Antitrust is having its moment. Skepticism about corporate power, a desire to revive state capacity, and a general sense that something is wrong with the current state of American capitalism have revived interest in curbing monopoly across ideological battle lines. Policymakers looking for a way into these debates should consider an important angle that too often goes overlooked: the role of intellectual property.
When policymakers hear about IP at all, it is generally from misleading viewpoints that can be placed between two extremes. At one end is the notion that intellectual property anywhere and everywhere creates monopoly. At the other is a “nothing to see here” approach that treats market concentration and market power as rare exceptions in the IP world.
In reality, the interplay between grants of exclusive rights and competition is complicated and evades simple classification.
A standard economic understanding of intellectual property
To start, let’s briefly consider the conventional economic wisdom on intellectual property. The fundamental component that underlies intellectual property is knowledge. New knowledge promises the creation of products that carry economic value. However, knowledge is not a typical market good; instead, knowledge is a textbook “public good.” First, knowledge is nonrival, meaning that my consumption of an idea does not impinge on the ability of the next user to consume that very same idea. Knowledge is also nonexcludable, meaning that it is costly or impossible for me to prevent others from using a piece of knowledge.
Economists will tell you that markets fail to provide a socially optimal level of public goods — goods such as national defense and law enforcement — absent government intervention. Public goods suffer from the classic free-rider problem: overuse by people who don’t pay for what they consume. In the realm of knowledge, government addresses this problem by creating legally enforceable, exclusive rights that fall under the umbrella term of “intellectual property” (think patents, copyright, trademarks, and trade secrets).
The next thing to know is that economists, as they often do, think about intellectual property in terms of tradeoffs. As pioneering economist Joan Robinson wrote in her 1956 The Accumulation of Capital, “The justification of the patent system is that by slowing down the diffusion of technical progress it ensures that there will be more progress to diffuse.”
However, framing this dilemma as a tradeoff between invention and “monopoly” is misleading. The Constitution grants copyright and patent owners the “exclusive Right to their respective Writings and Discoveries.” But an exclusive right is a feature of property in general, not necessarily monopoly as understood in either the colloquial or technical sense. Patents and copyrights cover more than the ownership of discrete chattel or land, yet they are not necessarily so all-encompassing as to automatically merit “monopoly” designation.
How IP interacts with market concentration, and how in turn that affects the pace of innovation, are questions economists have wrestled with for a long time.
Schumpeter, monopoly and the blessing of bigness?
Before diving into the question of IP and competition, it is fruitful to consider how economists think about the relationship between market competition and innovation in general. Joseph Schumpeter represents a good starting point.
An influential Austrian-American economist, Schumpeter took a sanguine approach to concentration and monopoly. In his famous 1942 book Capitalism, Socialism and Democracy, Schumpeter made the case that large firms with market power accelerate innovation because they have the resources to engage in research and development. Schumpeter saw transient market power as a vital component of the capitalist engine of progress.
A second element of Schumpeter’s theory is the notion that creative destruction opens up opportunities for new products and startups. The pursuit of “spectacular prizes” drives creative destruction and innovation. Schumpeter believed that the upstarts of today could become the monopolists of tomorrow by striking “not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.” The process is highly cyclical; the pursuit of “spectacular prizes” soon drives new rounds of creative destruction, birthing new monopolists as part of the cycle. Patents and other forms of intellectual property facilitate this process by enabling upstarts to better stake a claim to their new inventions. While upstarts dethroning incumbents in pursuit of such spectacular prizes is part of this dynamic, this pressure itself also forces incumbents to look over their shoulders. When “competition disciplines before it attacks,” then both incumbents and upstarts have incentives to innovate — even if the incumbents’ so doing merely forestalls their inevitable decline
However, Schumpeter’s view did not go uncontested. In a seminal 1962 paper, economist Kenneth Arrow argued that competition, rather than the cyclical rise and fall of monopolies, provides inventors with the greatest incentive to innovate. Dominant firms earning profit have a vested interest in the status quo and fail to invest in disruptive technologies with the potential to upend markets.
Monopolistic competition as the best model for IP-intensive markets
So, how does intellectual property impact economic competition and market structure? Or, at least, how should economists and policymakers think about IP and competition? On one hand, the exclusivity granted by intellectual property creates monopoly power only when substitutes are unavailable and entry barriers are high. Still, a growing body of research suggests that intellectual property rights increase market concentration. A 2019 working paper found evidence that patent ownership is highly correlated with market concentration in vital sectors of the economy. Theory would also suggest that strong intellectual property protections can lead to market concentration as firms realize economies of scale.
Authors that would paint intellectual property either as synonymous with monopoly or completely congruent with competition are missing the fundamental nature of IP. So, what would an approach that splits the difference look like?
A start would be for economists and policymakers to bravely venture into the world of monopolistic competition: a form of imperfect competition that may just capture some of the most important features of competition with intellectual property rights.
The defining feature of monopolistic competition is product differentiation. In markets with differentiated products, producers can raise their prices and maximize profits without losing all customers. Firms operating under monopolistic competition offer competing products that are similar but not identical; they also have limited market power.
This aligns well with the analysis of intellectual property. The time-limited nature of both patent and copyrights makes it so they are generally insufficient to produce durable monopoly. However, intellectual property rights often facilitate product differentiation by encouraging the practice of “designing around” — creating something similar to but legally distinct from a competitor’s invention or work. IP rights also allow upstarts to prevent the big guys from blatantly copying their work. This allows firms to stake out their claim around an invention, creating an effective safe zone for them to operate without fear of encroachment but still subject to competition from firms with similar products.
Facilitating product differentiation creates benefits for consumers and competition in the form of improved choice between distinct products. Heartening economic research suggests that monopolistic competition is an optimal market structure owing to its product diversity and innovation.
Alas, economic analysis with monopolistic competition is a tricky affair that doesn’t yield clear insights as to an optimal IP policy across industries and eras. Rather, the lens of monopolistic competition teaches that each market and case deserves its own special consideration.
At the same time, treatment of IP-intensive industries as monopolistic competitors implies a market vulnerable to capture. Because patents and copyrights are structured as private property, they can be sold just like any other tangible asset. The fact that ABC Corp., DEF Inc., and GHI Ltd. all have clear rules preventing them from simply copying one another’s inventions safeguards competition. Still, there’s nothing stopping ABC from gobbling up the rest of the alphabet’s IP portfolio in the same way it could buy them outright. In that world, XYZ startup not only has to navigate the thicket of three firms’ worth of patents: It has to do so going up against the nine-letter behemoth, too.
The monopolistic competition lens is useful, but case studies are necessary to paint a more complete picture. Some examples discussing the positive and negative effects of intellectual property’s influence on competition follow, hopefully shed some light on the subject. Without violating the proviso that this analysis must be treated on a case-by-case basis, one pattern becomes clear: Competition and innovation are protected when there is plenty of opportunity to enter a market through either “inventing-around” or licensing previous inventions. Absent those opportunities, there is a high likelihood that exclusive rights will be abused.
Example: Copyright concentrating the creation and distribution of works
Let’s take the case of copyright in the book publishing industry to help illustrate some elements of imperfect competition with exclusive rights. When an author writes a new book, they find themselves in a market surrounded by other authors with books similar to but not the same as their own. Copyright allows each author to stake a claim around their individual work and block copying. Surely, Ron Chernow’s Grant competes with other biographies of America’s 18th president and other presidential biographies, like David McCullough’s John Adams. Even the most strident IP critics would be hard pressed to say that intellectual property protection leads to monopoly in this instance, especially considering there is no shortage of biographies of John Adams.
Nonfiction is a special case because facts are unprotectable. But things get a bit more complicated when we move into the world of fiction. It is simply not the case that major franchises like Marvel, Star Wars, Star Trek, or Lord of the Rings are the same beast as standalone works like biographies. As franchises that profit from sequels and spinoffs, their interest is to ban not just outright copying, but any use of their characters and background settings.
Preventing outright copying allows investors to get a return on the money and effort put into production. It has the side benefit of incentivizing others wanting to enter the general space to develop something different even if it is quite similar: product differentiation in action. But the space for product differentiation is squeezed shut when the exclusive rights granted are so broad that the fictional world in question is fully controlled by an incumbent.
It’s beneficial for publishers to bid for works like Grant or John Adams while leaving space for competitors to publish American Ulysses and Passionate Sage. What’s less beneficial is a market where only Disney has the final word on what happens in a galaxy far, far, away or where CBS has the sole authority to dream up what strange new worlds the USS Enterprise explores.
A different problem appears when considering the distribution market. Because copyrights can be bought, sold, and transferred, mega-mergers put a large number of works in the hands of just a few actors. Disney’s acquisitions are a case study in this phenomenon. If you are a streamer with little to no original content, this means you have a smaller number of licensors to negotiate with. Worse, if the rightsholder has its own streaming service, it can potentially shut you out of the market entirely.
This needn’t be the case, of course. A rightsholder in an alternative world with a far more liberal licensing policy for the preparation of derivative works or the distribution of existing work can allow competitors to thrive while still collecting “spectacular prizes” on what they have invested in. Holding an exclusive right isn’t harmful, but weaponizing such exclusivity to prevent competition and a breadth of available products is.
Example: Pharmaceutical inventions with no room for error
Vigilance against monopoly is especially necessary when there is little or no room to “invent-around.” In the media world, copyright’s protection is sufficiently narrow that entry and disruption is still possible. And the stakes are relatively low. But the opposite is true in the case of pharmaceuticals, where drugs are highly targeted. It will always be possible to create a new fantasy epic. It’s far harder to come up with a radically new way to treat a given sickness.
Market concentration is particularly high in the pharmaceutical industry, and many drug companies can behave as monopolists within their respective markets. It’s difficult to argue that there is plenty of competition in the pharmaceutical industry because a rival drugmaker has a treatment or cure for a separate disease. And looking at the extraordinary decline in prices associated with just one firm offering a generic alternative to a drug, it’s clear that grants of exclusive rights do enable monopoly behavior.
What’s more, these monopolies are entrenching themselves using the patent laws. A 2021 report from the House Oversight Committee found that pharma companies work to extend the exclusivity of their rights long past the 20 years outlined in the Patent Act as part of a deliberate strategy to preserve profits, not to develop new and innovative products. The current system is Schumpeter gone wrong; it’s monopoly power without end. The entrance of upstarts is simply out of the question when the big companies have the dubious ability to extend their legal monopoly. Combine this with incumbents buying up younger, more innovative firms to pad their patent portfolios, and there is a strong case that the intellectual property system is being abused in the single sector of the economy where the stakes are, perhaps, highest.
A possible course correction would see the government encouraging licensing provisions while scrutinizing the old patents and dubious litigation techniques which help name-brand drugs to dominate the competition. Careful IP reform might just hold the key to the drug price problem, kick-starting both product differentiation and long-dormant market forces.
Example: Leveraging industry standards to squeeze competitors
Moving out of the pharmaceutical industry, it is also possible for companies to wield market power by preventing competitors from accessing Standard Essential Patents (SEPs). An SEP begins its life as any other patent. But if it protects a technology that winds up becoming a standard necessary for any player in a given industry to innovate and compete meaningfully, standard-setting organizations can designate it an SEP and, per contractual agreement with the patent holder, require it to be licensed under fair/reasonable and nondiscriminatory (F/RAND) terms.
But there is significant potential for abuse. In one notorious case, Qualcomm used its patent on standard technology that connects cell phones to networks in ways critics, including the Federal Trade Commission, alleged was anti-competitive. To simplify the facts, Qualcomm required that the purchasers of chips purchase a license before they could use them and did not license the patents to direct competitors. The FTC sued, but Qualcomm ultimately prevailed on appeal.
Qualcomm-standard chips go into a wide variety of products, many of which compete with each other. Yet, the Qualcomm SEPs functioned like castles along the Rhine to block access for those unwilling to pay a toll to go downstream.
A patent system that encourages the development of a technology so valuable that everyone in a given industry utilizes and relies upon it is a system worth celebrating. But when that reliance goes from participants paying proper tribute to inventors to paying ransom just to go about their business, problems emerge.
The existence of standards introduces a wrinkle into the typical analysis of IP and a potential threat to competition. The problem requires legislators and courts, as discussed above, to make policy changes that would create a more favorable environment to licensing standard essential patents. Without a steady hand on the tiller “inventing-around” and healthy licensing wither and die.
Moving out of the pharmaceutical industry, it is also possible for companies to wield market power by preventing competitors from accessing Standard Essential Patents (SEPs). An SEP begins its life as any other patent. But if it protects a technology that winds up becoming a standard necessary for any player in a given industry to innovate and compete meaningfully, standard-setting organizations can designate it an SEP and, per contractual agreement with the patent holder, require it to be licensed under fair/reasonable and nondiscriminatory (F/RAND) terms.
But there is significant potential for abuse. In one notorious case, Qualcomm used its patent on standard technology that connects cell phones to networks in ways critics, including the Federal Trade Commission, alleged was anti-competitive. To simplify the facts, Qualcomm required that the purchasers of chips purchase a license before they could use them and did not license the patents to direct competitors. The FTC sued, but Qualcomm ultimately prevailed on appeal.
Qualcomm-standard chips go into a wide variety of products, many of which compete with each other. Yet, the Qualcomm SEPs functioned like castles along the Rhine to block access for those unwilling to pay a toll to go downstream.
A patent system that encourages the development of a technology so valuable that everyone in a given industry utilizes and relies upon it is a system worth celebrating. But when that reliance goes from participants paying proper tribute to inventors to paying ransom just to go about their business, problems emerge.
The existence of standards introduces a wrinkle into the typical analysis of IP and a potential threat to competition. The problem requires legislators and courts, as discussed above, to make policy changes that would create a more favorable environment to licensing standard essential patents. Without a steady hand on the tiller “inventing-around” and healthy licensing wither and die.
Example: Competition today, monopoly tomorrow in repair markets
A final example worth considering is the relationship between aftermarket repair or upgrade of devices and concentration.
Repair and its associated markets, by definition, deal with what happens after the original devices have been sold. How competitive the market for a product is on the front end is immaterial to the repair market. While a product made up of countless patented inventions or lines of code protected by copyright does come with a form of exclusivity, it is entirely possible to have a market with healthy competition in that space.
But what happens after you drive your car off the lot, or unbox your iPhone? If the original equipment manufacturer (OEM) controls the market for repair services and parts, then the consumer has unwittingly become entrapped in a monopoly. The competitive market for new devices is available to you, of course, but there are massive switching costs associated with buying something new. If there isn’t competition for the products and services that make products work for their useful life, then the outcome can be as problematic as in a monopoly for the original purchase.
Conclusion: One size doesn’t fit all
Very few cases involving intellectual property lend themselves to simple interpretation. In most markets, patents are no guarantee of longevity or even monopoly rents. However, perfect competition remains a tenuous ideal in a world of intellectual property. The prospects of imperfect competition and potential industry abuses loom large; they ought to define the thinking and capture the attention of both economists and policymakers.
What this moment demands is both an acute awareness of the interconnectedness of competition and intellectual property along with a rejection of the old dogmas. Monopolistic competition and context-dependent analysis promise a rich and intellectually honest debate: a debate that discards once and for all the Fata Morgana of perfect competition and, on the opposite end of the spectrum, the misplaced prejudice against intellectual property of any stripe.