Innovation, intellectual property and capitalism

Economic history shows a remarkable similarity between economic and technological long term cycles. By looking at a timeline of inventions one can easily detect many points of contact. Indeed, given the two-way causality between technical progress and economic growth it is inevitable that most of the controversies are about the direction in the virtuous circle between science and economic growth. At a microeconomic level, microeconomic textbooks usually explain how innovation benefits both trading parties.

However, the role of capitalism is not just to ease the sharing of the benefits from technical progress. A further advantage, and possibly more important, is the stimulation of innovation. In fact, it is no coincidence that capitalism and technical advancement go hand-in-hand driven by two of the basic principles of capitalism.

First, the pursuit of profit maximization is a major driver of innovation. For instance, all the fantastic new drugs that pharmaceutical companies produce every year are not the result of their concern for the patients but of their lush for profits. Moreover, if they lag in innovation, their competitors will take over their market share. Thus, the profit motive plays simultaneously the role of carrot and stick in the motivation of innovation.

Second, the protection of intellectual property for only a limited period of time provides innovators with enough protection to recover their investment in research, while preventing the undue state protection for incumbent producers. Obviously, the duration of such protection is subject to discussion and in the end its desirable extension is as much a result of political discussion as of empirical analysis.

While the role of profit maximization is often accepted, the legitimacy of intellectual property is at the origin of much heated debate, namely on whether it represents the granting of a temporary monopoly or the protection of a property right.

Many of the issues may be gauged by considering the following question raised by Paul H. Rubin and Tilman Klumpp (2011): “On the one hand, ideas, novels, or musical compositions are products of the mind, and if a man owns his mind as much he owns his body then it seems that, indeed, he would acquire property over what he conceives in his mind. On the other hand, ideas are vague and often conceived in similar form by many people. Since two persons cannot, independently of each other, have ownership over the same good, how can property be acquired over an idea that one conceives the day after it was conceived by somebody else?”.

Thus, the products of the mind are not easily treated within the traditional marginalist cost-benefit analysis. Moreover, the debate between supporters and opponents of intellectual property is often, but not always, aligned politically.

Take for instance the following libertarian views.

Among anarcho-capitalists we have some arguing for infinite copyright terms similar to those applying to non-intellectual property while others oppose them on the grounds that they divert resources from fundamental to patented research.

While amongst left-wing libertarians some oppose intellectual property because it represents an infringement of freedom of speech and the press.

In turn, some conservative libertarians advocate that a distinction should be made on the basis of who supported the costs of R&D and on the purpose of the invention. For example, Deepak Lal (2006) argues against granting copyrights to fundamental research on the grounds that it is mostly done at public financed institutions while supporting them in the case of pharmaceutical companies developing new drugs but not in the music industry selling a new song.

However, others agree with patent and copyright laws but oppose laws protecting trademarks or anti-counterfeiting laws.

Finally, others champion against patents and copyrights on moral grounds, namely arguing that is immoral to refuse to give new medicines for people in need.

The moral dilemma is especially difficult when dealing with life threatening diseases, as illustrated recently during the 2004-2005 Ebola epidemic or with the new Sovaldi drug for Hepatitis C.

The latter, involved a dispute over the price charged by Gilead, the company selling this drug capable of curing this previously incurable disease (priced at US$ 84,000 an amount not covered under most insurance schemes). The company argued that the price was needed to obtain a “fair profit” in the investment of $US 11 billion she had made to acquire the small company that had developed the drug.

This example illustrates another complexity with the regulation of intellectual property – the transferability of copyrights and patents.

Another problem is the enforceability of intellectual property rights on a global scale since some countries do not recognize or enforce such rights. This has led the USA and the European Union to negotiate bilateral agreements (the so-called TRIPS) to secure the protection of patents and trademarks, but these have been perceived as promoting protectionism rather than free trade.

Overall, if one accepts copyrights, patents and other forms of intellectual property protection as a necessary evil in the form of a temporary monopoly the shorter it will be the better. Because, being a form of censorship, it precludes the greater good that comes from sharing each other’s ideas and discoveries.

Moreover, the Internet has created a new tool to achieve the ancient dream of compiling all human knowledge and culture and to store it for free use by present and future generations. The benefits of this universal access to knowledge may outweigh those of granting temporary protection to intellectual property.

However, this requires a difficult judgement whose answer depends on whether free access would erase the profit motive and the rate of capital accumulation. So far, the so-called creative industries have continued to develop through a mix of conventional secrecy, intellectual property protection and new business finance models based on the winner takes all dream and crowd-funding. Whether these new business models will be more capitalist-friendly or not is still too early to know.

The origins of capitalism

The origins of capitalism go as far back as the XI century when Pope Gregory VII dictated the Dictatus Papae letters asserting that the deposal of an emperor was under the sole power of the pope and excommunicated Henry IV to reinforce the power of the Church. Unintentionally, he created the church-state with most of the legal and administrative institutions necessary for the subsequent commercial revolution. However, capitalism only overtook the feudal system in the early XIX century.

During this long period of eight centuries the following events represent important milestones: the Champagne fairs in France (XII-XIII centuries), the banking and Italian Renaissance (XV century), the Portuguese and Spanish discoveries connecting Europe with the rest of the world (XIV-XVI centuries), the establishment of chartered companies and stock exchanges (1555,1652), the rise of mercantilism (XVI-XVII centuries), the scientific, transport and industrial revolutions (XVI-XVII centuries), the enlightenment (XVIII), the publication of Adam Smith’s Wealth of Nations (1776) and the emergence of joint stock companies (XVIII century).

The creation of a commercial economy at the beginning of the XIII century, initially in the eastern Mediterranean, but quickly extended to the Italian city-states and the rest of Europe brought not only new products (spices, etc.) but new developments in business practices. For instance, the Champagne annual fairs revived the international trade between France and Italy and led to the development of merchant law (Lex mercatoria) and the creation of an international payment system based on bills of exchange.

The development of a new class of rich merchants and bankers in Northern Italy enabled the development of the double-entry accounting system and new banking techniques. This new class was essential for the development of the new trade made possible by the Portuguese and Spanish maritime voyages of discovery and the cultural renaissance in Italy.

Foremost in the development of capitalism was the expansion of credit. This was permitted by the progressive abandonment of the usury laws initiated with the English law of 1550. At the same time, another important progress in terms of company law was the establishment of Charted companies that latter led to the joint stock company.

Mercantilism, as an economic theory, is the opposite of market capitalism. It advocates the role of the state to protect infant industries and domestic markets while trying to control the main trading routes to secure a balance of payments surplus. Nevertheless, paradoxically, by promoting a new form of imperialism based more on trade supremacy than on pure conquest, it was initially a major driver of the international trade that preceded the industrial revolution. But, its nationalistic and protectionist policies led inevitably to wars and inefficiencies that could only be solved by the rise of free trade and the progressive abandonment of mercantilism. However, today, in countries like China and other transition economies, mercantilism is still evident in their new type of state capitalism.

The birth of the so-called scientific revolution can be said to have started with the publication in 1543 of Nicolaus Copernicus's De revolutionibus orbium coelestium or with Newton's 1687 Principia. The subsequent debate on rationalism and empiricism revived the interest in science and the progressive development of experimental research that led to the subsequent revolutions in transportation and manufacturing.

First, long-distance transportation of coal and other heavy materials between the mining regions and the cities became possible due to the canal mania in England between 1790 and 1810, which was driven by financial speculation. This was continued by a new railway mania that followed the design by George Stephenson of first steam locomotive in 1814. Meanwhile, based on Watt’s 1794 improved steam engine, steam-powered beam engines stimulated the construction of more sophisticated power looms and increased the scale of production in textile mills in the early years of the so-called first industrial revolution.

On a doctrinal level, the enlightenment philosophers promoted the idea that God expressed his purpose through the laws of nature so that the legitimacy of the ruler’s power was no longer granted by God but by the enlightened elected men. And, most importantly, replaced the heaven paradise by the pursuit of prosperity on earth.

Among them, Adam Smith’s 1776 Wealth of Nations refuted mercantilism and advocated free trade as the basis of classical economic theory.

Finally, the English Joint stock companies act of 1844 and the Limited liability act of 1855 completed the institutional requirements needed to consolidate capitalism as the dominant economic system.

By then the six basic pillars of capitalism – private property, the profit motive, free markets, the rule of law, joint stock companies and limited liability – had been largely adopted in Western countries and capitalism began its process of globalization.