A one-word secret to economic growth

The Horatio Alger story is alive in most all of us: We dream of coming up with the proverbial better mouse trap, obtaining a patent and watching interested companies beat a path to our door to lavish us with millions. 

Most people understand that patents grant an inventor a limited monopoly or ownership right in an invention to prevent others from making, using or selling a product or from offering a service that is too close to the inventor’s patent. What many do not understand (or it is at least it may not be obvious) is why the government sees fit to issue patents at all. The simple answer is this: Patents spur innovation and advance technology. How does granting someone a monopoly over a new piece of technology spur innovation?

Some 150 years ago, John might sit at a desk adding and subtracting numbers and jotting them down in a ledger. Sometimes, he’d make mistakes. He’d reach for a block of rubber and erase the erroneous pencil markings. He’d lose his eraser; he’d take it home and forget it. Then it hits him, “What if the eraser and pencil were combined?”

He knew that if he came up with a way of joining the pencil and eraser, he could apply and receive a patent in the improvement, while preventing others from making the unique combination without his okay. Without the possibility of a patent it would not make sense for John to spend time on the idea, given that the second he introduced it to the public, a big pencil conglomerate would likely take the innovation and put it into their pencils. 

John could not compete with a pencil giant, but because there was the opportunity to obtain patent protection for his innovation, he spent months and his life savings perfecting a design.

John then approached No. 2 Pencil Company to manufacture his invention. The executives listened to him and after hearing the testimonials from John’s co-workers, they decided to give it a go. They exclusively licensed the improved pencil for a 5 percent royalty on sales. The company would need to spend substantial sums not only developing an economical process to manufacture the pencil but also in marketing and advertising it.

There was a huge risk that the new product would not catch on and their expenditures would be lost. Without the exclusive patent rights, competition, including the larger Empire Pencil Company, would leverage the money the No. 2 Pencil Company spent establishing the market to launch their own version. Of course, Empire, not saddled with millions in development and initial marketing costs, not to mention better economies of scale, would simply price No. 2 out of the market.  With the patent rights, however, No. 2 could alone realize the benefit of their investment.  If the eraser pencil took off, No. 2 might even supplant Empire as number one. 

Without the possibility of a obtaining a patent with a time-limited monopoly to make, use and sell the new pencil, John probably would have never spent the time and money to pursue his design.  Without the exclusive rights under the patent, the No.2 Pencil Company would have never spent millions establishing a new market for fear that their larger competitor would simply leverage their hard work.  Without the patent the world would have had to wait for a pencil with an eraser.

And the wait could have been a long one: Empire, arguably the company in the best position to develop an eraser pencil in a patent-less world, would have no economic driver to develop one given their market dominance. Finally, without patents, Empire and other pencil manufacturers wouldn’t be driven to engage in further research and development to design around John’s patent and come up with an even better, more advanced pencil that did not infringe the patent. 

The foregoing fictional account can be applied to just about any product in any industry.  Patents spur the small guy, whether an individual or company, to spend time and money developing new ideas as they level the marketplace playing field just a bit. Market leaders fearful of losing their dominant position are also spurred on to push innovation if for no other reason than to beat the competition to the punch.

Simply put, the government issues patents to grow the economy, increase a nation’s wealth and improve life for its citizens.