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Ideas and Innovations: Which should be subsidized

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Ideas and Innovations: Which should be subsidized?1Suzanne ScotchmerUniversity of California, Berkeley, and NBERThis version: October 20111I thank Nisvan Erkal for motivating discussions. I thank the Toulouse Network on InformationTechnoloyg, NSF Grant 0830186, and the Sloan Foundation for funding.AbstractThe Bayh-Dole Act allows universities to commercialize their research. University labora-tories therefore have two sources of funds: direct grants from the government and fundsfrom commercialization. In addition to giving direct subsidies to university laboratories,the government also subsidizes the commercial sector, for example, through tax credits.Subsidies to commerce contribute indirectly to the university's research budget, becausethey increase the prot from commercialization. This paper investigates the optimal mixof direct and indirect subsidies to the university, in a context where the role of universityresearch is to turn up \ideas" for commercial investments, and the role of commerce is toturn the ideas into innovations. It also asks whether there is an argument for protecting\ideas" as well as commercializations, as is authorized by the Bayh-Dole Act.JEL Classications: O34, K00, L00Keywords: research subsidy, tax credits, Bayh-Dole Act, research ideas1 IntroductionPublic subsidies to R&D go b oth to private rms and to noncommercial laboratories, suchas those in universities. About half of public subsidies in the U.S. go to commercial rms.These subsidies take many forms, from tax credits to competitively given grants, adminis-tered in a way that is similar to the university grant process.1With the Bayh-Dole Ac t of 1980, university research became less dependent on grants,and more dependent on commercialization. In order for the university to prot from com-mercializations, the knowledge they create must be protectable. The Bayh-Dole Act au-thorized universities to patent the outcomes of federally sponsored research, and to ownthe patents. This raises two questions: First, what is the best way to subsidize research?Given that the university can prot indirectly from subsidies given to commerce, how shouldgovernment subsidies be divided between subsidies to commerce and direct subsidies to uni-versities? Second, is the premise of the Bayh-Dole Act welfare-improving? That is, shouldthe knowledge turned up in universities be protectable?The Bayh-Dole Act only has an eect if the knowledge turned up in universities ispatentable. A principle of patent law is that ideas or abstractions are not patentable. Thepatent-ineligibility of abstract ideas was recently armed by the Supreme Court in Bilski.Bilski's patent application was on a business method that allows home owners to smooththeir heating bills and thus hedge against the risk of bad weather or uctuations in price.The application had been rejected by the Federal Circuit as not satisfying their machine-or-transformation test. The Supreme Court held that the machine-or-transformation testis not dispositive, but, citing their previous opinions, they still rejected the application asan attempt to patent an abstract idea.If there is no distinction between the kinds of research done in universities and in privaterms, then it is hard to understand why the research in these to spheres is funded dierently.The university depends much more heavily on grant funding, while commercial rms dependmore heavily on intellectual property.1See Chapter 8 of my 2004 book, Innovation and Incentives.1The distinction between commercial research and university research presumably hassomething to do with the level of abstraction. I will stylize this dierence by supposing thatthere are two distinct research activities: the activity of turning up abstractions (ideas) thatmight lead to investment opportunities, and the activity of turning the investment opportu-nities into innovations. Universities produce \knowledge," interpreted here as a ow of ideasfor investment, and rms commercialize the ideas. I thus follow O'Donoghue, Scotchmerand Thisse (1998), Scotchmer (1999), Erkal and Scotchmer (2007, 2009) in distinguishingbetween ideas for investment and the investments or innovations themselves. However, inthe earlier papers, the idea generation process was taken as primitive. Here, similarly toBanal-Esta~nol and Macho-Stadler (2010), I conceive of idea generation as cos tly. This hasthe defect of obscuring what is primitive (apparently the meta-idea to invest in the idea-generation process), but maps rather closely to the institutions through which knowledgeis created.In this stylization, the costs born by the university and those born by rms have dierentnatures. The university bears a ow cost of doing research, and the ow cost turns up aseries of random investment opportunities (abstract ideas). A higher ow cost of R&Dleads to a higher ow of ideas. In contrast, the costs born by rms are targeted to theimplementation of particular investment ideas.Much of the knowledge turned up in universities would not pass the Federal Circuit'smachine-or-transformation test, and could easily be categorized as "abstractions." Suchknowledge might not be patentable, which means that the Bayh-Dole Act has no eect.Perhaps because of this, university licensing oces have been much less lucrative than washoped when the Bayh-Dole Act was passed in 1980. Thursby and Thursby (2003) cite surveyevidence that licensing revenue constitutes less than 5% of universities' research budgets.Given that licensing revenues are very skewed across universities (there are a handful ofvery protable ones), this means that most licensing oces are deeply in the red.Part of my inquiry is whether the Bayh-dole Act was a good idea, and if so, whetherpatent law should be more accommodating of "abstractions." That is, should the ideas2produced in universities be patentable? I take this as a policy question.If the idea is protectable, then it can be auctioned exclusively to a commercializing rm,and the university will collect the prot. If the idea is not protectable, the university cannotauction the exclusive use of it. Because university researchers publish, the idea will enterthe public domain, and there may be a patent race to commercialize it. The patent racewill dissipate prot. Even though the commercial winner of the patent race will have aprotected product, the rms in the patent race make zero prot in


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