The Value of Everything (UK)

by Mariana Mazzucato

  Heads I Win, Tails You Lose

  Apple Computer Company had been founded in a Californian garage in 1976. When it went public in 1980 it was the largest IPO (initial public offering) since the venerable fifty-three-year-old Ford Motor Company’s back in 1956.16 Apple turned into a legend overnight. It also blazed a trail: the IPO has since become the rite of passage for hundreds of hopeful high-tech start-ups, synonymous in the public mind with the success of Silicon Valley – and for very good reasons.

  An IPO is the point at which expectation and potential come face to face with the realities of the marketplace. IPOs capture in one moment value generated over a long period, capitalizing the future profit potential of a business into a market price. For VC, in other words, timing is all.

  By orchestrating this moment of alchemy – when the long and winding, always uncertain, usually collaborative, journey of innovation is crystallized into hard cash – venture capitalists, other investors, founders and early-stage employees have been able to reap extraordinary rewards. In that one moment, the ‘trapped equity’ – the sum of all the ingenuity, effort, risk-taking, collaboration and persistence that went into developing the new idea – is released and paid out to the flotation’s controllers, who may not have been the original innovators or risk takers.

  IPOs are, first, a way for early investors to get their money out. The very possibility of an IPO encourages investment – although it has to be said that investors with one eye on the exit door and the other on the clock might not be ideal for nurturing a company to its potential. Second, IPOs can raise new capital for business expansion, which can be valuable in some sectors but less significant in others (like software), where the most important capital is human. Third, founders can realize the value of their ingenuity and sweat equity that has remained latent in the company. Fourth, employees, who may have been induced to leave secure jobs by the promise of equity in a risky venture, can realize the value of that equity – or at least see the possibility of doing so now that there is some liquidity in the company’s stock. This, indeed, was the primary motivation for Microsoft’s IPO in 1986, having awarded stock options to its employees since 1982.17

  To restate: investments in early-stage businesses are risky and most will fail. The volatility of returns to VC across the business cycle reveals the perils.18 Nonetheless, many venture capitalists have found themselves among the super-rich as a result of the success of high-tech firms in Silicon Valley. How has this happened? They have taken risks, of course – although mostly with other people’s money – which deserve to be rewarded. Yet the returns have come from investing in companies whose value was often created by decades of prior government investment. When the investment bets have paid off in a successful IPO or sale, the venture capitalists have benefited disproportionately from their favourable position as insiders. Then they have gained again from the increasingly favourable tax treatment of their capital gains within a tax system their industry has worked hard to shape.

  The allocation of shares during an IPO favours insiders, including investment banks that underwrite the deal. The insiders have incentives to encourage hype about the IPO, setting the price low and limiting the stock’s availability to encourage the price to spike. As outsiders clamour to get their hands on the latest hot tech stock, insiders can sell at a large profit.19 It is as close to a ‘heads I win, tails you lose’ bet as it is possible to make.

  All of which was writ large in the developing microelectronics industry of the 1980s, a fertile test bed for the evolution of the American VC industry. Previous post-war decades of US government investment meant that new companies in the sector could produce marketable products within the time horizons that VC investors demanded. Gradually the VC model migrated to other emerging sectors. The biopharmaceuticals industry, again, was built on massive US government investment, this time through the life sciences knowledge base, the National Institutes of Health (NIH), since 1938. Between 2009 and 2016, the NIH have been spending an average of $31.5 billion a year (in constant 2009 dollars), twice the level of the 1990s, and three times the level of the 1980s. In 2016 the amount totalled $32.3 billion. But in the biopharmaceutical sector the product cycles are much longer and more speculative than in microelectronics: less obviously a good fit with the VC financing model of exiting within five years.20 Along with firms like Amgen, Genzyme and Biogen, Genentech (now part of Roche) is one of only a small number of biopharmaceutical companies to keep their promise of producing a blockbuster drug (sales over $1 billion), of which the sector has generated only thirty in total.21

  Despite this patchy record, hundreds of biopharmaceutical startups have been able to raise finance through IPOs and continue in business for many years, often without the encumbrance of an actual product. These product-less IPOs (or PLIPOs) survive through R&D contracts with big pharmaceutical companies and through the speculative trading of their shares on NASDAQ, fermented by news about the success or failure of the latest clinical trial. Yet, if it has proved hard to make reliable money from the development of actual new blockbuster drugs, it seems that there have been plenty of ways to derive income by speculating about the possibilities of doing so. Nor has this unremarkable history of turning taxpayer-funded investments in life sciences into successful products prevented top executives in those companies being well rewarded in salaries and stock.

  The classical economists would have had little time for the way in which the VC industry has extracted value by shifting money around rather than creating value: for them the point was to nurture the production of value rather than its simple circulation.

  Yet the examples of the fortunes made in the 1990s and early 2000s by founders, venture capitalists, early-stage employees and senior executives from the Silicon Valley tech boom rippled out, resetting the norms and expectations for what leaders in more established sectors ought to be paid. Similarly, inflated expectations have also been built into the patent system, and more pervasively in innovative industries like ICT, biotech and pharmaceuticals. Patents, indeed, have become synonymous with value extraction.

  PATENTED VALUE EXTRACTION

  The second key way in which value has been extracted from the innovation economy is by the appropriation of returns through the patent system (IPR). In the last century patents, and associated tools like copyrights and trademarks, have gone from being devices to stimulate innovation to means of blocking it.

  Patents are protections granted to inventions that are novel, inventive (non-obvious) and suitable for industrial application. In theory they protect the innovator from having his or her idea copied. In practice, however, most innovations are not patented, which in itself shows that patents are not really necessary, as there are other ways to protect innovations, including lead-times and trade secrecy. One study found that between 1977 and 2004, only 10 per cent of ‘important’ innovations were patented.22 Patents tend to be granted for two reasons, which must be held in constant tension for the system to function effectively. The first is to reward and incentivize inventors for developing new ideas by granting them a time-limited monopoly entitlement over their inventions,23 or what is known as the appropriability function of patents. In exchange for this monopoly entitlement, the inventor must reveal detailed information about his or her invention. Which brings us to the second reason: once the patent has expired, the invention can diffuse rapidly through the economy in a process known as the disclosure function of patents. If the system works well, the appropriability function is properly balanced against the disclosure function and the public gains from the rapid diffusion of this new knowledge through the economy.24

  Looked at in this light, patents are best understood not as intellectual property ‘rights’ in the sense of something that is universal or immutable, but as a contract or deal based on a set of policy choices. Something is given up (information about the invention) in exchange for something gained (the ability to exploit the invention exclusively for a limited period). In balancing the
private benefits with the broader public good, policymakers must make trade-offs. Granting patents can help increase the incentives for inventors, which in the long run can result in higher rates of technical progress. But such grants also increase the market power of patent holders, resulting in less ‘economic efficiency’ during the time patents are enforceable, and slower knowledge diffusion.

  The original purpose of patents is value creation. Patenting your brilliantly cheap and effective innovation is meant to ensure that the hard work you put into the invention is protected for a period during which it earns profits until others are allowed to copy it. That period is currently twenty years. Not all industries make equal use of patents; they tend to be less important for areas like software25 and more so for science-based industries like pharmaceuticals. Indeed, there are also other ways to maintain market dominance, for example through first-mover advantages and secrecy.

  To understand how patents relate to the dynamics of value extraction, we must look both at what exactly is being patented and at the structure of the patents themselves. The current dominance of the narrative of entrepreneurs as wealth creators has, I would contend, shifted the balance of the patent system away from an emphasis on the diffusion of knowledge towards private reward.26

  Patents Can Inhibit Innovation

  Today, the patent ‘deal’ has become unbalanced, to the extent that the patent system no longer aids the innovation economy but inhibits it. Changes in four major areas are responsible for this unbalancing: what is being patented; the length of patent protection; the ease with which patents can be obtained; and the reasons for seeking patent protection.

  First, since the 1980s the patentability domain has been expanding in the US. The domain has moved ‘upstream’: that is, patents are no longer restricted to actual ‘inventions’ (products), but now include ‘discoveries’ (the knowledge behind products). This means that patents are no longer confined to inventions with ‘practical or commercial utility’. Now, they may also apply to discoveries that help in the exploration of future innovative possibilities, such as diagnostic procedures, databases, analytic methods, or scientific principles with some potential practical application. Patents, in other words, are now gatekeepers to the knowledge base.

  Instrumental in this shift was the US Bayh–Dole Act of 1980, which made it possible for universities and government research laboratories to hold patents on the results of publicly funded research.

  The aim of the Bayh–Dole Act was to strengthen university–industry interactions and incentivize commercialization. Yet granting an exclusive licence on a university-owned patent deters follow-on innovations. Firms must now negotiate – and pay for – a licence before entering a market to access proprietary information that would previously have been available in publications.27 Instead of encouraging better technology transfer – for example, of human stem cell patents held by the University of Wisconsin – the system has delayed technology diffusion.28

  Where the US led, the rest of the world has followed. Such university licensing challenges the traditional ‘open science model’, where basic research outcomes were – as they should be – freely and equally available to everyone. Today, a more proprietary and exclusionary model has taken over, as the university-licensed patents on online search engines such as Google and Netscape illustrate.

  Second, legal changes have extended the protection patents offer: now, patents can be renewed. These changes came on the back of persistent lobbying, for instance by pharmaceutical companies, whose pressure resulted in the US Hatch–Waxman Act of 1984, which besides getting the generics industry off the ground (by being able to circumvent some FDA regulations), also resulted in the extension of the patent life for brand-name drugs. And since then the Act has been manipulated by industry lawyers to get patents extended even more.29 There is a parallel here with copyright laws: over the last century the entertainment industry has increased copyright protection from fourteen years to ninety-five.30

  Third, patents are now much easier to obtain. The squeeze on budgets for courts and the FDA, which licenses medical drugs, has cut the number of staff checking patents, leaving them often more likely to grant a patent than not.

  And fourth, large companies have increasingly used ‘strategic’ patenting to patent around areas with a view to blocking competitors. This goes against the second role of patents, which is to allow the diffusion of resources. Such strategic patenting can be especially effective when a patent is obtained at an early stage of the development of a technology, before the technical standard is properly determined, or in fast-paced and patent-intensive fields such as ICT or biotech, where innovations are highly interdependent or complementary.31 An early patent gives its owner the chance of setting the dominant standard and blocking improvements others might make. The risk of infringing the patent can also prevent other firms from marketing their products or services.

  Another related and growing practice is ‘patent-trolling’: the strategic holding of patents, not to develop or commercialize the underlying idea but deliberately to collect royalties through patent enforcement. A market for patents has emerged in which the value of the patent is divorced – or effectively monetized – from the value of the production of goods or services the patent makes possible. It has been argued that strategic patenting can aid innovation by providing small firms with liquidity as they seek to bear the costs of development and commercialization32 – but the evidence suggests that this practice is also causing harm. James Bessen and Michael J. Meurer, authors of The Patent Litigation Explosion, estimate that ‘patent trolls cost defendant firms $29 billion per year in direct out-of-pocket costs’.33 Another study finds that in aggregate, ‘patent litigation destroys over $60 billion in firm wealth each year’,34 with the costs falling more heavily on smaller firms.35

  UNPRODUCTIVE ENTREPRENEURSHIP

  It might be said that these changes have, collectively, caused patents to result not in productive but in unproductive entrepreneurship. We cannot assume that entrepreneurship will always be ‘productive’, in the sense of leading to the discovery of new products, services or processes that increase society’s wealth. In many circumstances, entrepreneurship can be unproductive: where it involves innovations in rent-seeking, for instance, or discovering unused but effective legal gambits to deploy against competitors. Today, the patent system offers many opportunities for these kinds of ‘unproductive entrepreneurship’; patents can reinforce monopolies and intensify abuse of market power, block the diffusion of knowledge and follow-on innovations, and make it easier to privatize research that is publicly funded and collectively created. Indeed, in the words of economist William J. Baumol, ‘at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy’.36

  A common assumption is that rents are simply the result of imperfections in the competitive process that otherwise would lead to beneficial results for all. An alternative view, following Marx, is that rents (including those generated from patents) arise from value creation itself – i.e. not from cheating or breaking the rules of the system, but from the rules of the system itself. The way the modern-day patenting system is structured (e.g. allowing upstream patenting, and strategic patenting), I would contend, is analogous to what Marx called ‘unproductive labour’, because it extracts rather than creates value. The patent holder derives rents from enforceable property rights over productive resources simply by excluding others from access to those resources. Holders of patents can appropriate surplus value generated by labour and not paid out in wages. In the modern economy there are few limits to the accumulation of such IPR, and therefore few constraints on the scale of value appropriation. Duncan Foley, a heterodox economist in New York studying the relationship between modern value extraction practices and the classical approach to rent, claims: ‘Any individual creator [of strategically located intellectual property] can expand her or his income effectively without limit, but this does nothing to e
xpand social value production or surplus value appropriation.’37

  Today’s narrative, which plays up the role of the private sector in innovation and plays down that of the state, has created space for broader and stronger patents to proliferate. Such patents are justified as rewarding the efforts of entrepreneurs, who can then continue to shoulder the risks of innovation. But neither the risks of innovation nor support for future innovation – both undeniably important – are enough to justify tipping the balance so far in the direction of this prevailing story. Instead of the creation of value, the expansion of patents has fuelled rent-seeking, value extraction, value destruction, strategic gaming and the privatizing of the results of publicly funded scientific research. As The Economist has observed: ‘Patents are supposed to spread knowledge, by obliging holders to lay out their innovation for all to see … Instead, the system has created a parasitic ecology of trolls and defensive patent-holders, who aim to block innovation, or at least to stand in its way unless they can grab a share of the spoils.’38

  All of which has major implications for global development. Industrialization in today’s advanced economies like the US, Britain and Germany actually took place under much narrower and more flexible IPR rules than those we have today. And while later industrializing countries such as Japan and South Korea benefited from a ‘friendly’ or ‘loose’ international IPR environment, developing economies now encounter a more closed and privatized knowledge creation system, supported by international trade agreements.39

  PRICING PHARMACEUTICALS

  Perhaps nowhere is the modern patent system more pernicious than in pharmaceutical pricing. It is a vivid lesson in how the concept of value is abused. In patent-intensive sectors like pharmaceuticals, greater patent protection has not led to increases in innovation. In fact, the opposite has happened. We have more drugs with little or no therapeutic value.40 At the same time, there have been numerous lawsuits attempting to extend patent validity on existing drugs by reshuffling old combinations of compounds. These suits lend weight to the claim that the patent legal system has become the main source of value extraction, rather than providing incentives for value creation through pharmaceutical innovations. Worse, because public institutions funded most of the key scientific discoveries behind health innovations,41 taxpayers are now paying twice: first for the research and second for the premium that pharmaceutical companies charge for their drugs. Furthermore, increasing returns from patents reinforce the position of incumbents and lock out competitors.