Monday, July 06, 2009

Patents, Complexity, Marginal Returns: Hello, Devolution

Increasing layers of complexity act as a hidden tax on the economy. As costs rise and returns become increasingly marginal, the system collapses or devolves.

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Frequent contributor Michael Goodfellow and I have been discussing innovation and patents, and it seems clear U.S. patent law is another example of why the U.S. economy and government are about to undergo devolution.

Take any working system and then add layer upon layer of additional complexity--all in the name of "fixing" or "reforming" it. There are thousands of examples of this process in the U.S. economy, but let's take patent law because it's hidden from most people's view even as it influences economy-wide business decisions and costs.

As the costs and liabilities of the patent process rise (including, of course, defending one's enterprise from flagrantly spurious lawsuits and what amounts to extortion), then the costs of doing business in the U.S. also rise--with zero additional benefit to offset the expense. As the legal costs of defending and obtaining patents increase, the system doesn't get more efficient or fair; if anything, it gets slower and less fair.

In this way, the entire infrastructure of patent law acts as an economy-wide tax. The same can be said of healthcare, public employee benefits, and many other entrenched systems with runaway costs. The end result is a high-cost economy which cannot be reformed due to the immense political power of those benefitting from the overly complex, ever-higher-costs, ever-lower-returns system.

As the benefits resulting from the system diminish and its costs keep rising, then the only choice left to those not in the parasitic Elites being enriched by the Status Quo is to opt out, sell out, go underground or move one's enterprise offshore. That is devolution writ large.

I think you'll find Michael's commentary very interesting, as it explains how the present U.S. patent system is actually stalling/hindering innovation:

I think you need to compare the time to develop a product vs. the time to reverse engineer it, and the sales lifetime of the product. Then be aware that copyright and patent are two very different things. I'm all in favor of limited copyright, but patents are already a big negative, and getting worse.

If you have something like a cute t-shirt design that can be copied instantly, you are right that without copyright protection, you aren't going to be able to hold your market. The price will drop to manufacturing cost, and you'll lose out to the knockoffs. If copyrights are enforced, you might have a chance. Still, if your shirt is a cute kitten with a slogan, someone else can use a different kitten picture and a similar slogan, and never violate copyright. Stuff like that is just a very opportunistic market. It's really all about marketing and supply chain (for all the shirts), not about content.

If it's a fashion item, there's a more substantial reverse engineering, and a longer production cycle, so the original would have the market to itself for longer. Also, since fashion dates quickly, the useful lifetime of the product is shorter. So it's not clear to me that the knockoff could really capture a huge percentage of the market. The original producer can also drop prices as the item ages in the market, and keep down the amount of revenue that the knockoff can capture.

For something like the iPhone, the reverse engineering time is more substantial. You have to do a similar ID, write similar software, get prototypes debugged, etc. The iPhone has a lot of appeal due to its links to the App store and to iTunes, which Apple controls, and which depend on the device running the Apple OS. So it's going to be very hard for a knockoff to compete with it. Without patent protection, you'd see more of that kind of thing -- links to internet services controlled by the manufacturer. Other products like printers that know to take only ink cartridges from the manufacturer, are similar protection-via-engineering, not patent.

For something like Microsoft Windows, copyright is more than sufficient. No other company could afford to develop a knockoff, and nothing but an exact knockoff would run all the Windows software. It's taken the Linux community years to finally get some Windows emulation software to run applications properly. High-end server software still won't run under those emulation packages, because the Microsoft API is just endless (and poorly documented, and squirrelly.)

Plus people forget the downside of patents. Not only do you have patent trolls extorting money out of companies, based on ridiculously broad patents (and just wait till China and India start playing THAT game...), but any patent litigation costs a fortune and takes years. I think the current estimate is over $1 million per litigant, and I read about cases that drag on for 5-10 years. That's a nightmare to a company on the receiving end of a lawsuit. And as TechDirt is at pains to point out, most patent suits never allege actual theft of an idea. It's almost universally independently developed, because the Patent Office will approve ridiculously trivial patents.

See this item, for example, of a patent you've definitely violated yourself: Infamous Niro JPEG Patent Smacked Down Again:

Since then the patent has been asserted against a wide range of organizations, including some resort in Florida and the Green Bay Packers. Niro appears to claim that any site using a JPEG image violates the patent. Not only that, but in cases where the patent has been asserted, Niro has been known to go for something of a sympathy play, by noting that the inventors (or the widow of one inventor) named on the patent are "old and feeble"

It's being slowly cleaned up by the courts, but if a guy like that had targeted you, you'd have had no alternative but to fold, since you can't afford even a trivial lawsuit.

And this one on patent protection money: Intuit Pays $120 Million 'Don't Sue Us' Tax To Intellectual Ventures:

While it hasn't sued anyone, Myhrvold has made clear that's always an option. The company has remained incredibly secret, but it has somehow convinced some big companies to pay hundreds of millions to Intellectual Ventures (IV). Due to the secrecy, the details aren't clear -- and some of the deals apparently are a mix of "licensing" and an equity investment. But, still, the numbers are stunning. The latest, as pointed out by Stephen Kinsella is that Intuit has apparently paid $120 million to IV. For what? The right not to get sued.

Think about that for a second. This is a pure dead weight net loss to society. It's $120 million that Intuit could have put towards further innovating, or to pay off investors via a dividend. Instead, it goes towards nothing productive, in terms of actually creating new products. It will now likely be used to buy up more patents so that IV can get similar black hole money grabs from other companies, as well. It's like a black hole where real innovation goes to die.

The bottom line for me is that the patent system does not scale. It sort of worked when patents only affected a small range of industries. They immediately became a problem in software and biotech. Even then, at least people sort of understood the rules of the game. There was a disincentive to really be aggressive with lawsuits, since you could be a victim of someone else's suit. But when that game goes multinational, and the Chinese are "just playing by the rules", it will become open warfare.

The realistic alternative to patents is trade secrets and employment agreements, with technical hacks such as encryption and DRM to prevent complete reverse engineering. I think that does scale, and though it will be annoying, won't have the bad effects on innovation that the current system has.

My own software efforts, for example, are almost certainly illegal. My proposed system covers so many areas of UI, software development, online gaming, etc., that it would be a miracle if it didn't violate someone's patent. Even if I cared about that, there's no way I could do it right. There are thousands of patents, each with dozens of claims, all written to be as obscure and general as they could get away with. Even if you reviewed them all, without being a lawyer, you'd have no idea what would really be a violation. And it would take years to do it right. Then if you did go to market anyway, secure in the knowledge that you'd done all you could to be legal, you could still get sued, and the costs would bankrupt you.

So my attitude is, if the rules have been changed to make it impossible for you to win, why play by the rules?

Exactly--thank you, Michael. The way I would envision devolution occurring in patent law is twofold: one, everything takes even longer to resolve, and thus the eventual ruling becomes ever more meaningless (a company could fold in 10 years waiting for a ruling or appeal), and two, enterprises will simply start ignoring the judgments and rulings as enforcement degrades.

Get sued by a patent troll? Do nothing. If the troll wins in court, Just declare bankruptcy (or simply shutter the business and move away) and start the same enterprise elsewhere overseas where U.S. courts have no jurisdiction and cross-legal claims are tied up in bureaucracy.

U.S. firms are relocating to Ireland and Switzerland to avoid unfair U.S. corporate taxes (your competitors may pay near-zero rates while you foolishly pay 35% U.S. tax rates--the highest in the world; how long can you survive that imbalance?) but there may be other reasons, too--such as dodging U.S.-based patent trolls.

When extortion passes for "playing by the rules" and gaming the system earns more than actually innovating (or working productively), then the game is rigged. The only companies able to defend spurious lawsuits (and there is no mechanism to throw out spurious suits--that's what the entire process is designed to eventually do, at stupendous expense) are ones throwing off billions of dollars in profits like pharmaceutical and tech giants (Apple and IBM).

I am not knowledgeable enough in patent law to recommend reforms; but I can state that any reform which just adds additional layers of complexity and thus cost is not a reform; it is merely furthering an increasingly onerous status quo tax on the remaining productive economy.

Yes, "the garage inventor" patent owner may occasionally win a big settlement from a multinational, but please show me the statistics which reveal this to be a common event. It sounds more like the PR spouted by patent trolls to mask their parasitic nature than an assertion based on court statistics.

Lagniappe thought: Everything, even patent law, is dependent on oil remaining $100 or less per barrel. When oil is $300/barrel, even the legal system will be revealed as unsustainable. Courts are funded by tax revenues, and as those collapse then the court system will necessarily devolve, too.

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