New OECD report on intellectual property

The OECD has released a new report entitled Enquiries Into Intellectual Property’s Economic Impact. The report is part of Phase 2 of their project on New Sources of Growth: Knowledge-Based Capital. A summary of the finding of Phase 1 is contained as an annex in the new report and a synthesis report is available as a stand-alone document on-line.

[Note: Phase 1 of that project was kicked-off at a 2011 conference organized by Athena Alliance. As the result of that conference, we produced two reports. The first, Intangibles Conference Report September 2011 is our official report on the conference to OECD. The second, New Building Blocks for Jobs and Economic Growth: Intangible Assets as Sources of Increased Productivity and Enterprise Value -- Conference Observations, is my observations and synthesis. For more on the conference, including background papers and reports from the sessions is available at the conference archives. In 2013 OECD published Supporting Investment in Knowledge Capital, Growth and Innovation. This book-length report was the culmination of Phase 1. An Athena Alliance working paper, Knowledge about Knowledge: The OECD Project on Knowledge-Based Capital by Dr. Brian Kahin analyzed that report.]

The new report contains an overview/synthesis chapter and a number of analytical background papers. These include: “Measuring the Technological and Economic Value of Patents”; “Approaches to the Protection of Trade Secrets”; “An Empirical Assessment of the Economic Implications of Protection for Trade Secrets”; “Copyright in the Digital Era: Country Studies”; and “Legal Aspects of Open Access to Publicly Funded Research”. I was particularly interested in the chapters on “IP-Based Financing of Innovative Firms” and on “Design and Design Frameworks: Investing in KBC and Economic Performance”. The “Summary of the Expert Workshop, ‘Society’s Gain from the Intellectual Property Exchange’” was also very insightful.

Chapter 9 on “IP-Based Financing of Innovative Firms” explores a topic that Athena Alliance has spent a great deal of time on. [See "Commercialization of University Research - Using Intangible Asset Financing", "Intangible Assets in Capital Markets", "Intangible Assets: Innovative Financing for Innovation", Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance.]

The paper does a good job of summarizing the current situation:

In this context, intellectual property (IP) assets have two attractive features that may help firms to unlock new investment or obtain more favourable financing conditions. First, IPRs help to reveal to investors the quality of the firm’s management and of its technological capabilities. Second, as legally protected economic resources, IPRs can raise the projected profitability of a firm, and can be separated from the business and sold in case of financial distress. Notwithstanding these properties, IP-based finance appears to be under-exploited across OECD economies, especially with respect to those young SMEs who need to open new financing channels. To stimulate a more efficient use of IP-based finance, the governments of many countries are making increasing efforts to understand why IP-based finance is not well developed and are experimenting with new policy actions and initiatives.

Some of those barriers stem directly from the economic market problems of information asymmetry and various forms of moral hazard that limit financing of innovative companies. The paper also points out some of the practical difficulties of using IP for financing, including the problem of valuation and the fact that many small innovative companies tend to use informal mechanisms of protection such as trade secrets rather than formal patents. Other barriers include IP may be hard to redeploy with the accompanying assets such as other IP and employee know-how; IP exit markets are still immature; transactions costs for IP as collateral are high; and banks do not sufficiently understand IP assets

Policies to overcome these barriers include strengthening IP markets, including the creating sovereign patent funds. More direct ways of fostering the utilization of IP in financing involve government funded risk-sharing mechanisms either directly or through risk insurance. The paper also calls for building awareness and trust in IP financing. They note that improved corporate reporting of IP and other intangible assets will increase awareness of these valuable forms of capital.

Chapter 6 is on “Design and Design Frameworks: Investing in KBC and Economic Performance”. It looks at the nature of design as an intangibles asset and the mechanisms for treating design as intellectual property (“design-related IP”). The latter issue is of specific interest as nations have differing view of design-related IP. As the report points out, “Various nations and governing bodies use different terms for design intellectual property: Registered design, registered community design, design model, design patent, industrial design, etc.” Certain designs, such as websites, can also be protected under copyright. Trademarks and design are also linked. Confidentially agreements (a form of trade secrets) also play a role as an informal form of IP. The report explores issues in these areas and for numerous countries. Importantly, the report discusses the many non-IP means of protecting a competitive advantage via design. These include time-to-market, complexity, and tacit knowledge. As such it serves as an excellent primer on the subject.

The chapter recognizes the split personality of design as an intangible asset. One the one hand, it is a factor of production with an investment input (i.e. activity of design professionals) and an output (i.e. the ascetic and functional characteristics of a product or service). It is also an innovation process (aka “design thinking”). The report mostly focuses on the role of design as a factor of production, including a good discussion of measuring the value of the design inputs and the value-added of the outputs. However, while I understand the report is focused on intellectual property, I would have liked to seem more about the design-thinking process as an important intangible asset.

Chapter 8, the “Summary of the Expert Workshop, ‘Society’s Gain from the Intellectual Property Exchange’” was deliberately structured to look at topics not covered in the other sections. It could not help, however, to touch upon topics covered in other parts of the report. For example, the discussion raised the question of accounting for intangible assets in companies’ financial reports, the problem of valuing intangibles, and the issue of using intangibles as a means of company financing (a topic explored in depth in Chapter 6). Not surprisingly, this part of the discussion seems to have been lead by Tony Clayton, formerly of the UK Intellectual Property Office (IPO) and the driving force behind the UK IPO’s reports on Banking on IP? The role of intellectual property and intangible assets in facilitating business finance and Banking on IP: An Active Response.

The discussion was not just about items that often come up in such conversations. I found three points raised in the workshop that provided new insights (at least for me, I’m sure others readers will find others). The first concerned the need to view IP and intangible assets in the context of a bundle – not just a portfolio of interrelated patents but an interaction between types of IP (e.g. patents and trade secrets) and an interaction among types of intangibles (e.g. trademarks and marketing/customer relations). As the report points out in two separate areas:

Further work may need to be done on the notion of the ‘IP bundle,’ that is, where a single firm utilises a variety of IP instruments to protect its business processes and products. Although in certain situations some forms of protection–such as patents and trade secrets–may operate as substitutes, they are mostly complementary; yet these instruments may overlap and interact, so one should perhaps be wary of considering such overlapping rights in isolation.

and

The most important issue for the future is the relationship between different types of intangible assets held by a firm. Examining bundles of intangibles, Professor [Ahmed] Bounfour’s [University Paris-Sud] research identified a degree of complementarity between patents and R&D, and between trademarks and marketing. By contrast, there is a much weaker relationship between skilled labour and design rights.

I’ve noted before that a deeper understanding is needed of the relationship among the various forms of intangible assets and between the investment in specific intangibles and economic outputs (profits, GDP, productivity). I hope this is an area OECD will look at in the future.

The second new area to me was the linkage between copyright and text and data mining (TDM). I have not followed the policy discussions on “big data” closely so I don’t know how much this issue has been raised before, especially in the US. But the linkage is obvious:

Text and data mining (TDM) raises particular issues relating to copyright. Viewed as a promising means by which to both advance scientific and other research and to generate significant value for the wider economy, TDM may conflict with copyright insofar as it depends upon access to and extraction of data from large quantities of (often, proprietary) material. There is some evidence that researchers in certain jurisdictions (the EU and Brazil, for example) are inhibited from engaging in TDM due to fears of infringing copyright in the process. There are arguments both for and against crafting specific exemptions within the copyright rules to protect TDM, or relying on more general exemptions for fair use, while the scientific publishing industry argues that enhanced licensing arrangements facilitate TDM without any alteration of the existing copyright rules.

Most interesting of all was the discussion of patents and knowledge flows. A standard view of patents is that of the grand bargain. Actually it is two bargains. The first is the granting of a monopoly right which impedes consumer welfare in exchange for the promise of consumer benefits from innovation. In most thinking, the second is built into the first: the granting of exclusive rights in exchange for disclosure that will spur innovation. The disclosure requirement is not part of the incentives to the inventor but is meant to be a mechanism for spurring diffusion of the technology and for fostering follow-on innovation.

At its core, IP is about both creation and application of new ideas. The temporary right to exclude is granted as a means to incentivise innovation, so that, to the extent that IP policies fail to result in the creation and use of new ideas, they cannot be justified. Moreover, the emphasis is upon competition between ideas, not within ideas. The economic incentives provided by the IP system relate to the entire value chain: from inventors and authors, to ‘second movers’ that help to diffuse innovations, to distributors and intermediate users of innovative products and processes. The incentives particularly extend to open innovation partners, who need to be aware of which rights can be used in an increasingly important economy of knowledge exchange.

. . .

Two aspects of the knowledge diffusion process are of particular importance: disclosure (the information that is revealed) and dissemination (the accessibility of that information). Disclosure should enable third parties to use patented inventions once the patent has expired. It should thus allow a ‘person skilled in the art’ to understand how the invention works, be inspired and, potentially, make improvements. (Emphasis in original).

However, it is not clear that the disclosure and dissemination side of the bargain is working well. The workshop discussed the issue at great length and came to the following conclusion:

The effectiveness of disclosure as a means of knowledge diffusion in practice, however, has been called into question. Empirical evidence presented at the workshop suggests that patent disclosures can have a positive impact on innovation, but the effects may vary between industries, and there is evidence that the quality of disclosure may be inadequate in some instances. Greater emphasis should thus be placed on the sufficiency of disclosure at the patent examination stage.

Of particular interest to me is how this is framed in the current policy debate over patent reform. It appears to me that the entire discussion is over the incentives part of the bargains and ignores the diffusion aspects. Much has been said about how particular pieces of legislation will hurt or help inventors by either weakening incentives to patent or by protecting inventors from “patent trolls.” Little seems to be said about how the legislation will affect diffusion and follow-on innovation.

In conclusion, the OECD has prepared an interesting set of background papers that could help policymakers better understand the IP ecosystem. It remains to be seem what they do with this understanding.