Invention and innovation are critical aspects of the modern economy. In some sectors of the economy, firms that cannot invent or innovate are liable to die. Invention is a genuine discovery, whereas innovation is the introduction of a new product or process.
Invention is the discovery of a new product or process through research.
Product innovation refers to new or better goods or services.
Process innovation refers to new or better production or supply.
To this point we have said little that is good about monopolies. However, the economist Joseph Schumpeter argued that, while monopoly leads to resource misallocation in the economy, this cost might be offset by the greater tendency for monopoly firms to invent and innovate. This is because such firms have more profit and therefore more resources with which to fund R&D and may therefore be more innovative than competitive firms. If this were true then, taking a long-run dynamic view of the marketplace, monopolies could have lower costs and more advanced products than competitive firms and thus benefit the consumer.
While this argument has some logical appeal, it falls short on several counts. First, even if large firms carry out more research than competitive firms, there is no guarantee that the ensuing benefits carry over to the consumer. Second, the results of such research may be used to prevent entry into the industry in question. Firms may register their inventions and gain use protection before a competitor can come up with the same or a similar invention. Apple and Samsung each own tens of thousands of patents. Third, the empirical evidence on the location of most R&D is inconclusive: A sector with several large firms, rather than one with a single or very many firms, may be best. For example, if Apple did not have Samsung as a competitor, or vice versa, would the pace of innovation be as strong?
Fourth, much research has a 'public good' aspect to it. Research carried out at universities and government-funded laboratories is sometimes referred to as basic research: It explores the principles underlying chemistry, social relations, engineering forces, microbiology, etc., and has multiple applications in the commercial world. If disseminated, this research is like a public good – its fruits can be used in many different applications, and its use in one area does not preclude its use in others. Consequently, rather than protecting monopolies on the promise of more R&D, a superior government policy might be to invest directly in research and make the fruits of the research publicly available.
Modern economies have patent laws, which grant inventors a legal monopoly on use for a fixed period of time – perhaps fifteen years. By preventing imitation, patent laws raise the incentive to conduct R&D but do not establish a monopoly in the long run. Over the life of a patent the inventor charges a higher price than would exist if his invention were not protected; this both yields greater profits and provides the research incentive. When the patent expires, competition from other producers leads to higher output and lower prices for the product. Generic drugs are a good example of this phenomenon.
Patent laws grant inventors a legal monopoly on use for a fixed period of time.
The power of globalization once again is very relevant in patents. Not all countries have patent laws that are as strong as those in North America and Europe. The BRIC economies (Brazil, Russia, India and China) form an emerging power block. But their legal systems and enforcement systems are less well-developed than in Europe or North America. The absence of a strong and transparent legal structure inhibits research and development, because their fruits may be appropriated by competitors.
Rent seeking
Citizens are frequently appalled when they read of lobbying activities in their nation's capital. Every capital city in the world has an army of lobbyists, seeking to influence legislators and regulators. Such individuals are in the business of rent seeking, whose goal is to direct profit to particular groups, and protect that profit from the forces of competition. In Virginia and Kentucky we find that state taxes on cigarettes are the lowest in the US – because the tobacco leaf is grown in these states, and the tobacco industry makes major contributions to the campaigns of some political representatives.
Rent-seeking carries a resource cost: Imagine that we could outlaw the lobbying business and put these lobbyists to work producing goods and services in the economy instead. Their purpose is to maintain as much quasi-monopoly power in the hands of their clients as possible, and to ensure that the fruits of this effort go to those same clients. If this practice could be curtailed then the time and resources involved could be redirected to other productive ends.
Rent seeking is an activity that uses productive resources to redistribute rather than create output and value.
Industries in which rent seeking is most prevalent tend to be those in which the potential for economic profits is greatest – monopolies or near-monopolies. These, therefore, are the industries that allocate resources to the preservation of their protected status. We do not observe laundromat owners or shoe-repair businesses lobbying in Ottawa.
