The reward and contract theories of patents in a model of endogenous growth

Abstract

I develop a general equilibrium model of endogenous growth to jointly analyze two distinct theories of the patent system’s social value: (1) that patents stimulate innovation by enhancing private incentives to invest in R&D (reward theory) and (2) that patents disseminate technical information into the public domain through disclosure requirements (contract theory). The model features endogenous innovator selection into patents versus secrecy based on heterogeneous innovation size, the effective cost of disclosure, and expected licensing revenue from holding a patent. Innovation is cumulative, patent rights overlap across industries, and new innovators pay mandatory licensing fees to a subset of previous innovators if those innovators hold a patent. The economy’s endogenous patent propensity determines each new innovator’s licensing burden, consistent with the concept of patent thickets. The model captures the inherent tension between the two objectives of the patent system. In most cases, I find that stronger patent protection stifles innovation and reduces social welfare.