Previous Section of the Notes

• O. Digression on simplified pictures.
  • A. In thinking through the logic of a problem, whether in physics, mathematics, or economics, we frequently use simplified pictures, designed to bring out the particular issue we are interested in.
  • B. For example, we worth out the logic of Newtonian motion by analyzing the trajectory of canonballs in a vacuum--without worrying about the fact that in a vacuum, the canoneers would die before they could fire their cannons.
  • C. Similarly, much of what we are doing in this course involves deliberately simplified pictures, intended to let us think through the logic of one problem or another.
  • D. After doing so, one is better equipped to deal with the much messier conditions of real life problems.

   

• I. Property: The institution, not "vs liability"
  • A. What is special about property?
    • 1. Good against the world.
    • 2. Unlike contract.
  • B. The alternative is commons--things nobody owns and anyone may use.
  • C. Argument for property--why plant if I can't harvest?
  • D. Are there arguments against property? For example:
    • 1. Should the English language be property?
    • 2. Should all inventions, however trivial?
    • 3. Fictional characters?
    • 4. Air? Water? Oceans? Fish?
  • E. Application we will shortly get to--intellectual property.

   

• II. Costs: Why everything isn't property.
  • A. Cost of defining and measuring: The floating island.
  • Stack island, which belonged to someone, floated down the Mississippi (erosion at the upstream end, deposition at the downstream end), into a strip of the river where all islands belonged to the owner of the land on the west bank of the river. Who did it belong to?
    • 1. Why fish are not property--despite the obvious depletion problem.
    • 2. We could make fishing grounds, streams, etc. property--which solves the problem if fish stay put.
    • 3. What did Morse invent?
      • a. His patent application for the telegraph claimed all ways of using the electromagnetic power to transmit words or images to a distance.
      • b. The point being that ideas do not have obvious and natural boundaries around them
      • c. Which is a problem for patent law, which gives people property in ideas.
      • d. The court found that claim to be over broad.
  • B. Enforcement cost--the bionic burglar alarm.
  • Consider a primitive people trying to decide whether land should be private property or a commons. The cost of private property includes the cost of guarding it--there is no point in my planting wheat if my neighbor is going to come by at night and harvest it for himself. That cost was substantially lowered by the domestication of dogs, since dogs, being territorial can learn to identify their master's property and bark at trespassers. Perhaps that was what tilted the balance in favor of private property. If so, we may owe most of human civilization to the dogs.
  • C. Transaction costs: Owning English, a very quiet story.
    • 1. Hunting large animals across small plots.
      • a. Foxhunting conflicts in England.
      • b. Why you might want sharing rules in a primitive hunting society.
    • 2. Why there are all you can eat salad bars, spaghetti bars, but ...
    • 3. Rarely steak
    • 4. Because the deadweight cost of selling something for zero is larger the larger the cost of the something. See figure. The grey triangle is deadweight loss on units of food that are worth less to the consumer than they cost to produce.

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  • D. Rent seeking costs.
    • 1. Patent races. If I make my invention a day before you do, I get all the rights to it, you get none. So there is an incentive for an inefficient competition to be first.
    • 2. This should not be a problem for copyright. Nor is it a problem that someone who builds a house or an automobile in order to end up owning it. What is the difference?
    • 3. Crucial difference--homesteading or a patent race takes something from the commons. It eliminates a valuable opportunity (to homestead that piece of land or make that invention) that others previously had. The other examples do not.
    • 4. In other words, such an act confers a negative externality on others.
    • 5. But this may be a good thing if there is a positive externality to be balanced.
      • a. Perhaps the homesteading law was a good idea, because settlement that was "premature" in terms of the profit of farming to the farmer was not premature in terms of total costs and benefits. The first settlers might provide a "defense externality" by each making it easier for the others to defend themselves against Indians (or Canadians in the Pacific Northwest or Mexicans in the southwest).
      • b. Similarly, the inventor generates not only knowledge that he owns (how to practice his patent) but also knowledge (how to make other inventions outside of the patent, by using unpatented parts of his idea) of value to others. This is an argument for giving him a benefit in exchange (at other people's expense), but it is not an argument for making the benefit depend so heavily on when he makes the invention, since we get very little extra from his making it a week earlier--which may be what gives him the patent.
      • c. How soon we want something invented depends in part on how rapidly the cost of inventing it is falling with time. If it costs the same amount to invent it this year as next year, we might as well invent it this year; if it will cost a tenth as much to invent it a year later, we might be better off waiting. One advantage of trade secret protection over patent protection is that it gives qualitatively correct incentives in this regard. The faster the cost of inventing something is falling the shorter the period for which you can expect to maintain it as a trade secret, hence the lower the incentive to invent it early.
  • E. Note that all of these things depend in part on the relevant technologies:
    • 1. Photocopying means that some copyright are not, in practice, enforceable.
      • a. Contrast c. 1900, when you could enforce property rights you didn't have.(see below--British authors selling in the American mareket)
      • b. Now you can enforce against mass copying and sale, or against organizations that might have dissatisfied employees who know Bill Gates' email--but not against individuals.
    • 2. Ditto in spades for software copyrights
      • a.--and it will get worse. Computer networks, encryption, anonymous remailers, etc. are moving us towards a world where firms can operate anonymously with brand name reputation--making it possible to have a pirate archive, openly selling pirated software for digital cash.
      • b. But technology may come to the rescue. If you can tag each copy of your work that you sell, you can require the buyer to be liable if copies of his copy appear on the market--thus using contract law to replace intellectual property law.
    • 3. If you could tag animals, fish, whales, etc. it might be practical to make them private property.
      • a. You would want a method that included their offspring.
      • b. Genetic tags?
      • c. Own a species? The owner would have an incentive to pay for research on species diseases, etc. But a hard property right to enforce, since the members of the species are not under his eye.

   

• III. Benefits: Why Elasticity Matters
  • 1. What is the cost of leaving a positive externality external? That depends on how much the reduced incentive reduces output.
  • 2. I get only part of the benefit from not dressing horribly or not having a deliberately ugly house. But since it costs me very little (perhaps less than nothing) to do those things, even part of the benefit is enough--so few people have deliberately ugly clothing or houses.
    • a. In such situations, a problem arises only when tastes differ--so that your "deliberately beautiful" (or at least "desirable in some way") is my "deliberately ugly" (punk haircuts, for example).
    • b. Or when one party is malevolent and wants to hurt the other.
    • c. Or when one party is engaging in extortion--imposing costs on others in order to be paid to stop doing so. Most people are strongly committed to a strategy of not giving in and paying off in such situations.
  • 3. Would there be "almost enough" intellectual property even without protection?
    • a. Reputation and other tie-ins provide some incentive. People wrote books, poems, etc. long before the invention of copyright (Homer, Dante, ...). The first firm to come up with a product has a first mover advantage--consumers identify the product with that firm. The first firm may be able to establish standards, and consumers are uncertain whether other firms are successfully imitating them.
    • b. c. 1900 the U.S. did not recognize British copyrights, yet British authors got sizable royalties from their American sales. With large fixed costs and time delays due to typesetting, the first publisher (who got the manuscript from the author) had a sizable advantage over pirates (who had to wait for the first publisher to print his edition before they could start pirating it). Lotus has no patent on the idea of a spreadsheet (which would have gone to Visicalc anyway), yet has a large first mover advantage.
  • 4. A related issue is the supply curve of the copier. A good which is very expensive to copy (paintings, at least until recently, live lectures--although Hal Holbrook's Mark Twain performances may be a counter-example) may not need intellectual property protection.
  • 5. A related issue raised by Kitch is whether it is important to coordinate the production of intellectual property in some area, in order to make sure six people are not working on one part of the problem and none on another. Ownership of the area via a patent is one way of doing this. The owner can hire everyone else, or subcontract, and coordinate their efforts.

   

• IV. Intellectual Property: The Law
  • A. Copyright:
    • 1. According to the constitution, copyright protects "writings." What is a writing?
      • a. Is a computer program a writing?
      • b. Is a work of music? Yes
      • c. Is a drawing? Yes.
    • 2. What is protected is the expression, not the idea, but ,,
      • a. That isn't a clear distinction.
      • b. Derivative work--a translation is covered by the copyright of the original
      • c. So is a movie.
      • d. Is a superhero like Superman and expression (of the idea of ?) or an idea? Superman won the suit.
      • e. A lot of the recent action is in software copyright. Is the interface of Lotus 123 an expression or an idea?
    • 3.The protection is given on request. Anything you write is automatically copyright. Registering it gives you statutory damages--otherwise you can sue to make someone stop violating your copyright, or for actual damages.
    • 4. The protection lasts for a long time--life +50 years, 99 years, etc.
    • 5. It is not good against an independent creator--but that rarely happens.
  • B. Patent: Protects an idea.
    • 1. What is your idea? You answer that question in drafting your patent application--your claims define the boundaries of what you are claiming.
    • 2. Must be novel, non-obvious
    • 3. Meaning (roughly) that someone skilled in the art could not work it out for himself, on the basis of publicly available information, and ...
    • 4. Nobody has actually implemented your idea before--which is an argument for narrowing your claims.
    • 5. Must be useful:
      • a. 19th century interpretation--not pernicious. Cigar story. Artificially mottling tobacco made consumers believe it was of high quality, hence a fraud, hence pernicious--but not illegal. So the infringer argued that the patent was invalid--and he could commit the fraud too.
      • b. Current interpretation--positively useful. A process for synthesizing a chemical with no known uses is not patentable.
    • 6. You must have priority--first to invent. Elsewhere in the world the rule is first to file.
    • 7. Protection is short--14-21 years at various points in U.S. history.
  • C. The case of computer software:
    • 1. Is it a writing, hence copyrightable?
      • a. Some early cases said "no," since a machine language program is intended to control a machine, not be read by a human being.
      • b. They analogized it to a player piano roll in an early case, which was found not copyrightable.
      • c. Hersey (author and head of PTO) analogized it to an elaborate cam.
      • d. But when Congress revised the copyright act, they included software.
    • 2. Is it an invention, and patentable?
      • a. Early cases clearly held "no" under the mental steps doctrine. You can't patent the procedure for long division--and a computer program can be considered a description of a set of things to do.
      • b. But you can patent a machine--which a programmed computer is.
      • c. Or a process--which a program in some sense is.
      • d. The Supreme Court was dragged by the CAFC (Court of Appeals for the Federal Circuit--a specialized court created in part to handle patent cases) into effectively reversing itself, via the idea that although you could not patent an algorithm, a process using a computer program could be patented
      • e. So that now, in effect, programs are patentable--you just have to draft the application correctly.
      • f. An encryption algorithm is a process for transforming plaintext into cyphertext and back again--and patentable.
• V. Intellectual Property: The Economics
  • A. The basic arguments for protection are:
    • 1. Incentive to produce.
    • 2. Reduce or eliminate the costs associated with secrecy.
    • 3. Ability of the owner to coordinate further development--Kitch's prospect theory.
  • B. The arguments against protection are:
    • 1. Problem of defining the borders, observing trespass, etc.
      • a. Literal copying is easy to define and recognize, subject to some enforcement problems (i.e. individual copying is effectively invisible)
      • b. Non-literal infringement is more of a problem.
      • c. Ideas have much fuzzier borders, hence patent infringement is a much messier area than copyright infringement.
      • d. Which is a good reason for giving copyright protection more easily and for a longer term.
    • 2. Depleting the commons problem:
      • a. The chance that two people would independently write the same book is very close to zero, so when I write a book and copyright it I do not significantly limit your opportunities, so there is no significant negative externality, rent seeking problem, etc.
      • b. But two people working in the same area might easily come up with the same (or overlapping) ideas, so there is a serious commons problem in patent law. Indeed, there is often ligitation over who has priority when two labs were working on the same problem.
      • c. Hence the revenue from licensing a patent might well overstate the social value of what was produced.
      • d. Which is a good reason for giving patent protection only to non-obvious inventions (because they are one where a large part of the value is contributed by the inventor, not taken from the commons) and for a limited term (because someone else probably would have invented the same idea eventually, so the first inventor should only get rewarded with the benefit of having it earlier, not the full value of the idea for ever).
    • 3. Elasticity, ease of copying issue?
      • a. Arguably, copying writings is much easier than copying ideas, since all you have to do is photo-offset--no engineering required.
      • b. In which case eliminating copyright protection would reduce writing more than eliminating patent production would reduce invention.
      • c. By the same token, trade secret is much more practical for patent (Scientology as counterexample--they claim that their "religious texts" are trade secrets)
      • d. Which can be an argument either way--patent is unnecessary, because there is an alternative, or necessary, to prevent pushing people to the expensive alternative.

   

• VI. Trade Secrets:
  • A. The law:
    • 1. Trade secret law does not establish a property right--if someone gets possession of the trade secret without doing anything wrong (by reverse engineering, for example) he has a legal right to use it.
    • 2. It does establish rights against those who have gotten the trade secret wrongfully--by theft, or violation of an employee's duty to his employer, or ... .
    • 3. And limited rights against those they transmit the secret to.
      • a. If you find out that what you have is a stolen trade secret before you do anything with it, you are not allowed to use it, but ...
      • b. If you have already build the factory to employ the trade secret, so that not being able to use it would leave you worse off than you were before, you can run the factory.
    • 4.
      • Dupont v Christopher.
      • a. Dupont was building a new factory to employ a new chemical process.
      • b. Someone hired an aerial photographer to fly over the factory and photograph it--presumably in order to learn the process.
      • c. The court found that Dupont had a trade secret claim, even though the overflight was legal.
      • d. The justification was, in part, that it was unreasonable to require Dupont to keep their factory covered while they were building it. In other words, trade secret law as a way of reducing the cost of protecting trade secrets.
      • e. But that ought to imply that reverse engineering violates trade secret law--and it doesn't.
      • f. So this case is an outlier--one that states a legal principle not accepted by most courts.
    • 5. Scientology cases
      • a. The Church of Scientology charges people large amounts of money for a training process that is supposed to eventually make them into supermen (with lesser benefits along the way).
      • b. The "scriptures," alias "technology," used in this training is kept secret--held under lock and key, with people allowed to read it only on the church's property.
      • c. The Church of Scientology has sued people for publishing copies of this material--as a violation of trade secret as well as of copyright.
      • d. So far they have won their copyright claims but lost their trade secret claims--not because the material is not in principle protectable, but because once one person has posted it on the net it is no longer a trade secret, and a second poster is therefor not liable. And things can be (and were) posted anonymously.
      • e. On the other hand... current litigation (the CoS has been involved in a lot of litigation, mainly with ex-members) has raised the claim that the CoS doesn't really own the copyrights, due to a variety of complicating factors irrelevant to this course. If you are interested in what is really a fascinating story, part of which is presently playing in a San Jose court house, read the newsgroup alt.religion.scientology, or search the web for scientology related material.
    • 6. Reverse engineering the ROMs:
      • a. Trade secrets are not protected against reverse engineering (figuring out the trade secret by taking apart, analyzing, etc. the physical objects embodying it). Copyright is protected against copying or the making of derivative works, but not against independent creation.
      • b. Suppose I very much want to "independently create" a copyrighted work.
      • c. To be more specific, suppose I want to build an IBM PC clone. The software build into the PC's read only memory is copyrighted, so I can't legally copy it. But the software in my clone has to function exactly the same way, in order that programs for the IBM will run on it.
      • d. The solution is "clean room" reverse engineering. Team A looks at the IBM ROMs and writes out a detailed functional specification of exactly what they do. Team B is never allowed to look at the ROMs. Instead, they read team A's specifications, and write code that does exactly what team A says the original ROMs did.
      • e. Since copyright protects only expression not idea (in this case code but not function), this does not violate copyright law.
  • B. Is trade secret law preempted by patent law?
    • 1. In other words, does the fact that the Federal government controls intellectual property via patent law mean that the states cannot provide protection through trade secret law?
    • 2. The general rule is that this depends on whether the state protection interferes with the objectives of the federal protection.
    • 3. For example by giving inventors an incentive not to seek patents--since one objective of patent law is to make inventions public information, so that other inventors can build on them.
    • 4. In two cases (Sears v Steiffel and Compco v Daybright) the Supreme Court found that state IP protection that amounted to the equivalent of patent protection was preempted, and thus invalid.
    • 5 But a later case found that ordinary trade secret protection, as described above, was not preempted and thus was enforceable.
  • C. Not entirely--and shouldn't be.
    • 1. Trade secret fills in the gaps in our one size fits all patent system.
    • 2. By providing some protection for inventions that
      • a. Are unpatentable.
      • b. Or the PTO mistakenly believes are unpatentable, or
      • c. Are even more non-obvious than the patent law assumes--and thus deserve longer protection.
    • 3. There is no problem of over rewarding, since the secret is still in the commons--other people can invent it for themselves.
  • D. Plug mold statutes.
    • 1. What they are.
      • a. Sometimes it is possible to use a physical object in the process of making a mold to produce a duplicate.
      • b. For example, buy a (very well designed and successful) boat hull, and use it to make (and sell) exact copies.
      • c. Or do similar things with car parts
    • 2. Florida passed a statute to prohibit copying boat hulls in this way, other states passed other plug mold statutes.
      • a. In effect, they provided copyright protection against physical copying.
      • b. This makes sense, just as copyright for computer programs are. A boat hull is not a writing, but the economics of how it ought to be protected is just about the same.
    • 3. The court struct down such statutes, holding that they were preempted by patent law. The theory may have been that while such laws might be useful, they ought to be done on a national rather than a state level.

   

• VII. Coase Article: Classic article that laymen, or at least econ majors, can read.
  • A. The problem associated with an externality is jointly caused--the result of actions by both parties.
  • B. Farmer and cattleman, outcome does not depend on who is liable1. But bargaining, attempted extortion, etc., is possible
    • 2. So Coase's result holds when everything has been bargained through
    • 3. i.e. in a zero transaction cost world.
  • C. A bunch more cases with the same logic:
    • 1. Confectioner/doctor
    • 2. Bleaching coconut matting
    • 3. Blocking the draft of a chimney. Who "caused" the nuisance? Both.so
    • 4. Each should bear the full cost--and will under either rule with bargaining.
    • 5. Jolly Anglers brewing. Confined channel of air is presumptively property, byrule of lost grant belonged to the brewer. So the verdict is the opposite from thatin the chimney case--which also involved blocking an (unconfined) channel of air.
  • D. Judge's grounds for deciding the cases seem irrelevant to economist, but ...
    • 1. Perhaps all that matters is a predictable rule, (to reduce uncertainty andrent seeking) and the judges have one, or ...
    • 2. Perhaps the rule is a proxy for relevant considerations, such as
    • 3. Coming to the nuisance.
      • a. I have a pig farm; the city expands towards it.
      • b. When you build a housing development next to me, can you enjoin my pig farmas a nuisance, or ...
      • c. Can I win by arguing that you "came to the nuisance?"
      • d. The economic argument is the assymetry of sunk costs: It is cheaper for youto "move" your housing development before you build it by building it somewhereelse than for me to move my pig farm, which is already there.
      • e. So the doctrine of coming to the nuisance, which sounds like a moral argument,may make sense as an economic one.
      • f. Or at least as a rule of thumb. Consider the case where, even before you buildyour development, the value of the land it would be built on is drastically loweredby the existence of my pig farm.
      • g. Of course, that problem may get solved on the market--as someone buys up thepig farm and the surrounding land in order to shut down the pig farm and resell theland at a big profit.
      • h. In fact, in modern American law, courts mostly reject the doctrine. Shouldthey? Not clear.
  • E. A firm is one solution to the transaction costs of the market
    • 1. Consider a shopping mall.
      • a. The owner provides free parking, and makes his money back in store rentals.
      • b. He figures out what mix of stores, restaurants, etc. will make people wantto come, and so maximize the total return
      • c. He keeps the public areas clean
      • d. In fact, he provides a centralized alternative to nuisance law, government,etc.
    • 2. Whether it makes more sense to solve problems by putting both actors into onefirm depends on the tradeoff between administrative costs of the firm and the alternativemarket costs.
      • a. A shopping mall is actually a compromise.
        b. One firm owns the mall--but it rents out the space to independently owned stores.
        c. The complete single firm solution is not a mall but a department store--and theyseem to be losing out to malls.
        F. Government regulation is another solution
    • 1. Which has costs, and errors, and so may give worse results than the other solutions
    • 2. Or better.
  • G. And a final solution is to do nothing. Some problems cost more to cure than the cure is worth.
    • 1. That is how we deal with lots of externalities
    • 2. Positive ones like beautiful buildings, and
    • 3. Negative ones like people wearing ugly clothes.
  • H. Where transaction costs are high, court decisions matter, and cases suggestat least some general recognition of reciprocal problem and cost/benefit issues.
     

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