Patents, Research Exemption, and the Incentive for Sequential Innovation

We develop a dynamic duopoly model of R&D competition to improve the quality of a final good. The innovation process is sequential and cumulative, and takes place alongside production in an infinite-horizon setting. In this context we study the R&D incentive impacts resulting from a ﾓresearch exemptionﾔ or ﾓexperimental useﾔ provision. We specify and solve the innovation and production model under two distinct intellectual property right (IPR) regimes, essentially a patent system with and without a research exemption. The model applies closely to the question of the optimal mode of IPR protection for plants, where traditional plant breederﾒs rights allow for a well-defined research exemption, whereas standard utility patents do not. We characterize the properties of the relevant Markov perfect equilibria and investigate the profit and welfare effects of the research exemption. We find that firms, ex ante, always prefer full patent protection. The welfare ranking of the two IPR regimes, on the other hand, depends on the relative magnitudes of the costs of initial innovation and improvements. In particular, a research exemption is most likely to provide inadequate R&D incentives when there is a large cost to establish the initial research program.