Patents and the division of innovative labor

Abstract

Comment on “Specialized supply firms, property rights, and firm boundaries” by Ashish Arora and Robert Merges Arora and Merges (A&M) bring up a fairly unexplored topic. There is a growing economic and managerial literature on patents and intellectual property rights (IPRs). However, little attention has been paid to the implications of stronger or weaker IPRs for the vertical specialization of industries (Grindley and Teece, 1997 or Teece, 1998 being exceptions). According to A&M, an underappreciated implication of well-enforced patents is that they raise the bargaining power of smaller technology specialist firms in transactions in which they supply their technologies. Asymmetry in size and bargaining power is common in these transactions. Many technology specialist firms are small compared to the technology buyers (often large manufacturing companies). The problem arises because the specialists have no means to appropriate the rents from their inventions other than a legal stake on them. Weak IPRs then have two consequences. The technology suppliers may try to integrate downstream to secure the rents on their technologies by embodying them in the final products, a point made by Gans and Stern (2003). Alternatively, they have not enough incentives to create the technology in the first place. As a result, weak IPRs limit the division of labor because either the technology specialists become integrated firms themselves or the manufacturing firms have to integrate upstream since there are too few independent suppliers around.