Innovation and Economic Growth in China - Evidence from Patent Statistics

Table of Contents

Executive summary

List of Abbreviations

1 Introduction
1.1 Purpose of the thesis
1.2 Method
1.3 Structure

2 Patent System
2.1 Overview
2.2 Regional and national patent systems
2.2.1 European patent system
2.2.2 Chinese patent system
2.3 Global patent system under PCT
2.4 Basic grant procedures

3 Economics of Patents
3.1.1 Function of the patent system
3.1.2 Innovation incentives vs. social welfare
3.1.3 Innovation models

4 Growth theory
4.1 Introduction
4.2 Endogenous Growth models
4.2.1 Research and development models
4.2.2 Human capital models
4.2.3 Critics
4.2.4 Conclusions from endogenous growth models
4.3 Preliminary conclusion

5 Descriptive statistics
5.1 Methodological background
5.2 General trends in patenting
5.3 Trends in patenting at the SIPO
5.4 Hypotheses about China’s upsurge in patent counts
5.4.1 Hypothesis 1: R&D expenditures cause jump in patent counts
5.4.2 Hypothesis 2: Amendments in China’s patent laws
5.4.3 Hypothesis 3: FDI has caused the rising number of patents in China .. Innovation and Economic Growth in China: Evidence from Patent Statistics
5.4.4 Hypothesis 4: Increased patent production of state-owned institutions due to an improved educative sector
5.4.5 Preliminary conclusion
5.5 Patenting and economic growth in China
5.6 Quality of Chinese patenting activities

6 Conclusion

7 Appendix

8 Bibliography

Executive summary

There are different ways explaining economic growth in China. In this thesis, the author use patent statistics in order to demonstrate how China generates its tremendously high and stable growth rates. Based on the endogenous growth theory, fields of actions are identified that account for China’s rising patent activities. In addition to an intensifi- cation of research and development efforts, China benefits from FDI inflows as well as from its innovation friendly policy. In the end, the described development is embedded in a patent friendly environment, which shows not only China’s efforts for attracting foreign investors but also the importance of providing incentives for domestic firms. As a result, Chinese’s firms become more and more innovative in certain sectors.

List of Abbreviations

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1 Introduction

China has demonstrated an enormously high rate of economic growth over a period of more than twenty years. In fact, China’s economy advances to a driving force in order to overcome the consequences of the financial crisis in 2008. This is only one reason why China has be- come the major object for studying economic growth as shown by thousands of publications and articles. But up to now, there have been published only few papers dealing with China’s patenting activities. This is astonishing, given the fact that innovations expressed by patent counts are one of the key factors that drives long term growth and productivity.

Today emerging state’s economies like in China turn more and more into knowledge-based economies, where intellectual property rights play an elementary role. Moreover, IP protec- tion in form of patents can increase (as intangible asset) firm’s values. Furthermore, invest- ment decisions are sufficiently influenced by the existence of a reliable patent system. While intellectual property and its protection have an essential impact on creating economic growth, the neglect of this relationship has much more negative influence on economy’s develop- ment. If an invention can be costless copied by a competitor it would be impossible to cover the costs of the development or even to gain a profit out of it. Therefore, it is necessary to think about efficient incentive systems for inventors in order to reward their efforts. Unfortu- nately, it proves difficult to establish a patent system that maximises social welfare by provid- ing just enough incentives to invent, while limiting the temporary monopoly given to the pa- tentee. In general, strong patents (patent length, breadth and height) can encourage innova- tions but too strong patents could be contrary by reducing welfare.

Given China’s weak record of protecting intellectual property rights on the one hand and its economic growth on the other hand, there seems to be a contradiction. But, a closer look reveals China’s efforts for installing an efficient patent system. For example, after passing its first Patent Law in 1986, China has amended its Patent Law several times in order to bring it in line with international norms, as well as to support its effort to enter the WTO in 2001. However, China’s enforcement system is still weak. The installation of China’s patent system goes along with an incredible patent surge at annual growth rates of 20%.

1.1 Purpose of the thesis

Given this situation, the thesis aims at explaining economic growth in China by using patent statistics. The author wants to demonstrate the relationship between patents, innovations and economic growth descriptively. Hence, sub-ordinate targets of this thesis are:

- to analyse the current trend in patenting at China’s patent office (SIPO),
- to examine the origins of China’s patent surge,
- to show the efficiency of China’s innovation policy by evaluating patent quality and
- to analyse China’s growth by using the endogenous growth theory. In the end, the main question that arises is to what extent patent statistics can be used as an indicator for explaining economic growth.

1.2 Method

The method used within the thesis based on hypotheses which are developed from the theoretical part. The hypotheses are tested - whenever possible - by using relevant statistical data from the OECD database, from the Chinese National Bureau of Statistics or from the World Bank. Since current innovation models are highly sophisticated, somehow artificial and thereby bounded in their transferability into reality, the author uses a descriptive statistic approach (instead of inferential statistics).

1.3 Structure

The thesis is organised as follows. The next chapter provides a comprehensive overview about the global patent system, as well as an overview about the European and the Chinese patent system. Finally the basic grant procedure is presented. The third chapter deals with the economics of patents. First, I will focus on the contradiction between offering incentives (temporary monopoly power) for the patent holder on the one hand and social welfare on the other hand. Then, these aspects are discussed in detail using Nordhaus’s innovation model. The results can be used in order to describe an optimal patent system theoretically.

Based on this chapter, the next focus on the link between patent protection and innovation on the one hand and economy growth on the other hand. Therefore, this chapter serves as a basis for posing the right hypotheses. The following main chapter presents the findings and a discussion related to four hypotheses. Results are interpreted in terms of innovative activity and economic growth. Furthermore, I will analyse the current trend in global patenting, as well as the trend at the SIPO in particular. I conclude the chapter by exploring China’s patent quality. In the end, a conclusion is drawn in chapter 6.

2 Patent System

The objective of this background chapter is to provide the reader with basic information con- cerning the patent system and its terminology as well as to set up the framework for the later analysis.

2.1 Overview

There are a lot of slightly varying definitions for the term “patent”. All definitions common is the aspect of protecting an inventor by excluding third parties from the commercialisation of his invention. In fact, the European Patent Convention (EPC) does not define the term “in- vention” explicitly, but it provides a list of subject-matter that may not be regarded as inven- tion (Guide for applicants, 2010). However, the European Patent Office (EPO) defines a pat- ent as “a legal title granting its holder the right to prevent third parties from commercially ex- ploiting an invention without authorisation”¹. In order to obtain a patent, the owner (individual or institution) has to file an application at the patent office. If the applicant seeks protection in several countries, he can file for a patent in each country separately as well as file for a pat- ent at a regional patent office (e.g. at the EPO) or file at an international office (e.g. EPO, JPO or SIPO) and request the entry of national phase in each country of i]nterest. The differ- ent proceedings have a direct impact when evaluating patent counts. Therefore, it is neces- sary to take them into account by interpreting patent statistics (see chapter 5.1). However, the most common used procedure for protecting an invention is to file an application at a na- tional office which creates a priority rights (including a priority date) according to the Paris Convention from 1883. Then, applicants have up to 12 months to extend the original patent application to other member states by claiming for the earliest priority date. This date is also used to determine the novelty of the invention compared to the state of the art at that time. Having the central idea of priority rights in mind, I will introduce the framework of the patent system with its legal institutions and its regulations in the following. This chapter provides the reader with information which are essential in order to understand the procedures and con- clusions drawn in the main part.

2.2 Regional and national patent systems

2.2.1 European patent system

The expression “European patent system” (EPS) refers to a regional system that exists in Europe for guarantee a standardised grant processes. The EPS based on the “European Patent Convention” (EPC), which serves as the legal foundation for the grant process in Europe and which can be seen as the core of the IP system in Europe. The contracting states declare to strengthen the co-operation between the States of Europe in regard to IP right protection (EPO Office Journal, 2007). In those states the protection can be obtained by a single procedure for granting patents, which is valid - if desired - in all contracting states. Thereby the EPO provides a single patent grant procedure, but not yet a single patent from the point of view of enforcement. Hence the patents granted are not European Community patents or even Europe-wide patents, but a bundle of national patents (STOA, 2007). How- ever, a uniform patent right hasn’t been established by the member states yet.

Current law requires patent holders and their competitors to debate patent rights in front of national courts in all countries in which a patent has been violated - a very complicated state of affairs. The solution for this problem could be the foundation of an European Patent Court (EPO: Working Paper on Litigation, 2004). In 2007 the EPC was adapted to new developments in international law and the need to improve the procedure of patent granting, which was termed EPC 2000.

The institution which is directly responsible for granting patents in Europe is the European Patent Organisation (EPOrg). It was set up as a direct result of the EPC in 1977. The EPOrg consists of the European Patent Office (EPO), operating as the executive organ in granting patents and the Administrative Council (AC), which monitors the Office’s activities. In order to grant European patents the EPO carries out the search and examining procedure of patent applications. A more detailed description about the procedures is given in chapter 2.4.

The AC consists of members of the contracting states and is responsible for supervising the work of the EPO, including endorsing the budget and approving the actions of the office’s President (EPO Office Journal, 2007).

In summery, the European patent system is implemented by the European Patent Organisa- tion, which operates on the base of the European Patent Convention. Moreover, the Euro- pean Patent Organisation works on behalf of contracting states of the European Patent Con- vention. The whole constellation can be seen as the intention to install a uniform patent sys- tem in Europe, which is still incomplete from the point of view of a uniform patent right. Hence, the inventor or the suitor has to enforce or to contest the right in each state and by national laws separately.

Figure 1: European Patent system: institutions and actors (own illustration)

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Beside the application path at the EPO it is still common practice to file national (single) pat- ents at the national patent offices. Therefore, patent numbers from national offices provide information about the attractiveness on that market. However, if the applicant wishes a pro- tection in more than three EPC countries the EPO application path is preferred because of its cost advantage.

According to the scope of this thesis, it is not only necessary to understand regional patent systems but also to understand the principles of national patent systems, in particular that of China.

2.2.2 Chinese patent system

As shown later, China becomes a major technology and IP generator and creates a significant number of patents. This is partly paradox since China is known for its underdeveloped and weak protection of intellectual property rights. Therefore, this chapter should provide a deeper insight into the Chinese patent system.

Chinese government has early recognised the importance of protecting intellectual rights. In 1980 China joined the World Intellectual Property Organisation (WIPO), in 1994 China became a member of the Patent Cooperation Treaty (PCT) and in 2001 China agreed on Trade Related aspects of Intellectual Property Rights (TRIPS).

In 1984, the patent system was officially born in China by passing its First Patent Law, which grants patents for inventions as well as utility models and designs patents. Later on, in 1992 the Patent Law was extended to the protection of pharmaceutical, chemical and microbi- ological products and processes. The duration of protection was prolonged from 15 to 20 years. These efforts have to be seen in connection with China’s preparation to join the WTO. Moreover, in 1994 China became a member of the PCT, what shows that China met the in- ternational requirements proven by the WIPO. From that point of view one may say that China’s patent system is in line with international standards (Fang, 2006).

In 2001 a new amendment of patent law became effective, which simplifies application pro- cedures and improves judicial enforcement procedures in order to meet the conditions for TRIPS.

In general, China’s patent system is orientated on the European, respectively the Japanese system. Therefore, the conditions for receiving a patent are similar, which means that an in- vention have to be novel, including an inventive activity and it must be industrial applicable. Not patentable are scientific discoveries, business methods (like in the US), methods for di- agnostic or treatment of diseases as well as everything that is contrary to social morality. Any Chinese inventor can apply for a patent, whereas foreign applications must be made through registered patent agents which are employed by the Chinese government (Fang, 2006). The ownership of a patent depends on whether the inventor belongs to a state-owned entity or a private (also foreign) entity. In the first case, the state is owner of the patent, in the second case the private entity owns the patent.

Unlike to the US system, Chinese patent law has adopted the “first to file” rule (Europe, Japan), where the patent right is granted to the applicant who first files its invention. Like in Europe, the application must include a request, a description of the invention and the claims. The application must be written in Chinese.

At the SIPO, the procedure of examining contains four steps: preliminary examination, publication of the application, request for substantive examination and the substantive examination itself. These steps are identical to those at the EPO.

In case the application is rejected, the applicant has the right to appeal the decisions of the Patent Office and to demand for a re-examination procedure. The final decision is subjected to People’s Court if the lawsuit is filed within three months after receiving the decision of the re-examination.

From the point of view of enforcement there are two principal mechanisms in China. First, the parties involved try to resolve the infringement dispute by negotiation or mediation. Second, a civil litigation is filed in order to enforce IP rights in an Intermediate People’s Court (Fang, 2006). Finally, Chinese patent law contains some exceptions of infringement. For example, person or entities that use the patent for scientific research or in some means unconscious are excluded from infringement.

Over the last 25 years major progress has been made on IP protection in China as shown in the above explanations. Today, the patent system is mainly in accordance with international rules and standards, its framework is orientated on that of Europe and the SIPO acts as one of the international search agencies under the PCT.

It is no surprise that the SIPO has set a goal to become the world leading IP office. This can be underlined by its increase in staff of about 4400 in 2006. As described in chapter 5.3 the number of patent application rose from 8.558 in 1985 to 314.573 in 2009. China also intensi- fies its international cooperation with the U.S., the European countries and other international institutions. In this context a senior EPO official said: “When the patent avalanche from China comes, we want to be ready" (www.EPO.org, [accessed on 03.05.2010]).

2.3 Global patent system under PCT

The scope of a patent is limited geographically. European patents for example are only valid in the contracting states of the EPC. The most important patent markets beside Europe are in Japan (Japan Patent Office) and in the US (United States Patent and Trademark Office). Moreover, the influence of the emerging markets like in China (State Intellectual Property Office of China) or in India (Indian Patent Office) has become more and more important. Un- fortunately, the principles and rules for patent protection among these markets differ (STOA, 2007) strongly. While for example the European and the Japanese system base on a first-to- file system, the US system bases on a first-to-invent system. The latter means that a patent is granted to the inventor who first practiced the invention instead of the person who first filed the invention. Furthermore, the number of applications differs strongly due to the different granting standards and proceedings.

But, based on the PCT it is possible for applicants who like to apply for patents in many countries (133 so far) to file an international patent application. The PCT provides a uniform procedure for filing an application, which results in a search and a preliminary examination regarding the patentability of the invention executed by one of the seven International Search Authorities (ISAs). A PCT application can be filed at an ISA (e.g. EPO or SIPO) or at the Wold Intellectual Property Institute (WIPO)² as a priority filing or within a 12 month period from an existing priority filing. The applicant has to name the PCT contracting states in which he wants receive patent protection. After receiving the application the ISAs prepare and pub- lic the international search report after 18 months from the priority date. The report is accom- panied by a written opinion on the patentability (non-published). Therefore, the applicant can objectively decide whether he likes to maintain his application or not. In case of a prosecution the international application will enter the national phase after 30 month from the priority date. In the end, the relevant national authorities (e.g. the German patent office) can make use of the search and examination report at relatively low costs (STOA, 2007). However, it should be noted that a PCT application is only an option for a future (30 months) patent ap- plication at national patent offices around the world.

An application under the PCT is advantageous for the applicant since he can postpone the national or regional grant procedures up to 30 month after the priority filing. Hence, the applicant gains time which he possibly needs in order to estimate the value of his inventions before paying application fees in several national patent offices.

From a global point of view, the PCT defines international standards in order to protect IP rights. Another step towards international harmonisation was taken by the Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement under the guidance of the Word Trade Organisation (WTO) in 1994. TRIPS sets up comprehensive standards for many forms of intellectual property regulation and ensure that the patent system is applied in WTO’s member states including China. The minimum standards for protection and enforcement of IP rights, which were established by TRIPS, are orientated on those of the EPC. Finally, Figure 2 shows the global patent system under the PCT.

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Figure 2: Global Patent system under PCT (own illustration)

2.4 Basic grant procedures

There are basic procedures for obtaining a patent that are common in all countries. First, the applicant must file an application at a patent office. The application must disclose the invention together with single claims, which contain all aspects of the invention in detail. In order to obtain a patent the application must fulfil the so called patentability criteria, which are defined for example by the EPC as follows:

- involving an inventive step
- be novel
- industrial applicable
- have a technical character and
- meet the formal requirements.

Since an invention solves a technical problem, scientific theories, discoveries or programs for computers without a technical aspect cannot be seen as patentable. Furthermore, there are categories of non-patentable like inventions, which commercial exploitation would be against the public or morality or methods for treatment of the human or animal body. The last one doesn’t exclude products or medicaments for use in such methods.

An inventive step is defined by the fact that the invention wouldn’t be obvious to someone skilled in the art. If the invention doesn’t belong to the state of the art, it is defined as novel.

Searching for the state of the art is one of the main tasks of a patent examiner. Furthermore, an invention is industrial applicable if it can be used in industries. The formal requirements such as a sufficient disclosure of the invention can be found in (EPO Office Journal, 2007). In the end a patent examiner, who has got a certain level of expertise in a special technical field is responsible for the granting process.

For example, at the EPO the granting consists of an examination on filing and a substantive examination. During the phase of examination on filing a formality check and a search includ- ing a search report is carried out by an examiner. The search report, which results from the search procedure, lists documents which disclose similar technical apparatus compared to that in the patent application. The most relevant documents are taken into consideration for deciding whether the application is novel and contains an inventive step. The application is published together with the search report including a search opinion (Extended European Search Report) after 18 month from the date of filing. The search opinion gives a proposition whether the application meets all requirements or not and is sent to the applicant, who has six months to decide whether he wants continue with the application or not. After paying the examination fees³ the substantive examination starts.

The substantive examination is related on the requirements for patentability written down in the EPC. In the end, if the examining division is of the opinion that all requirements are met it grants the patent. Furthermore, within 9 months everyone (e.g. a competitor) can file a pro- test, if he/she is of the opinion that the granted patent shouldn’t have been granted. After examining the opposition either the patent is maintained in the current form (or in a slightly modified form) or it is revoked.

The suitor can file an objection against this decision within two months of the date of notifica- tion. Appeals are debated by EPO’s board of appeal. Once a “European” patent is granted and transformed into a national patent, the holder can take action for infringement at a na- tional court.

While the application process for an “European” patent is harmonized, the enforcement of patent right have to be handled at national court yet. At the moment the formation of a European Patent Court is under discussion (EPO: Working Paper on Litigation, 2004).

3 Economics of Patents

While the foregoing passage describes more technical aspects of the grant procedure and the patent system itself, this chapter provides information about how an optimal patent sys- tem should look like theoretically. From an analytical point of view, the characteristic of an optimal patent design can be described in three dimensions: Patent length, patent width and patent height. Based on the monopoly theory, these aspects are discussed in detail using Nordhaus’s innovation model.

But first, I will focus on the contradiction between offering incentives (temporary monopoly power) for the patent holder on the one hand and social welfare on the other hand.

3.1.1 Function of the patent system

The principle objective of the patent system is to enhance social welfare and economic growth by improving the level of innovation and knowledge within the society. In turn, econ- omy growth leads to technological changes by higher investments in R&D, which in turn yields a higher rate of innovations and knowledge diffusion due to patent protection. One condition which maintains this circle is a sufficiently high entry barrier for granting patents - well known under the key word of patent quality. The author will stress this aspect in chapter

5.6.

Abbildung in dieser Leseprobe nicht enthalten^{4 5}

Figure 3: Idealised circle for the function of the patent system (own illustration)

The named principle objective of the patent system is achieved by the exclusive property right over the invention granted to the applicant and the obligation to disclose technical de- tails in a sufficient manner which allows experts to understand and implement the invention. At this point, it is obvious that an exclusive right yields a competitive advantage over com- petitor and therefore the possibility to demand a higher product price. From a public point of view, that kind of monopoly should be avoided because of undesirable welfare losses for the society. But on the other hand, increased earnings are important for new investments in new technologies, which contribute for welfare gains as well. That is the reason why patents can encourage innovation and economic growth under certain conditions and hamper it under others (EPO: Scenarios for the Future, 2007). The question which has to be answered is which are the conditions or the framework of an optimal patent system in order to enhance social welfare.

Indeed, it is worth noting that the quasi-monopoly for a patent owner is limited for 20 years in general and therefore a competitive situation will be re-established later on. Moreover, the owner is obligated to disclose his invention which could otherwise have been kept in secret. Hence, others might be influenced or inspired to invent further innovations (sequential inven- tion).

Moreover, from the legal point of view there are the patent law and the competitive law in the EU (STOA, 2007) which seem to be in contradiction. But, they have to be seen as complementary in order to enhance innovation and competition. Nevertheless, there might be situations, where a patent covers a technology which shields his holder against his competitor totally. In this case, the competition law serves as a basis for granting a compulsory licence which forces the holder to grant a licence.

3.1.2 Innovation incentives vs. social welfare

In general, an institutional system can be seen as effective if the benefits exceed the costs or at least if there is a balance between both. Concerning the patent system, this means that benefits from technological progress and knowledge diffusion must be (at least) in balance with costs incurred by giving (temporary) monopoly power.

If technological development is important for economic growth which in turn stimulates social welfare, it is necessary to think about incentive systems for inventors in order to reward their efforts. Otherwise, if an invention can be costless copied by a competitor it is impossible to cover the costs of development or even to gain a profit. In order to solve this dilemma there are different solutions imaginable (STOA, 2007).

Firstly, the inventor might keep details of the invention secret. Thereby, an imitation would be difficult and costly, which also would hamper the cumulative effect of inventions. This results in welfare losses for the society. That point shows again the importance of the disclosure regulation in the patent system for producing new knowledge which is available for other for making further developments.

Secondly, the society could directly subsidise the production of knowledge. Nowadays and in the past, this method has been applied mainly in the scientific sector of universities and re- search institutes. The generated knowledge that is freely available serves mostly as a pure base for creating marketable products latter on. The subsidies should be allocated on a gen- eral and broad level (e.g. fundamental research in surface reactions instead of subsidising the development of a specific type of catalytic converter, the same counts for nanotechnol- ogy, biotechnology, environmental technology, nuclear research, particle physics and more). In contrast to a broad and general subsidising of research stands the grant of research pro- jects close to the market. Latter could be encouraged more effectively by a patent system than by a system of subsidies. For further aspects see the discussion made in chapter 4.2.4.2.

Thirdly, a patent system could solve the incentive problem which is again not costless. As mentioned before patent rights produce desirable incentives, but on the other hand a kind of monopoly is created which also raise product prises. Therefore, we are looking for the opti- mal patent design in terms of patent length, and patent width (number of possible claims which are protected by the patent) and patent height (“degree” of novelty). There have been done various studies concerning these aspects. A comprehensive overview is given by (Lampe and Niblett, 2003). But it is difficult to derive a general conclusion. However, it seems that a limited patent length or patent width could be somehow optimal. For example, too broad patents might lead to a strong dependency on a specific patent which hinders further developments by granting their inventors too many rights. Whereas a too narrow patent pro- tection might produce not enough incentives to allocate resource into R&D. Similar state- ments can be drawn for the patent length.

It is therefore evident that the question of an optimal patent design is complex and depends on the specific environment (industrial sector) - what excludes a universal solution for an optimal patent system.

To sum up the situation, it is undisputable that patents create an incentive for innovative in- vestments, but it also creates transactions costs (STOA, 2007). Especially for start-up’s pat- ents are important since it grants them an exclusive market entry, whereas on a long-term perspective patents held by powerful companies can seriously hinder competition which leads to welfare losses.

As (Lampe and Niblett, 2003) pointed out, strong patents (patent length, breadth, height) can encourage innovations but too strong patents could be contrary and reducing welfare.

3.1.3 Innovation models

Before taking about an optimal patent system, it is necessary to describe the process of in- vention itself. Thereby, one may suppose that an R&D lab produce innovations (output) from a given input factor. According to firm’s production function, we are looking for a relationship between R&D investments as an input factor and earnings created by an invention as an output factor. Table 1 shows common innovation models and their characteristic.

Table 1: Overview about innovation models

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As shown in Table 1, there are models which assume a deterministic (Nordhaus, 1969) or a stochastic relationship (Dasgupta and Stiglitz, 1980) between R&D efforts and the outcome of an invention. Without doubt, an inventive activity is somehow uncertain in time and in their realization. Nevertheless it can be argued that the underlying probability density function for an inventive activity is unknown and difficult to measure. Moreover, an systematic procedure in inventing (Zobel, 2001) reduce significantly the uncertainty of time and realisation. Fur- thermore, the deterministic innovation function in the model of Nordhaus can be expressed in terms of expected values as well.

The models of (Wright and Tandon, 1983) as well as of (Dasgupta and Stieglitz, 1980) take into account the competitive process during the phase of R&D. Thereby, additional research labs accelerate the rate of innovation (adding up the single probabilities for the discovery). The inventor, who invent first gets the reward, whereas the others have produced sunk costs (Kotowitz and Schure, 2006). Under certain circumstances, this can increase the optimal patent length in order to reward the inventor since the expected profit of each competitor is reduced (Langinier and Moschini, 2002).

All models assume that innovations are isolated events without an impact of further developments. Roughly spoken, a strong patent protection (high patent length) encourages initial inventors and discourages sequential inventors. This thematic is also related to the question of how strict the novelty requirement of an invention should be in order to separate the subsequent invention from the original invention. A complete discussion about this aspect can be found in (Langinier and Moschini, 2002).

In the following, I will focus on the model of Nordhaus (Nordhaus, 1969), since he has been the first who created a comprehensive model for predicting optimal patent life. Moreover, the mathematical description was geometrically reinterpreted by Scherer in 1972, which simplifies the understanding of an optimal patent life.

Following Nordhaus, we assume that a process innovation⁶ consume R&D costs and reduce production costs. This relation is shown in Figure 4, where the deterministic function B(R&D) relates the expenditures on R&D to the percentage of unit production cost reduction. As shown in Figure 4, there are increasing marginal returns first and then diminishing marginal returns. However, this schematic sketch should depict a possible effect of inefficiency in the long run of R&D projects. The assumed “S”-shaped innovation path in Figure 4 is widely used in managerial decision making processes about the technological evolution. What means that a new technology starts below that of an existing one, crosses the performance of the older and ends finally at a higher plateau. The belief in that cure influence strongly de- cisions about abandoning a maturing technology and embrace a new one to stay competitive (Sood and Tellis, 2005). However, Sood and Tellis found out that instead of an “S” shaped curve, evolution seems to follow a step function. In their empirical research, they analysed 14 technologies (e.g. printers, monitors, memory devices) regarding the shape and the competi- tive dynamics. For the ongoing description of Nordhaus’s innovation model, it is important to keep in mind the discussion on invention’s curve shape. I will exhibit the different conse- quences by using either an “S” shaped curve or a step function in the end of this paragraph.

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Figure 4: “S” shaped curve for innovations (based on: Scherrer, 1972)

In order to understand the market situation before and after launching the invention which is protected by a patent, Figure 5 shows a typical supply and demand diagram.

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¹ Source:http://www.epo.org/about-us.html, accessed 22.04.2010

² The WIPO is an agency that belongs to the United Nations and which was created for the protection of intellectual property throughout the world.

³ Filing a patent can be expensive for the applicant. There are administration fees, translation fees, process costs (set up an application, correspondence towards the office) and maintenance costs (re- newals fees after 20 years). According to a survey in 2003, for a standard Euro patent costs incurred of on average 30.000€ (PCT application destined for Europe on average 46.700 €) (OECD, 2009).

⁴ Standard Poisson process

⁵ Standard Poisson process

⁶ The findings are similar for the case of a product innovation (see also Kotowitz and Schure, 2006)