ECO 204 - Final Paper

Robin Marchione
Guilherme Vieira Dumit
Anton Claude Bettink
Adrian Di Felice Mezquiriz
ECO 204 - Dr. Baranes
Innovation
Abstract:
This paper examines the economic effects of technological advancements, and
patents as property rights, with regards to innovation. In researching the effects
of technological advancements on the economy, this work discusses and
contrasts scholarly Mainstream, Institutionalist, and Austrian perspectives. For
all economic schools discussed, it was hypothesized that they would, to some
degree, be in accordance that technological advancements stimulate economic
growth. However, different schools have varying opinions on the processes that
cause and affect technological advancements on the economy. This work is
responsible for depicting these views and discusses the role of patents in
different perspectives
Introduction
Innovation can be defined as the application of more effective or generally
better solutions to market desires. It is regularly acquired through new products
or services that are considered original and help society or a market create more
efficient production. As seen in Romer's Endogenous technological change,
"technological change arises in large part because of intentional actions taken by

people who respond to market incentives" (Romer, 1990, 72). The innovation
process works as a barrier to entry as well as improving economic conditions,
depending on the environment. In both cases, innovation plays a crucial role as a
catalyst for growth, for industries, and the economy as a whole.
In the past, there has been a lot of discussion regarding the purpose,
functioning, and impacts of patents on free and regulated markets. The
introduction of patents has led to debate over the conflicting theories from
various schools of economic thought. This paper will support the claim that
patents are used to preserve monopolistic rights and thus cultivate the existence
of monopolies while spurring innovation and economic growth. In order to
juxtapose this hypotheses effectively, and to create a sensible conclusion, it is
necessary to analyze mainstream, as well as alternative economic perspectives.
Despite examining the role of intellectual property rights, this paper will
emphasize how intellectual property rights have affected technological
innovation, therefore economic growth, and the role of intellectual property going
forward.
Technological Advancement
As Robert Solow and Trevor Swan mainly indicate through their Solow-
Swan model, economic growth is reliant on increasing inputs and technological
progress in the long run (Solow, 1956, 66). Solow was responsible for stating the
idea that capital accumulation would lead to an increase in labor productivity
through his model of investment and growth. What is meant by "capital" varies
throughout different economic schools. This fairly recognized definition is

significantly based on what is called the "constant-returns-to-scale production"
technology (Grossman & Helpman, 1991, 22). CRS production reflects a
manager's decisions in a case of, for example, when all inputs are doubled, new
values for output will be also doubled. Additionally, Romer states in Endogenous
Technological Change, "[g]rowth ... is driven by technological change that arises
from intentional investment decisions made by profit-maximizing agents",
(Romer, 1990, 71), which through intentional investment decisions, Romer aims
at government investment prevenient from taxes and current organizations.
These profit-maximizing agents encompass the goals and aims of current
organizations, as they only focus on improving their returns. Therefore, at the
same time the supporters of this mainstream view see innovation based primarily
on capital accumulation. They all relatively agree on having one goal that comes
from variables such as resources, labor, and organization of the modern
enterprises: profit.
Similar Mainstream views to Romer's mentioned in Increasing returns and
new developments in the theory of growth. He depicts that most recent
economical models show an increase in returns when innovations are included in
the production process (1989, 29). Thus, it can be suggested that the
mainstream perspective shows that besides the specific production variables that
stimulate development, the original concepts of labor and capital that are
incorporated in the production process essentially improve production to such an
extent that economic growth is achieved. Also, in a sense this view supports the
case in which economic growth arises from increases in technological change,
which is fairly recognized as innovation. As mentioned then, innovation is the
main catalyst of this profit-making process looking to reach growth through more

accelerated methods. This mainstream view has for long been the most widely
accepted, with the exceptions of other schools' supporters, such as
institutionalists and austrians.
In the case of the Institutionalists, technology is seen differently: it is
regarded as the determinant of how instrumental functions are achieved.
Technology, whether it be physical matters or know-how related, allows us to
continue the process of societal and economical development, just as it has
brought us to what we see today as a civilized society. Therefore, this view, as
John Foster denotes, sees technology as a determinant of "the character of the
means of life and the character of the process of providing those means." (1981,
912) This can be understood as that every experience in life is changed and
created by technology, as well as the tools and means to provide technologies,
with an obvious goal to solve social problems. For Institutionalist economists,
separating technology is also essential. It is viewed as a process that divides
between the tools and machinery that make up "technology", and/or the creation
of new goods or processes. Since each social problem requires a solution, the
existence of these technologies in society is such that the answers to those must
rely on institutional adjustment.
In The theory of institutional change, Bush (1987) defines institutional
adjustment in two phases: (1) ceremonial encapsulation, where all technological
innovation is enveloped; and (2) progressive institutional change, where
instrumental values are prioritized before ceremonial values. This process allows
for more desirable technological changes, instead of focusing on values that do
not add to the social "knowledge fund", the fund can be expanded with a reliance
on these instrumental values. For Veblen, institutions are responsible for

determining how technologies are implemented into society, where some
institutions tend to favor "ceremonial" values, based on managerial decisions
(Veblen, 1904). Veblen saw technological change as a process of cumulative
causation, which refers to changes in technologies as well as societal behavior.
This means that he saw technology arising out of gaps or deficiencies in society,
a kind of combination of “intellectual curiosity” and a drive for more efficient
processes: “[a] change in prevalent habits of thought”. ‘[A]ccording to the
institutionalist perspective, especially in regards to the economic system,
technological 'innovation’ is evidently more of a cultural process, where
knowledge and creation (innovative ideas) are created by a more collective
collaboration in society. Following his view, Veblen agrees on the idea that
institutional adjustment should be pursued to make the use of technology more
aligned with 'instrumental values’'. As human life is in a state of constant
development and trying to solve certain social problems, technological advances
cannot be stopped (and vice-versa), because that would lead to an obstruction of
society and there would be no institutional adjustment present, meaning a
stagnation in society's development. Then, how does technology and institutional
adjustment relate to innovation in this view? Considering the amount of problems
that a society encounters, they substantially work as a stimulus for innovative
methods and tools. As Bush sees it (1987), throughout the years these changes
have facilitated the transformation in the industrial environment and worked as an
incentive for more innovation to take place. Therefore, the Institutionalists are
aware that there is a constant necessity for these innovative changes that have
shaped modern industries in this society to a position where innovation has not

only become a constant feature but also the main key to problem-solving
embedded in the community.
Austrian supporters see innovation coming from a different, though vital
source. As noticed by Baumol and Schumpeter, the entrepreneur has not only
the willpower to "break down the resistance that the social environment offers to
change" (Schumpeter, 1947, 157) but also the attention to recognize
opportunities that may become profits. That attention promotes and ensures a
free market that can only be more and more efficient, considering these will
always look for innovative and productivity-enhancing opportunities. As their job
is to realize imperfections that may result in future profits, they find themselves in
an environment where using the available resources efficiently also meets their
other goal that is realizing gains. As a proof of the austrian view on innovative
methods, in the Creative Response in Economic History, Schumpeter states that
"the entrepreneur and his function are not difficult to conceptualize: the defining
characteristic is simply the doing of new things or the doing of things that are
already being done in a new way (innovation)." (1947,151) Schumpeter defines
innovation (the catalyst for economic growth) as "creative response", which can
be anything that is outside of the range of existing methods or practices done by
an industry, economy, or some firms (1947). Schumpeter also finds innovations
to be different from inventions, as inventors have no connection with
entrepreneurs, since an entrepreneur "gets things done", but does not
necessarily represent something scientifically new. He discusses the fact that
industries must constantly revolutionize their economic structure internally, which
means innovating through more effective processes or better products.
Nonetheless, he argues that “creative destruction is the essential fact about

capitalism.”, meaning that a process of industrial change must take place
regularly, often creating these new processes. Also, in The theory of economic
development; an inquiry into profits, capital, credit, interest, and the business
cycle (1934), Schumpeter sees our economy as a non-stationary one that
rewards innovative entrepreneurs "above-natural" profits or surplus gains, what
would be prevented from the existence of competition in the market. Concluding
Schumpeter's view, in any condition, technological improvement is acquired from
society, since it is a "central feature of economic development" (1934, 40), while
he also argued that economic development cannot happen with innovation,
entrepreneurs, and market power. For Schumpeter, the idea of constant
innovative methods coming from entrepreneurs could provide better outcomes
than the price competition system that is fairly known. In this school's view then,
innovation is acquired mainly as an entrepreneur's product, where it is the
maximum profit-seeking activity, and originally set as a main goal by these
entrepreneurs and austrian supporters.
In conclusion, advancements in technology stimulate economic growth,
improving technologies necessitates the various aspects that play a role in
economic development, such as labor, investment, human capital, etc.
The mainstream school of thought, as supported by Romer, reinforces that
technological advances encourage growth as they are driven by intentional profit
maximizing behaviors. These can range from individual to political behaviors,
such as government investment towards innovation through tax collection.
Therefore, the Mainstream frame of thought supports the benefits of promoting
innovation in the production process as well as the factors of labor and capital.
This is because technological advances are implemented as methods for profit

maximization. Although this theory seems very eloquent and culturally accepted,
there are different schools of thought that differ in their approach to the area of
innovation and technological advances. For example, for Institutionalists,
technological advances are not viewed solely as means for economic growth but
also a measure for understanding society and its influence on the civilization.
There is a reciprocal relationship between humanity and technology as
technology originates, impacts and culminates from societal factors. In addition,
Institutionalists view technology as a factor that influences the way institutions
are created as technology promotes institutional principles based on instrumental
values rather than ceremonial. Thorstein Veblen suggests that technology is
important as it shapes societal conduct because it arises from gaps in society
and aims to satisfy them. In this regard, we can affirm that: for Institutionalists,
technology and innovation are collective rather than individualistic, and that
technological advances should be directed towards social development and
instrumental behaviors.
Another important approach to this subject is that of the Austrian school of
thought where technological advances arise in a different form. Austrian
followers, emphasize the role of the entrepreneur. They suggest that the
entrepreneur is driven by profit seeking attitudes where they aim to anticipate
methods where innovation can maximize efficiency and profitability. In this view,
the structure of the free market is necessary as it enables the entrepreneur to
engage in processes that promote gains from using technological advances
towards higher efficiency. In other words, the entrepreneur, by creating or
revolutionizing existing methods of production is able to benefit from higher
surplus created by more efficient allocation of resources, new machinery, et

cetera. Also, it is important to note the difference between invention and
innovation, as the latter one is actually able to promote change. Innovation
supports the concept of creative destruction where innovation destroys existing
structures and implements the more efficient one, and thus the process of
creative destruction is key for capitalism as well as economic growth. So, for
Austrians, the entrepreneur is the figure that by innovation achieves overly profits
while promoting economic development.
We can venture to affirm that these three schools of thought see
innovation and technological advances as factors that promote positive outcomes
for the economy and for society. Mainly, they differ in aspects such as the nature
from which innovation arises as well as its overall effects. However, economically
speaking, innovation is seen as the engine that drives economic growth and
development, as well as influence society and its institutional basis.
Patents and Property
As an originator of economic growth, innovation has been assured
primarily through patents, allowing for the protection of ideas. A patent is defined
as an intellectual property, or certain quantity of exclusivity rights granted by a
governmental or dominant organization that allows for a timely constrained use of
an innovative product or process. In ancient Greece, a cook was awarded an
exclusive right for one year to sell a dish if it were considered "new and
fabulous." As it can be seen then, back in those years an expression of the
invention did not matter as much, as people were more concerned with the
knowledge utilized and put into the production process that originated that

exclusivity. To add to those rights awarded, in the early 1400's, an architect
named Filippo Brunelleschi was granted the first modern patent for his invention
of a river transport vessel through which he could transport marble. Along with
various others, this patent originated a statute in 1474 to define some means of
control on that issue. This statute required three main constraints: (1) usefulness,
where it should be useful for some process utilized in society; (2) newness,
where it requires to be the first one of its kind or not equal to anything that has
the same purpose; and (3) time limits, where there was a specific period that
these patents 'protection' lasted for.
It was at that time that a philosophical shift became evident, as we
engaged into the era of classical liberalism, when more collectivistic philosophic
thoughts were shifting to more individualistic philosophic thoughts, what was
necessarily essential to patents. At this time, three key shifts needed to occur in
order for patent rights to take hold: (1) a technological shift, affecting the way in
which new knowledge was created, since the knowledge you first learned could
be used to create more, resembling a more collectivist view of knowledge
creation; (2) a legal shift, where the goods being produced were to be viewed as
important matters, and for those you would have to be able to protect; (3) a
philosophical shift, where the exceptional work of an individual inventor was
judged as the main source of knowledge creation.
On the basis of economic theory, ownership is conceived to be in line with
Locke’s natural rights and theory of property, in that what is produced by one’s
labor, can then be considered to be owned by the producer. According to Locke,
the natural owner of something, is the person who produced or procured such an
object. However, we often overlook the fact that ownership is not often an

individualistic thing. Generally, ownership arises from collective “cooperation of
an industrial community” (Veblen, 1898, 353) and through this community the
knowledge and resources that are available are in some way involved in the
production process. So the idea of natural rights and the notion that ownership is
because of individual labor is what Veblen describes as “absurd”. Ownership,
then can be described, in terms of individual ownership of an object or resource,
by suggesting that the owner has designated control over what is done to or with
the resource.
According to Jaffe and Lerner “Reforms in the US patent system have
caused an explosion in patent applications.” (Jaffe and Lerner, 2004) These
reforms have been imposed to protect the patent holders, as strengthening the
protection policies of patents can spur innovation and economic growth. “Initially,
patents were awarded to benefit the Royal’s favorites. The connection between
invention and exclusive property rights that was then introduced, was an
institutional revolution that helped spur invention and arguably paved the way for
the industrial revolution” (Acs and Sanders, 2008). This implies that the inventor,
theoretically is the person who is entitled to “legal ownership” over the product.
The creation of a good by an individual spurred the ownership of these
methods and enabled one to obtain patents, paving the way for the industrial
revolution. As this sense of ownership is sought from many individual creators,
some philosophers tried to define private property.
Generally, property is what belongs to someone or with something, and is
used to describe the rules for which people are able to access and control
belongings such as: land, means of production, any representation of capital,
manufactured goods, ideas, inventions, and intellectual products. From a

philosophical standpoint, property can be divided into three main components,
which are private property, common property, and collective property. In a private
property system, rules and regulations govern the idea that resources are
allocated according to the deciding authorities or to the assigned individuals.
Individuals that have been assigned resources then have control over them, and
it is up to them to decide what should or could be done with the resources.
However, private property still has to fit within the governing rules of society.
When considering common property, resources are governed by rules that allow
for resources to be used and be available for the whole of society. This could be
a public park or library. The central concept of this is to allow fair access for
anyone who wishes to use the resource and restrict preclusion by others. Finally,
a collective property is when a community determines how resources are going
to be allocated. This is done on a basis of social interest, in what way will the
allocation of resources be most beneficial for the collective society. For the
reference of patents, private property rights are enforced and sought. Property
rights are then, by definition, any formations supported by society in order to
restrain a resource or good to one individual, organization, or government. By
acquiring property rights, the owner obtains the rights to: use the resource, earn
income from it, transfer it to others, and enforce its right of ownership.
According to John Locke, given that all men are equal, “every man has a
property in his own person” and no one else has the right to it but himself (Locke,
1689). A man’s physical labour that he produces with the use of his body is
considered to become his property. Basically, what a man is able to cultivate
from his own labour, essentially (according to Locke) becomes property of the
labourer. However, this is on condition that there are enough resources left for

others to do the same. Locke further explains that when a man or labourer
contributes something additional to nature (appropriating his labour towards it),
bringing it out of the state of nature, then the process of property begins. Locke’s
theory is based on three restrictions on accumulation of property: (1) one may
only appropriate as much as one can use before it spoils; (2) one must leave
“enough and as good” for others (sufficiency restriction); and (3) one may only
appropriate property through one’s own labor. (Locke, 1690).
If we consider a mainstream perspective on patents we have to examine
Paul Romer’s theory on economic growth, as it has been one of the main driving
forces behind the “new growth theory”. In his interview on economic growth held
by Russell Roberts in 2007, Romer talks about “the importance of ideas, the role
of institutions and the legal environment for creating incentives for new idea.”
According to Romer, the United States has been experiencing growth rates in the
last couple of decades that have clearly increased over time even though the
economy must invent more products every year to maintain a certain percentage
of growth. He explains this development by referencing the combined effects of
“knowledge building on knowledge” and the educational shift towards new
discovery, accelerated by the growth in population. In his view, institutions have
been providing incentives to individuals to engage in innovative research through
research conducted in universities as well as the issuance of intellectual property
rights. In 2007, Romer claimed that the US economy is moving towards more
constricted patents, raising the question whether this movement will hamper or
spur the progress of technological innovation. In his view, moving towards more
limited patents, either in terms of the number of issuances or the time period of
validity, would hamper innovative development as it decreases the incentives for

people to invent new products and create, by definition, innovation. The reason
for this is the fact that the innovative individual will not be able to capture most of
the value or returns, leading to a larger value to society. In order to reinforce
these incentives for individuals, the government must reward students getting
additional education (science related) through grants or vouchers, what is similar
to Friedman's view. Some of these grants should financially support educational
degrees so that students can take risks and engage in the process of developing
new goods and mainly "innovating." This should include giving firms financial
incentives to innovate.
For the institutionalist view, it is important to analyze Veblen's view on
patents. Veblen makes it clear in On the Nature of Capital: Investment, Intangible
Assets, and the Pecuniary Magnate that the rights that patents "award" are
detrimental in the sense that they prevent the new knowledge to be used by the
community. Following this concept, it restrains society from the "serviceability" of
innovation, as no previous patented knowledge can be used. For Veblen, patent
rights are initially seen through this view that it does not allow society to prosper
and innovate when instituted. Then, they are seen as partially effective: "The
patent right becomes effective for the purpose only in the material working of the
innovation covered by it; and monopolistic control is a source of gain only in so
far as it effectually modifies or divides the supply of goods." (Veblen, 1908)
Therefore, in a second view, patents are seen effective for the individual creating
the good, because it can properly use his knowledge without facing competition,
and obviously acquire possible monopolistic control. A primary difference
between Veblen’s take on patent roles and mainstream economic theory is to do
with the production of goods in society. For Veblen, ideally, production should be

carried out for the common good of society, while for the mainstream view, the
objective of production is more aligned with production for profit, although they do
believe that there is some natural relationship between the two, in which case
producing for profit can be seen as beneficial for society. An example of this is
when mainstream economists believe that “the incentives provided by the
monopoly profits generated by patent protection guarantee that there will be an
innovative effort which will result in more efficient production of better goods”
(Fiani, 2009). However, on the contrary, Veblen opposes this view as he believes
that this relationship between production for profits and the common good are not
natural as they do not account for any realistic alternative (pecuniary) motives.
Another important distinction that needs to be made is that of tangible and
intangible asset patenting. Tangible assets are those that are of “technological or
industrial character”, and intangible assets are, which are particularly difficult to
evaluate, include things like patents, copyrights, and trade markings.
The invention or innovation covered by the patent right is a
contribution to the common stock of technological proficiency. It
may be (immediately) serviceable to the community at large, or it
may not; [...]But, whether the innovation is useful or not, the patent
right, as an asset, has no (immediate) usefulness at large, since its
essence is the restriction of the usufruct of the innovation to the
patentee. Immediately and directly the patent right must be
considered a detriment to the community at large, since its purport
is to prevent the community from making use of the patented
innovation, whatever may be its ulterior beneficial effects or its
ethical justification. (Veblen, 1908, 116)

Basically, Veblen is describing the detrimental relationship between patenting
and innovation. Veblen holds this perspective because he thinks that knew
innovative knowledge should be used for the greater benefit of the community,
and in the case of patent rights, it dramatically restricts the ‘serviceability’ of
innovation.
The Austrian school of thought argues that the granting of intellectual
property rights slows rather than inspires technological innovation and thus
economic growth. As Heller & Eisenberg (1998) stress in Can Patents Deter
Innovation? The Anticommons in Biomedical Research, the economic use of
patents has developed into a phenomenon of the ”anticommons” where inventors
have been subject to underusing available resources by ‘blocking’ each other,
caused by the presence of patents. Even though the paper is more specifically
concerned with the use of patents in biomedical research, its theory can be
applied to any market. This argument goes along with Schumpeter’s view on
innovation, which he claims is endogenous. According to his theory on ‘creative
destruction’ in Can Capitalism Survive?, innovation emerges from within the
existing modes of organisation and revolutionizes it. Technological innovation
makes old methods unprofitable and creates new ones in which the entrepreneur
sees an opportunity to gain a profit. However, in the Austrian perspective,
monopolies prevent creative destruction in order to defend their economic power
in the market. In order to do so, they purchase patents preventing new
entrepreneurs to enter the market. In the Austrian point of view, with an
emphasis on Schumpeter’s theory, creative destruction (capitalism) cannot
survive as long as monopolies keep gaining privileges through the central
governments and their issuance of patents.

Acs & Sanders also discussed the initial purpose of patents and their
effects on the generation of growth within an economy. Even though research
has shown that the issuance of patents has increased the rate of research
(measured in patents), theories claim that the actual “quality” of patents has
decreased while their issuance has not fulfilled the expected generation of
economic growth (Jaffe and Lerner, 2004). In Intellectual Property Rights and the
Knowledge Spillover Theory of Entrepreneurship, Acs and Sanders (2008) state
that there must be an “optimum level of protection” in a sense that too many
patents issued could be “too much of a good thing”, while an equilibrium would
still enforce incentives for innovation. Ultimately, the optimum level would
resemble the peak of an inverted U-shaped relationship among the number of
issued patents and their effect on economic growth.
Furthermore, they follow the so-called knowledge spillover theory and
emphasize their distinction between invention and innovation, including
commercialization. In their view, knowledge is created by inventors, which spills
over other participants in the market through commercialization, which is
undertaken by entrepreneurs. Even though combining these two factors go hand
in hand when generating growth is pursued, it is essential to Acs and Sanders to
make a distinction. As opposed to inventors, entrepreneurs receive a reward
(commercial rent) for investing in R&D, seeing the commercial potential of the
invention, and finally taking the risk of commercializing it. With the introduction of
patents, however, the rewards shifted over from the entrepreneur side to the
inventor side, reducing the incentives for entrepreneurs to commercialize
inventions. Consequently, less commercialization is going to hamper the spillover
effect of knowledge and thereby reduce economic growth. As Jaffe and Lerner

(2004) stress, the excessive issuance of patents in the US system has passed
the ‘optimum’ balance and rents should partially be reallocated to the
entrepreneurs in order to spur more more innovation besides invention.
Patents as Property or Monopoly Rights
Fairly known in the world of economics and related to innovation matters,
patents are also often referred as intellectual property rights (IPRs). Intellectual
property rights refer to creations of the intellect used by a monopoly that is
designed to specify ownership according to an authoritarian body. Monopoly
rights are defined as privileges granted by an authority (governmental or
authoritarian individual) to a person or entity in order to exclude all others from
using, producing or selling a certain good or service, giving them enough power
to construct a monopolistic industry around its protected good. See the
resemblance? "Monopoly" rights are called so due to the great dominance
imposed in the industry originated from those. For a long time now, these
monopoly rights have been defined in a similar manner as have patent rights and
the giving sense of ownership to a good or service considered innovative.
Although, alternative economic perspectives do see this similarity in a different
manner. For example, institutionalists see that any kind of monopoly right is also
a property right, since it allows them to own the matters for controlling of
production of that good. In the view of Austrians, patent rights are not very
supported, as they believe that some kind of government intervention should be
induced in order to control the dominance awarded to these "inventors".

Patents are often mislead with property because they can be bought and
sold, as well as the fact that the patent owner has the power to exclude others
from the process of manufacturing or selling, just by using an innovative
invention. Although, if we consider the use of patents for drugs that act as the
only treatments for a disease, then they are obviously used with a monopolistic
purpose. Actually, pharmaceutical companies are known for issuing more and
more patents yearly with only monopolistic purposes. Unlike natural resources,
patents are not limited, meaning that one can innovate as often as his creative
capacity allows. Following this thought, granting patents is a process that is not
limited, where no immediate amount restraints are imposed, meaning that
companies engage in a race for growing the volume of patenting and enjoying
the benefits of those.
Therefore, after analyzing the role of patents and innovative methods in
economic growth, it can be deduced that monopoly rights and property rights are
extremely similar as they conclude to the same benefits of being used for
monopoly developing purposes, instead of preserving the common rights to
private property.
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