Patent rights, product market reforms, and innovation

GAICIL Insights

Competition destroys rents; patents create them.¹ Surely the two pull in opposite directions? Patent rights, product market reforms, and innovation, by Philippe Aghion, Peter Howitt and Susanne Prantl, finds they can pull together. Strong patent rights may complement competition-increasing product market reforms in fostering innovation.

The evidence comes from the European Union's large-scale internal market reform of 1992. The reform enhanced innovative investments, on average, in manufacturing industries of countries with strong patent rights, and not in industries of countries with weaker patent rights. The positive response was more pronounced in industries where innovators rely more on patent protection, with one exception: electrical, medical and optical equipment, including computing and telecommunications equipment, where patent thickets and other impediments to cumulative innovation are most likely to exist. The same single market produced innovation in some countries and silence in others.

A step-by-step innovation model explains the complementarity. Product market competition encourages firms to innovate to escape competition. Better patent protection prolongs the period over which a firm escaping competition by innovating enjoys higher rents from its upgrade. Stronger patents raise the reward for escaping competition, so competition and patents together spur more innovation than either alone. Competition supplies the push; patents make the escape worth the effort.

The exception teaches as much as the rule. Where patent thickets impede cumulative innovation, stronger protection may not complement competition. When innovation builds on many prior inventions, dense patent webs raise costs and slow progress. The value of patent protection depends on each industry's innovation structure.

The parallel with today's technology is close. Artificial intelligence lives near that exception. AI innovation is cumulative, building on prior models, algorithms and datasets. The exception for computing and telecommunications equipment, industries close to AI, counsels caution about assuming stronger patents always complement competition in AI. Patent thickets could impede cumulative AI innovation as they appear to in related industries. An AI field carpeted with overlapping patents might innovate less under competition.

The main finding still offers guidance. Where innovation is less cumulative and patents clearly protect distinct advances, strong IP rights can amplify competition's innovation benefits. AI applications in specific domains might fit this pattern better than foundational AI research. Policymakers should consider how innovation structure in each AI segment affects optimal protection strength. One patent regime for all of AI may be one too few.

Policy design gains a principle. Competition-increasing reforms like the EU single market can spur innovation, especially where innovators capture rewards from escaping competition. For AI, competitive markets plus appropriate protection for genuine advances may produce the strongest incentives.

Institutional context shapes outcomes. The same reform had different effects depending on each country's patent rights. AI policies may likewise work differently across jurisdictions depending on IP regimes and other institutions. Copying another region's AI rules without its IP framework may not reproduce its results.

Software and data add complexity. Much AI innovation is embodied in code, models and training data, where protectable boundaries are less clear than in traditional manufacturing.

The research counsels nuance on AI intellectual property. Blanket strengthening or weakening may not be optimal. Tailoring protection to innovation structure, guarding against thickets in cumulative fields while protecting distinct advances, could best support innovation. Combined with open, competitive markets, the benefits can multiply.

Pulled together, competition and patent protection can jointly foster innovation, with important exceptions where thickets impede cumulative progress. The 1992 EU reform enhanced innovation where patent rights were strong, except in thicket-prone industries. As AI becomes central to the economy, this evidence offers a framework for intellectual property and competition policy in a cumulative, fast-evolving field.

Something for AI patent offices to sit with: the risk to watch may be the thicket. In a field built on stacking prior work, granting too many overlapping claims could quietly turn competition's push into a stall.