Monopoly Basics

Innovation & Monopoly

The link between innovation and monopoly involves a tension between two different regulatory regimes: antitrust law, which is designed to fight monopolies, and patent law, which grants and enforces monopolies.

For much of the 20th century, Americans did a good job of reconciling this tension. Regulators used patent law to reward independent inventors for their new ideas while also using antitrust law to prevent large corporations from using patents to monopolize markets. Policies put into place during the New Deal refined the balancing act by limiting the patent rights of large corporations and forcing many to license their technologies to all comers, for free.

But beginning in the 1980s, thinkers and politicians from both parties joined together to rewrite the nation’s patent and anti-monopoly policies along more libertarian lines. These changes radically altered antitrust law, permitting ever-larger companies and abuses of market power that for decades had been illegal. They also lengthened the duration of patents, making it easier for corporations to use patents to grow larger and more powerful. Today the results of these changes are bigger and more dominant industrial corporations, fewer pathways for inventors and upstart companies, and a sharp decline in innovation in many sectors of the economy.

Federal patent policy stretches back to the earliest days of the Republic. Ben Franklin, perhaps the greatest American inventor, wrote that ideas should be shared “freely and generously” in the public square. Thus, he refused to patent such inventions as the circulating stove, the bifocal lens, and the lightning rod.

But the founders also understood that patent monopolies could serve an important public purpose by encouraging inventors. The result was a provision in the Constitution that allowed the government to grant inventors the “exclusive right” to their ideas for “limited times.” Thomas Jefferson, who generally agreed with Franklin that all ideas should be public, described patent monopolies as an “embarrassment” but also necessary.

By the early 19th century, the United States had become a hotbed of innovation, as “tinkerers” and “mechanics” harnessed and perfected steam power and gained a reputation for “Yankee ingenuity.” By the middle of the 19th century, however, giant corporations increasingly exploited patents to monopolize markets; the tension between patent law and market monopoly became unstable.

For instance, Samuel Morse, inventor of the Morse code, asserted patent rights over telegraph technology that were so broad they significantly hindered the growth the telegraph industry. That changed in 1854 when the Supreme Court narrowed Morse’s patent rights in a way that allowed new upstarts—including the company that would become Western Union—to enter the world of telegraphy. Healthy competition in telegraphy was short-lived, however.  In 1866, Western Union acquired its two biggest rivals and gained dominance over the sector.

By the end of the 19th century, financiers were using patents to control and manage entire industries. JP Morgan, for instance, engineered a takeover of the nascent electrical industry by buying up the patents and businesses of Thomas Edison, George Westinghouse, and other early innovators.

The first proposal to use antitrust law to address this abuse of patents was made by Jeremiah Jenks, a political scientist, in 1900. But, it was not until the 1930s that Americans struck upon a formula to benefit the inventor while ensuring competition at all levels of the economy to promote innovation.

The precipitating event was a report published by the Temporary National Economic Committee (TNEC), a group established by Congress in 1938 to study how companies like RCA, DuPont, and General Electric wielded their power. The task force found that dominant firms often sat on new ideas and products because they had no incentive to introduce new technologies. AT&T, for instance, developed but neglected to introduce office switchboards, new handsets, and automatic dialing.

Based on the TNEC’s findings, the U.S. Department of Justice’s antitrust division—led by Thurman Arnold—began using lawsuits and consent degrees to force companies to license out their patents. This freed inventors, tinkerers, and upstarts across the nation to build on technologies that RCA, DuPont, Xerox, General Electric, and United Shoe Machinery had locked away. In all, the federal government forced companies to license out between 40 and 50,000 patents during this period.

In one of the most famous instances, the DOJ’s actions drove AT&T to license out an invention it called the electric transistor to thirty-five companies. Smaller, younger, nimbler firms like Motorola, Fairchild, and Texas Instruments were among those that bought the product—now known as the semiconductor—and improved upon it to launch the computer revolution.

As the U.S. government implemented this dual-purpose regime—alongside other strong, anti-monopoly policies—the rate of new business formation expanded as most markets became more competitive and less monopolistic during the postwar period and into 1970s. At the same time, productivity surged and the roll-out of new technologies—ranging from plastics and aluminum, to jet airliners, solid-state televisions, and personal computers—remade American life.

But in the 1980s, these anti-monopoly and pro-innovation policies were dismantled on two fronts. Politicians of both parties undermined anti-monopoly policy and adopted laxer antitrust enforcement. Meanwhile, Congress passed laws and the Supreme Court decided several cases that ultimately increased the powers afforded to patent monopolies. Federal courts also made several decisions during the 80s and 90s that extended patent protection to new industries, including software and biotech.

During these years, libertarian thinkers also advanced a new philosophy of innovation. In place of the traditional American belief that innovation is a function of political decisions striking a careful balance between monopoly and competition, libertarian thinkers argued that innovation is a natural creation of a free market. Influenced by Joseph Schumpeter, these libertarians argued that monopolists would be the most innovative companies of all, because they could capture all of the profits from their new inventions without facing any competition. Moreover, they argued that even if monopolists did overcharge customers or crush rivals, they wouldn’t last long. “Creative destruction,” as Schumpeter called it, would ensure that big, anti-competitive incumbents would soon enough be crushed by small, inventive upstarts.

The today’s highly monopolized and slow growing economy belies this prediction and theory behind it. Over the last three decades, as industry has become far more concentrated, rates of new business formation and productivity growth have fallen to a fraction of the levels achieved between the 1940s and the early 1980s. The economist Robert Gordon, a professor at Northwestern, argues that most of our modern “innovations” do far less to promote material advancement than such inventions as refrigeration and the internal combustion engine.  Even libertarian economist like Tyler Cowen write of “The Great Stagnation” that has come over the American economy.

Meanwhile, dominant technology companies are increasingly using their monopoly profits not to invest in new research and development, but to acquire or bankrupt their competitors, buy back stock, hire lobbyists, or simply hoard cash. Unlike the libertarian theory that “creative destruction” would unseat the country’s biggest monopolists, the same four tech companies—Google, Amazon, Facebook, and Apple—continue to dominate the country’s tech sector.  To regain the balance that led to so much innovation and broad prosperity during the mid-20th century, both patent and antitrust law must be reformed.

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In America today, wealth and political power are more concentrated than at any point in our country’s history.

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