“Inventing Prizes: A Historical Perspective on Innovation Awards and Technology Policy,” B. Z. Khan (2015): B. Zorina Khan is an excellent and underrated historian of innovation policy. In her new working paper, she questions the shift toward prizes as an innovation inducement mechanism. The basic problem ... is that patents are costly in terms of litigation, largely due to their uncertainty, that patents impose deadweight loss by granting inventors market power... (as noted at least as far back as Nordhaus 1969), and that patent rights can lead to an anticommons which in some cases harms follow-on innovation (see Scotchmer and Green and Bessen and Maskin for the theory, and papers like Heidi Williams’ genome paper for empirics).
There are three main alternatives to patents, as I see them. First, you can give prizes, determined ex-ante or ex-post. Second, you can fund R&D directly with government, as the NIH does for huge portions of medical research. Third, you can rely on inventors accruing rents to cover the R&D without any government action, such as by keeping their invention secret, relying on first mover advantage, or having market power in complementary goods. We have quite a bit of evidence that the second, in biotech, and the third, in almost every other field, is the primary driver of innovative activity.
Prizes, however, are becoming more and more common. ... What Khan notes is that prizes have been used frequently in the history of innovation, and were frankly common in the late 18th and 19th century. How useful were they?
Unfortunately, prizes seem to have suffered many problems. ..., prize designers don’t know enough about the relative import of various ideas to set price amounts optimally, prizes in practice are often too small to have much effect, and prizes lead to more lobbying and biased rewards than patents. We shouldn’t go too far here; prizes still may be an important part of the innovation policy toolkit. But the history Khan lays out certainly makes me more sanguine that they are a panacea. ...
[July 2015 NBER Working Paper (RePEc IDEAS). I’m afraid the paper is gated if you don’t have an NBER subscription, and I was unable to find an ungated copy.]