Patent Protection as a Tax on Competition and Innovation

I introduce patents into a general equilibrium model of innovation, where innovators choose between creating a new product market and competing in an existing market. Patent holders demand royalties from sequential innovators, but are constrained by the ability of innovators to work around patents. I show patent protection acts as a net tax on sequential innovators, reducing both competition and productivity growth. Calibrated to match moments from U.S. data, the model predicts that eliminating patent protection in the U.S. would generate a 23% increase in steady-state productivity growth as well as an increase in welfare equivalent to that from a 16% increase in annual consumption. I test several implications of the model using both U.S. and cross-country data. Consistent with the model, the data suggests an increase in the strength of patent protection reduces both productivity growth and the average quality of innovations.