The True Story of How the Patent Bar Captured a Court and Shrank the Intellectual Commons

Libertarians intuitively understand the case for patents: just as other property rights internalize the social benefits of improvements to land, automobile maintenance, or business investment, patents incentivize the creation of new inventions, which might otherwise be undersupplied.

So far, so good. But it is important to recognize that the laws that govern property, intellectual or otherwise, do not arise out of thin air. Rather, our political institutions, with all their virtues and foibles, determine the contours of property—the exact bundle of rights that property holders possess, their extent, and their limitations.

Outlining efficient property laws is not a trivial problem. The optimal contours of property are neither immutable nor knowable a priori. For example, in 1946, the U.S. Supreme Court reversed the age-old common law doctrine that extended real property rights to the heavens without limit. The advent of air travel made such extensive property rights no longer practicable—airlines would have had to cobble together a patchwork of easements, acre by acre, for every corridor through which they flew, and they would have opened themselves up to lawsuits every time their planes deviated from the expected path. The Court rightly abridged property rights in light of these empirical realities.

In defining the limits of patent rights, our political institutions have gotten an analogous question badly wrong. A single, politically captured circuit court with exclusive jurisdiction over patent appeals has consistently expanded the scope of patentable subject matter. This expansion has resulted in an explosion of both patents and patent litigation, with destructive consequences.

Patent Politics without Romance

James Buchanan coined the phrase “politics without romance” to define public choice, a research agenda that studies political outcomes in light of the incentives and constraints that politicians, bureaucrats, judges, and voters face. Contra elementary-school civics lessons (to say nothing of the academic literature), many public policies are enacted not in the general interest, but to benefit groups that successfully manipulate the political system. By concentrating benefits and dispersing costs, the few are able to take from the many.

In patent politics, the romance has been gone for at least three decades. Here’s why. In most areas of law, the loser in a federal trial appeals to the circuit court corresponding to the federal judicial district in which the trial was held. But in 1982, at the urging of the patent bar, Congress consolidated appellate review of all patent cases in a newly created Court of Appeals for the Federal Circuit.

The patent bar had sought this consolidation for some time. As early as 1951, Simon Rifkind, a former federal judge in New York City, warned in a prescient essay that then-current proposals to create a specialized patent court would lead to “decadence and decay.”

The patent Bar is already specialized. At present, however, patent lawyers practice before nonspecialized judges and accommodate themselves to the necessity of conveying the purposes of their calling to laymen. Once you complete the circle of specialization by having a specialized court as well as a specialized Bar, then you have set aside a body of wisdom that is the exclusive possession of a very small group of men who take their purposes for granted.

The consolidation of patent appeals into a single court also concentrated the benefits that pro-patent interests could get by lobbying to affect the judicial nomination and confirmation process. They now could focus their scrutiny on just 12 seats, rather than monitoring appointments across the entire federal appellate judiciary.

The creation of the court has significantly altered the law. Using a dataset of district and appellate patent decisions for the years 1953–2002, economists Matthew Henry and John Turner find that the Federal Circuit has been significantly more permissive with respect to affirming the validity of patents. They estimate that patentees are three times more likely to win on appeal after a district court ruling of invalidity in the post-1982 era. In addition, following the precedents set by the Federal Circuit, district courts have been 50 percent less likely to find a patent invalid in the first place, and patentees have become 25 percent more likely to appeal a decision of invalidity.

With patents more likely to be upheld in the Federal Circuit era, the incentive to patent has increased. Bronwyn Hall finds a highly significant structural break in patent applications occurring between 1983 and 1984. The number of patents granted by the U.S. Patent and Trademark Office also increased, from 63,005 in 1982 to 275,966 in 2012—a quadrupling of the rate in only 30 years.

Figure 1. Patents Issued by Year

 

Source: U.S. Patent and Trademark Office

The change in the law wrought by the Federal Circuit can also be viewed substantively through the controversy over software patents. Throughout the 1960s, the USPTO refused to award patents for software innovations. However, several of the USPTO’s decisions were overruled by the patent-friendly U.S. Court of Customs and Patent Appeals, which ordered that software patents be granted. In Gottschalk v. Benson (1972) and Parker v. Flook (1978), the U.S. Supreme Court reversed the Court of Customs and Patent Appeals, holding that mathematical algorithms (and therefore software) were not patentable subject matter. In 1981, in Diamond v. Diehr, the Supreme Court upheld a software patent on the grounds that the patent in question involved a physical process—the patent was issued for software used in the molding of rubber. While affirming their prior ruling that mathematical formulas are not patentable in the abstract, the Court held that an otherwise patentable invention did not become unpatentable simply because it utilized a computer.

In the hands of the newly established Federal Circuit, however, this small scope for software patents in precedent was sufficient to open the floodgates. In a series of decisions culminating in State Street Bank v. Signature Financial Group (1998), the Federal Circuit broadened the criteria for patentability of software and business methods substantially, allowing protection as long as the innovation “produces a useful, concrete and tangible result.” That broadened criteria led to an explosion of low-quality software patents, from Amazon’s 1-Click checkout system to Twitter’s pull-to-refresh feature on smartphones. The GAO estimates that more than half of all patents granted in recent years are software-related. Meanwhile, the Supreme Court continues to hold, as in Parker v. Flook, that computer software algorithms are not patentable, and has begun to push back against the Federal Circuit. In Bilski v. Kappos (2010), the Supreme Court once again held that abstract ideas are not patentable, and in Alice v. CLS (2014), it ruled that simply applying an abstract idea on a computer does not suffice to make the idea patent-eligible. It still is not clear what portion of existing software patents Alice invalidates, but it could be a significant one.

Observers on all sides widely recognize that the Federal Circuit routinely undermines Supreme Court precedent. Patent attorney Gene Quinn reacted with dismay to the Supreme Court’s ruling in Mayo v. Prometheus (2012), but consoled himself with the thought that the ruling would not stand forever.

How long will it take the Federal Circuit to overrule this inexplicable nonsense? The novice reader may find that question to be ignorant, since the Supreme Court is the highest court of the United States. Those well acquainted with the industry know that the Supreme Court is not the final word on patentability, and while the claims at issue in this particular case are unfortunately lost, the Federal Circuit will work to moderate (and eventually overturn) this embarrassing display by the Supreme Court.

Supreme Court justices also recognize the Federal Circuit’s insubordination. In oral arguments in Carlsbad Technology v. HIF Bio (2009), Chief Justice John Roberts joked openly about it:

Mr. Rhodes: I can’t suggest what the Court might finally decide other than to say that—that, again, the circuit courts of appeal have uniformly applied this. They seem to be—

Chief Justice Roberts: Well, they don’t have a choice, right? They can’t say, I don’t like the Supreme Court rule so I’m not going to apply it, other than the Federal Circuit.

[Laughter]

The economic consequences of the Federal Circuit’s misbehavior, however, are not so funny.

The Opportunity of the Commons

As a result of the Federal Circuit’s pro-patent jurisprudence, our economy has been flooded with patents that would otherwise not have been granted. If more patents meant more innovation, then we would now be witnessing a spectacular economic boom. Instead, we have been living through what Tyler Cowen has called a Great Stagnation. The fact that patents have increased while growth has not is known in the literature as the “patent puzzle.” As Michele Boldrin and David Levine put it, “there is no empirical evidence that [patents] serve to increase innovation and productivity, unless productivity is identified with the number of patents awarded—which, as evidence shows, has no correlation with measured productivity.”

While more patents have not resulted in faster economic growth, they have resulted in more patent lawsuits. Software patents have characteristics that make them particularly susceptible to litigation. Unlike, say, chemical patents, software patents are plagued by a problem of description. How does one describe a software innovation in such a way that anyone searching for it will easily find it? As Christina Mulligan and Tim Lee demonstrate, chemical formulas are indexable, meaning that as the number of chemical patents grow, it will still be easy to determine if a molecule has been patented. Since software innovations are not indexable, they estimate that “patent clearance by all firms would require many times more hours of legal research than all patent lawyers in the United States can bill in a year. The result has been an explosion of patent litigation.” Software and business method patents, estimate James Bessen and Michael Meurer, are 2 and 7 times more likely to be litigated than other patents, respectively (4 and 13 times more likely than chemical patents).

Software patents make excellent material for predatory litigation brought by what are often called “patent trolls.” Trolls use asymmetries in the rules of litigation to legally extort millions of dollars from innocent parties. For example, one patent troll, Innovatio IP Ventures, LLP, acquired patents that implicated Wi-Fi. In 2011, it started sending demand letters to coffee shops and hotels that offered wireless Internet access, offering to settle for $2,500 per location. This amount was far in excess of the 9.56 cents per device that Innovatio was entitled to under the “Fair, Reasonable, and Non-Discriminatory” licensing promises attached to their portfolio, but it was also much less than the cost of trial, and therefore it was rational for firms to pay. Cisco stepped in and spent $13 million in legal fees on the case, and settled on behalf of their customers for 3.2 cents per device. Other manufacturers had already licensed Innovatio’s portfolio, but that didn’t stop their customers from being targeted by demand letters.

Litigation cost asymmetries are magnified by the fact that most patent trolls are nonpracticing entities. This means that when patent infringement trials get to the discovery phase, they will cost the troll very little—a firm that does not operate a business has very few records to produce. But discovery can cost a medium or large company millions of dollars. Using an event study methodology, James Bessen and coauthors find that infringement lawsuits by nonpracticing entities cost publicly traded companies $83 billion per year in stock market capitalization, while plaintiffs gain less than 10 percent of that amount.

Software patents also reduce innovation in virtue of their cumulative nature and the fact that many of them are frequently inputs into a single product. Law professor Michael Heller coined the phrase “tragedy of the anticommons” to refer to a situation that mirrors the well-understood “tragedy of the commons.” Whereas in a commons, multiple parties have the right to use a resource but not to exclude others, in an anticommons, multiple parties have the right to exclude others, and no one is therefore able to make effective use of the resource. The tragedy of the commons results in overuse of the resource; the tragedy of the anticommons results in underuse.

Consider a new product that must license ten patents in order to come to market. If each patent holder demands a third of the product’s revenue, the product won’t be viable. The holdout problem and other transaction costs associated with bargaining to an efficient solution can be prohibitive. Now consider that products like smartphones build on many thousands of licensed patents. Although Apple and Samsung have been able to navigate these licensing waters well enough to bring profitable products to market, the patent licensing and litigation thicket creates economies of scale in the legal department that make smaller firms less competitive.

In order to cope with the tragedy of the anticommons, we should carefully investigate the opportunity of  the commons. The late Nobelist Elinor Ostrom made a career of studying how communities manage shared resources without property rights. With appropriate self-governance institutions, Ostrom found again and again that a commons does not inevitably lead to tragedy—indeed, open access to shared resources can provide collective benefits that are not available under other forms of property management.

There is evidence that open access leads to greater innovation in science. Fiona Murray and coauthors exploited a natural experiment in research involving patented mice, in consequence of an unanticipated shock in which some varieties of engineered mice, but not others, suddenly became available on an open access basis. They found that greater openness encouraged the exploration of more diverse research paths, including those followed by entrants new to the mouse research arena. Importantly, they found no decline in the creation of new varieties of mice. This suggests that—litigation costs aside—patent law could be reducing the stock of ideas rather than expanding it at current margins.

Advocates of extensive patent protection frequently treat the commons as a kind of wasteland. But considering the problems in our patent system, it is worth looking again at the role of well-tailored limits to property rights in some contexts. Just as we all benefit from real property rights that no longer extend to the highest heavens, we would also benefit if the scope of patent protection were more narrowly drawn.

Reforming the Patent System

This analysis raises some obvious possibilities for reforming the patent system. Diane Wood, Chief Judge of the 7th Circuit, has proposed ending the Federal Circuit’s exclusive jurisdiction over patent appeals—instead, the Federal Circuit could share jurisdiction with the other circuit courts. While this is a constructive suggestion, it still leaves the door open to the Federal Circuit playing “a leading role in shaping patent law,” which is the reason for its capture by patent interests. It would be better instead simply to abolish the Federal Circuit and return to the pre-1982 system, in which patents received no special treatment in appeals. This leaves open the possibility of circuit splits, which the creation of the Federal Circuit was designed to mitigate, but there are worse problems than circuit splits, and we now have them.

Another helpful reform would be for Congress to limit the scope of patentable subject matter via statute. New Zealand has done just that, declaring that software is “not an invention” to get around WTO obligations to respect intellectual property. Congress should do the same with respect to both software and business methods.

Finally, even if the above reforms were adopted, there would still be a need to address the asymmetries in patent litigation that result in predatory “troll” lawsuits. While the holding in Alice v. CLS arguably makes a wide swath of patents invalid, those patents could still be used in troll lawsuits because a ruling of invalidity for each individual patent might not occur until late in a trial. Current legislation in Congress addresses this class of problem by mandating disclosures, shifting fees in the case of spurious lawsuits, and enabling a review of the patent’s validity before a trial commences.

What matters for prosperity is not just property rights in the abstract, but good property-defining institutions. Without reform, our patent system will continue to favor special interests and forestall economic growth.

 

 

Some parts of this essay are drawn from my Mercatus working paper (in press at Public Choice), which is coauthored with Alex Tabarrok, whom I wish to thank, credit, and saddle with blame for any errors I have introduced.

Also from This Issue

Response Essays

  • Facts and Fables: A Long-Run Perspective on the Patent System by B. Zorina Khan

    B. Zorina Khan challenges Eli Dourado’s story of regulatory capture: The substantial growth of patent issuance in recent years is due overwhelmingly to an influx of foreign inventors, not to a flawed U.S. patent system. That system is neither broken nor even very different from its historical norms. Throughout our history, it has served us well, even if outsiders sometimes find it hard to understand. We should therefore resist any sweeping changes to it.

  • In Favor of “Good Property-Defining Institutions” … and Opposed to Bad “Reforms” by John F. Duffy

    John F. Duffy likens software patents to medical patents. At one time, medical patents were considered unethical, but nowadays, they are considered an important tool for spurring innovation in a field that otherwise might not get much of it. Software patents are very similar, he argues, and they should not be abolished. Yet some reforms in the patent system make sense to him, including ending the complete centralization of patent cases in the Federal Circuit. Duffy takes issue with several of the empirical studies that lead essayist Eli Dourado uses to make the case for software patent abolition - these, he contents, do not show that total abolition would yield good outcomes. He suggests some reforms that this evidence may support instead.

  • What’s the Best Way to Fix the Patent System’s Problems? by Christina Mulligan

    Christina Mulligan tackles the problem of patents and innovation by looking at two different philosophies of law: In one approach, rules predominate. Rules are clear, simple, and easily enforced, but they may over- or underinclude problematic behaviors. In the other approach, standards predominate: Standards express in much more detail what constitutes good and bad behavior, but applying them can be costly for everyone involved. The choice between these two philosophies of law will always to some degree depend on the situation at hand. In this case, she favors a rule, which would be to end software patents. The costs of forming standards here are simply too high, she argues.

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