Knowledge Goods and Nation-States

By Daniel J. Hemel & Lisa Larrimore Ouellette. Full text here.

The conventional economic justification for global IP treaties begins from the premise that nation-states, if left to their own devices, will rationally underinvest in innovation incentives such as IP laws, grants, tax credits, and prizes (the “underinvestment hypothesis”). Under this account, nation-states will free-ride on each other’s knowledge production unless they find some solution to their collective-action problem. The solution that nation-states have struck upon is international IP law: IP treaties harmonize domestic laws and thus ensure a baseline level of investment in knowledge production (the “harmonization hypothesis”). Moreover, IP is the only such solution available to nation-states, because a global regime of grants, tax credits, or prizes would require a global public finance system—and no such system exists. IP is thus unique among innovation policy options in that it can be implemented at the international level (the “uniqueness hypothesis”). Previous authors have adopted this logic while lamenting its implications: IP appears to be a necessary evil in an interconnected world—necessary to solve the free-rider problem; lamentable because it results in sizeable deadweight losses.

This account of IP treaties is informative but incomplete. The underinvestment hypothesis is robust only to the extent its assumptions about the nature of knowledge goods and the behavior of nation-states are accurate. But not all knowledge goods are global public goods, and nation-states have motivations to invest in knowledge production that the conventional account fails to capture. More fundamentally, the harmonization hypothesis rests on a misapprehension of the link between global and domestic IP laws. States can comply with IP treaties while relying primarily on non-IP innovation incentives and non-price mechanisms for allocating knowledge goods within their own borders. In the starkest case, a government body subsidizes production of a knowledge good through prizes or grants, takes title to the resulting IP rights, and then licenses the knowledge good to the government of another nation-state. The government in the consumer nation-state has the option of financing royalty payments to the producing country through taxation and then distributing the knowledge good to its own citizens at marginal cost. In this stylized example, IP law operates only at the international—not the domestic—level. While in practice states generally choose to rely on IP at least to some extent, we show that many real-world arrangements resemble the stylized example in important respects.

Our more nuanced account does not imply that international IP laws are misguided; rather, our analysis highlights the specific function that IP treaties serve. Most significantly, international IP laws establish a framework for setting the size of payments from states that consume knowledge goods to states that produce those knowledge goods. At the same time, international IP laws allow each signatory state to choose its own mix of innovation incentives and its own method of allocating access to knowledge goods within its own borders. The international IP regime thus allows nation-states to pursue non-IP policies at the domestic level while at the same time allowing those states to participate in an IP-based system of cross-border cost-sharing.