“Intellectual Property” and the Structure of the American Domestic Economy

Download: “Intellectual Property”: A Libertarian Critique

I. The Ethics of “Intellectual Property”
II. Privilege as Economic Irrationality
III. “Intellectual Property” and the Structure of the American Domestic Economy
IV. “Intellectual Property” and the Global Economy
V. “Intellectual Property,” Business Models and Product Design
VI. Is “Intellectual Property” a Necessary Incentive?

Patents promoted the stable control of markets by oligopoly firms through the control, exchange and pooling of patents.

According to David Noble, two essentially new science-based industries (those that “grew out of the soil of scientific rather than traditional craft knowledge”) emerged in the late 19th century: the electrical and chemical industries. [35]

In the electric industry, General Electric had its origins first in a merger between Edison Electric (which controlled all of Edison’s electrical patents) and the Sprague Electric Railway and Motor Company, and then in an 1892 merger between Edison General Electric and Thomas-Houston — both of them motivated primarily by patent considerations. In the latter case, in particular, Edison General Electric and Thomas-Houston each needed patents owned by the others and could not “develop lighting, railway or power equipment without fear of infringement suits and injunctions.” [36] From the 1890s on, the electrical industry was dominated by two large firms: GE and Westinghouse, both of which owed their market shares largely to patent control. In addition to the patents which they originally owned, they acquired control over patents (and hence over much of the electrical manufacturing market) through “acquisition of the patent rights of individual inventors, acquisition of competing firms, mergers with competitors, and the systematic and strategic development of their own patentable inventions. As GE and Westinghouse together secured a deadlock on the electrical industry through patent acquisition, competition between them became increasingly intense and disruptive. By 1896 the litigation cost from some three hundred pending patent suits was enormous, and the two companies agreed to form a joint Board of Patent Control. General Electric and Westinghouse pooled their patents, with GE handling 62.5% of the combined business. [37]

The structure of the telephone industry had similar origins, with the Bell Patent Association forming “the nucleus of the first Bell industrial organization” (and eventually of AT&T) The National Bell Telephone Company, from the 1880s on, fought vigorously to “occupy the field” (in the words of general manager Theodore N. Vail) through patent control. As Vail described the process, the company surrounded itself

with everything that would protect the business, that is the knowledge of the business, all the auxiliary apparatus; a thousand and one little patents and inventions with which to do the business which was necessary, that is what we wanted to control and get possession of.

To achieve this, the company early on established an engineering department

whose business it was to study the patents, study the development and study these devices that either were originated by our own people or came in to us from the outside. Then early in 1879 we started our patent department, whose business was entirely to study the question of patents that came out with a view to acquiring them, because… we recognized that if we did not control these devices, somebody else would. [38]

This approach strengthened the company’s position of control over the market not only during the seventeen year period of the main patents, but (as Frederick Fish put it in an address to the American Institute of Electrical Engineers) during the subsequent seventeen years of

each and every one of the patents taken out on subsidiary methods and devices invented during the progress of commercial development. [Therefore] one of the first steps taken was to organize a corps of inventive engineers to perfect and improve the telephone system in all directions …that by securing accessory inventions, possession of the field might be retained as far as possible and for as long a time as possible. [39]

This method, preemptive occupation of the market through strategic patent acquisition and control, was also used by GE and Westinghouse.

Even with the intensified competition resulting from the expiration of the original Bell patents in 1894, and before government favoritism in the grants of rights-of-way and regulated monopoly status, the legacy effect of AT&T’s control of the secondary patents was sufficient to secure them half the telephone market thirteen years later, in 1907. [40] AT&T, anticipating the expiration of its original patents, had (to quote Vail again) “surrounded the business with all the auxiliary protection that was possible.” For example, the company in 1900 purchased Michael Pupin’s patent on loading coils and in 1907 acquired exclusive domestic rights for Cooper-Hewitt’s patents on the mercury-arc repeater — essential technologies underlying AT&T’s monopoly on long-distance telephony. [41]

By the time the FCC was formed in 1935, the Bell System had acquired patents to “some of the most important inventions in telephony and radio,” and “through various radio-patent pool agreements in the 1920s… had effectively consolidated its position relative to the other giants in the industry.” In so doing, according to an FCC investigation, AT&T had gained control of “the exploitation of potentially competitive and emerging forms of communication” and “pre-empt[ed] for itself new frontiers of technology for exploitation in the future….” [42]

The radio-patent pools included AT&T, GE and Westinghouse, RCA (itself formed as a subsidiary of GE after the latter acquired American Marconi), and American Marconi.43 Alfred Chandler’s history of the origins of the consumer electronics industry is little more than an extended account of which patents were held, and subsequently acquired, by which companies. This should give us some indication, by the way, of what he meant by “organizational capability,” a term of his that will come under more scrutiny in the next chapter. In an age where the required capital outlays for actual physical plant and equipment are rapidly diminishing in many forms of manufacturing, one of the chief functions of “intellectual property” is to create artificial “comparative advantage” by giving a particular firm a monopoly on technologies and techniques, and prevent their diffusion throughout the market.

The American chemical industry, in its modern form, was made possible by the Justice Department’s seizure of German chemical patents in WWI. Until the war, some 98% of patent applications in chemical industry came from German firms, and were never worked in the U.S. As a result the American chemical industry was technically second-rate, largely limited to final processing of intermediate goods imported from Germany. Attorney General A. Mitchell Palmer, as “Alien Property Custodian” during the war, held the patents in trust and licensed 735 of them to American firms; Du Pont alone received three hundred. [44]

More generally, “intellectual property” is an effective tool for cartelizing markets in industry at large. They were used in the automobile and steel industries among others, according to Noble. [45] In a 1906 article, mechanical engineer and patent lawyer Edwin Prindle described patents as “the best and most effective means of controlling competition.”

Patents are the only legal form of absolute monopoly. In a recent court decision the court said, “within his domain, the patentee is czar…. cries of restraint of trade and impairment of the freedom of sales are unavailing, because for the promotion of the useful arts the constitution and statutes authorize this very monopoly.”

The power which a patentee has to dictate the conditions under which his monopoly may be exercised has been used to form trade agreements throughout practically entire industries, and if the purpose of the combination is primarily to secure benefit from the patent monopoly, the combination is legitimate. Under such combinations there can be effective agreements as to prices to be maintained…; the output for each member of the combination can be specified and enforced… and many other benefits which were sought to be secured by trade combinations made by simple agreements can be added. Such trade combinations under patents are the only valid and enforceable trade combinations that can be made in the United States. [46]

And unlike purely private cartels, which tend toward defection and instability, patent control cartels — being based on a state-granted privilege — carry a credible and effective punishment for defection.

Through their “Napoleonic concept of industrial warfare, with inventions and patents as the soldiers of fortune,” and through “the research arm of the ‘patent offensive,’” manufacturing corporations were able to secure stable control of markets in their respective industries. [47]

Today, “intellectual property” serves as a structural support for corporate boundaries, at a time when the desktop revolution has undermined control of physical capital as their primary justification. The growing importance of human capital, and the implosion of capital outlay costs required to enter the market, have had revolutionary implications for production in the immaterial sphere.

In the old days, the immense value of physical assets was the primary basis for the corporate hierarchy’s power, and in particular for its control over human capital and other intangible assets.

As Luigi Zingales observes, the declining importance of physical assets relative to human capital has changed this. Physical assets, “which used to be the major source of rents, have become less unique and are not commanding large rents anymore.” And “the demand for process innovation and quality improvement… can only be generated by talented employees,” which increases the importance of human capital.48 This is even more true since Zingales wrote, with the rise of what has been variously called the Wikified firm, the hyperlinked organization, Enterprise 2.0, etc.

Tom Peters remarked in quite similar language, some six years earlier in The Tom Peters Seminar, on the changing balance of physical and human capital. Of Inc. magazine’s 500 top-growth companies, which include a good number of information, computer technology and biotech firms, 34% were launched on initial capital of less than $10,000, 59% on less than $50,000, and 75% on less than $100,000. [49]

In many industries, the initial outlay for entering the market was in the hundreds of thousands of dollars or more. The old electronic mass media, for instance, were “typified by high-cost hubs and cheap, ubiquitous, reception-only systems at the end. This led to a limited range of organizational models for production: those that could collect sufficient funds to set up a hub.” [50] The same was true of print periodicals, with the increasing cost of printing equipment from the mid-nineteenth century on serving as the main entry barrier for organizing the hubs. Between 1835 and 1850, the typical startup cost of a newspaper increased from $500 to $100,000 — or from roughly $10,000 to $2.38 million in 2005 dollars. [51]

The networked economy, in contrast, is distinguished by “network architecture and the [low] cost of becoming a speaker.”

The first element is the shift from a hub-and-spoke architecture with unidirectional links to the end points in the mass media, to distributed architecture with multidirectional connections among all nodes in the networked information environment. The second is the practical elimination of communications costs as a barrier to speaking across associational boundaries. Together, these characteristics have fundamentally altered the capacity of individuals, acting alone or with others, to be active participants in the public sphere as opposed to its passive readers, listeners, or viewers. [52]

The central change that makes this possible is that “the basic physical capital necessary to express and communicate human meaning is the connected personal computer.”

The core functionalities of processing, storage, and communications are widely owned throughout the population of users…. The high capital costs that were a prerequisite to gathering, working, and communicating information, knowledge, and culture, have now been widely distributed in the society. The entry barrier they posed no longer offers a condensation point for the large organizations that once dominated the information environment. [53]

The desktop revolution and the Internet mean that the minimum capital outlay for entering most of the entertainment and information industry has fallen to a few thousand dollars, and the marginal cost of reproduction is zero. If anything that overstates the cost of entry in many cases, considering how rapidly computer value depreciates and the relatively miniscule cost of buying a five-year-old computer and adding RAM. The networked environment, combined with endless varieties of cheap software for creating and editing content, makes it possible for the amateur to produce output of a quality once associated with giant publishing houses and recording companies. [54] That is true of the software industry, the music industry (thanks to cheap equipment and software for high quality recording and sound editing), desktop publishing, and to a certain extent even to film (as witnessed by affordable editing technology and the success of Sky Captain). Podcasting makes it possible to distribute “radio” and “television” programming, at virtually no cost, to anyone with a broadband connection. A network of amateur contributors have peer-produced an encyclopedia, Wikipedia, which Britannica sees as a rival. As Tom Coates put it, “the gap between what can be accomplished at home and what can be accomplished in a work environment has narrowed dramatically over the last ten to fifteen years.” [55]

It’s also true of news, with ever-expanding networks of amateurs in venues like Indymedia, alternative new operations like Robert Parry’s and Greg Palast’s, and natives and American troops blogging news firsthand from Iraq, at the very same time the traditional broadcasting networks are shutting down.

This has profoundly weakened corporate hierarchies in the information and entertainment industries, and created enormous agency problems as well. As the value of human capital increases, and the cost of physical capital investments needed for independent production by human capital decreases, the power of corporate hierarchies becomes less and less relevant. As the value of human relative to physical capital increases, the entry barriers become progressively lower for workers to take their human capital outside the firm and start new firms under their own control. Zingales gives the example of the Saatchi and Saatchi advertising agency. The largest block of shareholders, U.S. fund managers who controlled 30% of stock, thought that gave them effective control of the firm. They attempted to exercise this perceived control by voting down Maurice Saatchi’s proposed increased option package for himself. In response, the Saatchi brothers took their human capital (in actuality the lion’s share of the firm’s value) elsewhere to start a new firm, and left a hollow shell owned by the shareholders. [56]

Interestingly, in 1994 a firm like Saatchi and Saatchi, with few physical assets and a lot of human capital, could have been considered an exception. Not any more. The wave of initial public offerings of purely human capital firms, such as consultant firms, and even technology firms whose main assets are the key employees, is changing the very nature of the firm. Employees are not merely automata in charge of operating valuable assets but valuable assets themselves, operating with commodity-like physical assets. [57]

In another, similar example, the former head of Salomon Brothers’ bond trading group formed a new group with former Salomon traders responsible for 87% of the firm’s profits.

…if we take the standpoint that the boundary of the firm is the point up to which top management has the ability to exercise power…, the group was not an integral part of Salomon. It merely rented space, Salomon’s name, and capital, and turned over some share of its profits as rent. [58]

Marjorie Kelly gave the breakup of the Chiat/Day ad agency, in 1995, as an example of the same phenomenon.

…What is a corporation worth without its employees?

This question was acted out… in London, with the revolutionary birth of St. Luke’s ad agency, which was formerly the London office of Chiat/Day. In 1995, the owners of Chiat/Day decided to sell the company to Omnicon — which meant layoffs were looming and Andy Law in the London office wanted none of it. He and his fellow employees decided to rebel. They phoned clients and found them happy to join the rebellion. And so at one blow, London employees and clients were leaving.

Thus arose a fascinating question: What exactly did the “owners” of the London office now own? A few desks and files? Without employees and clients, what was the London branch worth? One dollar, it turned out. That was the purchase price — plus a percentage of profits for seven years — when Omnicon sold the London branch to Law and his cohorts after the merger. They renamed it St. Luke’s…. All employees became equal owners… Every year now the company is re-valued, with new shares awarded equally to all. [59]

David Prychitko remarked on the same phenomenon in the tech industry, the so-called “break-away” firms, as far back as 1991:

Old firms act as embryos for new firms. If a worker or group of workers is not satisfied with the existing firm, each has a skill which he or she controls, and can leave the firm with those skills and establish a new one. In the information age it is becoming more evident that a boss cannot control the workers as one did in the days when the assembly line was dominant. People cannot be treated as workhorses any longer, for the value of the production process is becoming increasingly embodied in the intellectual skills of the worker. This poses a new threat to the traditional firm if it denies participatory organization.

The appearance of break-away computer firms leads one to question the extent to which our existing system of property rights in ideas and information actually protects bosses in other industries against the countervailing power of workers. Perhaps our current system of patents, copyrights, and other intellectual property rights not only impedes competition and fosters monopoly, as some Austrians argue. Intellectual property rights may also reduce the likelihood of break-away firms in general, and discourage the shift to more participatory, cooperative formats. [60]

In this environment, the only thing standing between the old information and media dinosaurs and their total collapse is their so-called “intellectual property” rights — at least to the extent they’re still enforceable. Ownership of “intellectual property” becomes the new basis for the power of institutional hierarchies, and the primary structural bulwark for corporate boundaries. Even corporate apologists like Bill Gates and Tom Peters celebrate the network revolution and flattening of hierarchies: they just favor domesticating the process within a corporate framework enforced by ownership of “intellectual property.” But the networked designers within Microsoft are doing essentially the same thing that teams of Linux programmers are doing outside the corporate walls. “Intellectual property” is the only thing that prevents the walls from dissolving, and the Microsoft programmers becoming part of a larger environment of loose peer design networks, with the firm replaced by self-organized, project-based teams — with teams constantly gaining members from and losing them to other teams, projects discontinuing or forking, etc., on the Linux model.

Without “intellectual property,” in any industry where the basic production equipment is affordable to all, and bottom-up networking renders management obsolete, it is likely that self-managed, cooperative production will replace the old managerial hierarchies. The network revolution, if its full potential is realized,

will lead to substantial redistribution of power and money from the twentieth century industrial producers of information, culture, and communications — like Hollywood, the recording industry, and perhaps the broadcasters and some of the telecommunications giants — to a combination of widely diffuse populations around the globe, and the market actors that will build the tools that make this population better able to produce its own information environment rather than buying it ready-made.” [61]

Another effect of the shift in importance from tangible to intangible assets is that a growing portion of product prices consists of embedded rents on “intellectual property” and other artificial property rights rather than the material costs of production. Tom Peters cited former 3M strategic planner George Hegg on the increasing portion of product “value” made up of “intellectual property” (i.e., the amount of final price consisting of tribute to the owners of “intellectual property”): “We are trying to sell more and more intellect and less and less materials.” Peters produces a long string of such examples:

…My new Minolta 9xi is a lumpy object, but I suspect I paid about $10 for its plastic casing, another $50 for the fine-ground optical glass, and the rest, about $640, for its intellect… [62]

It is a soft world…. Nike contracts for the production of its spiffy footwear in factories around the globe, but it creates the enormous stock value via superb design and, above all, marketing skills. Tom Silverman, founder of upstart Tommy Boy Records, says Nike was the first company to understand that it was in the lifestyle business…. Shoes? Lumps? Forget it! Lifestyle. Image. Speed. Value via intellect and pizazz. [63]

“Microsoft’s only factory asset is the human imagination,” observed The New York Times Magazine writer Fred Moody. In seminars I’ve used the slide on which those words appear at least a hundred times, yet every time that simple sentence comes into view on the screen I feel the hairs on the back of my neck bristle. [64]

A few years back, Philip Morris purchased Kraft for $12.9 billion, a fair price in view of its subsequent performance. When the accountants finished their work, it turned out that Philip Morris had bought $1.3 billion worth of “stuff” (tangible assets) and $11.6 billion of “Other.” What’s the other, the 116/129?

….Call it intangibles, good-will (the U.S. accountants’ term), brand equity, or the ideas in the heads of thousands of Kraft employees around the world. [65]

Regarding Peters’ Minolta example, as Benkler points out the marginal cost of reproducing “its intellect” is virtually zero. So about 90% of the price of that new Minolta comes from tolls to corporate gatekeepers, who have been granted control of that “intellect.” In an economy where software and product design were the product of peer networks, unrestricted by the “intellectual property” of old corporate dinosaurs, 90% of the product’s price would evaporate overnight. To quote Michael Perelman,

the so-called weightless economy has more to do with the legislated powers of intellectual property that the government granted to powerful corporations. For example, companies such as Nike, Microsoft, and Pfizer sell stuff that has high value relative to its weight only because their intellectual property rights insulate them from competition. [66]

The same goes for Nike’s sneakers. I suspect the amortization cost of the physical capital used to manufacture the shoes in those Asian sweatshops, plus the cost of the sweatshop labor, is less than 10% of the price of the shoes. The wages of the workers could be tripled or quadrupled with negligible impact on the retail price.

How many extra hours does the average person work each week to pay tribute to the owners of the “human imagination”?

The good news is that, as “intellectual property” becomes increasingly unenforceable, we can expect two things: first, for the ownership of proprietary content to become untenable as a basis for corporate institutional power; and second, for the portion of commodity price reflecting embedded rents on artificial property rights to implode.

“Intellectual property” also serves as a bulwark to planned obsolescence and high-overhead production. It’s an example of a general law stated by Thomas Hodgskin: Social regulations and commercial prohibitions “compel us to employ more labour than is necessary to obtain the prohibited commodity,” or “to give a greater quantity of labour to obtain it than nature requires,” and put the difference into the pockets of privileged classes. [67]

A major component of the business model that prevails under existing corporate capitalism is the offer of platforms below-cost, coupled with the sale of patented or copyrighted spare parts, accessories, etc., at an enormous markup. So one buys a cell phone for little or nothing, with the contractual obligation to use only a specified service package for so many years; one buys a fairly cheap printer, which uses enormously expensive ink cartridges; one buys a cheap glucometer, with glucose testing strips that cost $100 a box. And to hack one’s phone to use a different service plan, or to manufacture generic ink cartridges or glucose testing strips in competition with the proprietary version, is illegal. To manufacture generic replacement parts for a car or appliance, in competition with the corporate dealership, is likewise illegal.

As it is now, appliances are generally designed to thwart repair. When the Maytag repairman tells you it would cost more that it’s worth to repair your washing machine, he’s telling the truth. But he fails to add that that state of affairs reflects deliberate design: the washing machine could have been designed on a modular basis, had the company so chosen, so that the defective part might have been cheaply and easily replaced.

Absent legal constraints, it would be profitable to offer competing generic replacements and accessories for other companies’ platforms. And in the face of such market competition, there would be strong pressure toward modular product designs that were amenable to repair, and interoperable with other the modular components and accessories of other companies’ platforms. Absent the legal constraints presented by patents, an appliance which was designed to thwart ease of repair through incompatibility with other companies’ platforms would suffer a competitive disadvantage.

Notes:

35. David F. Noble, America by Design: Science, Technology, and the Rise of Corporate Capitalism (New York: Alfred A. Knopf, 1977), p. 5.

36. Ibid., p. 9.

37. Ibid., pp. 9-10.

38. Ibid., pp. 11-12.

39. Ibid., p. 12.

40. Ibid., p. 12.

41. Ibid., p. 91.

42. Ibid., p. 92.

43. Ibid., pp. 93-94.

44. Ibid., p. 16.

45. Ibid., p. 91.

46. Ibid., p. 89.

47. Ibid., p. 95.

48. Zingales, “In Search of New Foundations,” Journal of Finance, vol. 55 (2000), pp. 1641-1642.

49. Tom Peters. The Tom Peters Seminar: Crazy Times Call for Crazy Organizations (New York: Vintage Books, 1994), p. 35.

50. Yochai Benkler, The Wealth of Networks: How Social Production Transforms Markets and Freedom (New Haven and London: Yale University Press, 2006), p. 179.

51. Ibid., p. 188.

52. Ibid., pp. 212-13.

53. Ibid., pp. 32-33.

54. Ibid., p. 54.

55. Tom Coates, “(Weblogs and) The Mass Amateurisation of (Nearly) Everything…” Plasticbag.org, September 3, 2003 <http://www.plasticbag.org/archives/2003/09/weblogs_and_the_mass_ amateurisation_of_nearly_everything>.

56. Zingales, “In Search of New Foundations,” p. 1641.

57. Ibid., p. 1641.

58. Raghuram Rajan and Luigi Zingales, “The Governance of the New Enterprise,” in Xavier Vives, ed., Corporate Governance: Theoretical and Empirical Perspectives (Cambridge: Cambridge University Press, 2000), pp. 211-212.

59. Marjorie Kelly, “The Corporation as Feudal Estate” (an excerpt from The Divine Right of Capital) Business Ethics, Summer 2001. Quoted in GreenMoney Journal, Fall 2008 <http://greenmoneyjournal.com/article.mpl?articleid=60&newsletterid=15>.

60. David L Prychitko, Marxism and Workers’ Self-Management: The Essential Tension ( New York; London; Westport, Conn.: Greenwood Press, 1991), p. 121n.

61. James C. Bennett, “The End of Capitalism and the Triumph of the Market Economy,” from Network Commonwealth: The Future of Nations in the Internet Era (1998, 1999) <http://www.pattern.com/bennettj-endcap.html>.

62. Tom Peters, The Tom Peters Seminar, p. 10.

63. Ibid., pp. 10-11.

64. Ibid., p. 11.

65. Ibid. p. 12.

66. Michael Perelman, “The Political Economy of Intellectual Property,” Monthly Review, January 2003 <http://www.monthlyreview.org/0103perelman.htm>.

67. Thomas Hodgskin, Popular Political Economy: Four Lectures Delivered at the London Mechanics’ Institution (London: Printed for Charles and William Tait, Edinburgh, 1827), pp. 33­34.

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