Thursday, April 28, 2016

Jonathan Masur on Improving Cost-Benefit Analysis at the PTO

Federal agencies are required to use cost-benefit analysis (CBA) for all "economically significant" regulations—those with an impact of at least $100 million. Given the economic importance of patents, even small procedural changes at the PTO likely cross this threshold. But as Jonathan Masur notes in CBA at the PTO, the PTO regularly promulgates regulations without following CBA procedures. The PTO did deem its recent fee-setting regulations economically significant, and Masur writes that "the PTO deserves commendation for attempting CBA in such a difficult field." Yet the resulting analysis "misunderstands basic precepts of patent economics."

CBA is supposed to measure the social costs and benefits of a proposed regulation, not just the private costs and benefits for the agency and the regulated party. The PTO's analysis for its fee-setting regulation correctly counted PTO operating costs as a real administrative cost. But the only other costs and benefits it considered related to the quantity and speed of patent grants—where more/faster patents were viewed as benefits, and fewer/slower patents were viewed as costs. The PTO viewed a "decrease in successful patent application filings" as a "cost to society." As Masur notes, this approach "improperly conflates the private value of patents to their owners with the value of patents to society at large." (As I've previously discussed, this distinction can also be conflated in academic work.) The private value of a patent—the supracompetitive rents it enables—is a transfer from consumers to the patent owner, not a social gain. If there is a social benefit, it is in the dynamic incentives the patent creates.

In addition to making this "fundamental" error about the benefits of patents, the PTO's CBA "entirely ignores the costs that accompany patents" such as deadweight loss and inhibition of follow-on innovation. The PTO did note that uncertainty about the scope of others' patent rights can inhibit innovation, but this was treated "as a cost created by pending patent applications, as if the cost disappears entirely when the patent is granted"—which Masur notes is "entirely backward." In prior work, Masur has explained that high patent filing fees can serve the benefit of screening out low-value inventions. The PTO's CBA, however, "errs by treating lower fees—and greater numbers of patents—as an unalloyed good."

Masur acknowledges that the PTO could be correct in its approach if one assumes that (1) the substantive rules governing patents are correctly calibrated to maximize welfare and (2) patent examiners always properly follow those rules. However, these are "as heroic as assumptions can be," and there is ample evidence to counter each assumption. Masur thus concludes that the PTO's attempt at CBA "is plagued by both conceptual and epistemic errors."

Perhaps even more striking is the PTO's justification for not using CBA when setting forth all the procedural rules for the new proceedings created by the America Invents Act such as inter partes review (IPR). Included in these rules was the decision to give claims their "broadest reasonable interpretation," an issue that is now before the Supreme Court in Cuozzo. Masur writes:
The PTO’s analysis of the regulation's economic impact is striking in that it displays a type of myopia very different from that present in its fee-setting CBA. The only costs or benefits the PTO included as part of its economic significance analysis were the costs of filing or defending the IPR petitions. In other words, the agency only tabulated the administrative costs, which fell below $100 million. It ignored entirely the costs and benefits that would result from patents—in some cases very valuable patents—being invalidated (or upheld) in IPR and other proceedings.
It seems clearly right that the invalidation of many patents—particularly pharmaceutical patents—would have a $100 million effect on the economy.

So what should the PTO be doing instead? Masur does not merely criticize the current approach; in Part IV of his article, he also offers some guidance for future CBA at the agency, beginning with a more accurate conceptualization of the costs and benefits of patents, and then walking through how this framework might be applied in the fee-setting case. Masur acknowledges that there is significant uncertainty at each step of this calculation, but "agencies frequently complete cost-benefit analyses where the science and economics are in some dispute." It would likely be better to have educated guesses that are at least focused on the right questions (and that can be updated over time) than to proceed with a CBA approach that bears little relation to the true costs and benefits of PTO rules.

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