Patent reform and entrepreneurs

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Government's protection of property is critical to economic growth. That includes protecting intellectual property — or IP — such as inventions and innovations through patents.

This should be obvious, particularly in today's high-tech economy. But history also provides a reminder that protecting IP has been an economic imperative for some time.

For example, Nobel Prize winning economist Douglass C. North argued that "the Industrial Revolution was an acceleration in the rate of innovation" due to "better specified property rights," which raised "the rate of return on innovating."

He explained: "The failure to develop systematic property rights in innovation up until fairly modern times was a major source of the slow pace of technological change." Mr. North added that "a systematic set of incentives to encourage technological change and raise the private rate of return on innovation closer to the social rate of return was established only with the patent system."

Indeed, property rights provide a necessary foundation for what might be called the four "i's" — investment, improvement, innovation and invention. Why invest, improve, innovate or invent, if others are free, in effect, to steal those investments, improvements, innovations or inventions?

Given our comparative advantages in entrepreneurship and innovation in the global marketplace, protecting intellectual property is particularly crucial for the U.S. economy.

Keep in mind that, as the U.S. Small Business Administration's Office of Advocacy reports, of the estimated 26.8 million businesses in this country, 99.9 percent have fewer than 500 employees. Small business is big business in the United States, and smaller firms are the wellspring of innovation, invention and jobs.

In fact, in IP-based industries, most firms are smaller businesses. For example, based on 2005 (latest available) firm size data from the U.S. Census Bureau, note the percentage of firms in some key patent industries with fewer than 500 employees: 98 percent in telecommunications, 97 percent in software publishing, 92 percent in aerospace products and parts manufacturing, 90 percent in pharmaceutical and medicine manufacturing, and 87 percent in semiconductor machinery manufacturing.

So, why do small businesses — and everyone else — need patent reform? There are three key problems with today's patent system.

(1) The first is lack of patent quality. There is widespread agreement that the quality of patents has declined, in particular failing to meet an adequate or rigorous enough test for inventions being nonobvious. This raises questions and potential costs for the small business community. Even straightforward business practices can drag a small business into the patent thicket, with broad and poorly defined patents granted for business practices and strategies. Small business innovation is constrained by possibly running afoul of patents that do not pass the test for being nonobvious.

(2) Litigation costs plague the patent arena, just as they do most areas of business. Of course, large firms have the resources to better weather litigation, while just one lawsuit can terminate a small, entrepreneurial firm.

(3) We have international costs. An international patent system fractured by region and/or nations is quite costly. The U.S. grants patents on a first-to-invent basis, rather than the first-inventor-to-file system the rest of the world follows. First-to-invent is inherently ambiguous and costly, and as various studies have shown, offers no particular advantage to small businesses and individual inventors.

What needs to be done? Reforming how other parties in the private sector can submit prior art during the examination process for a patent application would boost patent quality, for example. Restraining the litigation monster would be another big plus. And shifting to a first-inventor-to-file patent system to harmonize patent policy in an increasingly integrated world economy would reduce costs.

The U.S. House of Representatives passed a patent reform bill last year, and the U.S. Senate is expected to consider its own soon. The Senate bill (S.1145) has some clear benefits, including changing to a "first-inventor-to-file'' system; making it simpler for patent applicants to file and prosecute their applications; prior art reforms; codifying and clarifying standards for calculating reasonable royalty damage awards, as well as awards for willful infringement; and improving venue in patent cases to reduce "forum shopping."

Congress has been wrestling with patent reform legislation for several years, and the opportunity is at hand for substantive change that would benefit entrepreneurs, small businesses and our economy. Reforms that advance the cause for high-quality patents and reduced costs will serve to advance those very important four "i's" — investment improvement, innovation and invention.

Raymond J. Keating is the chief economist for the Small Business & Entrepreneurship Council.