Imperfect Patent Protection and Innovation

Abstract

We present a model of process innovation that offers an explanation for the negative relationship between patent strength and R&D investment. We show that under the popularly used damage rule of reasonable royalties, the innovator might favor imitation. Since imitation is discouraged for strong levels of patent protection, we find that R&D investment is often maximized for an intermediate protection level. In addition, an increase in patent protection can enhance the innovator's reliance on damages. This, in turn, can reduce the innovator's incentives to pursue R&D because the compensation is not directly linked to the size of the innovation. These findings have an important policy implication: when the equilibrium investment is below the socially efficient level, a further reduction in investment as a result of stronger protection decreases social welfare. Furthermore, we observe instances in which overinvestment occurs in equilibrium. In this case, if stronger protection generates more R&D investment, a socially desirable policy calls for weaker patents.