Incentives – Page 9 – artdiamondblog.com

Our “Patently Absurd” Patent System

(p. A15) The Founders might have used quill pens, but they would roll their eyes at how, in this supposedly technology-minded era, we’re undermining their intention to encourage innovation. The U.S. is stumbling in the transition from their Industrial Age to our Information Age, despite the charge in the Constitution that Congress “promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”
. . .

Both sides may be right. New empirical research by Boston University law professors James Bessen and Michael Meurer, reported in their book, “Patent Failure,” found that the value of pharmaceutical patents outweighed the costs of pharmaceutical-patent litigation. But for all other industries combined, they estimate that since the mid-1990s, the cost of U.S. patent litigation to alleged infringers ($12 billion in legal and business costs in 1999) is greater than the global profits that companies earn from patents (less than $4 billion in 1999). Since the 1980s, patent litigation has tripled and the probability that a particular patent is litigated within four years has more than doubled. Small inventors feel the brunt of the uncertainty costs, since bigger companies only pay for rights they think the system will protect.
These are shocking findings, but they point to the solution. New drugs require great specificity to earn a patent, whereas patents are often granted to broad, thus vague, innovations in software, communications and other technologies. Ironically, the aggregate value of these technology patents is then wiped out through litigation costs.
Our patent system for most innovations has become patently absurd. It’s a disincentive at a time when we expect software and other technology companies to be the growth engine of the economy. Imagine how much more productive our information-driven economy would be if the patent system lived up to the intention of the Founders, by encouraging progress instead of suppressing it.

For the full commentary, see:
L. GORDON CROVITZ. “OPINION: INFORMATION AGE; Patent Gridlock Suppresses Innovation.” Wall Street Journal (Mon., JULY 14, 2008): A15.
(Note: ellipsis added.)

“Clear Relationship in Rice Farming Between Effort and Reward”

(p. 236) What redeemed the life of a rice farmer, however, was the nature of that work. It was a lot like the garment work done by the Jewish immigrants to New York. It was meaningful. First of all, there is a clear relationship in rice farming between effort and reward. The harder you work a rice field, the more it yields. Second, it’s complex work. The rice farmer isn’t simply planting in the spring and harvesting in the fall. He or she effectively runs a small business, juggling a family workforce, hedging uncertainty through seed selection, building and managing a sophisticated irrigation system, and coordinating the complicated process of harvesting the first crop while simultaneously preparing the second crop.

And, most of all, it’s autonomous. The peasants of Europe worked essentially as low-paid slaves of an aristocratic landlord, with little control over their own destinies. But China and Japan never developed that kind of oppressive feudal system, because feudalism simply can’t work in a rice economy. Growing rice is too complicated and intricate for a system that requires farmers to be coerced and bullied into going out into the fields each morning. By the fourteenth and fifteenth centuries, landlords in central and Southern China had an almost completely hands-off relationship with their tenants: they would collect a fixed rent and let farmers go about their business.
“The thing about wet-rice farming is, not only do you (p. 237) need phenomenal amounts of labor, but it’s very exacting,” says the historian Kenneth Pomerantz. “You have to care. It really matters that the field is perfectly leveled before you flood it. Getting it close to level but not quite right makes a big difference in terms of your yield. It really matters that the water is in the fields for just the right amount of time. There’s a big difference between lining up the seedlings at exactly the right distance and doing it sloppily. It’s not like you put the corn in the ground in mid-March and as long as rain comes by the end of the month, you’re okay. You’re controlling all the inputs in a very direct way. And when you have something that requires that much care, the overlord has to have a system that gives the actual laborer some set of incentives, where if the harvest comes out well, the farmer gets a bigger share. That’s why you get fixed rents, where the landlord says, I get twenty bushels, regardless of the harvest, and if it’s really good, you get the extra. It’s a crop that doesn’t do very well with something like slavery or wage labor. It would just be too easy to leave the gate that controls the irrigation water open a few seconds too long and there goes your field.”

Source:
Gladwell, Malcolm. Outliers: The Story of Success. New York, NY: Little, Brown, and Co., 2008.
(Note: italics in original.)

Democratic 1997 Tax Break Fed Housing Bubble

Source of graph: online version of the NYT article quoted and cited below.

(p. A1) “Tonight, I propose a new tax cut for homeownership that says to every middle-income working family in this country, if you sell your home, you will not have to pay a capital gains tax on it ever — not ever.”
— President Bill Clinton, at the 1996 Democratic National Convention
Ryan J. Wampler had never made much money selling his own homes.
Starting in 1999, however, he began to do very well. Three times in eight years, Mr. Wampler — himself a home builder and developer — sold his home in the Phoenix area, always for a nice profit. With prices in Phoenix soaring, he made almost $700,000 on the three sales.
And thanks to a tax break proposed by President Bill Clinton and approved by Congress in 1997, he did not have to pay tax on most of that profit. It was a break that had not been available to generations of Americans before him. The benefits also did not apply to other investments, be they stocks, bonds or stakes in a small business. Those gains were all taxed at rates of up to 20 percent.
The different tax treatments gave people a new incentive to plow ever more money into real estate, and they did so. “When you give that big an incentive for people to buy and sell homes,” said Mr. Wampler, 44, a mild-mannered native of Phoenix who has two children, “they are going to buy and sell homes.”
By itself, the change in the tax law did not cause the housing bubble, economists say. Several other factors — a relaxation of lending standards, a failure by regulators to intervene, a sharp decline in interest rates and a collective belief that house prices could never fall — probably played larger roles.
But many economists say that (p. A22) the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.
Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for “fueling the mother of all housing bubbles.”

For the full story, see:
VIKAS BAJAJ and DAVID LEONHARDT. “1997 Tax Break on Home Sales May Have Helped Inflate Bubble.” The New York Times (Fri., December 19, 2008): A1 & A22.
(Note: ellipses added.)
(Note: the online version of the article is dated December 18, and has the somewhat different title: “The Reckoning; Tax Break May Have Helped Cause Housing Bubble.”)

“Ryan J. Wampler made nearly $700,000 on three sales of his own homes in eight years.” Source of caption and photo: online version of the NYT article quoted and cited above.

Even Dogs “Have a Sense of Fairness”

For the full commentary, see:

Page, Clarence. “Vouchers and Obama Daughters.” Omaha World-Herald (Sat., Nov. 15, 2008): 7B.
(Note: ellipsis added.)

“This series of photos from the National Academy of Sciences shows a dog being asked for its paw and obeying, left. In the second photo, the dog watches its partner in the experiment receive a food reward that it didn’t receive. In the third photo, the dog refuses to give its paw and avoids looking at the experimenter.” Source of caption and photos: online version of the Omaha World-Herald article quoted and cited below.

(p. 2A) Ask them to do a trick, and they’ll give it a try. For a reward, they’ll happily keep at it.

But if one dog gets no reward and then sees another dog get a treat for doing the same trick, just try to get the first one to do it again.
Indeed, the animal may turn away and refuse to look at you.
Dogs, like people and monkeys, seem to have a sense of fairness.
. . .
In the experiments described in today’s edition of Proceedings of the National Academy of Sciences, Range and colleagues experimented with dogs that understood the command “paw” to place a paw in the hand of a researcher. It’s the same game as teaching a dog to “shake hands.”
. . .
The dogs sat side by side with an experimenter in front of them. In front of the experimenter was a divided food bowl with pieces of sausage on one side and brown bread on the other.
The dogs were asked to shake hands and could see what reward the other dog received.
When one dog got a reward and the other didn’t, the unrewarded animal stopped playing.

For the full story, see:
Associated Press. “It’s a Dog’s Life Only When Someone Else Gets Treat.” Omaha World-Herald (Tues., Dec. 9, 2008): 2A.
(Note: ellipses added.)

Inability to Patent Sulfa, Delayed Its Marketing

When new uses of old, unpatentable drugs are discovered, there seems to be inadequate incentive to publicize them, and bring them to market. (For example, I think I have seen research suggesting that aspirin and fish oil capsules, are as effective in fighting heart disease as some newer drugs, but are nonoptimally utilized because of perverse incentives.) Maybe a revision of the patent law should be considered that permits some patenting of new uses of old drugs and substances?

(p. 172) It was wonderful that this powerful, inexpensive medicine was now available, but for a year after the Pasteur Institute announcement, no one marketed it seriously in its pure form as a medicine. Because it was not patentable, it was difficult for major chemical or drug firms to see a way to make much of a profit from it. It was not until months after the Pasteur group’s first publication on sulfa that the president of Rhône-Poulenc, an industrial supporter of Fourneau’s laboratory, visited the Pasteur Institute to hear about it. After talking with the researchers he decided to launch Septazine, a variation on pure sulfa that he felt was different enough to allow patenting—and hence profits. Septazine reached the marketplace in May 1936.

Source:
Hager, Thomas. The Demon under the Microscope: From Battlefield Hospitals to Nazi Labs, One Doctor’s Heroic Search for the World’s First Miracle Drug. New York: Three Rivers Press, 2007.

French Entrepreneur Fourneau Was Against Law, But Used It

The existence and details of patent laws can matter for creating incentives for invention and innovation. The patent laws in Germany and France in the 1930s reduced the incentives for inventing new drugs.

(p. 141) German chemical patents were often small masterpieces of mumbo jumbo. It was a market necessity. Patents in Germany were issued to protect processes used to make a new chemical, not, as in America, the new chemical itself; German law protected the means, not the end. . . .
. . .
(p. 166) Fourneau decided that if the French were going to compete, the nation’s scientists would either have to discover their own new drugs and get them into production before the Germans could or find ways to make French versions of German compounds before the Germans had earned back their research and production costs—in other words, get French versions of new German drugs into the market before the Germans could lower their prices. French patent laws, like those in Germany, did not protect the final product. “I was always against the French law and I thought it was shocking that one could not patent one’s invention,” Fourneau said, “but the law was what it was, and there was no reasons not to use it.”

“The Authorities Were Shocked” at Private Airport Success

“Investors renovated a terminal at Domodedovo and oversaw construction of a train line to Moscow.” Source of caption and photo: online version of the WSJ article quoted and cited below.

(p. B9) MOSCOW — A heated battle for passengers between the Russian capital’s main airports offers an unlikely model of competition for the aviation industry.

In most cities, airports are monopolies. Even in cities that have more than one, including New York, Paris and Tokyo, airports are usually owned by the same operator. That means airlines can rarely make the kind of choices passengers take for granted, such as choosing an airport for its efficiency, shopping or lounges.
Not so in Moscow, where two international airports, Domodedovo and Sheremetyevo, owned by rival organizations, battle for business. The result is lower fees, better service and fast-improving facilities all around.
Domodedovo Airport, for example, recently convinced several top airlines to make it their Russian base, thanks to a major modernization that added more than 20 new restaurants, jewelry boutiques and a shop where passengers can rent DVDs to watch in booths.
Sheremetyevo Airport responded by building a fast rail link to Moscow, complete with a Starbucks at the airport station.
Moscow’s airport rivalry highlights a paradox of the global aviation industry: Airlines compete fiercely with each other for customers, but they face many monopolist suppliers, such as air-traffic control systems, fuel distributors and airports. Resulting costs and poor services get passed on to travelers.
. . .
During Russia’s privatization drive of the 1990s, local investors bought Domodedovo, which was previously Moscow’s airport serving Soviet Central Asia. The investors, grouped into an upstart charter-airline operator, East Line Group, renovated a terminal at Domodedovo and oversaw construction of a train line to Moscow.
East Line charged airlines landing and operating fees that undercut Sheremetyevo by around 30%. For passengers, Domodedovo’s rail link guaranteed a 40-minute trip to downtown Moscow. Private Russian carriers, largely frozen out of Aeroflot’s base at Sheremetyevo, expanded quickly at the spacious Domodedovo.
East Line’s big break came in 2003, when British Airways announced it would switch from Sheremetyevo to Domodedovo.
“The authorities were shocked that a major airline would leave the government airport,” recalls Daniel Burkard, BA’s former country manager for Russia.

For the full story, see:
DANIEL MICHAELS. “Moscow Points the Way With Airport Competition; While Most Nations Sport Monopolies, Rivalry Between Two Russian Gateways Ushers in Improvements for Carriers, Travelers.” The Wall Street Journal (Mon., DECEMBER 1, 2008): B9.
(Note: ellipsis added.)

Source of graph: online version of the WSJ article quoted and cited above.

Good Laws Protect the Innovator

James Burke writes well, and what he writes is often stimulating, and thought-provoking. On the other hand, some of what he writes is exasperating—he writes in sweeping generalities, and often his ‘connections’ are exaggerations, giving no weight (or even mention) to alternative, equally plausible accounts.
But on balance, I enjoy listening to him. Here is one of the bits I especially liked:

(p. 19) Because the rule of law exists, and above all because it encourages and protects acts of innovation with patent legislation, we in the modern world expect that tomorrow will be better than today. Our view of the universe is essentially optimistic because of the marriage between law and innovation. Law gives an individual the confidence to explore, to risk, to venture into the unknown, in the knowledge that he, as an innovator, will be protected by society.

Source:
Burke, James. The Day the Universe Changed: How Galileo’s Telescope Changed the Truth and Other Events in History That Dramatically Altered Our Understanding of the World. Back Bay Books, 1995.

Obama’s Tax Policies Would Be “a Significant Step Towards” Another “Great Depression”

Lee Ohanian is the co-author of a much-cited article in the highly-ranked Journal of Political Economy on the economics of the Great Depression. Below is a paragraph from his recent analysis of our current situation:

(p. A17) I am particularly concerned about bad policies because significantly higher taxes have been proposed by Barack Obama. His plan would raise the marginal tax rate on the most productive workers more than 10 percentage points — an increase that would bring us near Western European levels. His plan would also raise capital income taxes, taxing capital gains and dividends at 20%, compared to a 15% rate under Sen. John McCain’s plan. A five percentage-point difference might strike you as small, but it is not. I have calculated that a five percentage-point difference in overall capital income taxation over the long haul is equal to a difference in the nation’s capital stock of about 18%. This means a 6% difference in GDP and a 6% difference in the average wage rate. This means that real GDP and the average wage would fall, gradually but persistently declining about 6% after 25 years. That’s not quite a Great Depression, but a significant step towards one.

For the full commentary, see:
LEE E. OHANIAN. “Good Policies Can Save the Economy; Why we need lower tax rates and more skilled immigrants.” The Wall Street Journal (Weds., OCTOBER 8, 2008): A17.

The academic article co-authored by Ohanian is:
Cole, Harold L., and Lee E. Ohanian. “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis.” Journal of Political Economy 112, no. 4 (August 2004): 779-816.

Fewer Jobs Under Obama’s High-Cost Health Plan

“Dave Ratner, owner of four pet stores in Western Massachusetts, is worried about being able to pay into a state health benefits plan.” Source of caption and photo: online version of the NYT article quoted and cited below.

(p. A16) AGAWAM, Mass. — Dave Ratner, owner of Dave’s Soda and Pet City, is pretty sure he is about to get “whacked” by the new state law that requires employers to contribute to health care benefits for their workers or pay a $295-per-employee penalty. In order to avoid thousands of dollars in fines, Mr. Ratner is considering not adding part-time workers at his four pet supply stores in Western Massachusetts.

But the penalty in Massachusetts is picayune compared with what some health experts believe Senator Barack Obama, the Democratic presidential nominee, might impose as part of his plan to provide affordable coverage for the uninsured. Though Mr. Obama has not released details, economists believe he might require large and medium companies to contribute as much as 6 percent of their payrolls.
That, Mr. Ratner said, would be catastrophic to a low-margin business like his, which has 90 employees, 29 of them full-time workers who are offered health benefits.
“To all of a sudden whack 6 to 7 percent of payroll costs, forget it,” he said. “If they do that, prices go up and employment goes down because nobody can absorb that.”

For the full story, see:

KEVIN SACK. “Businesses Wary of Details in Obama Health Plan.” The New York Times (Mon., October 27, 2008): A16.