Causes and Consequences of Productivity Growth Declines

By Neal Solomon
September 19, 2016

Rollercoaster conceptWith growth averaging about 2% annually, the recovery from the recession that ended in 2009 has experienced the slowest growth of any American economic recovery in almost a century. The critical factor behind slow economic development lies in declining productivity growth data. Productivity growth has been about 1% annually since 2010, with productivity growth declining to negative in 2016.

What is behind the productivity growth data? There appears to be a causal connection between productivity growth declines and a decline in business investment. One argument suggests that with weak demand, companies have little incentive to invest in businesses. Without more investment, productivity growth declines and, with it, aggregate economic growth.

Economists parse out the components of productivity growth into capital, labor and total factor productivity (TFP). TFP represents a cluster of factors under the umbrella of technology innovation. The levels of business investment in the main components of productivity have generally been stagnant since the end of the recession, and appear to be weakening. Although productivity growth increased in the aftermath of the recession as reduced aggregate employment increased efficiency for the remaining workers, the long-term trend shows that productivity growth began to slow before the recession, in the mid-2000s, suggesting a structural economic transformation.

Economists have a number of explanations of productivity growth declines in recent years. First, some argue that innovations have peaked in recent generations and that innovation is simply not robust enough to increase productivity. Second, some argue that we are in an era of secular stagnation driven by limited demand, which results in limited production. Third, some argue that the productivity data are mismeasured, particularly since industrial nations like the U.S. no longer maintain a substantial manufacturing industry. Fourth, some argue that there are lags in productivity data in which major productivity growth gains will result from recent innovations as the technology works its way through the economy. Finally, some argue that the concentration of wealth for the top Americans constrains investment since they have no compelling reason to invest.

While all economic views of productivity growth may have a grain of truth, I argue that all of these theories of productivity growth are fundamentally wrong. The economic evidence shows clear relationships between the trend of decline in productivity growth and the trend in declines of the U.S. patent system. As the patent system has been weakened in the last decade, there is less investment by start-ups in technology R&D. At the same time, the technology industry has become highly concentrated, with big tech incumbents dominating their industries. The combination of increasingly concentrated competitive configurations in the technology industry with the reduction in key rights embedded in patents, has resulted in substantially reduced incentives to invest in R&D innovations.

The reduction of patent rights is not new. In the 1970s, before the creation of the U.S. Court of Appeals for the Federal Circuit, patent law was weakened. During this period, productivity growth was also reduced along with reduced business investment. The tremendous growth of the venture capital industry during the 1980s and 1990s, spurred by an era of strong patents, in turn generated a technological revolution that catalyzed productivity growth.

There are two major forces that contribute to a reduction in patent rights. First, on the far right, big tech incumbents have an incentive to protect their monopoly profits by attacking patents since patents are the main tool to protect innovations by market entrants. Second, on the far left, progressives have attacked the property right in a patent in order to develop a system for public benefits. Progressives ignore ex ante costs of R&D and seek to mandate technology for the public interest. They see the patent system, and its private rights, as blocking a socialist agenda. Together, radicals from both the left and the right, have succeeded in dramatically transforming patent law. These changes began in the mid-2000s, about the time of the decline in productivity growth.

Today, the patent system is a shadow of its former self. Critical elements of patent law have been changed, including the examination system in the U.S. Patent and Trademark Office (PTO). The new system consists of a two-part examination approach that includes a very expensive and onerous reexamination of an issued patent. In addition to changes in examinations, patent remedies have been restricted. For instance, injunctions to stop others from using a patented invention are now very rare, thereby shifting the system to one of instituting liability rules rather than property rules. In addition, patent damages are generally reduced from a decade ago because patents are narrowly apportioned to a specific feature of a system, without considering qualitative weighting of specific innovations that provide a market advantage.

These changes in patent law have had the effect of actually encouraging infringement and eliminating the voluntary licensing market. Rather than license a patent, big tech incumbents ignore patents and refuse to deal with patent holders. This reverse hold out by incumbents forces patent holders to enforce patents in the courts.

One main effect of the changes in patent law is that transaction costs of patent examinations and patent enforcement have now increased dramatically. It is precisely these much higher transaction costs that are influencing the decisions by innovators not to invest in new technologies, particularly at the margins.

However, the degradation of rights in patents and the dramatic increase in transaction costs to enforce patents have had adverse effects. Since big tech incumbents can use others’ technologies without fear of an injunction, they have engaged in the practice of “efficient infringement” in which they infringe patents with impunity and then pay a licensing fee only if a patent holder meets the barriers of high transactions costs.

The patent system worked well from 1790 to about 2000. During this two hundred year period, the U.S. was the location for the industrial revolutions that propelled economic growth to historic levels. The core impetus for this massive industrialization was the incentives provided in the intellectual property clause of the U.S. Constitution, which embedded “for limited times” an “exclusive right” to an inventor’s discoveries. Patents are disclosures of inventions that enable others to learn about original work and provide the opportunity to build on it with other novel work. In this way, the patent system both encourages investment in hard technical problems and supplies economic progress.

Because of these high transaction costs for patent enforcement, only a few market entrants can enforce patents. Also, since the big tech incumbents are collectively refusing to deal with market entrants, the voluntary licensing market has receded, bringing nearly all matters to the courts. Without a voluntary licensing market, the time to obtain returns on investments has dramatically extended, thereby effectively blocking the innovation market. Since market entrants are not compensated significantly for their work, they do not have capital to invest in more R&D, so the system of continued invention is stopped.

For market entrants, high transaction costs for patent reexams and enforcement, combined with reduced licensing settlements, result in a squeeze on limited capital resources. Given these higher costs and reduced rewards, incentives to invest in risky research are diminished. This describes the process behind the persistent slowdown of investment into innovation for market entrants. These enhanced challenges in a weak patent regime are evident in historically low business starts.

Ironically, the large tech incumbents have enjoyed remarkable profits in recent years and have stored most of these profits as cash. The cash hoard of the top five technology companies was recorded at over $530B. In addition, the four highest capitalized corporations in the world are big tech incumbents. Yet, they have not substantially invested these record profits into more investment. This diminished investment can be explained because they do not need to invest in new technology if they can infringe others’ technologies and only pay a nominal fee.

When both market entrants and incumbents restrict innovation investment, productivity growth naturally declines. Consequently, the patent system degradation may be a major component in the mechanism explaining the decline of productivity growth in the last decade.

The good news is that if the changes in the patent system of the last decade are a core cause of the decline in productivity growth, a repair of key components of the patent system may restore productivity growth. The policy recommendations to change the patent system include modifying PTO rules so as to substantially increase the bar to institute reexams. This is straightforward and increases certainty by restoring rules for the presumption of patent validity. Second, restore a targeted injunction in a patent that only focuses on the relevant component of an invention. By restoring a limited injunction to protect the patent property right, the era of compulsory licensing will be ended. Third, penalize technology companies that repeatedly infringe patents in order to encourage them to voluntarily license technology under fair and reasonable terms. Doing so would eliminate the majority of enforcement matters driven to the courts. Finally, enforcing competition laws against large technology companies would even the playing field for smaller competitors.

These simple modifications will restore strong patents that protect inventor rights and encourage investment into risky research projects. Until the patent system is modified to restore key rights, there is no reason to believe that incentives will encourage critical investment, particularly by market entrants that are responsible for a majority of innovation.

Without implementing these changes, there is no reason to expect a change in dismal productivity growth or aggregate economic growth data for a generation.

The Author

Neal Solomon

Neal Solomon is CEO of Advanced System Technologies Inc. A prolific inventor of technologies involving semiconductors, communications, data management, imaging, robotics and healthcare, he holds degrees from Reed College and the University of Chicago.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 14 Comments comments.

  1. Chris Gallagher September 19, 2016 11:10 am

    Well said, concise, and spot on… Now ..if it could just be condensed into an “elevator speech” for delivery on Capitol Hill.

  2. Anon2 September 19, 2016 12:48 pm

    Agreed.

    It should be obvious that the productivity of an individual declines with the decrease in legal rights (property) of the individual to the fruit of his/her own productivity.

    Causality and the correct nature of man generally are such that an irrational plea to “produce more” for “less” (less ownership in what is produced) at least would be met with indifference and at best (morally) should be met with indignation.

  3. Curious September 19, 2016 1:38 pm

    One of the best written articles I’ve seen in a very long time.

    The patent system has been subject to the perfect storm of detractors from both the far right and far left: incumbent large corporations who want to prevent disruptive competition and intellectual-property communists from the age of Napster who believe everything should be “free” in the “commune.” In the end, both the large corporations and IP communists are getting what they want — no-cost (to them) technology developed by others who have realized (too late) that they cannot monetize these technological developments.

    Ultimately, while the current crop of innovators may have realized too late that they cannot reap the benefits of their inventions, the new crop of (potential) innovators will see how hard it is to obtain and enforce their intellectual property rights that they won’t even bother and will choose a different path rather than innovating. Why invent a new product when you can just copy what somebody else has done? As currently constituted, the current patent system has misplaced incentives that favor copying over innovating.

    This same problem with misplaced incentives doomed communism as an economic policy. Why work harder (or even at all) if the fruits of your labor are going to be shared with millions? A rational actor, when faced with a communist economic policy, would choose not to work at all since any additional work the actor performs only provides a miniscule benefit to the commune.

    A strong patent system rewards those that innovate, and innovation is a prime driver for increased productivity. I hope that we don’t look back 20 years from now, wondering why the US has slipped in its preeminence as an economic power and realize too late that the weakening of our intellectual property system was to blame.

  4. Anon September 19, 2016 3:01 pm

    Curious @3,

    Too late.

    The reason why I say this is that even five years after the AIA has been on the books, there is still rampant anti-patent fervor coming from the Left and Right, and Congress has yet to wake up and seriously take notice.

    This is why I suggested right after Alicr came out that perhaps we do not try to avoid the unavoidable crash coming up and instead accelerate that crash and bring the Supreme’s nonsense to its inevitable conclusion sooner.

    The sooner the fall, the sooner we can get back to a strong patent system.

  5. Night Writer September 19, 2016 4:34 pm

    @3 Curious: you know the communist system had a patent system that Alice is modeled after. Several wankers looked at what you did and decided with no evidence whether you should get a patent. Basically, the no analysis of elements and no combination arguments.

    I would add the article more evidence about Google spending a fortune (2nd only to Goldman Sachs) to weaken the patent system. And evidence that Google is afraid of patents.

  6. Paul Morinville September 19, 2016 5:36 pm

    Neal, I wish I had your pen. Absolutely the best summarization and explanation of the disastrous state of the patent system I have read.

  7. Edward Heller September 19, 2016 5:41 pm

    A couple points: big tech companies normally do not sue each other, but engage in cross licensing or in some cases cooperative licensing pools. Competition with each other forces innovation regardless of the patent system, while the patent system is necessary for the cooperative licensing pools. Significant barriers to entry protect against new competition within the product space of the big company.

    Big companies tend to iterate old technology rather than to develop new technology. Real breakthroughs come from inventors who are not working on improving existing technology. They can be employed by big companies, but these breakthroughs they come from people who leave big companies to start their own firms to develop their own ideas.

    Without the aid of the patent system, investing in new products and new technology is a fools errand. When the patent system is defanged such that patents can be ignored with impunity, only fools invest their money in developing new products and technology. There has to be a direct correlation between the decline of the patent system and the declined investment in new products and new technology.

    The most significant events in the last 10 years that have led to the decline in the patent system are

    1. EBay
    2. Seagate
    3. IPRs (and the abuse of reexaminations).

    True, there have been abuses by patent owners, such as by Lemelson. But the one does not throw the baby out with the bathwater, and that is what has happened.

  8. Prizzi's Glory September 19, 2016 6:15 pm

    As I wrote previously on Misleading PTO statistics hide a hopelessly broken PTAB, the USPTO is infested with vulgar Schumpeterism. It’s a real problem that can only be addressed with pro-patent activism.

  9. Prizzi's Glory September 19, 2016 6:22 pm

    Unfortunately, the USPTO can’t be fixed until corrupt USPTO officials are purged.

    As I pointed out on Use of PTAB Decisions in District Court Litigation, ridding the USPTO of corruption is probably the most important issue in the USA today, but only IP professionals understand, and the presidential contenders only address stupid trivia.

  10. Anon September 19, 2016 6:56 pm

    Mr. Heller,

    I would add the point to your post that the emergence of the entity that “does not make” created a new force that the large established entities with their war chests of sometimes questionable patents (large established multi-nationals were often more concerned with merely the size of the hoard, rather than any individual value or even validity) were the very reason why the myth of the “Patent Tr011” was born and bred so completely out of proportion of any bad actors in the system.

    It is directly an offshoot of this propaganda effort that spawned the AIA (and the echoes of that spawning are very much still around).

  11. Prizzi's Glory September 19, 2016 9:55 pm

    In Why Nations Fail Daron Acemoglu and James A. Robinson explain the importance of patents in the economic development of the USA.

    [Note that without time-limited exclusive title to their inventions, inventors would have far less collateral with which to secure a loan.]

    HAVING AN IDEA, STARTING A FIRM, AND GETTING A LOAN

    The Industrial Revolution started in England. Its first success was to revolutionize the production of cotton cloth using new machines powered by water wheels and later by steam engines. Mechanisation of cotton production massively increased the productivity of workers in, first, textiles and, subsequently, other industries. The engine of technological breakthroughs throughout the economy was innovation, spearheaded by new entrepreneurs and businessmen eager to apply their new ideas. This initial flowering soon spread across the North Atlantic to the United States. People saw the great economic opportunities available in adopting the new technologies developed in England. They were also inspired to develop their own inventions.

    We can try to understand the nature of these inventions by looking at who was granted patents. The patent system, which protects property rights in ideas, was systematised in the Statute of Monopolies legislated by the English Parliament in 1623, partially as an attempt to stop the king from arbitrarily granting “letters patent” to whomever he wanted — effectively granting exclusive rights to undertake certain activities or businesses. The striking thing about the evidence on patenting in the United States is that people who were granted patents came from all sorts of backgrounds and all walks of life, not just the rich and the elite. Many made fortunes based on their patents. Take Thomas Edison, the inventor of the phonogram and the light bulb and the founder of General Electric, still one of the world’s largest companies. Edison was the last of seven children. His father, Samuel Edison, followed many occupations, from splitting shingles for roofs to tailoring to keeping a tavern. Thomas had little formal schooling but was home-schooled by his mother.

    Between 1820 and 1845, only 13 percent of patentees in the United States had parents who were professionals or were from recognizable major landowning families. During the same period, 40 percent of those who took out patents had only primary schooling or less, just like Edison. Moreover, they often exploited their patent by starting a firm, again like Edison. Just as the United States in the nineteenth century was more democratic politically than almost any other nation in the world at the time, it was also more democratic than others when it came to innovation. This was critical to its path to becoming the most economically innovative nation in the world.

    If you were poor with a good idea, it was one thing to take out a patent, which was not so expensive, after all. It was another thing entirely to use that patent to make money. One way, of course, was to sell the patent to someone else. This is what Edison did early on, to raise some capital, when he sold his Quadruplex telegraph to Western Union for $10,000. But selling patents was a good idea only for someone like Edison, who had ideas faster than he could put them to practice. (He had a world-record 1,093 patents issued to him in the United States and 1,500 worldwide.) The real way to make money from a patent was to start your own business. But to start a business, you need capital, and you need hanks to lend the capital to you.

    Inventors in the United States were once again fortunate. During the nineteenth century there was a rapid expansion of financial intermediation and banking that was a crucial facilitator of the rapid growth and industrialization that the economy experienced. While in 1818 there were 338 banks in operation in the United States, with total assets of $160 million, by 1914 there were 27,864 banks, with total assets of $213 billion. Potential inventors in the United States had ready access to capital to start their businesses. Moreover, the intense competition among hanks and financial institutions in the United States meant that this capital was available at fairly low interest rates.

    [Why Nations Fail, pp. 26-27.]

  12. Lawrence Lockwood September 19, 2016 11:04 pm

    Amazing Congress has ignored the evidence while limiting patent rights by AIA. Instead of encouraging innovation and growth, just the opposite.
    http://www.citylab.com/work/2014/05/rate-new-business-formation-has-fallen-almost-half-1978/9026/

  13. Prizzi's Glory September 20, 2016 5:42 am

    Why Nations Fail provides an excellent analogy in la Serrata of Venice to the AIA and the internal USPTO corrupt conspiracy that has created SAWS, Second Look, and similar unlawful or illegal secret programs.

    [The Venetian elite staged a coup against economic and political inclusiveness and put the Venetian Republic into permanent catastrophic decline. La Serrata is comparable to the AIA except that the Venetian elite was much honest about the real goals.]

    HOW VENICE BECAME A MUSEUM

    These [Venetian] political reforms led to a further series of institutional innovations: in law, the creation of independent magistrates, courts, a court of appeals, and new private contract and bankruptcy laws. These new Venetian economic institutions allowed the creation of new legal business forms and new types of contracts. There was rapid financial innovation, and we see the beginnings of modern banking around this time in Venice. The dynamic moving Venice toward fully inclusive institutions looked unstoppable.
    But there was a tension in all this. Economic growth supported by the inclusive Venetian institutions was accompanied by creative destruction. Each new wave of enterprising young men who became rich via the commenda or other similar economic institutions tended to reduce the profits and economic success of established elites. And they did not just reduce their profits; they also challenged their political power. Thus there was always a temptation, if they could get away with it, for the existing elites sitting in the Great Council to close down the system to these new people.

    At the Great Council’s inception, membership was determined each year. As we saw, at the end of the year, four electors were randomly chosen to nominate a hundred members for the next year, who were automatically selected. On October 3, 1286, a proposal was made to the Great Council that the rules be amended so that nominations had to be confirmed by a majority in the Council of Forty, which was tightly controlled by elite families. This would have given this elite veto power over new nominations to the council, something they previously had not had. The proposal was defeated. On October 5, 1286, another proposal was put forth; this time it passed. From then on there was to be automatic confirmation of a person if his fathers and grandfathers had served on the council. Otherwise, confirmation was required by the Ducal Council. On October 17 another change in the rules was passed stipulating that an appointment to the Great Council must be approved by the Council of Forty, the doge, and the Ducal Council.

    The debates and constitutional amendments of 1286 presaged La Serrata (“The Closure”) of Venice. In February 1297, it was decided that if you had been a member of the Great Council in the previous four years, you received automatic nomination and approval. New nominations now had to be approved by the Council of Forty, but with only twelve votes. After September 11, 1298, current members and their families no longer needed confirmation. The Great Council was now effectively sealed to outsiders, and the initial incumbents had become a hereditary aristocracy. The seal on this came in 1315, with the Libro d’Oro, or “Gold Book,” which was an official registry of the Venetian nobility.

    Those outside this nascent nobility did not let their powers erode without a struggle. Political tensions mounted steadily in Venice between 1297 and 1315. The Great Council partially responded by making itself bigger. In an attempt to co-opt its most vocal opponents, it grew from 450 to 1,500. This expansion was complemented by repression. A police force was introduced for the first time in 1310, and there was a steady growth in domestic coercion, undoubtedly as a way of solidifying the new political order.

    Having implemented a political Serrata, the Great Council then moved to adopt an economic Serrata. The switch toward extractive political institutions was now being followed by a move toward extractive economic institutions. Most important, they banned the use of commenda contracts, one of the great institutional innovations that had made Venice rich [and that played an economic role similar in effect to pre-AIA US patents]. This shouldn’t be a surprise: the commenda benefited new merchants, and now the established elite was trying to exclude them. This was just one step toward more extractive economic institutions. Another step came when, starting in 1314, the Venetian state began to take over and nationalize trade. It organized state galleys to engage in trade and, from 1324 on, began to charge individuals high levels of taxes if they wanted to engage in trade. Long-distance trade became the preserve of the nobility. This was the beginning of the end of Venetian prosperity. With the main lines of business monopolized by the increasingly narrow elite, the decline was under way. Venice appeared to have been on the brink of becoming the world’s first inclusive society, but it fell to a coup. Political and economic institutions became more extractive, and Venice began to experience economic decline. By 1500 the population had shrink to one hundred thousand. Between 1550 and 1300, when the population of Europe rapidly expanded, that of Venice contracted.

    Today the only economy Venice has, apart from a bit of fishing, is tourism. Instead of pioneering trade routes and economic institutions, Venetians make pizza and ice cream and blow colored glass for hordes of foreigners. The tourists come to see the pre-Serrata wonders of Venice, such as the Doge’s Palace and the lions of St. Mark’s Cathedral, which were looted from Byzantium when Venice ruled the Mediterranean. Venice went from economic powerhouse to museum.

    [Why Nations Fail, pp. 147-149.]

  14. Night Writer September 20, 2016 1:06 pm

    I think Jimmy Carter realized this and that is why he set up the Fed. Cir., although it was Reagon that signed the bill.

    Carter wanted to use patents to end the great malaise and it worked. The multi-nationals have the malaise back now.

    And, consider this: if you can easily take any technology, then isn’t spending money on R&D corporate waste? Maybe not if you can claim that it expands markets.