Archive for economics
Abraham Lincoln said that the patent system “added the fuel of interest to the fires of genius.” Today the fires of genius and the fire of innovation itself is getting doused with something less helpful than fuel. These fires are being cooled and, in some cases, extinguished with harsh attacks on the IP rights that once enabled and motivated lone inventors and small businesses to take the fruits of their genius to the market.
The owners of small businesses, the people who generate most of the innovation and business growth in the United States have good reason to be worried. Their ability to attract funding through valuable intellectual property is being compromised. Their ability to protect their products and innovations from the power of corporate giants is being whittled away. This has come from many quarters, but there is a widespread anti-patent movement driven by politics and misinformation. It’s the bitter fruit of a bitter anti-property rights movement that exaggerates the threat of a few bad actors to justify widespread weakening of property rights in ways that will hurt the economy and our society for years to come.
We have seen a recent series of Supreme Court cases that have made it much harder to obtain patents and enforce them. We have seen massive changes in US patent law that make it easier to invalidate patents after they are granted and make it harder and more costly to stop infringers if your patent survives. Now the bogeyman of “patent trolls” is held up as a threat to America that requires more sweeping “patent reform” to make it even harder to enforce a patent, and it looks like both parties are united in a quest to do “something big” to shake up the IP rights that helped drive the American economy for so many decades. Corporate giants benefit from this reform as it clears away the annoyance of other people’s IP rights standing in the way of their marketing muscle. But the economy as a whole and the rights of many are hurt in this process this amplifies innovation fatigue .
Several recent articles highlight just how serious the problem has become. Louis Carbonneau in “Toxic Asset: The Gradual Demise of the American Patent” (IPWatchdog.com, December 10, 2014), surveys the radical changes in the past two or three years:
On the judicial front, in 2014 we saw no fewer than 5 Supreme Court decisions going against patent holders on the various subjects of obviousness (a key test for patent validity), what constitutes “abstract ideas” (which now undergo a more stringent test for patentability), business method patentability, indefiniteness (how you construe claims), reasonable royalty (how you calculate damages), willful infringement (how you punish the “bad actors”) and fee shifting (making losers pay for winners legal fees). All of these decisions have collectively made it harder for patent owners to: i) maintain the validity of duly issued patents (previously presumed by law), ii) pursue infringement claims, ii) prove damages (let alone treble damages), iv) have open discussions with potential infringers prior to litigating, and have left the unsuccessful patent owner at risks of paying millions in legal fees to the other side if the judges so decides.
Parallel to judicial reform at the federal courts, recent US patent reform with the American Invent Act (AIA) introduced a new post grant review mechanism called Inter Partes Review (IPR) which allows a party to challenge the validity of any issued patent before the Patent Trial & Appeals Board (PTAB). Strangely, despite the PTAB being an emanation of the same USPTO that delivered all these patents in the first place, there is no longer a presumption of validity before the PTAB for the patents being challenged while other rules make it easier to invalidate patents based on prior art.
Finally, on the political front, in 2013 the US House of Reps. passed the Goodlatte bill, which would erode rights conveyed to all patent holders despite being primarily directed at NPEs. It is now expected that the new Republican led Senate will revive the bill -currently on hold- in early 2015 and, with a rare showing of bipartisanship from the White House, it is expected to be signed into law. At the same time, 27 US States have passed or are in the process of passing laws that make it harder for people to assert the patents they own.
Carbonneau goes on to explain that in recent Federal Circuit cases, patent owners are being crushed, and in Inter Partes Review (IPR) cases before the USPTO, nearly 80% of the owners of challenged patents are being told by the USPTO that their patents are not valid over the prior art that the USPTO itself supposedly considered before granting the patent in the first place. Carbonneau puts it rather wryly:
The most interesting statistics come from the PTAB [the USPTO’s Patent Trial and Appeal Board, which processes IPR cases] because it only focuses on validity issues based on prior art; the very same prior art patent examiners are supposed to have found and analyze prior to issuing a patent. Since patents going through IPRs are usually the same ones that being litigated, you would assume that owners did a lot of due diligence before investing in a costly patent lawsuit. Well, the PTAB is declaring 77.5% of reviewed patents invalid! And this is not limited to “abstract” software; patents related to biotech and pharmaceuticals, medical and mechanical devices, are being invalidated at an even higher rate! Remember, this is an offspring of the very same agency that inventors paid thousands of dollars in the first place to review applications and issue their patents. Now, after having to pay a quarter to a half million dollars in legal fees (average cost of an IPR procedure for a patent holder), the same agency is telling patentees nearly 80% of the time: “Very sorry we made a mistake; we would not have allowed your application had we looked more carefully for existing prior art. And no, there is no refund available.”
Personally, I cannot think of any industry that could survive more than a month with a nearly 80% defective rate, let alone by forcing you to spend a fortune for the “privilege” to confirm that indeed your title was invalid in the first place! Only a government can come up with such a broken system and get away with it.
The impact of these anti-patent efforts has been a surprisingly sudden break from the trend of increasing IP litigation, with litigation in 2014 down about 13% from the previous year according to a new 2015 PwC report on patent litigation. The problem of explosively increasing patent litigation, a common excuse to justify the slashing of patent rights, is not supported by the data.
Richard Lloyd, writing for the IAM Blog, draws this observation from the PwC report:
Of these three classes [of patent litigants considered], NPE [non-practicing entity] companies have been successful 31% of the time in patent cases brought since 1995; this compares with a success rate for universities and non-profits of 48% and a lowly 18% for individual inventors. Individual patent owners also do far worse with damages pay-outs, getting a median award of $3 million compared with $11.5 million for company NPEs and $16.2 million for universities/non-profits.
There could be many reasons for individual inventors doing relatively badly. Although the PWC study doesn’t provide any, it’s easy to speculate that small inventors may have lower average quality patents to begin with, while they probably don’t have the same kind of litigation savvy as other NPEs and are much less likely to have access to the same kind of litigation expertise that larger, better funded patent owners can turn to.
But what PWC’s numbers also strongly suggest is that the US patent litigation system is strongly stacked against small, patent owning entities. Bearing this in mind, it is worrying that the main packages of reform proposed in the House of Representatives (the Innovation Act) and the Senate (the PATENT Act) are only going to penalise them further.
Lloyd notes that potential irony now that many lone inventors, recognizing that they have little chance of winning and have almost no chance of affording the punitive legal bills they may face if they sue and lose, may be more likely to turn to NPEs (“patent trolls”) for help as the most practical way to realize any benefit from their work.
There is a need to rebuild an innovation climate in the United States, starting with educating our leaders about the need for IP rights and the value of patents. If we don’t teach this lesson from within, it will eventually be taught rather loudly from without, for Europe and China are both moving to strengthen IP rights and strengthen IP enforcement. Europe’s Unitary Patent system could be a boon to IP there, though much remains to be seen, but the changes in China are strong and dramatic. That nation has gone from no patents and no IP system in the early 1980s to the world’s biggest source of IP generation and IP litigation, with many changes steadily strengthening the nation’s IP system. There is a long ways to go for China still and there have been some setbacks, but at current rates we can see China becoming a leading source of global innovation while the US loses its lead.
Will the flames of innovation be largely quenched in that nation? Much depends on what we do with IP rights now, the rights that will shape our culture and economy for decades to come. May the fires of genius be encouraged with something other than the cold water Congress and Courts have been sloshing.
At the Marcus Evans Innovate 2014 Conference in Shanghai today, I met Rosalie Wu, the head of marketing in China for the rapidly growing startup, Uber. Rosalie was Uber’s first hire in China and exemplifies the energetic, entrepreneurial spirit that is driving Uber to global success. She spoke about the development of Uber’s innovative business model and the many innovations they continue to add in their unique approach to “glocalization,” wherein a company going global adapts its products and business model to the unique constraints and opportunities of each local market. I see Uber at the poster child for sound and innovative glocalization.
Uber began when one of its founders and first CEO, Travis Kalanick, attended Le Web in Paris in 2008 and struggled to get a cab in snowy weather. He realized there had to be a better way to use the free market to solve the basic problem of getting a ride. His passion for solving this problem resulted in forming a San Francisco start-up that began in 2010 with a mobile app for ride sharing in San Francisco. Today they offer a refined and clever business model with services in over 200 cities. Beijing was #200, and Uber is marching rapidly across China and other parts of the world. Rosalie’s enthusiasm for Uber is contagious and really stirred the audience here at the Hongqiao Marriott Hotel.
Uber’s business model innovation includes systems for registering, insuring, and rating drivers. It offers flexible pricing that helps tap the power of the free market much better than conventional taxi pricing and taxi systems can. With Uber you can select quality drivers and have simple, positive experiences getting to where you need to go when you want to be there. The business model is being extended with many other innovations such as delivery of products and even services (in China, they have even offered the service of having a traditional Chinese lion dance sent to be performed in your office). The innovate their offerings to meet local needs and adapt to local regulations and customs, while finding clever ways to continually make people’s lives better. This will inspire the competition to do more and bring ongoing innovation that will benefit us all. Amazing what a bad snowy night can do when an innovator is around.
Less than a year ago, Uber was valued at over US$3.5 billion. A few months ago in 2014, Uber was valued at around $17 billion. This is the power of doing something that brings people together in new ways.
Uber has faced and overcome a host of innovation barriers. Funding challenges, regulatory burdens, and stiff competition. But they have forged ahead with a relentless focus on making life better for its customers with green, energy saving, disruptive innovation . May the path before them remain wide open. Kudos, Uber!
One of the biggest problems from economies directed by bureaucrats rather than a free market is that the bureaucrats don’t just spend money on foolish areas that don’t make sense economically, but their diversion of funds causes money to dry up where it is needed. Thus the housing bubble, created by government intervention and waste, resulted in billions of dollars being lost for unnecessary home building when it could have been helping small business grow. When government creates artificial markets and bubbles that are sure to pop, there is a lot of hidden carnage in addition to the obvious disasters one sees down the road. A top victim of bureaucratic excess and meddling in the economy is innovation.
Right now, for example, the government continues to direct billions into solar energy in the name of advancing innovation, while simultaneously increasing the cost of patent protection for all innovators by about 15% due to the harmful new patent legislation that was just signed into law. Government interventions in the field of energy are often likewise tailored to increase the cost of energy to consumers in order to achieve political objectives that make little economic sense. We have not yet learned from the Solyndra scandal but continue to misdirect billions into areas with simply no hope of being economically competitive. The problem, again, is not just that those projects will fail. The deeper problem is that the innovators who really could make a difference are less likely to gain access to capital and less likely to be noticed in the market because of the artificial barriers they will face. The market is being skewed and real innovation by real entrepreneurs, the kind of innovation that can succeed and make economic sense, is likely to suffer as a result.
One of the mysteries of the current economy is why so little capital is going into business investment now in spite of all the billions being dumped into the economy. Part of the problem is that the artificially low interest rates being set by the Fed create an easy, low-risk way for banks to make money at our expense. They can borrow money from the government for almost free and then simply buy treasuries to collect the interest. When a risk-free cash cow is created this way, why should they want to make money the risky, market-based way by investing in businesses that can fail? But this cash cow distorts the economy and makes innovation more difficult in the long run. Innovation fatigue.
Want less innovation fatigue? Let’s not pretend that bureaucrats in DC know which innovations deserve billions of dollars. Let the market decide. And ditto for interest rates. Get the Fed out of that equation and let the market set the cost of money.
Chemical engineers interested in innovation and entrepreneurship should consider attending the AIChE 2010 Annual Meeting in Salt Lake City. On Wednesday, Nov. 10, I will chair a session featuring four outstanding speakers on topics that should be of interest to many engineers, including university researchers, corporate researchers, and managers. If you are conducting research that could lead to a new business, if you are involved in leading or managing R&D, if you are part of an effort where intellectual property could make a difference, then you should attend our session, “Intellectual Assets in the Digital Era.” You need to register for this conference through AIChE.
Time: Wednesday, November 10, 2010: 8:30 AM-11:00 AM
Location: Salt Palace Convention Center, Grand Ballroom G, Salt Lake City, UT
Chair: Jeff Lindsay, Director of Solution Development, Innovationedge, Neenah, WI
Co-Chair: Ken Horton, Gore School of Business, Westminster College, Salt Lake City, UT
Schedule of Papers and Abstracts:
8:30 AM, Paper #406A, “Business Development, IP, and Manufacturing Success: Perspectives From Utah’s Manufacturing Extension Partnership” by David Sorensen, Executive Director of Utah’s Manufacturing Extension Program. (See biographical information below.)
Abstract: The Manufacturing Extension Partnership of Utah has assisted many companies in strengthening their strategy for success and continued growth. We will discuss what it takes to advance your business, including lessons relative to leadership, vision, intellectual property, and coping with changing regulations and policies.
9:10 AM, Paper #406b, “The Role of IP in Successful Startups,” Mike Alder, Director of Technology Transfer, Brigham Young University.
Abstract: Many AIChE members will be involved with a startup at some point in their career. While the capabilities of the management team is of utmost importance, in numerous cases, the success of the startup also depends on the quality of its intellectual property. In this era, an IP-savvy team can take several steps to secure competitive advantage and realize greater value from the technology, products, or services the company offers. This presentation will draw upon experience with many startups and startup teams and will provide guidance to researchers, business leaders, and future entrepreneurs on how to better prepare for success.
9:45 AM, Paper #406c, “An Introduction to IP Law: The Underpinnings of Intellectual Assets,” Ken Horton, Kirton & McConkie, Salt Lake City, UT
Abstract: An understanding of the basics of intellectual property law can help chemical engineers in advancing their own research, in evaluating competitive efforts, in building their own business, or in general advancing their career. This presentation will cover some of the key concepts that engineers should know, including the nature of patents, the different kinds of patents (provisional, utility, design), the role of trademarks and copyrights, what it takes to be patentable, and how changes in patent law may affect your career and business.
10:20 AM, Paper #406d, “Cost-Effective Pursuit of IP in a Down Economy,” by Jonathan Lee
Abstract: How does one get the most protection and benefit from intellectual property when the economy is down? How can patents and other forms of intellectual property be obtained in a cost effective manner when budgets are tight? In this presentation, an experienced patent attorney shares insights into cost effective IP with guidance directed to managers, research leaders, inventors, and entrepreneurs.
Mr. Sorensen has over 35 years of experience in a wide variety of technical and managerial assignments requiring comprehensive knowledge in several disciplines relating to engineering, manufacturing, information technology and business systems. He has been directly responsible for major contracts with industry and government agencies and has a proven record of technical competence, customer relations, and business planning in rapidly expanding technical companies. Mr. Sorensen has held increasingly responsible positions in product and service organizations. He is innovative, resourceful, and aggressive in accomplishing assigned responsibilities with major strengths in strategic planning, marketing and management. He holds a Bachelor of Engineering Science and a Masters in Manufacturing Engineering Technology from Brigham Young University.
Since 1995 he’s been the Director of the Utah Manufacturing Extension Partnership (MEP-Utah), serving primarily the 6,200 manufacturers in the state of Utah. MEP-Utah was selected to initiate and manage the NIST Information Technology Network for over 60 MEP Centers nationwide. Mr. Sorensen is also a BYU adjunct faculty member and the Associate Dean of Technology, Trades and Industry at Utah Valley State College. With a staff of 18, in one year MEP-Utah helped create or save 2,719 jobs in Utah, increased manufacturing sales by more than $121 million and increased employee payroll by more than $84 million.
He’s been the Chairman & CEO for Echo Solutions, a start-up software products and services company; Executive VP of Eyring Research Institute; General Manager of EG&G Services; Director of Engineering at EG&G Idaho Inc.; Manager of Architect Engineering and Construction at Aerojet Nuclear Company and Manager of Power Generation Equipment at Bunker Ramo. He also has experience with GE’s Nuclear Instrumentation as a Senior Applications Engineer, and in engineering positions at Kennecott Copper, Intermountain Industries, and F.C. Torkelson Engineers.
Mike is Director of Technology Transfer at Brigham Young University, where his work has been nationally recognized by BusinessWeek and others for their success. Mike is also Chair of the Board for WestCAMP Inc. where he has also chaired the National Centers of Excellence (NCOE), a division of WestCAMP. Mike is formerly the CEO of the Biotechnology Association of Alabama. He was also a Venture Partner with Redmont Venture Partners, Inc. He has been heavily involved in the founding of Tranzyme, Inc.; Vaxin, Inc.; Folia, Inc.; Chlorogen, Inc.; Allvivo, Inc. and Cr3, Inc. All but one of these are biotechnology companies (Folia produces specialty biopolymers).
Mr. Alder has 30 years of experience in leading technology-based startup companies. He was previously CEO of Emerging Technology Partners in Birmingham, Alabama from 1997 to 2003. Prior to coming to Alabama in 1994 he co-founded the Grow Utah Fund that focused on creating technology-based businesses. In 1989 he was asked by the Utah Governor to head the State’s Office of Technology Development, which he did for 5 years as its Executive Director, helping bring Utah’s Centers of Excellence programs to national prominence. In 1973 he founded NPI, a plant biotechnology company in Salt Lake City, Utah and served as President, COO and Vice Chairman of that company for 15 years as it grew to over 700 employees.
Ken Horton is a member of Kirton & McConkie‘s Intellectual Property Practice Section in Salt Lake City. His practice includes domestic and foreign patent prosecution, patent opinions, intellectual property litigation (including both state and federal court actions), domestic and foreign trademark prosecution, trademark opinions, copyrights, trade secrets, intellectual property evaluations and due diligence, as well as technology and intellectual property agreements. Mr. Horton has extensive experience in both pharmaceutical and semiconductor technologies. He is a frequent speaker on the topic of intellectual property law and strategy, speaking both at the 2007 and 2010 A.I.C.H.E. annual conferences and the 2009 A.C.S. annual conference. Additionally, Mr. Horton is an Associate Professor in these topics in the MBA Technology Management Program at the Gore School of Business of Westminster College.
Jonathan Lee is a registered patent attorney and a member of the Utah State Bar practicing at ALG (AdvantEdge Law Group). His practice focuses on adding real-world value to companies, both large and small, by acquiring, securing, and protecting intellectual property rights.
Mr. Lee has prepared and successfully prosecuted hundreds of patent applications throughout his career, primarily in the electrical, electro-mechanical, and computer engineering fields. He currently helps a number of Fortune 1000 companies manage and develop their domestic and worldwide patent portfolios. He also regularly counsels clients in other aspects of intellectual property law, including litigation, licensing, and opinion work, as well as due diligence examinations, copyrights and trademarks, and patent reexamination proceedings.
Prior to joining ALG, Mr. Lee worked for nationally recognized law firms in Washington, D.C. and Salt Lake City, Utah.
Mr. Lee was recently selected as a Mountain States Rising Star by Super Lawyers, a peer-reviewed publication.
Our idea was simply to form a microscopic mold as a template, fill it with metal, and remove part of the template leaving individual metal hairs surrounded by an insulator. Then, we could use any number of methods to coat the hairs and form solar cells. At the end of the day, its not too far technically removed from fabricating a micro scale Popsicle using a semiconductor foundry.
When our technical work started in earnest, we thought we might have been a bit deluded to think we scooped the big boys of the world (GE, BP, Sharpe). Off to my basement I went. I worked through the physics. I looked through hundreds of journal articles. I read through over 3000 patent abstracts. All the while, simply using Google, the US PTO, and the WIPO search engines. While I prefer using search engines like Aureka, it really isn’t to bad doing a search manually either. As long as you are short on money and don’t mind working like a mad man, it’s not a problem. I was worried that I must have missed something so I double-checked my search against an IP search using artificial intelligence. No significant prior art came up.
It become evident that geometry of the nano scale hairs was perfect to create a super solar cell. The solar cells are probably coated with what are referred to as nano dots or at least coatings so thin that phenomena that cause electrical losses due to excessive thickness disappeared. The cells are also super light absorbent and conserve rare materials. This was not lost on the theoreticians. However, their further belief was that semiconductor equipment is cost prohibitive for the use in solar cells, which is correct for machines found in state-of-the-art foundries. What they missed was that older, more primitive equipment was sufficient to make the nano-wire solar cell cost effectively. General George Patton once said, “If we’re all thinking the same thing, someone isn’t thinking.” In retrospect, groupthink in the solar industry left us a brief crack of time, which we used to patent and develop the technology. In the years that followed, we learned a lot of work had started a short time after ours.
The intellectual property needed to be done flawlessly. In my mind, that meant that I should draft the applications myself. However, the group voted to go with a big name national legal firm. Since we were bootstrapping the enterprise, we were starting with a provisional patent application. To save on legal fees, I drafted the application. Next, I spent the two weeks bringing an entry-level patent attorney up to speed on our technology, and then she let us know that the application was excellent and she supported filing it. No added claims. No significant improvements to the specification. Only a big “atta boy” and an invoice for $15,000. I think that when you work with a large legal firm and you are a fledgling startup, it is very unlikely that you will get the “A” level support. In the end, I suppose I did what I set out to do; we were just poorer for the experience. My only other qualm with our process is that our team viewed IP development as an ancillary activity. Some people just don’t get the value of IP until it is too late. Eventually excellent counsel was located through a recommendation of a former colleague, and the final application was done well.
Now all we needed was money. We chose two avenues, grants for academic research and angel money. Neither path is easy, but we managed to get several grants. The grants were nice to keep members of the team solvent, but they can also be a trap where too much focus is on writing papers. We found this to be the case, and eventually refocused fund raising on angel investors. That is not easy either. To get angel money, you need to have a good idea, and you need to have someone they know on your team. People who are trusted by angel investors or venture capitalists are not necessarily people that can be trusted. I cannot over emphasize how difficult it is to find a good person that meets that criterion. Mark Twain once said “A man who carries a cat by the tail learns something he can learn in no other way.” You cannot do too much background work. Fund raising last year was not fun. A Nobel Prize winner, a Stanford electrical engineer who graduated top his class in two and a half years, and few dozen other technical leaders, vetted us out. It was our experience that the complexity of the idea got lukewarm responses or ridicule from VC’s with little technical depth, but fantastic responses from investors with high levels of technical skill.
As grants and angel money trickled in, I frantically yet frugally raced to develop a prototype always working to stay one step ahead of the money. One problem was that there was no other technical support. Another problem was that manually performing operations that are normally automated around the clock is challenging. After many months of grueling work, it was gratifying to find that everything worked as I thought it would. Finally, individual investors gave us the money we needed to enter into long-term process development. The project has been moving forward according to plan. However, my personal and business priorities were not a match with the new management of the company, and the company no longer employs me. I am back in the consumer products business enjoying a brisk consulting business. This type of venture is not for anyone with a weak stomach for long hours, high risk, or high stress. However, if you are willing to pay the price and can work with trustworthy people, it can be the most satisfying and financially rewarding adventure in your career.
During our last snowstorm in my part of Wisconsin, I took the photo above of a traffic light whose traffic signals were largely hidden by snow. I saw it as a metaphor for what happens when times of economic chill blind entrepreneurs and businesses to the opportunities around them. A downpour of discouraging economic data and fear can pile up like snow on a traffic light and obscure the green light of opportunity that otherwise could be telling you to move ahead. The lesson is not to just plow ahead, nor is it to remain at a standstill until the chill ends, but to learn to look for the fainter clues that show the true color of the largely hidden glow.
This may be the right time to move ahead for the opportunity before you. Indeed, many great companies have their roots in times of economic recession. While others are cutting back on innovation and preparing to put their companies permanently in park, those who invest in innovation now will have the decisive advantage and be miles ahead of the competition when the chill ends. Look closely – there may be a green glow under all that snow.
I recently shared a presentation about the economic innovation in Brasilia, where bold actions to reduce the size of government and strengthen the climate for private sector growth have resulted in record unemployment and social progress. I have some additional information I’d like to share on some of the foundational work that has been done since 2006 to create the ecosystem for economic and innovation success in the future.
If you are interested in taking advantage of the economic opportunities in Brasilia or in better understanding the future of innovation there, let me know. And if you have perspectives that we might be able to share in our next book on some international aspects of conquering innovation fatigue, please contact me. Contact information us at the the end of the Pixetell video, or email me at jlindsay at innovationedge dot com.
In the latest Harvard Business Review, Edmund S. Phelps and Leo M. Tilman have a short essay calling for government action to better fund innovation. In “Wanted: A First National Bank of Innovation,” they paint a picture that agrees with what we describe in Conquering Innovation Fatigue, where we review some of the “innovation fatigue” problems we are observing in the United States and elsewhere:
Dynamism has been in decline over the past decade. Venture capitalists bemoan a dearth of innovative ideas, and investors bewail a precipitous drop in their rates of return. IPOs of venture-capital-backed firms have steadily declined from the levels of the 1990s. Total venture investment is now running at less than $20 billion per year. Institutional investors and equity analysts now pressure CEOs of public companies to hit steadily growing earnings targets. That pressure distracts from long-term value creation. And the patent system, which at first encouraged invention, now threatens inventors with a tangle of infringement suits.
The current financial system is choking off funds for innovation. It lacks transparency, and incentives for risk takers at financial firms are fundamentally misaligned with the interests of stakeholders. Outdated accounting conventions and inadequate disclosures make it impossible to evaluate the business models and risks of financial firms. Excessive resources are allocated to proprietary trading, to lending to overleveraged consumers, to regulatory arbitrage, and to low-value-added financial engineering. Financing the development of innovation takes a backseat. Whatever self-reforms and regulatory reforms are now in the works, we do not believe they are likely to restore the rollicking times of old, when banks lent to and invested in businesses, steering the economic transformations of the late nineteenth and early twentieth centuries.
In the next decade, the inadequacy of the financial system will become only more glaring. Opportunities in clean technologies and nanotechnology require large-scale, long-term investments. Unfortunately, most financial firms lack the expertise to invest in business ventures on a sufficient scale, now that a generation of financial professionals has been trained to focus elsewhere. Unless something changes, the gap in funds for business innovation will keep widening.
The solution the authors propose is a government program to provide additional funds that could be loaned to entrepreneurs. The system would be designed to “foster judicious business decisions, competent risk management, and well-aligned incentives.” Recognizing the possibility of politicians doing the things that politicians do, they make this statement: “Of course, every effort should be made to keep FNBI (the First National Bank of Innovation) free of political patronage and popular pressures.”
It’s a valuable idea, one that could really help if done properly. Unfortunately, government programs often have unintended consequences (the bigger the program or policy shift, the bigger the surprise), and any program created and guided by politicians could suffer from political distortions. Could it be done fairly? Is there a risk that money might be misallocated or ultimately diverted from healthy to unhealthy regions of the economy? Crafting an organization that fosters judicious business decisions may not be a reasonable expectation for politicians, so many of whom are unfamiliar with the challenges and rigors of running a business. With the right help and understanding of the challenges and needs innovators face, it could help. But is it solving the right problem? Would there be new unintended negative consequences?
The financial barriers to innovation that many entrepreneurs are facing today can, in my opinion, be largely traced to the failures of previous government efforts to help the economy. Even overlooking the role of the Federal Reserve Bank, Fannie Mae, Freddie Mac, Congress, and other government organizations in creating the housing bubble, the present tightness in credit, in spite of all the misallocated billions of bailout money, can be at least partially traced to the artificially low interest rates created by the Federal Reserve Bank, which allows banks to borrow money for almost free and get safe, lucrative returns by investing in treasuries, whereas loans to entrepreneurs are high risk.
The government actions and policies that have made credit very tight for innovators and people like you and me are discussed in a recent (Dec. 30, 2009) article at Motley Fool, “The Real Reason Banks Aren’t Lending” by Chuck Saletta. Here’s an excerpt:
For one thing, there’s an interesting “carry trade” going on right now that only banks can access. The Federal Reserve set the Federal Funds Rate at around 0%, giving banks an opportunity to borrow at essentially no cost. But 10-year Treasury yields — the typical proxies for mortgages — are around 3.8%. As a result, banks can earn an essentially risk-free 3.8% borrowing from the Fed system and lending to the Treasury, rather than lending to risky borrowers like you and me.
That’s easy money if you’re a bank. With the Federal deficit ballooning, the Treasury is certainly offering the banks plenty of opportunity to buy government bonds, rather than take a risk on traditional lending.
Theft by government fiat
And speaking of risk, several other government policies are dramatically adding to lenders’ risk. . . .
In essence, these policies have diminished the property rights of lenders. In effect, they turn every loan otherwise secured by a change of ownership in bankruptcy into the equivalent of an unsecured credit card. When banks and bondholders lose their ownership rights in bankruptcy proceedings, they lose much of their incentive to loan to anybody that needs the money. That doesn’t make lending impossible, but it certainly makes it tougher and costlier.
Hitting banks particularly hard is the concept of mandatory mortgage modification. Such enforced after-the-fact contract changes make it perfectly clear to lenders that they don’t have the same rights to foreclose they thought they had when they made the loan. Bank of America (NYSE: BAC), for instance, had to set aside $8.4 billion in a mortgage modification settlement with various states.
Without a credible threat of foreclosure, banks have no protection against speculators leveraging up with the banks’ money if those speculators can simply demand a sweetheart deal when their gambles don’t work out.
Other lenders have been hit hard by bad government policy as well. Some of the more pernicious examples include strong-arming bondholders into accepting deals whereby …
•Chrysler was handed over to its unions, Fiat, and the U.S. and Canadian governments, while its bondholders were given a few dimes on the dollar.
•General Motors was also handed over largely to its unions and the U.S. and Canadian governments, with its bondholders getting only about a 10th of the company. . . .
In fact, every time Uncle Sam dictates that lenders have to adjust the terms of their loans, or that bondholders do not deserve their seat at the table when an indebted company files bankruptcy, it threatens to weaken the debt market further. As President Obama’s feckless plea to banks to lend more money underscores, no amount of jawboning will really get banks to widely open their lending spigots again.
Government programs often cause unintended problems that are “fixed” by new government programs, which . . . In this case, I suggest that instead of giving politicians another hand at directing the flow of money to where they think it should go, let’s let the market do that. Let’s restore market rates rather than creating a source of free money for banks, at the expense of the rest of the economy. Let’s let banks compete, along with the rest of us, and let them fail, no matter how big, so that failure will not be subsidized by the rest of us. It was the free market, with the inherit ability to reap reward or failure in taking risk, that made the United States so successful in innovation. That track record of success was not due to government funding or programs, apart from generally appropriate efforts to help people protect their property rights (with some abuses, to be sure, from politicians and barons). Now that there is innovation fatigue in many quarters, the best solution may not be another government program, but perhaps the dismantling of programs or policies that are the source of current innovation fatigue and related barriers.
The road to innovation fatigue is paved with good intentions embodied in laws, regulations, and even corporate policies. Leaders at all levels must be aware of uninteded innovation-killing consequences that may follow from their good intentions. Staying in touch with the “voice of the innovator,” as we advocate in Conquering Innovation Fatigue, is vital in avoiding such pitfals.
The Wall Street Journal from Dec. 4 offers two columns with examples of innovation fatigue factors that can be introduced by well-intended actions. The first article I wish to mention is “Near-Zero Rates are Hurting the Economy,” an opinion column from David Malpass, president of Encima Global, LLC. He argues that the artificially low interest rates created by the Federal Reserve Bank in the name of rescuing the US economy have actually been driving capital overseas and starving small companies–the leading sources of most innovation, economic growth and job creation, as studies from the Kaufmann Foundation and others have shown. Here is an excerpt:
[M]ore than a year after the heart of the panic, the Fed is still promising near-zero interest rates for an extended period and buying over $3 billion per day of expensive mortgage securities as part of a $1.25 trillion purchase plan. Capital is being rationed not on price but on availability and connections. The government gets the most, foreigners second, Wall Street and big companies third, with not much left over.
The irony of the zero-rate policy, coupled with Washington’s preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. For gold and oil, the low-rate policy works, weakening the dollar so commodity prices go up and providing traders with ample funds to buy into the expanding bubble. Those markets are almost daring the Fed to try to break out of its zero-rate box.
But for small businesses and new workers, capital rationing is devastating, spelling business failures and painful layoffs. Thousands of start-ups won’t launch due to credit shortages, in part because the government and corporations took more credit than they needed (because it was so cheap).
Already countries with higher interest rates, Australia for one, are viewed as less risky because they have room to cut rates if there’s another emergency. This wins them capital and jobs that might otherwise be ours.
According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment.
When single individuals or organizations make policies that affect millions, it is far too easy for good intentions to translate into new problems, unless the decision maker is essentially omniscience. Failing ominiscience, perhaps market forces should be given a try, allowing the invisible hand mediated by the mechanism of price to determine the right allocation of resources. But even with a reluctance to use market forces to set interest rates and allocate capital, wiser decisions could be made by policy makers if they understood the personal side of innovation and the barriers faced by the innovators seeking to propel our economy forward. Unfortunately, the real innovation engines of the future aren’t likely to be powerful, highly connected people today, but may be a lone entrepreneur or president of a small company today that could grow and create many thousands of jobs, if only given a chance. Giving credit and bailouts to well-connected dinosaurs can be based on good intentions, but it may be a misallocation of resources that only makes things worse for the most important prospective innovators and job creators out there.
A second article in the Dec. 4 Journal is “Sarbanes-Oxley on Trial” (p. A24), an op-ed piece that briefly mentions the economic burdens this 2002 law has imposed, and urges government to modify its implementation to be more accountable. There is much more that could be said, some of which we discuss in our book. Sarbanex-Oxley is especially burdensome on small, innovative companies and has driven many innovators to look outside the United States in launching a start-up. Intended to make businesses safer and more accontable, it has slowed job creation and economic growth, in the eyes of some experts. Unintended consequences. It’s something every policy maker and business leader needs to be worried about. Are you listening to the voice of the innovators who have to live with your decisions? That could be the difference between success and innovation fatigue.
With a hearty hat tip to PatentlyO, one of the best blogs on intellectual property issues, here is a video of Judge Randall R. Rader of the US Court of Appeals for the Federal Circuit (CAFC) in a brief interview about the role of intellectual property rights. He scores several excellent points about the benefits that accrue when a nation encourages innovation by protecting intellectual property rights.
We mention the CAFC in the book in a passage that resonates with the words of Judge Rader:
The way of the individual patent holder has long been a hard one, often with little chance of winning suits from larger infringers equipped with deep pockets and excellent lawyers. The playing field was somewhat leveled in 1984 with the creation of the Court of Appeals for the Federal Circuit, resulting in a court that understood patents and gave their legitimate holders a reasonable chance of enforcing them. This time period corresponds with rapid escalation in the stock market, attributed to the increasing value of companies due to their intangibles—especially intellectual property.
The greatest fatigue of the inventor is experienced in countries where corruption or poorly developed legal systems result in little IP protection. So argues Hernando de Soto, a Peruvian economist and winner of many awards such as the 2006 Innovation Award from The Economist magazine for the promotion of property rights and economic development. De Soto has shown that lack of property rights has been a key factor in keeping poor nations poor. It is respect of property rights that creates the means for men to be equal in opportunity. The lone inventor can stand, patent in hand, before the giant corporation and declare, “This is my property, and you have no right to take it as your own for free.” It’s not easy, but IP gives the inventor a chance.
Remove the protection of IP rights, and innovators quickly experience the fatigue induced by theft.
There seem to be currents of decreasing respect for IP in some nations. These are currents that must be carefully navigated and, we hope, reversed, to provide the protection and motivation inventors need to take on the risk of innovation. Innovation needs liberal encouragement for the welfare of each nation.
Source: J. Lindsay, C. Perkins, and M. Karanjikar, Conquering Innovation Fatigue, New York: John Wiley & Sons, 2009, pp. 135-136.