelihood that Undeserving Applications Will Be Approved • PTO could create a system of escalating examinations – Most patents would receive only the basic review – For those patents that matter, interested parties would have both the incentive and the opportunity to bring information forward • Introducing third party, pre-grant opposition • Giving stronger teeth to any post-grant administrative review • Need to limit firms’ ability to use this process strategically EPP_Lecture 6 -22 Spring 2009

Reducing the Likelihood that Undeserving Applications Will Be Approved • PTO could create a system of escalating examinations – Most patents would receive only the basic review – For those patents that matter, interested parties would have both the incentive and the opportunity to bring information forward • Introducing third party, pre-grant opposition • Giving stronger teeth to any post-grant administrative review • Need to limit firms’ ability to use this process strategically EPP_Lecture 6 -23 Spring 2009

Providing Better Protection to Worthy Innovation • Improve patent quality – Conducting more rigorous examination • Reduce uncertainty – Granting patents to real innovative inventions and discoveries • Enhancing the ability of judges or special masters (rather than lay person juries) to decide technical issues in patent disputes • Allow all evidence in patent suit disputes EPP_Lecture 6 -24 Spring 2009

Encourage Cross-Licensing • Increases cooperation among competitors which may improve innovations – Collusion and anti-trust implications as well • Potential to reduce excessive patent infringement litigation EPP_Lecture 6 -25 Spring 2009

Public Policy to Facilitate the Commercialization of Applied Research • Patent law and policy – Providing economic incentives to innovation • Policy designed to encourage the commercialization of university-based research – Realizing economic potential of universitybased research • Anti-trust law – Preventing monopoly while acknowledging the proper role of cooperation EPP_Lecture 6 -26 Spring 2009

The Commercialization of University-based Research: Policy Background • Policy seeks to balance two objectives – Ensuring that large firms have broad access to university-based research – Encouraging entrepreneurs start new businesses out of university-based research • The 1980 Bayh-Dole Act of 1980 sought to promote commercialization of Federal-funded R&D – Allowed universities to claim legal rights to innovations by their faculty using federal funding – Focus on patents, not copyrights • Many universities have focused on creating a centralized Technology Trade Office (TTO) as a gateway to facilitate the flow of innovation EPP_Lecture 6 -27 Spring 2009

Some Observers Argue that TTOs are Inefficient • Many believe TTOs have become gatekeepers rather than gateways • Universities structure their TTO operations only to maximize revenues in the short term • TTO officers focus their limited time and resources on the technologies that appear to promise the biggest and fastest payback EPP_Lecture 6 -28 Spring 2009

Policy Proposals to Revise the Role of University Technology Trade Offices (TTO) • Change the objective of technology transfers from • • maximizing profits to maximizing volume Standardize licensing agreements by including royalty applied to sales Experiment with giving faculty the choice of going through TTOs or acting on their own Combine resources to share a single technology trade office among universities in the same region Abandon TTOs and rely on innovators’ give-back for financial support EPP_Lecture 6 -29 Spring 2009

The Role of Federal Government in Encouraging the Commercialization of University-based Research • The federal government could play a constructive role by encouraging the leadership of universities to pay more attention to commercialization of innovations – Making commercialization performance one criterion for granting further federal funding – Educating universities regarding the importance of commercialization EPP_Lecture 6 -30 Spring 2009

Public Policy to Facilitate the Commercialization of Applied Research • Policy designed to encourage the commercialization of university-based research – Realizing economic potential of universitybased research • Patent law and policy – Providing economic incentives to innovation • Anti-trust law – Preventing monopoly while acknowledging the proper role of cooperation EPP_Lecture 6 -31 Spring 2009

Anti-trust Law and Innovation • The goal of anti-trust law is to prevent monopolies and improve economic welfare • There are benefits to cooperation which must be weighed in – Cross-licensing – Commercialization EPP_Lecture 6 -32 Spring 2009

Discussion Questions • In this lecture, we discussed some of the criticisms with the current patent system. Do you think these issues affect new businesses differently from established businesses? – Ease of getting a patent => race to file – Ease of defending a patent of questionable merit • What are the potential implications for VC funding? For IPO investment? • How would you study this issue? EPP_Lecture 6 -33 Spring 2009