The Welfare Economics of Invention

Abstract

This essay is not an attempt to analyse or assess the whole complex of forces that cause the market for inventions to function in a suboptimal manner. In spite of the obvious practical relevance of risk, a model of the market for inventions is constructed here on the assumption of perfect foresight. Furthermore, no allowance is made for conventional investment or technical change other than a single invention, nor for the subtle relations among the branches of research that cause investigation in one area to cast light in unexpected ways on problems elsewhere, so that most research yields at least some useful by-products that cannot be appropriated by any . Invention is examined here as the most complete and perfect form of the deviation from a Pareto optimum classified under the heading of indivisibility. An invention is the production of a production-possibility curve. In so far as invention adds to society's stock of knowledge, invention has something in common with ordinary investment that augments the stock of standard factors of production. Investment in knowledge differs from investment in things in that knowledge once acquired can never be used up. It is like a road broad enough to accommodate any amount of traffic without congestion and durable enough never to be in need of repair. As the use of existing knowledge has no alternative cost, its optimum price is zero and the owner of knowledge is uncompensated. A patent system is required to create an artificial and uneconomic scarcity of newly-created knowledge so that profit-seeking people or firms have an incentive to invent. At this level of abstraction the patent system is surely the lesser evil. All the same, it causes the behaviour of the competitive system to deviate from a Pareto optimum in a number of ways. Subject to a battery of simplifying assumptions it will be shown that (1) any commercially profitable invention confers a net benefit on the community as a whole; (2) the patent system causes under-production of the newlyinvented product; (3) some inventions are worth undertaking to the community as a whole even though they are unprofitable under the patent system; and (4) the patent system results in under-investment in productivity. These four propositions are derived directly from a simple model of the market for inventions. A fifth proposition is suggested by the model without actually being an implication of it. This final proposition is that (5) commercially profitable inventions tend to provoke wasteful competition.