REFORMING HOW INFORMATION IS TRANSFORMED:

INTELLECTUAL PROPERTY AS NATURAL MONOPOLY

Ari Allen

Georgetown University Law Center

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I. Introductory Remarks

The Congress shall have Power To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their

respective Writings and Discoveries.1

In the depths of Article I of the United States Constitution, the Founders of our

nation hid a fundamental principle of governance: promote the Progress. Without very

much instruction or specificity, the Constitution instructs all future legislators to promote

progress. Of course, its scope is limited to the entire library of human knowledge,

industry and creativity. And of course, it does give some instruction: intellectual property

can be granted protection for any time spanning less than perpetuity.

Indeed, this seemingly innocent clause prompts a very large question, with very

little direction. And so, like most contentious debates, two sides of the same coin have

emerged rather independently: intellectual property and antitrust law. Emphasis on

intellectual property often leads to conclusions that reflect Joseph Schumpeters view that

market concentration increases innovation, while emphasis on antitrust law reflects

Kenneth Arrows desire for competition as a driving force of innovation.2

Yet both of these views are accurate, depending on the circumstances at hand. In

this paper I will most broadly attempt to reconcile these views and show that market

concentration and intellectual property rights are often necessary to spur revolutionary

innovations in fragile emerging markets, while antitrust law must be used as a tool to

reignite competition in markets that are matured and potentially stagnant. In recent years,

it has become more obvious that these two approaches are converging and find each other

1 U.S. Const. art. I, 8, cl. 8. 2 Michael Carrier, Two Puzzles Resolved: Of The Schumpeter-Arrow Stalemate and Pharmaceutical Innovation Markets, 93 Iowa L. Rev. 396 (Feb., 2008).

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quite complementary. Soon enough perhaps, they will find themselves more properly

integrated under a larger subheading that seems to be implicitly intertwined with

promoting progress: innovation. Exploring the means and ends of this essential

integration is the aim of this paper.

The rest of Part I will be dedicated to preparing the reader for the theoretical

analysis that follows. Specifically, I will make brief remarks explaining the following

fundamental intuitions: (a) progress is best understood through the lens of innovation; (b)

innovation is the product of the transformation of information the essential input of

every product, service and market; and (c) information is protected as intellectual

property, but is more properly classified as a form of natural monopoly.

In Part II, I will argue that: (a) similarly to the grant of legal monopoly status to

natural monopolies, the grant of intellectual property rights are vital to maintaining ex-

ante incentives to innovate and establish new markets; (b) similarly to mandates of equal

access imposed upon legal monopolies, compulsory licensing regimes should be

instituted when such intellectual property falls under the essential facilities doctrine; and

(c) compulsory licensing and antitrust mechanisms are just as legitimate a form of

government intervention as the initial grant of intellectual property rights.

In Part III, we will explore the theoretical framework through the following

practical examples: (a) a case study on the Google Books settlement; and (b) price

discrimination in the pharmaceutical industry.

In Part IV, I will conclude by briefly recapping the argument, tying it together

into a brief synthesis, and recommending future areas of possible theoretical and practical

development.

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a. Progress as Innovation

Defining progress may be the most fundamental debate pondered by political

theorists and legal jurists. It is, most literally, the direction of the future, and we all have

different views of what that future should look like. However, all of these views share

one overarching theme: progress always involves change. Nobody proclaims that the

world is perfect (although some may be resigned to the fact that it can never be better).

Progress then, is defined by change, although we may disagree about what type of change

is appropriate. However, we also know that change never happens without the

introduction of something new innovation. As such, every angle from which progress

is approached involves a propensity toward innovation. Even social progress involves

innovation: the creations of new social norms and perceptions. Martin Luther King Jr.s

I Have A Dream speech something one may define as a cultural artifact, is also a type

of social innovation. It is also intellectual property.3 Indeed, innovation is the mechanism

underlying all types of progress, and it is promoted and protected through intellectual

property rights and antitrust law.

There are other common understandings of progress as well, especially within the

economic domain. Firstly, there is progress in terms of efficiency improving the ratio of

beneficial output (in terms of quantity, or quality) to input costs. Increases in efficiency

lead to greater revenues and lower costs, increasing profits while lowering prices.

Consequently, both businesses and consumers benefit as does society as a whole.

On the other hand, there is progress in terms of equity. Increases in efficiency can

lead to increases in equity (by making products more affordable), but equity can also be

3 David Firestone, King Estate and CBS Settle Suit Over Rights To Famous Speech, N.Y. Times (July 14, 2000).

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encouraged independently of price mechanisms. Greater accessibility or interoperability

may enhance equity by allowing more consumers to reach a product. For example,

former FCC chairman, William Kenner has described one innovation, the Internet, as

the great equalizer.4

Yet increases in efficiency and equity can both be reduced to innovative

improvements.5 Increases in efficiency and equity are both changes that result from

innovations that range from establishing new growth strategies that capture economies-

of-scale to the introduction of entirely new product lines. Indeed, innovation may be the

term of convenience we seek in defining progress whether it is increases in efficiency,

equity or novelty. Thus, the breadth of progress is not fully captured by greater freedom,

equality, wealth or justice yet innovation can lead to all of the above. E pluribus unum.

From a policy standpoint, promoting progress is about protecting market

participants just enough so that they will actually participate, while also putting pressure

on them to continue to innovate and provide greater access preventing complacency,

stagnation and bottlenecking. As such, progress is maintained by promoting active

participation in the innovative process the creative introduction of new intellectual

property into the stream of commerce and consciousness. This process represents the

transformation of information.

b. Innovation as Transformation of Information

The fundamental unit of innovation is information. Essential to every tangible

product or service is the intangible thought or idea that lies behind it. In this sense, while

4 William Kennard, The Great Equalizer, Remarks at Supercom 2000 International Dinner (June 5, 2000). 5 In fact, innovation is often termed dynamic efficiency, as contrasted against static efficiency.

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it is only beginning to receive the attention it deserves, information has always been an

essential input to progress. Indeed, it is now commonly accepted that knowledge is

power.

It is this fundamental distinction that separates real from intellectual property.

Intangible and disembodied intellectual property is the genetic code of tangible and

embodied real property. As such, the transformation of this information is the impetus

behind the innovation of every good. However, transformation requires investment

labor, capital and time. Consequently, transformation does not occur on its own. How,

then, does this transformation occur? How is innovation promoted?

c. Intellectual Property as Natural Monopoly of Information

Investment in innovation will only occur if the proper ex-ante incentives are in

place namely, adequate returns on the initial investment. No innovators will risk and

invest capital, effort or time in an endeavor that will cost them more than they stand to

benefit. As a result, intellectual property rights were created to protect investment

incentives and consequently, to promote innovation.

Since its inception however, intellectual property has struggled with the tension

between its legal excludability and its intrinsic nonrivalrous quality. A modern adage of

unknown origin reflects that information wants to be free.6 Yet, information is also

only born, or transformed, through its granted excludability. From an economic

standpoint, intellectual property often involves high fixed costs and extremely low

marginal costs. More simply stated, creating or transforming information often involves

intense research and development upfront, but is relatively inexpensive to duplicate or

6 The source is of unknown origin, though it is often attributed to a hacker at 1984 computer conference.

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copy after this initial effort is expended. Information is born in chains, but wants to be

free.

Indeed, many have proclaimed that intellectual property is in fact, better described

as a type of monopoly, because a single entity is granted rights of exclusion over a

nonrivalrous resource. Furthermore, ownership of a disembodied idea allows

monopolization over the entire market of goods that embody that idea. As a result,

monopolistic prices are charged because marginal costs being near zero, are easily

surpassed by supracompetitive prices. Adam Smith recognized this problem at the very

outset of capitalist thought:

[T]he author of a new book has an exclusive privilege of publishing and selling his books [for a limited time] Some indeed contend that the book is an [e]ntire new production of the authors and therefore ought in justice to belong to him and his heirs for ever, and that no on should be allowed to print or sell it but those to whom has given leave But it is evident that printing is no more than a speedy way of writing. Now suppose that a man had wrote a book and had lent it to another who took a copy of it, and that he afterwards sold this copy to a third would there be here any reason to think the writer was injured. I can see none, and the same must hold equally with regard to printing. The only benefit one would have by writing a book would be that he would have the first of the market and may be thereby a considerable gainer. The law has however granted him an exclusive privilege for [a limited time], as an encouragement to the labours of learned men But there are few so harmless. All monopolies in particular are extremely detrimental.7

Harvard Professor Lloyd Weinreb remarked more succinctly, the most that can

be said confidently about copyright or patent is that it confers a monopoly.8 Smith,

however, makes a crucial observation about this necessary evil, and views it as an

encouragement to the labours of learned men. In these words, Smith is alluding to the

7 Adam Smith, Lectures on Jurisprudence, 83 (R.L. Meek, D.D. Raphael & P.G. Stein eds., Oxford Univ. Press 1978) (1896). 8 Lloyd L. Weinreb, Copyright for Functional Expression, 111 Harv. L. Rev. 1149, 1205 (1998).

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notion that supracompetitive prices are necessary to recoup the fixed costs that are not

accounted for in marginal costs.

However, Smith also points out that printing is no more than a speedy way of

writing. Thus, after the fixed costs are recouped, and returns on investment satisfied, we

must not forget that authors do not handwrite every copy of the information on the page,

but rather, provided their contribution only initially, by transforming the information that

would later be copied. As such, the innovator may be compensated beyond the intensity

of his efforts. Indeed, the author may be rewarded for Guttenbergs efforts in inventing

the printing press, and many others efforts in establishing the Internet. While of course,

Guttenberg would be an extreme example; it is illustrative of the fact that innovators are

often rewarded with profits from related competitive markets in which labor was not

applied.

Understanding the contribution of the printing press to every future author also

illustrates the underlying unity between intellectual property and natural monopoly

namely, high fixed costs with extremely low marginal costs. These marginal costs are

heavily depressed by innovations such as the printing press, and thus, enhance the

nonrivalrous nature of the intellectual property. If it can be easily copied and transferred,

then it is more clearly a nonrivalrous good. In other words, as the marginal cost

approaches zero, the good approaches being perfectly nonrivalrous.

The combination of high fixed costs and low marginal costs can be unified under

the single phrase, declining average costs. This phenomenon defines the nature of

natural monopoly a firm that can provide supply at continually increasing economies of

scale. The natural monopoly phenomenon has been observed in many industries,

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including: common carriers, transportation, electric utilities and telecommunications.

Interestingly, every revolution whether in transportation, energy or

telecommunications has been accompanied by this natural monopoly phenomenon. The

revolution provides for a sudden decrease in marginal costs, and thus, declining average

costs. Thus, it becomes more efficient for a single firm to supply the entire market. In the

age of the information revolution, information is becoming increasingly subject to the

same phenomenon. From the printing press to the Internet, it seems that information truly

does want to be free and it is increasingly becoming so.

However, the law has not yet fully taken account of this transformation in the way

information is transformed. Natural monopolies are providers of excludable and

nonrivalrous goods namely, club goods. Due to their low marginal costs, club goods are

often supplied by selling access to the good, rather than the good itself. Since

nonrivalrous goods can be easily duplicated, access is enough to provide a consumer with

an opportunity to tap into the multiplicative resource. As a result, a television viewer

doesnt pay for the amount of hours he watches television, but rather for access to the

broadcast television network. As an aside, it may be worthwhile to note that in natural

monopoly industries where marginal costs are still relatively substantial (but still

markedly less than fixed costs), a consumer may still need to pay a marginal price. The

point however, is that access is a precondition to being a consumer in the market itself.

As such, access retains its primacy in all club goods. Consequently, and as we will

explore later, unilateral exclusionary conduct (forbidding access) is particularly harmful

in these types of markets.

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Yet in this age of information, it is becoming increasingly true that disembodied

information is easily duplicable. Moreover, certain types of informationespecially

copyrights (e.g., books, music and film)are also becoming easily duplicable in its

embodied form.9 Records have become MP3s, and books have become e-books. As a

result, these embodiments are becoming increasingly centralized through emerging

centralized service providers (such as Google Books, iTunes and Hulu). Indeed,

intellectual property is becoming increasingly subjected to the phenomena of declining

average costs, and in many cases, represents a natural monopoly over every embodiment

of a disembodied idea. The idea need only be created once any additional investments

would be duplicative and socially inefficient. As such, intellectual property owners may

increasingly find themselves as the owner of a club, regulated by admission, rather than

the owner of an invention, physically produced for consumption.

II. Theoretical Framework

a. Intellectual Property and Legal Monopolies

Pioneers are unlikely to explore new frontiers if they are not adequately equipped

with protections that guarantee returns on successful investments. Intellectual property

rights confer these protections by granting the pioneer a legal monopoly over the usage of

their innovation. This protection ensures that pioneers will profit from their innovations,

and not be too quickly driven to marginal cost pricing that prevents the recouping of

fixed costs. Thus, similarly to natural monopolies, the economies of scale inherent in

9 The difference between embodied copyrights, which have become increasingly subject to declining average costs, and disembodied patents, which sometimes require high marginal costs to provide for embodiment, will be discussed later in Part III.

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intellectual property require initial legal protections that allow the emerging innovation to

reach the critical point at which these scales can be realized.

In short, the granting of intellectual property rights is tantamount to the granting

of natural monopoly status an example of necessary government intervention in order

to promote the Progress. However, before we become too comfortable with these

protections, we must remember that intellectual property rights are not a moral right,

but a legal tool that encourages economic utility.

Two illustrative examples come to mind. First, consider a competitor who has

expended as much (and possibly more) effort and investment on the same innovation, but

has lost the race to the finish line. This competitor is excessively damaged by the sudden

excludability of these rights. On the verge of a great breakthrough, another innovator may

be the victim of the antiquated rule of capture that defines early property laws, and lose

his entire investment in the matter.10 Similarly, and secondly, future innovators not even

born yet are afforded no opportunity to independently discover the same innovation

rather, future generations are forever indebted to past innovators, and are subject to their

monopolistic will. Even an independent effort to recreate the same innovation, in an

attempt to avoid dealing with the monopolist, is forbidden by the legal right of exclusion.

Yet both of these examples are illustrative of the absurdity of intellectual property

rights in the face of its nature as a nonrivalrous resource. An innovator who is granted

exclusive intellectual property rights becomes the owner of a disembodied idea, but also

10 Similarly to early determinations on hunting cases, ideas can be considered ferae naturae in that they are wild and up for capture. See Pierson v. Post, 3 Cai. R. 175 (N.Y. 1805). This reasoning was also later applied to cases of oil. See e.g., Prohosky v. Prudential Ins. Co. of Am., 584 F. Supp. 1337 (N.D. Ind. 1984).

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inherits a monopoly over all embodied iterations of that idea preventing anybody from

utilizing (or independently formulating) a specific thought.

b. Essential Facilities and Compulsory Licensing

If the granting of private monopoly over ideas sounds a bit absurd, then the

recommended remedy will come as a welcome addition to this framework. In industries

characterized as natural monopolies, grants of legal monopoly status often come with a

symmetrical and complementary mandate to provide equal access at competitive prices.

An example of this is in the public utility industry, in which a public utility is granted a

legal monopoly over the provision of electricity in a specified geographical region, but is

also mandated to equally serve all consumers within that region.

In short, a protected market must at some point be opened up and allowed access

both for consumer welfare and for its own growth and efficiency. The newfound

accessibility of the good allows it to be both utilized, and innovated upon. In the case of

intellectual property, permitting improvements of the idea allows for the further

transformation of the information at stake evolutionary, rather than revolutionary

innovation.

While it may not be desirable to impose a similar mandate on all grants of

intellectual property rights, it may be necessary in certain circumstances. Proper

identification of intellectual property that should receive such a mandate can be achieved

through the analogous antitrust analysis that is applied in identifying natural monopolies:

the essential facilities doctrine. Such essential facilities can be made accessible through

compulsory licensing regimes that ensure continued revenues for the innovator.

Yet, the right of exclusion is fundamental within the bundle of rights proscribed to

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property. Indeed, under the Colgate doctrine, a firm is free to unilaterally refuse to deal.

However, the Supreme Court has noted that such a right is not absolute; it exists only if

there are legitimate competitive reasons for the refusal.11 Thus, the essential facilities

doctrine developed as the applicable antitrust limitation on this unilateral exclusionary

conduct.!In brief, the essential facilities doctrine renders a unilateral refusal to deal subject to potential liability as a monopolization violation of Section 2 of the Sherman

Act.12!For example, in 1983, the Seventh Circuit Court of Appeals required a monopolist

provider of telecommunications services to provide access to its local service network to

competitors in long-distance services.13 Many other examples are prevalent within the

history of antitrust litigation, and promise to continue to stir up contentious debates.14 A

subset of these debates should most certainly apply to questions of the extreme

dominance provided by intellectual property rights. Whether specific information, or

intellectual property, should be openly accessible is a question of whether the information

satisfies the four factors of essential facility analysis: (1) control of the essential facility

by a monopolist; (2) a competitors inability to practically or reasonably duplicate the

essential facility; (3) the denial of the use of the facility to a competitor; and (4) the

feasibility of providing the facility to competitors.15 Former Chairman of the FTC,

11 See Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. 451, 483 n.32 (1992). 12 Robert Pitofsky, The Essential Facilities Doctrine Under United States Antitrust Law, Submission to European Commission In Support of National Data Corporation, 3 (2001). 13 Id., at 4 (citing MCI Communications v. American Tel. & Tel. Co., 707 F.2d 1081, 1132-33 (7th Cir. 1983)). 14 See also, Associate Press v. United States, 326 U.S. 1 (1945); Otter Tail Power Co. v. United States, 410 U.S. 366, 377-79 (1973). 15 Pitofsky, supra note 12, at 6 (citing MCI Communications, 708 F.2d at 1132-33).

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Robert Pitofsky, notes that [t]his test for antitrust liability has been adopted by virtually

every court to consider an essential facilities claim.16

However, prior to analyzing the claim under these four factors, it must first be

established that the facility is truly essential to competition i.e., constitutes an input

without which a firm cannot compete with the monopolist.17 In the case of intellectual

property, this is a common occasion. The benefit provided by accessing Ayn Rands

Atlas Shrugged cannot necessarily be matched by some other substitute. In this sense,

creative pieces are often unique enough to form a market of their own, without adequate

substitutes although this point is surely up for a debate beyond the scope of this paper.

Specifically, however, the Antitrust Guidelines of the Federal Trade Commission and

Department of Justice refuse to presume that intellectual property rights confer

monopolization.18 However, this lack of presumption is no reason to avoid the frequency

of its occurrence.

Consequently, intellectual property often satisfies the first two conditions rather

easily. An intellectual property right essentially confers control of the essential facility

by a monopolist, and competitors are generally excluded from practically or reasonably

duplicat[ing] the essential facility. Moreover, from a societal standpoint, the efforts to

duplicate the essential facility, or invent around it, would be considered a wasted

overinvestment in something already provided for.

16 Id. 17 Id. 18 U.S. Department of Justice and Federal Trade Commission, Antitrust Guidelines for the Licensing of Intellectual Property, 2.2 (The Agencies will not presume that a patent, copyright, or trade secret necessarily confers market power upon its owner.)

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The third and fourth conditions however, provide the pivot point at which the

analysis turns. First, if the intellectual property owner is not exhibiting anticompetitive

conduct in relation to the relevant information (i.e., refusing to deal or gouging prices),

then, tautologically, access is being provided at a competitive rate. Second, if it is

unfeasible to provide access to competitors, then of course, such access should not be

mandated. However, in cases of intellectual property, it is generally extremely feasible to

share the facility (especially in its disembodied form) due to the low marginal costs and

nonrivalry implicit in the good. Consequently, it seems that the essential facilities

doctrine may apply broadly to intellectual property and information, which has already

been identified as an essential input to innovation.

Relevantly, Pitofsky notes that [t]he doctrine seeks to prevent the firm with

monopoly control over an essential asset from unlawfully excluding actual or potential

rivals, or from extending its monopoly over that asset to the final stage of production.19

Hence, in the case of information, the doctrine prevents intellectual property owners from

utilizing their control over an essential input (the information) in order to monopolize the

final stage of production namely, the embodiment of the disembodied idea, and more

importantly, the innovation market as a whole.20 In 1992, the Supreme Court observed

this dynamic: The Court has held many times that power gained through some natural or

legal advantage such as patent, copyright or business acumen can give rise to liability if

19 Pitofsky, supra note 12, at 10. 20 See Pitofsky, supra note 12, at 12 (United States courts are sensitive to concerns that limiting intellectual property protections may dampen incentive for innovation. However, the courts have recognized that permitting antitrust liability in proper circumstances appropriately promotes competition, and, ultimately, innovation as well.).

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a seller exploits his dominant position in one market to expand his empire into the

next.21

However, the feasibility element of the essential facilities test may come into

consideration when fixed costs are not adequately recouped. In these cases, the

innovation must be protected from renewed creative gales of destruction,22 so that

mandated access does not inhibit the defendants ability to serve it customers

adequately.23

From this analysis, it seems clear that intellectual property and natural monopoly

share the essential facilities doctrine as a potentially procompetitive legal framework.

Indeed, United States courts have applied the essential facilities doctrine [to intellectual

property] just as they have when the undisputed natural monopolies involved utilities,

transportation facilities or other physical assets.24

c. Government Intervention as Cause and Remedy

One important theme emerges from the prior analysis: compulsory licensing

regimes and natural monopoly regulations are not some sort of an interventionist crusade.

Rather, government intervention occurs at many stages within the lifecycle of intellectual

property, including the very grant of those property rights. Jeremy Bentham wrote:

Before laws were made there was no property; take away laws, and property ceases.25

This notion cannot be more clearly revealed than through this analysis of intellectual

21 See Eastman Kodak Co., 504 U.S. at 479 22 Joseph A. Schumpeter, Capitalism, Socialism and Democracy, 87 (Harper Perennial 1976) (1942). 23 Hecht v. Pro-Football, Inc., 570 F.2d 982, 992-93 (D.C. Cir. 1977). 24 Pitofsky, supra note 12, at 11. 25 Jeremy Bentham, Principles of Civil Code, Pt. 1, Ch. 8.

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property. Before the law, nobody could own an idea, and this notion should be quite

obvious from the very absurdity that it arises.26

With an attempt to silence free market ideologues that cling to conservative

principles, such as those set forth in the Colgate doctrine, I now move on to remedy the

situation at hand. No remedies are possible, or even debatable, until the possibility of

remedy is viewed as a legitimate form of government intervention. Fortunately, the

fundamental principle underlying remedies to intellectual (or natural) monopoly is also

the foundation of the modern era: increased access and inclusivity the fruit of

innovation in the age of information.

Rebutting criticism is simple when one notes that even when compulsory licenses

are imposed, some property rights remain attached to the owner of the intellectual

property. In other words, the property is not taken away without compensation. Rather,

compulsory licensing remedies ensure that such mandates continue to compensate the

innovator. The process by which these licenses are priced and administrated is beyond the

scope of this paper. However, the proper execution of this process is essential to the

remedys success.

III. Practical Applications

a. Case Study: Copyright Law and the Google Books Settlement

The recent Google Book settlement is a fruitful example to examine under this

framework. Two fundamental features of the settlement are relevant to our analysis: first,

the orphan works problem; and second, Googles potential monopolization of the digital

26 See e.g., Reiko Aoki and John Small, Compulsory Licensing of Technology and the Essential Facilities Doctrine, Department of Economics, University of Auckland, 6 (Sept. 2002).

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book market. The orphan works problem is a legal dilemma arising out of the Copyright

Act of 1976.27 The Act ended the requirement that copyrighted materials be registered

with the U.S. Copyright Office. As a result, thousands of works would be published

without any central record of copyright ownership. Thus, contacting copyright-holders

for potential licensing has become near impossible. In a sense, the Act granted a mass of

legal monopolies without any way of regulating these monopolies (orphan works). As a

result, current efforts to consolidate the mass of human knowledge into megalibraries,

such as Google Books Search, have become especially difficult.

Yet it has never been clearer that these libraries are the wave of future innovation.

In the age of information, these libraries have begun to emerge everywhere (e.g., iTunes,

Wikipedia, Hulu, and many others). Centralization has become a form of innovation.

However, there seems to be no library more important than the entire wealth of human

knowledge all books, accessible to anyone, from a single location.

This effort becomes impossible without viewing intellectual property properly

as a form of natural monopoly. Recognizing this fact allows us to mandate access to an

innovation after it has been granted its initial protections, so long as the intellectual

property is considered an essential facility. In the age of information, knowledge has

become power, and access to that knowledge has become essential.

Applying an essential facility analysis in this instance is rather simple. First, as

discussed earlier, a legal monopoly has been conferred upon the intellectual property

owner books tend to be unique enough to create a market of their own (although again,

this is a contentious point of debate). Second, new authors are legally precluded from

27 Copyright Act of 1976, Pub. L. No. 94-553 (1976).

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attempting to duplicate the work. Third, the feasibility factor is easily proven as satisfied:

Google has already digitized a large mass of these books. Finally, the last factor

whether there is a refusal to dealis particularly interesting in this scenario. While the

owners of orphan works are not explicitly refusing to deal with Google, they are

implicitly refusing to deal by making their whereabouts unknown. While the refusal to

deal has not typically been approached from this perspective, it could be pivotal in

resolving the orphan works problem.28

The Google Books Settlement seems to recognize the shakiness of the refusal to

deal factor by providing a compulsory licensing regime in which all books are

licensable, by default, so long as the author does not opt out of the settlement. This

scheme of providing licenses by default solves a large coordination problem that is a

legal barrier to centralization namely, identifying authors of unregistered orphan works.

It also resolves the equally difficult problem of negotiating individual licenses with each

owner of millions of scattered pieces of intellectual property. However, it simultaneously

maintains the authors right to refuse to deal, so long as there is a legitimate business

reason to do so (which would be assumed to be rare in this scenario).

However, the original Google Books Settlement, as proposed in October 2008,

was flawed in that it would have potentially created a new monopoly that of Google

Books itself.29 This is a flaw, because unlike most natural monopolies, Google Books

requires no protections to encourage its creation in fact, for the most part it has already

28 It is important to note that Google can easily be considered a retail competitor, seeking to sell books amongst a wide collection. On the other hand, the author may be viewed as a wholesaler of the essential input the book. 29 See Proposed Settlement, Authors Guild v. Google Inc., No. 05 CV 8136 (S.D.N.Y. filed Oct. 28, 2008).

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been created. The question to be posed is whether or not the digitization of books requires

a grant of legal monopoly in order for it to be economically feasible. Considering the fact

that Google has already undertaken much of this endeavor, and other competitors such as

Amazon and Yahoo are equally eager to do so, it does not seem that the emergence of a

centralized book market requires a grant of legal monopoly. Indeed, these databases are

classic public goods, and neither Google nor the Registry will need exclusive rights over

them as an incentive.30

The new settlement, released in November 2009 recognized this flaw. It seems

that the new settlements has emerged with new language that has begun to remove

Googles exclusivity from the agreement.31 In other words, the compulsory licensing

regime would remain, but anybody, not only Google, could become a licensee (though

interpretations of the settlement remain highly contentious). It is hopeful that a final

settlement will emerge that allows Google to digitize books, but also frees orphan works

to the general public. This result would provide for an equality of access that promotes

competition sustaining both dynamic efficiency (or innovation) and static efficiency

(competitive pricing and output).32

b. Extremity Stress Test: Patent Law and Essential Pharmaceuticals

30 James Grimmelmann, How To Fix The Google Book Search Settlement, Journal of Internet Law, 10(1): 2, (April, 2009). 31 See Amended Settlement, Authors Guild v. Google Inc., No. 05 CV 8136 (S.D.N.Y. filed Nov. 19, 2009). 32 This would also help avoid the current predicament within the music industry regarding Performance Rights Organizations. These organizations act as an exclusive central registry, through which works can be licensed. Many scholars have criticized this as a collective monopoly. See Ariel Katz, The Potential Demise of Another Natural Monopoly: Rethinking the Collective Administration of Performing Rights, Journal of Competition Law and Economics, 1(3) (2005).

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While patents, in contrast to copyrights, often face higher marginal costs for the

embodiment of intellectual property, the intellectual property itself remains easily

duplicable. Additionally, the fixed costs, such as research and development, are usually

even higher for patents than for copyrights. As a result, the declining average cost

phenomenon remains in tact.

One area of intense patent debate often surfaces in the pharmaceutical industry.

Intellectual property in this area often represents an intermediate good or input of

production. Additionally, the final good often represents an essential drug that could

provide massive social benefits if access is promoted. As one scholar has noted:

The biopharmaceutical industry is characterized by the cumulative innovation paradigm, wherein the discovery of a gene sequence is only the first step It is feared that patents over upstream gene sequences may block further downstream research and consequently adversely impact drug discovery.33

However, similarly to our earlier examples, if access is mandated without

providing for sufficient returns on investment, these important initial innovations will not

occur in the first place. As a result, it is of the utmost importance that compulsory

licensing regimes in this area are particularly sensitive to the ex-ante incentives it creates.

Yet pharmaceuticals are equally demanded across the globe. An HIV vaccine

created in the U.S. may have an even higher demand in Africa. Unfortunately however,

the socioeconomic level of most Africans is significantly lower than an American, and

so, access can be difficult for a majority of the demand-side of the market.

This problem can be solved through a compulsory licensing regime that permits

price discrimination. In fact, such a regime, if executed correctly, could have a positive

33 Shamnad Basheer, Block Me Not: Are Patented Genes Essential Facilities?, Berkeley Electronic Press, 1 (2005).

21

impact both on society (more affordable drugs) and on the drug company (increased

revenues through sales previously unattainable due to nondiscriminatory pricing).

However, getting to this positive resolution still requires the analysis explored in previous

sections.

First, as we have already discussed, the grant of intellectual property rights is

necessary to encourage innovation in the first place. The rights must be granted so that

the innovator can be properly compensated both by initial supracompetitive sales, and

eventual compulsory license revenues.

Second, these pharmaceuticals (or their intermediate methods and inputs) are

often classifiable under the essential facilities doctrine. As in most cases of intellectual

property, the equivalent of a legal monopoly has been granted over the facility. The

ability of competitors to practically or reasonably duplicate the facility is blocked by the

excludability granted with this legal monopoly.34 Additionally, since information is often

easily transferrable in the age of information, it seems unlikely that providing the facility

to competitors would be considered unfeasible.

Lastly, the only element on which the analysis hinges is whether or not the

innovator is denying use of the facility to a competitor which often occurs within the

ultracompetitive pharmaceutical industry. However, in the rare case that a benevolent

pharmaceutical company decides to share its innovations with competitors, an essential

facility test may fail (being unnecessary).

34 Even if an adequate substitute or invent-around technology could be designed, such a duplicative investment is inefficient and a waste of capital making it unreasonable to duplicate the relevant capacities of the facility.

22

In 2001, the WHO released a report recommending that such facilities be subject

to differential pricing (or price discrimination). Specifically, they call for a more

coherent global framework for differential pricing [to] . . . facilitate the mobilization of

the funds necessary to ensure that differential pricing actually contributes to meeting the

needs of the poor for access to essential drugs. Another report notes that, [p]rice

discrimination in this context almost certainly raises total consumer welfare.35 However,

most importantly: If low-price users cover at least their marginal costs and make some

contribution to R&D costs, prices paid by other users can be lower than they would have

been in the absence of price discrimination.36 In other words, as long as the price being

charged to a specific socioeconomic group is above marginal cost, that additional revenue

will help recover fixed R&D costs. Consequently, the pharmaceutical company will be

able to capture revenues previously unattainable. In short, since marginal costs are low,

any additional sales (and especially licenses) are bound to increase profits for the

innovator.

It is important to note that I have framed this discussion primarily around the

pharmaceutical producer and the end consumer. In reality, compulsory licenses

would likely take place between the producer and a foreign competitor that seeks to

produce the pharmaceutical locally. This dynamic is simplified in the previous discussion

because the intermediary does not change the end result: higher profits for the innovator

and greater access for consumers.

IV. Concluding Thoughts

35 Patricia Danzon, Making Sense of Drug Prices, Regulation Magazine, Cato Institute, 23(1): 62 (July 11, 2000). 36 Id.

23

Antitrust deals with the implicit paradox that competition is, by nature,

anticompetitive and thus, something that needs to be continually restored. Like a

chicken-and-egg, innovation protection and promotion must be carefully balanced. A

chicken must protect its eggs, but once the egg is hatched, its development and growth

must be encouraged, and it must be permitted the opportunity to live a life of further

innovations and transformations. Eventually the revolution is complete, and new one

begins a new egg is hatched.

Intellectual property rights maintain ex-ante incentives to innovate, and have long

been properly justified under economic reasoning. Antitrust on the other hand, restores

competition when competition becomes anticompetitive when the gales of creative

destruction preclude future creative gales. In this way, intellectual property and antitrust

law are necessary complements. This is becoming increasingly true in the age of

information. Information has finally taken its stand in the spotlight as the backbone of

progress, and the essential input to innovation. Consequently, we must come to terms

with the fact that intellectual property is, and will continually become, an essential

facility an essential input for competition.

However, while intellectual property is commonly accepted as a normal form of

government intervention, antitrust actions are often seen as an exception to the norm.

This perception is absurd. No innovator is discouraged from innovating for fear of

becoming a monopoly subjected to antitrust action. If anything, this result would be

desired because it signifies the innovators success and profitability. Moreover, the

antitrust actions recommended in this papercompulsory licensing regimesrepresents

a continued source of revenue for the innovator.

24

It is true that it is difficult to set prices in compulsory licensing regimes.

However, such difficulty should not preclude us from reaching for the optimality that

would come with its success. As such, we must overturn the stilted perception that

antitrust is a less legitimate form of government intervention than the assigning of

intellectual property rights. Indeed, market power associated with an essential facility

arises because of the absence of a specific legal action (declaration) to remove it, whereas

market power associated with intellectual property arises because of the presence of a

specific legal protection.37 Recognizing this factthat the freedom of the market

actually arises out of government interventionmay be the necessary paradigm shift in

order to reform the way we view the transformation of information. As a result, it is

hoped that we can finally, with full force, aim to maximize innovation and promote the

Progress.

37 Aoki, supra note 26, at 5.