Katonomics 1: An Economic Perspective on IP: The Social Contract Theory of IP

Looking attentive in Economics classes
was the easy bit. The big problem was
remembering all those funny terms ...

Who or what is Katonomics? There is no science of that name as yet, but it's the title of the promised mini-series on IP economics for IPKat readers -- the vast majority are either not economists or don't think they like them very much, perhaps having been bitten by one at a tender age or, more likely, having found that, while economists talk about their beloved IP rights in cold, abstract terms, governments and policy-makers tend to pay more attention to those of us who are happier dealing with actual events like licensing our friends and suing our foes.

This weblog is proud to welcome its own Katonomist, Nicola Searle, who has kindly agreed to give of her time and effort in order to bring the economics of IP to lawyers in a clear, intelligible, friendly manner by providing the IPKat and his friends with a short series of Katonomics articles. The first installment in the Katonomics series tackles something that even IP lawyers who aren't too focused on economics have some familiarity with: social contract theory.  Let Nicola Searle take it from here:

"An Economic Perspective on IP: The Social Contract Theory of IP 

For the first in this series in economics of IP, I thought I would start by looking at a key economic approach to IP.  Economists look at the IP system and ask “why”?  Why would you have a system that rewards rights holders with monopolies?  Why does the state regulate private transactions?  Why do we spend so much money on a system that appears to benefit the few at the expense of the many?  Yes, these are the questions that keep economists awake at night. 

The short answer to these questions is innovation.  From an economic perspective, innovation contributes to growth and increases the overall welfare of economies (e.g. better medicines, more efficient cars, improved cultural experiences). In order to have long-term, continued innovation, there must be incentives for innovators (for more on this topic, I highly recommend Suzanne Scotchmer’s book Innovation and Incentives). For IP, the incentive created is the legal monopoly created by exclusive rights.  The legal monopoly allows innovators the means to capture the financial rewards of their innovation. 

A popular theory that furthers this incentives-to-innovate concept is the social contract theory (also known as contract theory).  Social contract theory argues that IP is a contract between society and innovators.   Society recognises that innovation is socially beneficial and that the knowledge underlying innovation is intangible.  Given that the knowledge is intangible, innovators may have difficulty capturing the rewards from innovation.  Without rewards, innovators may stop innovating and society loses out. The solution to reward innovators is the IP system. 

"Monopoly? I distinctly heard
you say 'temporary monogamy'..."

However, the IP system is not without costs.   Society grants the innovator a temporary monopoly via exclusive rights.  This temporary monopoly means that the innovation will be sold at lower quantities and higher prices than if there were no monopoly.  This is a cost to society that translates into a benefit for innovators who earn more from their innovation.  Running the IP system is also not without costs as administering and enforcing rights can be expensive (indeed, costs were cited in two of the four points of investigation for the Hargreaves review). In return for these costs to society, the innovator eventually turns the innovation over to the public domain. Once in the public domain, the innovation is no longer constrained by exclusive rights and may be freely used to develop further innovations. 

The underlying concept is that the short-term inefficiency of the monopoly created by IP is tolerated in order to achieve the long-term efficiency of continued innovation.  Therein lies the social contract: a contract between society and innovators in which innovators reap the rewards to innovation and society benefits from continued innovation.  

Social contract theory differs significantly from other theories of IP including that of the labour-deserve theory (or labour theory of acquisition).  Labour-deserve theory argues that an individual has rights over the fruits of their labour.  For example, I have natural rights over this blog post because I have applied my labour to write it.  To generalise, labour-deserve theory begins with the individual, while social contract theory begins with society.  They both come to the same conclusion: that the IP system should exist.  However, the two theories get there in different ways. 

The IPKat fondly recalls
the days before the current
Eurozone crisis, when
nations still had wealth ...

These are not new concepts.  John Locke looked at labour-deserve theory in the 1700s (Chapter 5 of his second book).  At the same time, Adam Smith argued for property rights as a means of increasing efficiency (see An Inquiry into the Nature and Causes of the Wealth of Nations).  Their contemporary, Johann Gottlieb Fichte, also recognised the tensions between the fairness of rewarding innovation and the social benefits of innovation (see Proof of the Illegality of Reprinting: a Rationale and a Parable).  Debate between these theories is also not new and has erupted many times over the years (for a good discussion cataloguing the historical debates, see Christine MacLeod here).  Modern analysis of IP and social contract theory can be found in a number of papers including those of Landes and Posner,  Denicolo and Franzoni and Lemley.  

The debate over copyright term extension is a good example of how social contract theory and other theories can clash.  Under social contract theory, increasing the rewards to an existing innovation represents a violation of the contract.  The innovator and society entered a contract at the time of the publication of the copyright-protected work; later changes to this contract break this agreement.  

  Amendments also fail to provide incentives to innovate: how does extending the term of protection now encourage innovation occurring 50 years ago?  For supporters of labour-deserve theory, term extension is less problematic.  Innovators still deserve to benefit from the fruits of their labour and to receive a “just reward”.  If these fruits are still culturally and economically relevant, why shouldn’t innovators still benefit from their efforts? 

And here, I leave you to contemplate the relative merits of social contract theory with my question of the week: Is IP a social contract or an inherent individual right? Do economists really lose sleep over innovation? Comments on a postcard.  Or in the handy box below".

Okay, readers: you've had your first lesson. What do you think?