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by Joshua S. Gans and Scott Stern
First Draft: 15th September 2008 This Version: 26th January 2009
This paper draws on recent work in market design to evaluate the conditions under which a market for ideas or technology (MfTs) will emerge and operate in an efficient way. While most research on MfT have focused primarily on bilateral exchanges, market design principles suggest that any single transaction takes place in the shadow or all other potential transactions. As highlighted by Roth (2007), effective market design must ensure four basic principles: market thickness, lack of congestion, market safety, and avoidance of “repugnance.” Taken together, these conditions ensure that participants in a market have opportunities to trade with a wide range of potential transactors (market thickness), that the market is rapid enough (relative to the speed of transactions) that market participants can feasibly turn down offers in order to seek better matches (lack of congestion), potential market participants have a high incentive to participate in the market and avoid strategic interaction which might undermine allocative efficiency and social welfare (market safety), and that market trade is not undermined by other social values which limit the ability to charge positive prices for a good (avoidance of repugnance). This paper provides a critical examination of these criteria for MfT. Our analysis suggests that microeconomic, strategic, and institutional factors likely inhibit the allocative efficiency of MfT in most circumstances. For example, Arrow’s disclosure problem suggests that the value of a given idea to any one buyer may be decreasing in the number of other potential buyers who have been able to evaluate the idea (due to information leakages in the valuation process). As a result, a key property of ideas - the potential for expropriation - limits the potential for market thickness and lack of congestion identified by Roth. At the same time, key institutional developments such as the development of formalized IP exchanges and increased attention on how to design the patent system to facilitate technology transfer suggest that effective market design may be possible for some innovation markets. Perhaps most intriguingly, our analysis suggests that markets for ideas are beset by the “repugnance” problem: from the perspective of market design, Open Science is an institution that places normative value on “free” disclosure and so undermines the ability of ideas producers to earn market-based returns for producing even very valuable “pure” knowledge. Journal of Economic Literature Classification Number: O31. Keywords. ideas market, intellectual property, market design, repugnance, appropriation.
We thank Ashish Arora, Alfonso Gambardella, Carl Shapiro, Harold Demsetz and participants at the Madrid Markets for Technology and Industrial Evolution Conference, the FTC Microeconomics Conference for helpful comments and the Australian Research Council for financial assistance. Responsibility for all errors lies with the authors. Correspondence to: J.Gans@unimelb.edu.au. The latest version of this paper is available at www.mbs.edu/jgans.
Markets have the potential to generate high social returns by enhancing allocative efficiency.
Though the virtues of markets are easy to idealize (and overstate), it is nonetheless true that marketbased exchanges play an important role in facilitating voluntary trade across many areas of the economy, from traditional commodities markets to modern developments such as eBay. At least in principle, the potential value arising from voluntary trade through organized markets also exists for ideas or technology. Individual ideas may be valuable to many users and may be productively employed in applications or contexts far removed from the locus of the idea’s generation or invention. When the value of an idea can only be realized by “matching” that idea with key complementary assets (Teece, 1986), markets that facilitate matching and efficient distribution in a timely fashion will provide significant social returns. It is thus something of a puzzle that markets for ideas are relatively uncommon. While there are transactional exchanges in both ideas and technologies, and the rate of “ideas trading” seems to be increasing over time (Arora, Fosfuri, and Gambardella (hereafter, AFG), 2001), it is still very rare for ideas or technologies to be traded in what economists would traditionally refer to as an organized market. Instead, most exchanges of abstract knowledge or prototype technology occur under conditions that are best described as a bilateral monopoly: the buyer and seller engage in negotiations with limited outside options in terms of alternative exchanges. Buyers (sellers) are unable to play potential sellers (buyers) off against one another, limiting the potential for competitive discipline, and even successful negotiations vary widely in terms of the price and terms over which knowledge is transferred. As Mark Lemley and Nathan Myrvhold note, “Patents … exist in ... a blind market. Want to know if you are getting a good deal on a patent license or technology acquisition? Too bad.” (Lemley and Myrvhold, 2008; see also Troy and Werle, 2008) Not simply a matter of how the rents from a given idea are distributed between buyer and seller, the lack of transparent price signals results in distorted and inconsistent incentives to produce and commercialize new ideas. Is there a market for ideas? We address this question by combining insights from two prior
literatures – the market design literature and the markets for technology literature – which, by and large, have mostly developed independently of one another. On the one hand, the market design literature utilizes formal game-theoretic approaches, most notably from mechanism design, to evaluate how the rules that govern exchange and allocation impact the efficiency of alternative market institutions (Myerson, 2008; Roth, 2002, 2008). Over the past two decades, the insights from market design have been applied in a diverse set of real-world application, from auctions for telecommunications spectrum to exchanges for kidney donation. Our analysis builds directly on the recent synthesis of this literature by Al Roth. Roth (2008) draws on the emerging body of empirical evidence from real-world market design applications to offer a framework and conditions upon which market designers can evaluate the effectiveness of their prescriptions. Specifically, Roth highlights three cross-cutting features of markets that seem to be associated with efficient market-level exchanges: market thickness (both buyers and sellers have opportunities for trade with a wide range of potential transactors), lack of congestion (the speed of transactions is rapid enough to ensure market clearing but slow enough so that individuals have the opportunity to seek alternatives when considering an offer), and market safety (agents do not have incentives for misrepresentation or strategic action that undermines the ability of others to evaluate potential trades). In other words, Roth suggests that the ability to achieve efficiency in real-world markets depends on participation by a sufficient number (and diversity) of buyers and sellers, the ability of buyers to play off different sellers against each other (and vice versa), and the provision of sufficiently accurate information about buyers and sellers to evaluate alternative transactions. Roth also identifies an important (and, to traditional economic theorists, surprising) feature of real-some world markets that he terms repugnance. In some markets such as those for kidneys or sex, market designers are significantly constrained because of social norms or legal restrictions that limit the use of the price system as an allocation mechanism. To apply this framework to the case of innovation, we draw on cross-cutting insights from research on markets for technology (MfT). The MfT literature explores how technological innovation (and other intangible knowledge goods) differs from more traditional goods and services, and the implications of these differences for business and public policy. To focus our analysis in order to
develop specific insights, we highlight two core theoretical issues. First, ideas are subject to an appropriability problem (Arrow, 1962; Teece, 1986): in the absence of strongly delineated and easily enforceable intellectual property rights, ideas producers may be unable to capture the value created by their ideas once those ideas are disclosed. Second, ideas are partially non-rivalrous (Romer, 1990; Bresnahan and Trajtenberg, 1995): a single idea may have multiple applications, and, once the fixed cost of producing the idea is incurred, may be replicated and diffused at low (or even zero) marginal cost.1 The main contribution of this paper is to use the market design evaluation scheme proposed by Roth to assess how these two fundamental features of ideas impact the viability, operation and structure of a market for ideas. We highlight three main findings. First, the nature of ideas undermines the market for ideas. The appropriability problem and non-rivalry significantly undermine the ability to achieve certain types of contracts and engage in certain types of bargaining essential for an effective multilateral trading mechanism. For example, both the market thickness and market safety conditions identified by Roth suggest that ideas buyers should be able to consider multiple offers from multiple potential buyers before contracting with a particular buyer. This type of transparency is undermined by Arrow’s disclosure problem; not only will this distort the price at which ideas are bought and sold, but, more damaging from the perspective of welfare, is likely to lead to poor “match quality” when valuations are idiosyncratic but the appropriability problem is pervasive. Similarly, for ideas that are truly non-rivalrous, the initial seller of an idea in an organized market faces the prospect that the first buyer is likely to subsequently become a seller. In this case, the very existence of an organized exchange undermines the ability to conduct any trade at all. Our second central finding is a corollary of the first. Specific institutions, most notably formal intellectual property rights such as patents, play a crucial role in overcoming the key challenges raised by market design. For example, when patents
These two insights are central to much of the research in MfT, including the prevalence and rise of ideas and technology trading across different economic sectors (Arora, et al, 2001; Lamoreaux and Sokoloff, 2001; Gans and Stern, 2003), the determinants of the innovative division of labor, particularly with respect to “general purpose” technologies (Arora and Gambardella, 1994; Bresnahan and Trajtenberg, 1995; Gambardella and Giarrantana, 2008), and the special role played by formal intellectual property rights (such as patents) in facilitating knowledge transfer across firm boundaries (Arora, 1995; Gans, Hsu and Stern, 2002; 2007). Troy and Werle (2008) consider a related set of questions concerning trading in patents but emphasize uncertainty in a manner similar to the MfT literature as opposed to the broader market design focus we take in this paper.
are effective and enforceable, buyers are able to overcome both the disclosure problem and the potential for resale by buyers, which facilitates multilateral bargaining and raises the potential for efficient matching. Indeed, this pattern is reflected in the phenomena – the rise of formalized patent exchanges and auctions such as Ocean Tomo demonstrate the potential for organized markets in abstract ideas that are protected through the patent system. Our final and perhaps most speculative observation is that most robust markets for ideas are those where ideas are free. This is not simply because, in many respects, those markets satisfy Roth’s conditions for effective market design but also because those markets overcome constraints arising from repugnance. Together, these conclusions raise subtle issues about the role of property rights in innovation (Demsetz, 1967). From an historical perspective, a great deal of knowledge has been produced and diffused through, effectively, communal ownership: Open Science is premised on a near-absence of formal property rights that allow the researcher who produces the knowledge to restrict use by others in the scientific community. Given the non-rivalry of many types of scientific knowledge, it is perhaps not surprising that such communal ownership has been the norm. At the same time, there has been a shift towards the use and enforcement of formal intellectual property rights, even for upstream basic research. At least in part, the inability to develop effective institutions to support market-level exchanges of basic research knowledge is shaped by the very significant transactions costs of doing so, particularly in the face of long-standing communal norms regarding sharing and the free use and exploitation of ideas. We emphasize that this analysis is inherently speculative and incomplete. First, while there has been significant progress in understanding the role of institutions and the strategic context that shapes bilateral trade in ideas and technology, it is fair to say that, outside of some extreme cases, the MfT literature has essentially abstracted away from the conditions that would allow the production and distribution of ideas to be efficient (in the strong sense indicated by the market design literature). While we could evaluate the market design implications of other central themes of the MfT literature (from network effects to the dynamics of knowledge accumulation), we focus here on the appropriability problem and non-rivalry in order to illustrate how these two central features of ideas raise fundamental challenges for the design and operation of a market mechanism that results in
allocative efficiency. Second, while we draw heavily on prior empirical research and more qualitative assessments of the underlying phenomena and institutions, this paper does not break new empirical ground. While the analysis does hold several testable empirical implications, and we hope to evaluate these implications in future work, the objective of this paper is to synthesize key implications of our theoretical and empirical understanding of the MfT in light of the questions raised by a market design approach. Finally, so that we can focus on “extreme” cases that get at the essential elements of the underlying phenomena, our analysis is essentially focused on the challenges of market design for relatively abstract and pure “ideas.” While the MfT literature incorporates both pure ideas and technologies at a more advanced stage of development and commercialization, our examples and analysis will focus primarily on the ability to exchange and distribute ideas that are disembodied from physical artifacts (such as a product) over which well-defined property rights can be established. The outline of this paper is as follows. In the next section, we provide an overview of the lessons from market design for the effective functioning of markets. Section 3 then considers how the nature of ideas themselves impacts upon the effectiveness of markets for ideas. Section 4 then examines the impact of repugnance and how this has potentially led to the creation of certain institutional structures that might support the market for ideas. A final section concludes.
Lessons from Market Design
Though the role of institutions in supporting market exchange was appreciated by classical
economists, including Adam Smith, the formal study of market design can be traced back to the Arrow Impossibility Theorem (Arrow, 1951). Building on Arrow’s development of social choice theory, Leo Hurwicz introduced a rigorous and formal framework for evaluating alternative rules for exchange and market institutions (Hurwicz, 1972; 1973). Hurwicz’s crucial and fundamental insight was that potential participants in a market voluntarily agree to play by the rules of the “game” associated with a particular “market mechanism,” and that different market mechanisms can lead to very different outcomes in terms of participation and efficiency. In other words, market design matters, and there was a significant opportunity to enhance efficiency through the design of the
market mechanism (i.e., mechanism design). This game theoretic (and highly abstract) approach to evaluating market and social institutions took off as a subfield within economics in the late 1970s, focusing in particular on the case when potential participants to an exchange hold private information, and it becomes critical to examine the incentives agents have to (truthfully) reveal that information.2 Though extremely elegant, most research in mechanism design from the 1970s (and even today) is highly abstract and removed from the design and operation of real-world markets. However, an emerging body of research (and an emerging group of researchers) is attempting to use the tools and insights from mechanism design to evaluate (and even design) real-world markets and exchange institutions. From the design and operation of government auctions for telecommunications spectrum (McMillan, 1994; Milgrom, 2004; Klemperer, 2004; Cramton, 2002, 2008) to the evaluation of algorithms for “matching” medical residents with hospitals (Roth, 2002) to the development of online auctions for search engines such as Google (Edelman, Ostrovsky and Schwarz, 2007), there has been an explosion of applications in which the tools of mechanism design are used in the service of market design. For example, the introduction of auctions for telecommunication spectrum not only served to enhance the revenue raised by agencies such as the FCC but is designed to ensure that the allocation of spectrum rights reflects the valuation of those rights by telecommunications firms. It is useful to recall exactly how market design – the rules of the game by which exchange can occur -- matters for the efficiency of market operation. Consider a simple illustration. Suppose that a seller, S1, holds an asset, A1, and is engaged in negotiation with a potential buyer, B1. If S1 values the asset at c1 (i.e., would prefer to “consume” the asset themselves rather than trade at any price less than c1) while the buyer values it at v1 (i.e., would prefer to have no asset rather than pay more than v1), an exchange is between S1 and B1 is desirable if v1 > c1. Of course, if the only opportunity for exchange is within the context of a bilateral negotiation between S1 and B1, and S1 and B1 do not know the precise valuation placed on the asset by the other party, there are significant opportunities for inefficiencies arising from strategic bargaining. For example, desiring to capture as much value as
These contributions were recently honored with the 2007 Nobel Prize in Economics, awarded to Hurwicz and two preeminent follow-on researchers Roger Myerson and Eric Maskin. This follows on from previous Nobel prizes along the same research stream including Reinhard Selton, John Nash, John Harsanyi, James Mirrlees and William Vickery.
possible, S1 may demand a price well above v1; if that price is above the (also distorted) offer from B1, it is possible that S1 and B1 are unable to reach an agreement even though an agreement between v1 and c1 would benefit both parties. From the perspective of market design, a bilateral exchange mechanism may suffer from significant bargaining inefficiencies. Now consider what might occur under a multilateral exchange mechanism. Suppose there is a market mechanism in which (a) many buyers and sellers are able to participate, (b) each seller is offering an imperfect substitute for the goods of other sellers, and (c) the active offers of all buyers and sellers are publicly revealed to all market participants (such a set-up is not too dissimilar from an online auction site such as eBay or a ticket reseller such as StubHub). Relative to an isolated bilateral negotiation, the “outside option” for any given transaction is no longer the value realized from “no exchange” but is now shaped by the next best transaction available in the market at the time that trading occurs. The existence of close and available substitutes greatly limits the scope for strategic bargaining, reducing the potential for inefficiency and bargaining breakdown. In other words, with a public multilateral market exchange, the allocation of assets and the prices at which assets are traded are a function of the endogenous outside options of both buyers and sellers, enhancing the efficiency of potential trade. There are two additional properties of such an allocation mechanism that of considerable interest relative to bilateral negotiations. First, since the prices that are being offered are public, the resulting allocations of assets may (under the right conditions) be stable. For example, if a second potential buyer, B2, has a valuation for the S1 asset of v2, and v2 > v1, it may be possible to design the market so that it is much more likely that B2 ends up outbidding B1 in the context of a multilateral negotiation. When an allocation is unstable, market participants have incentives to engage in strategic behavior in order to provide themselves opportunities outside of the official market (e.g., trying to close deals before the market opens, or posing as a buyer in order to become a seller later on); in contrast, a market design that results in a stable and efficient allocation also maximizes the incentives for (non-strategic) market participation. Second, multilateral markets require interested parties to compete with one another, resulting in the transformation of private information about value into public information about relative prices. In other words, when there is a sufficiently large number of
buyers and sellers and the market mechanism allows for vigorous competition among buyers and sellers, respectively, the range of prices at which transactions take place are considerably narrowed as the result of the emergence of endogenous outside options and the requirements for a stable allocation. The transparency of prices not only enhances the ability to allocate assets within a market, but, over time, allows the market to provide informative signals about the value of different assets (or activities), and allows benchmarking across transactions over time. The contrast between isolated bilateral exchange and a transparent multilateral market is, of course, extreme, and does not provide the diagnostics required for evaluating the market for ideas. To accomplish that objective, we draw on the synthesis of Roth (2008), who offers three interdependent criteria for evaluating alternative market designs: thickness, lack of congestion and market safety. Roth acknowledges that each of these elements interacts with the others, and, drawing on the extensive work of market design economists over the last 15 years, suggests that balancing these objectives seems to be more art than science. With that said, it is useful to define and develop each criterion as a precursor for our identification of the potential challenges (and potential institutional approaches) for establishing markets for ideas with desirable properties.
Market thickness is the degree to which a large number of buyers and sellers participate within a market so that each buyer and seller has an opportunity to engage in an effective “match.” When all buyers and sellers are very similar to each other, the importance of match quality is relatively low and market thickness is of reduced concern. However, while traditional economic theory tends to emphasize markets with large quantities of substitutable goods, a central challenge for real-world market design is that the value from exchange within a market often depends on whether potential trading partners that allow idiosyncratic matching participate in that market. Consider Roth’s example of kidney exchange. While many patients with end stage renal disease are able to find a willing (living) donor, many potential donors are an incompatible match with their intended recipients (as the result of incompatible blood types, etc). While the potential for a match between any two individuals is low, the potential for matching increases dramatically if each
donor pair (i.e., pair of individuals where one requires and one is willing to donate a kidney) is allowed to engage in exchange with other donor pairs. The introduction of a “thick” market for kidney exchange among donor pairs allows a range of useful kidney donations that might not have otherwise occurred, as the result of the ability of that market design to facilitate matching.
Lack of Congestion
The second property of effective market design is ensuring a low level of congestion. Congestion arises when the timing or circumstances of potential trades requires that trades are completed without being able to assess alternative options in the marketplace. Even if many agents are participating in a market, the ability to achieve a high match quality and use the power of market institutions to limit the scope for strategic bargaining depends on the ability of each potential trader to consider alternative trading options. While a prerequisite for a lack of congestion is market thickness (i.e., you need to have enough traders in the market to make bargaining with others worthwhile), the degree of congestion also depends on the precise rules and timing of the market mechanism.3 For example, most houses in Melbourne, Australia, are sold by auction. These live (i.e., non-electronic) auctions are conducted at a time chosen by the seller in front of the house for sale. If two similar homes are auctioned at the same time, a single seller cannot physically be in both locations and so sellers effectively have to choose to bid in one auction rather than the other (though mobile phones provide some opportunity for coordination). Conversely, if the homes are sold at different times, buyers must choose between completing a sale for a house currently at auction or foregoing that house and participating in a future auction (where the selling price is not yet known!). Though the market for Melbourne homes is thick in a technical sense, the design of that market has resulted in a significant congestion problem. There are at least two sources of inefficiency arising from congestion. First, similar to market thickness, congestion can result in inefficient matching between buyers and sellers (e.g., in a less congested market, there may be opportunities for trade in which the winners of two different auctions
Roth provides some dramatic illustration of congestion in the market for medical residents. We focus on the case of the Melbourne housing market to illustrate that congestion can occur even in relatively unregulated markets.
effectively traded with each other, and each believed that they were better off). Second, and more subtly, the degree of congestion is perhaps the central determinant of whether exchanges take place in the shadow of an endogenous outside option for both parties. Specifically, in a congested market, the trading mechanism precludes playing multiple offers against one another (the timing does not allow it), enhancing the scope for strategic bargaining and increasing the likelihood that some transactions will simply not occur. This is most easily seen when market timing unravels as one-side of the market tries to preempt competition with early offers (Roth and Xing, 1994). While prices and trades in an uncongested and thick market are likely to be consistent, transparent, and stable, the outcomes from a congested market are uninformative and unstable. In a congested market, it is difficult for market participants to infer (even after the fact) whether the prices for a given transaction reflected fundamental aspects of relative supply and demand or whether prices and transactions simply reflected strategic bargaining outcomes.
The final aspect of effective market design is market safety – ensuring conditions so that market participants are willing to (truthfully) reveal their preferences and “type.” For example, in order to encourage an efficient level of supply, potential sellers who face a high manufacturing cost may only be willing to sell at a high price. The challenge for market design is to design market institutions that allow this information to be revealed without being exploited. In the traditional automobile “market,” potential buyers have had to visit individual dealerships, and negotiate with individual automobile salespeople. Concerned about the potential for exploitation in the bargaining process, potential buyers routinely hide their degree of interest in a particular car (or buying at all), and attempt to reach an agreement well below the maximum price they might be willing to pay (of course, the reverse incentive is true for the car seller). Recent innovations such as Autobytel and online second-price automobile auctions allow potential buyers to truthfully reveal their level of interest in an automobile as the result of a market mechanism in which the price is determined by competition among multiple dealers (in the case of Autobytel) or by the behavior of other bidders (in the case of a second price auction). Indeed, recent evidence suggests that those who seek out
multilateral trading mechanisms are often those who may be expected to be particularly disadvantaged in the context of isolated bilateral negotiations (Scott Morton, et.al., 2001; Zettelmeyer et.al., 2004). In other words, alternative market designs induce very different types of information revelation, and, in many cases, it is possible to structure the market so that information revealed by market participants allows all potential traders to increase their expected gains from trade.
How does the nature of ideas impact the market for ideas?
This section applies the market design criteria proposed by Roth to evaluate the challenges
(and conditions under which) a market for ideas may be feasible and/or efficient. Our analysis builds on the emerging body of research on MfT that highlights the potential gains from trade in ideas and the strategic foundations of commercialization through the market for ideas (Teece, 1986; AFG, 2001; Gans and Stern, 2003). At the heart of the MfT literature is the simple but powerful notion that the value of ideas depends on the institutions and organizations in which those ideas are embedded. As originally emphasized by Teece (1986), the ability to create value from innovation depends, in large part, on whether the underlying idea can be combined with complementary assets that allow potential users and consumers to benefit from a new technology. In many cases, the key complementary assets required for effective commercialization are not under the direct ownership or control of the innovator – indeed, this mismatch between the origin of innovation and the effective locus of commercialization is inherent to the uncertainty surrounding the innovation process itself (Rosenberg, 1998). An important corollary of this Teecean logic is that the incentives for innovation are themselves dependent upon the effectiveness and efficiency of process by which ideas are “matched” with potential downstream applications and users. Our objective here is not to provide a thorough evaluation of the crucial role of matching and complementary assets in the commercialization and diffusion of new ideas and technology; instead, we focus on the narrow question of how the nature of innovation impacts the feasibility and potential effectiveness of a market for ideas. In particular, while we acknowledge that isolated bilateral transactions in ideas and technology are quite valuable, we are seeking to extend that analysis by
considering the conditions and terms under which a true market for ideas (or, relatedly, a market for technology) can emerge (and if not, why not). Is it possible to develop construct trading environments for ideas in which (a) outside options emerge endogenously as the result of competition, (b) pricing and value division are transparent to both buyers and sellers, and (c) allocations are stable (i.e., would survive even if additional opportunities for negotiation and trade emerged)? We focus on three central characteristics of innovation that we believe offer insight into the feasibility and efficiency of the market for ideas: ideas complementarity, value rivalry, and user reproducibility. Each of these characteristics is a distinctive aspect of innovation, and each may be more important for some types of ideas or technologies rather than others. First, ideas complementarity results from the fact that the value of any given idea depends on its combination with others. For example, the value of a software algorithm depends crucially on the availability and properties of related pieces of software (and hardware, for that matter). When ideas are of little value in isolation, downstream users may require access to multiple ideas in order to gain value from each idea. Ideas complementarity arises from the interdependence among different ideas in particular applications and contexts (Rosenberg, 1998), and the ability to trade a given idea (and the terms of that trade) may depend crucially on the availability and terms of access to other ideas for which such a strong interdependency exists. Second, value rivalry is a subtle consequence of the non-rivalry of ideas (Romer, 1990). In the traditional formulation, ideas and knowledge are non-rivalrous in use but also in valuation: the ability to read a book does not depend on whether others have read that same book, and the enjoyment that one reader gets from a book is independent (at least to first-order) of whether others have also had access to the same reading material. However, in many applications and contexts, ideas may be non-rivalrous in use (many people can have access to the same piece of information) but may be rivalrous in value (the value gained from having access to that information is declining in the number of other individuals who have access to the same idea). To take but one extreme case, insider information in about a financial asset is non-rival in use (many people could in principle have access to that information) but the advantage received from the information depends on it being maintained as a secret. A less extreme case of value rivalry arises in the context of drug development – while many firms can, in principle, take advantage of a scientific insight into the
origins of a disease (e.g., the role of a particular gene), the private value of that scientific knowledge is higher if only a single downstream firm is able to take advantage of it in the commercialization process. The degree of value rivalry, thus, depends on whether the value of an idea to a potential user/buyer declines when others have access to the same idea. Finally, user reproducibility is a particular manifestation of the low cost of replication of information an ideas. While the low replication cost of information is well studied, we will focus on the case when the buyer of an idea can also be in the position to replicate that idea for use by others. To take but one extreme example, the replication cost of music has been low since the development of recording technologies such as the phonograph and magnetic tapes; however, the development of digital music formats combined with the connectivity of the Internet meant that individual music consumers could also share (or even sell) that recording to a large number of other potential listeners (as indeed occurred with the rise of Napster and other music sharing exchanges). The degree of user reproducibility is measured by the extent to which potential ideas buyers are able to replicate that idea at low cost and share or sell that idea with other potential ideas buyers. Each of these three distinctive properties of ideas – ideas complementarity, value rivalry, and user reproducibility – are likely to pose distinctive challenges for the feasibility and operation of a market for ideas. In the remainder of this section, we focus on the influence of each of these factors on the criteria proposed by Roth. By construction, we do not seek to offer a comprehensive assessment; instead, we seek to illustrate in an exploratory fashion how the nature of ideas impacts the market for ideas, and the potential for alternative institutions in shaping the feasibility of organized exchange in ideas.
Market Thickness and Ideas Complementarity
Market thickness is perhaps the central challenge in establishing a well-functioning market exchange system, particularly when matching is important. In the absence of participation by a sufficient number of buyers and sellers, transactions may reflect a low level of match quality or not occur at all. While market thickness is a challenge in many settings, many have particularly noted the lack of thickness in the market for ideas and knowledge (Lemley and Myhrvold, 2008; Troy and
Werle, 2008). Even when strong intellectual property rights exist (e.g., ideas are embedded in patents), market development has been of only limited scale and scope (Lamoreaux and Sokoloff, 2001). Notably, while patent auctions have long been discussed (Barzel, 1968; Kitch, 1977; Kremer, 1998; Abramowicz, 2006), their historical relevance has been very limited. As we discuss in more detail below, formal patent auctions, such as those organized by Ocean Tomo, have only operated for the past few years, and most analysis of these auctions suggest that they cover a relatively narrow range of innovation and winning bids are at relatively modest prices (Kanellos, 2006). The lack of a thick market in patented ideas seems at first puzzling, given that there should (in principle) be little difference between a patent market and a secondary market for a more traditional capital good such as machinery, property or collectibles. While the lack of market thickness for knowledge – even patented knowledge – may have many sources, ideas complementarity is likely to pose a central challenge to market design. If the value of a given (patented) idea depends on access to other (patented) ideas, then the returns to participation in a market depends on whether the market is likely to include all of the required knowledge inputs. In the absence of being able to aggregate across a “package” of intellectual property assets, potential buyers do not have incentives to offer a high price for any individual asset. From the perspective of a potential seller, it would indeed be preferable if all other sellers first engaged in trade with a particular buyer, thus offering a significant opportunity for hold-up as the last remaining IP bottleneck. While the challenges of hold-up over intellectual property and the potential for patent thickets has been extensively discussed (Grindley and Teece, 1997; Shapiro, 2001; Heller, 2008), we are making the more nuanced claims that the potential for hold-up undermines the incentives for both buyers and sellers to participate in an organized exchange where many (but not all) relevant IP assets may be offered.4 It is important to emphasize that the lack of market thickness is not simply due to the potential for hold-up (we will discuss potential institutions to mitigate hold-up below). In particular, a
The market design problem that arises from ideas complementarity is analogous to the more general problem in auction design when different items have interdependent valuations. Milgrom (2007) emphasizes that the problem of interdependency is among the most challenging issues in effective auction design, and proposes a framework for evaluating how to develop a mechanism that allows for such interdependencies to be taken into account in certain applications such as telecommunications spectrum auctions.
key challenge in commercialization is that the value from a single innovation is only realized over time with the uncertain emergence of complementary ideas and technologies (Rosenberg, 1998). When ideas are developed over time, and ideas are complementary with one another, it is extremely difficult to develop a market mechanism in which each idea receives an appropriate market valuation (McDonald and Ryall, 2004).5 The market design challenge is heightened when the precise form and timing of future ideas and technologies are difficult to anticipate, and some of the most valuable “packages” are serendipitous combinations that emerge from disparate settings. It is useful to note that, when ideas complementarity is relatively unimportant, it is possible to support thick markets for knowledge and ideas. For example, the recent rise of platforms for buying and selling applications software – such as Apple’s iTunes Application Store – seem to provide concrete examples where an exchange mechanism can exist as long as the interdependency among different offerings is not too severe. Apple offers developers free (and easily accessible) product development and digital rights management tools to develop their ideas and applications. Then, while Apple assesses potential applications to ensure that they meet minimum quality thresholds and technical standards, Apple allows developers to offer their iTunes applications for sale on an integrated platform, choose their own pricing (including the option of free distribution), and has established a standard revenue sharing plan (in which Apple retains 30 percent of all revenue). In part by designing a platform technology that minimizes the interdependency between individual innovations, Apple has induced the development and exchange potential for more than 15,000 different application ideas, resulting in more than 500 million exchange-based transactions.6 When complementarity between ideas is important (and cannot be overcome through a modular technology design approach), and assuming that effective intellectual property rights are available (a topic we return to below), it is still possible to aggregate different ideas into a single package. Both patent pools and formal standard-setting processes reflect partial attempts to solve this aggregation problem. Patent pools combine different pieces of intellectual property owned by
This is once again analogous to the problems of combinatorial auction design emphasized by Milgrom (2007). Though we do not pursue it here, the market design challenges involved in aggregating ideas developed over time offers a potentially useful social function for so-called patent trolls or speculators, who acquire IP rights during an embryonic phase 6 CNet News, 16th January, 2009.
different rights holders into a package which potential users can license in order to gain the freedom to use a set of interdependent technologies. These cooperative marketing agreements by IP rights owners have the potential to overcome the coordination problem involved in selling overlapping ideas, and seem to serve as a mechanism in which a single (aggregate) seller encourages participation by potential buyers through the availability of “one-stop shopping” (Lerner and Tirole, 2004; Chiao, et.al., 2007). Standard-setting organizations also play a role in encouraging market thickness, and do so in an institutional context in which the values of both buyers and sellers are explicitly weighed in the standard-setting process (Lerner and Tirole, 2006; Simcoe, 2008). A final institutional response is to simply design the market in a way that allows the entire “solution” of complementary ideas to be combined (and valued) in a single package. This is the essence of a prize system. While the concept of innovation prizes have been around for centuries (Mokyr, 2008), there has been a recent flurry of innovation prize offerings (mostly by philanthropic organizations) ranging from reusable spacecraft to energy efficient cars to the development of specific vaccines.7 Of course, while a prize mechanism does encourage supply and provides a particular type of predetermined demand for an innovation, most ideas production is resistant to a prize mechanism because of the inability to completely and accurately specify the performance criteria and relevant parameters in advance (indeed, specifying the fundamental requirements of a design is often the most important “idea” regarding that design). More generally, it is useful to emphasize that each of the three institutional responses to ideas complementarity -- patent pools, standard-setting, and prizes -achieve market thickness by (a) limiting the range of technical alternatives that can be combined (i.e., one may not be able to achieve operability outside the “standard” or one may ignore key design elements in the prize specification) and (b) leaving the status of future ideas and technologies ambiguous.
Prizes and forward contracts need not be large scale. For example, Innocentive allows established firms (who are vetted for credibility) to post problems they seek to have solved. One challenge set $100,000 for the delivery of a non-ion sensitive super absorbent polymer while another by Kraft looks for bakeable cheese technology partners and many have been awarded (100 in all). Overall more than 140,000 people from most countries in the world have registered as potential solvers on the site.
17 Congestion and Value Rivalry
Congestion – the difficulty of considering multiple options at a given point in time – arises when market participants have an incentive to manipulate market timing to either pre-empt or delay trade. Roth emphasizes that, even if exchange is occurring in what seems to be a thick market, congestion can significantly reduce market efficiency by limiting opportunities for effective matching and distorting the prices at which transactions take place. We build on this logic by examining the impact of value rivalry – a condition arising when the value of the idea to each potential buyer is declining in the number of other potential buyers with access to that idea – on market congestion. When an idea is truly non-rivalrous, both in use and in value, potential buyers are not directly influenced by whether others have had access to or even purchased the same idea. As a result, buyers have no particular incentive to limit whether a seller seeks additional sales of that idea (and, indeed, encouraging additional sales may have a positive impact by encouraging innovation incentives). However, when there is a high degree of value rivalry, the disclosure of the idea (even if not the sale) to one potential buyer reduces the value of that idea to other potential buyers. As emphasized by Anton and Yao (1994) and Gans and Stern (2000), the bargaining power of an ideas seller in a bilateral negotiation arises in part from their ability to agree to keep the idea a bilateral secret, conditional on a sale.8 However, bilateral secrecy is at odds with the ability of an ideas seller to play multiple potential buyers off against one another before agreeing to an exclusive sale to the highest bidder. If the disclosure of the idea to all potential bidders undermines the valuation of the idea by each of those bidders, ideas sellers may be very limited in their ability to consider multiple offers for a single idea. There are, of course, some sectors in which a limited market for ideas exists, and where it is possible to observe the consequence of value rivalry and limited appropriability. For example, in the market for movie scripts, a screenwriter will prepare a short treatment that, in some circumstances, can be marketed simultaneously to multiple potential movie production companies. While this facilitates effective matching (and, in the best of circumstances, allows the screenwriter to play
This is a refinement on the classical statement on disclosure due to Arrow (1962) and emphasized in discussions of the degree of appropriability (Teece, 1986; Levin, et.al., 1986).
different producers off against one another), the history of the movie industry is littered with stories in which a movie treatment is originally “rejected” by a producer who then develops the idea or a very similar variation. In some cases, this can lead to multiple studios producing very similar movies at the same time, limiting the box office success of each offering.9 It is perhaps not surprising that the main consequence of value rivalry is likely to be congestion. Rather than dilute the valuation of all potential buyers by disclosing (at least part of) the idea broadly, a buyer and seller may agree to engage in bilateral negotiations for a fixed period of time, with significant penalties for disclosure to third parties. That is, they retain value by limiting use. For example, in high-technology industries such as biotechnology and software, there are fairly well-established protocols in which a bargaining over the details of a license (including the detailed disclosures of the underlying technology) are conducted on an exclusive basis, and with both parties agreeing to limit contact with other potential buyers and sellers for a certain amount of time (and conditions). When trade in ideas is structured in this way, as a series of bilateral negotiations rather than a multilateral market, there may be significant efficiency losses due to poor match quality and significant uncertainty regarding the “fair” price for an idea of a given quality. As emphasized by Lemley and Myhrvold (2008):
Willing licensors and licensees can’t find each other … no one can know whether they are getting a steal or being had. When parties do license patents, the prices are (to the extent we can tell) all over the map. And the rest of the world has no idea what those prices are. This, in turn, means that courts lack adequate benchmarks to determine a “reasonable royalty” when companies infringe patents. The lack of a real, rational market for patent licenses encourages companies to ignore patent rights altogether, because they cannot make any reasonable forecast of what it would cost them to obtain the licenses they need and because they fear that they will pay too much for a technology their competitors ignore or get on the cheap. At the same time, ignorance of prices permits unscrupulous patent owners to “hold up” companies that make products by demanding a high royalty from a jury that has no way of knowing what the patent is actually worth.
In other words, value rivalry poses a market design challenge that results by and large in a sharp tradeoff for buyers and sellers in the market for ideas: either engage in isolated bilateral transactions that involve inefficient allocation or multilateral market-based bargaining that can reduce the productive value of completed trades.
See McAfee (2002), Table 7.1, p.155. Similar releases around the same time include Robin Hood (1991), volcano (1997), animated ants (1998), asteroids (1998), mars missions (2000), animated urban to wild animals (2005), animated penguins (2007) and Truman Compote (2007).
19 Safety and the control of user reproducibility
The efficient functioning of markets relies on participants being willing to make pricing offers that reflect their valuation or cost of the transaction. However, when such offers can be exploited, transactions can become unsafe and caution can lead to a lack of transparency as well as reluctance to enter negotiations or making credible pricing offers. Put simply, the ability of prices to signal opportunities for productive trade are muted or eliminated. The risk that price signals break down in the context of ideas trading can arise in several ways. The first is directly related to user reproducibility. When users can reproduce an idea at a zero or very low marginal cost, there are significant limitations on whether the seller can control how users exploit or distribute the idea. For example, it may be that the majority of potential customers for a digital song intend to use it themselves and value that song at $3 per user. However, there may exist another agent, indistinguishable from ordinary users, who has the capacity to re-sell or otherwise distribute that song. So instead of being able to price that song at $3, the seller needs to price it against the potential competition from potential re-sellers (or their and buyers’ expectations of their existence). At the extreme, no positive price can be secured.10 The ability to expropriate ideas is particularly salient in the presence of an organized market mechanism. While most discussions of Arrow’s disclosure problem tend to emphasize its impact on bilateral negotiations, the potential losses arising from disclosure may be more salient when the seller has an opportunity to offer a competing “version” of the same or a very similar idea. The opportunity for buyers to also engage in selling the idea (thus undercutting the sales of the original seller) are more likely when there is a well-functioning market that facilitates low-cost transactions.11 The simplest way to address the potential for user reproducibility is by creating significant cost to additional sharing by users. Two approaches stand out. First, in the face of massive sharing of
Boldrin and Levine (2008) argue that, in many settings like this, inertia on the part of would be re-sellers would limit this extreme outcome. Nonetheless, it remains true that pricing signals are distorted because of potential competition leading to strategic behavior that is a barrier to market efficiency. 11 The intermittent windshield wiper illustrates the classic case of this problem (Seabrook, 1996). First invented by Bob Kearns, he fitted his Ford with a prototype and drove it down to the company to see if they were interested in purchasing it. They looked over it extensively and even employed Kearns for a time. In the end, Ford built the device into their cars without any compensation or rights traded from Kearns. Kearns went on to spend the rest of his life fighting car companies for that compensation (successfully as it turns out).
digital media (particularly music), a number of alternative digital rights management technologies were developed and deployed over the last decade. Interestingly, while DRM is usually effective against sharing for the average user, most DRM technologies have not been able to withstand sustained attempts at decryption by hackers who are strongly committed to free sharing of music and other digital media (a phenomena we discuss in more detail in Section 4). Because the Internet allows markets for free music to be developed relatively easily (and with few opportunities for enforcement by music companies), technological approaches to DRM have tended to be undermined by the presence of markets and the inability of record producers to distinguish between passive consumers and active file-sharers. Second, the recording industry has incurred significant costs (both monetary and in terms of their reputation) through attempts at aggressive enforcement of those involved in file sharing, particularly individuals who provide significant levels of supply without copyright permission. While there are some high-profile cases, the costs of enforcement against average users would be extraordinary, and so the recording industry currently is unable to use its intellectual property in a way that allows it to enforce against infringement by buyers who face a low cost of user reproducibility. Taken together, our analysis suggests that striking facets of the nature of innovation and ideas – ideas complementarity, value rivalry, and user reproducibility each pose specific and fundamental challenges for the market design criteria proposed by Roth. While one could of course argue that Roth’s criteria are not perfect, or are more applicable to the particular context which he studies (e.g., matching markets for medical residents), the analysis does suggest that the lack of organized markets for ideas in many contexts are not simply an historical accident or a reflection of the fact that a market would have little value; instead, there are significant limitations on the feasibility of the market for ideas given the inherent challenges in market design. In other words, in the absence of specific institutional mechanisms to overcome these challenges, the nature of ideas undermines the effectiveness of the market for ideas.
The role of intellectual property on the design of markets for ideas
So far, we have been ambiguous about the precise role played by formal intellectual property
rights in shaping the feasibility and efficiency of a market for ideas. However, a review of each of the three prior sections offers a striking lesson: in each case, effective intellectual property rights (along with an ability to enforce) provided at least an imperfect solution to the challenges raised by the nature of ideas for the market for ideas. While formal IPR such as patents have been rated traditionally as having only a modest importance in capturing the rents from innovation (Levin, et al, 1987; Cohen, et al, 2000), this evidence has mostly been based on firms and settings where the main way in which intellectual property is being used is as a mechanism to insulate a company from competition during commercialization. When the opportunities arising from contracting and collaborative commercialization are high, formal intellectual property such as patents play a far more prominent role. Effective formal intellectual property rights allow potential users to aggregate multiple ideas covered by disparate patents (thus reducing the challenges arising from ideas complementarity), offer disclosure without the risk of expropriation (reducing the problems arising from value rivalry), and, if enforcement is feasible, constructing an entry barrier that significantly reduces the potential for user reproducibility. The special role played by formal intellectual property in organized exchange markets for ideas is apparent across a range of settings and applications. First, and perhaps most strikingly, the rise of so-called innovation exchanges such as OceanTomo have evolved over time into auctions and transactions focused on technologies covered by formal intellectual property protection (in their most recent auction, the entire portfolio of auctioned items are covered under a US patent grant). A similar phenomena can be seen in the context of organized university licensing – while many invention disclosures do not induce a patent, a very high majority of all university licensing activity involves inventions for which a patent has been applied. Second, while the management of IPRs – especially with regard to diverse ownership of complementary ideas – is an issue for creating market congestion, the ways in which patents can be used may directly help to enhance market operation. For example, in Gans, Hsu and Stern (2008), we find direct evidence that the hazard rate of licensing an innovation in the market for ideas (by a technology entrepreneur) is closely linked to whether a patent for that idea has been granted;
apparently, it is far more difficult to achieve a licensing agreement in the absence of a patent grant (a finding which also raises the idea of the potential value from accelerating the process of application and grant). Similarly, Lemley and Myhrvold (2008) argue that changes in the rules regarding licensing can have a dramatic impact on the effectiveness of the market for ideas:
The solution is straightforward—require publication of patent assignment and license terms. Doing so will not magically make the market for patents work like a stock exchange; there will still be significant uncertainty about whether a patent is valid and what it covers, particularly since patents tend by their nature to be unique goods. But it will permit the aggregate record of what companies pay for rights to signal what particular patents are worth and how strong they are, just as derivative financial instruments allow markets to evaluate and price other forms of risk. It will help rationalize patent transactions, turning them from secret, one-off negotiations into a real, working market for patents. And by making it clear to courts and the world at large what the normal price is for patent rights, it will make it that much harder for a few unscrupulous patent owners to hold up legitimate innovators, and for established companies to systematically infringe the rights of others.
This would certainly allow some benchmarking and make it easier to define prices although enforcement might be costly. However, it does highlight the potential for considering alterations to patent right obligations that might facilitate the establishment of markets. Finally, IPRs provide some degree of protection against the market safety issues outlined above. For instance, patent rights explicitly prevent would-be buyers from using the idea for commercial gain without the permission of the seller. However, even in this case, as Arora (1995) notes, tacit knowledge can accompany patent rights and this tacit knowledge is vulnerable to expropriation. Nonetheless, in environments were the subsequent use of an idea – through sales, revenues or profits – can be measured in a verifiable way, an IP rights holder can offer a licensing contract absent full disclosure ex ante that shares the risk or insures the buyer against the possibility that the idea turns out to be of low quality or limited use. More generally, this discussion highlights the fact that formal IP rights play a special role in facilitating the operation of a market for ideas. Whereas Gans, Hsu and Stern (2002) emphasize that formal IP rights such as patents encourage collaborative (but bilateral) commercialization, the analysis here suggests that patents play an even more important role in multilateral settings, where the potential costs of expropriation are large as the result of the ability of an expropriator to exploit that market in taking advantage of the ideas seller’s disclosure. This results in our second key finding: specific institutions, most notably formal intellectual property rights such as patents, play a crucial
role in overcoming the key challenges raised by market design. However, as we discuss in the next section, it is also true that the exercise of market power through patents also has the ability to undermine the operation of the market for ideas as the result of significant restrictions on monetary transfers.
Repugnance in the Market for Ideas
While our previous discussion indicates significant challenges in the design and operation of
the market for ideas, the paucity of organized ideas exchange at positive prices is still something of a puzzle, given the potentially high returns to be realized from matching and transparency. Roth (2007) notes similar puzzles – a lack of exchange mechanisms at positive prices -- across a wide range of contexts. For example, there are legal restrictions on establishing markets in areas such as organ trading or the tossing of dwarves. These laws are (a) hard to explain in pure economic terms (for instance, there is no prohibition on organ donation and non-dwarves can be tossed with abandon) and (b) vary over time and jurisdiction. Roth instead argues that there is an exogenous constraint on the establishment of some markets: repugnance. To be precise, repugnance is not necessarily a complete constraint on exchange but is instead a constraint on the use of money to facilitate trade. For example, while organ donation is legal, significant legal restrictions exist to bar payments for an organ. While the source of repugnance to monetary transactions differs across contexts (e.g., while repugnance against organ trading seems to be grounded in concerns regarding exploitation of potential supplies, repugnance in other areas seems to be driven by concerns regarding social equality), Roth argues that market designers should simply identify the constraints arising from repugnance and work around them in the context of considering alternative allocation mechanisms and rules. Interestingly, Roth does not analyze the case of ideas and knowledge. However, the unpriced flow of ideas and knowledge – knowledge spillovers – are a pervasive part of economic activity and are indeed a crucial building block to modern theories of economic growth (Romer, 1990). In other words, while the inability to place a positive price on some types of transactions may
be important in the context of their own application, our understanding of the process by which economic growth occurs depends heavily on the fact that (at least some) ideas producers have only limited appropriability over their ideas and are unable to earn their marginal product through an organized and competitive market for ideas. In the remainder of this section, we raise the hypothesis that this is not simply a matter of market design but the result of repugnance. To be clear, our prior analysis suggests that there key properties of ideas limit the ability to charge a positive price for an idea, such as when an idea has a low cost of user reproducibility. However, we suggest that it may be possible to distinguish a lack of appropriability from repugnance. For example, while ineffective appropriability benefits buyers (who certainly benefit from ideas at a zero price), we also observe that many sellers are averse to the use of monetary price signals to value ideas and settle exchange opportunities. We certainly acknowledge that the hypothesis of repugnance requires careful empirical evaluation in future work. However, we also think it is useful, in the spirit of Roth, to consider the impact and role that repugnance might play in the market for ideas, and evaluate the potential impact of alternative policies and institutions designed to promote the exchange of ideas and knowledge in light of the repugnance hypothesis. We emphasize two aspects of repugnance that seem to characterize exchanges regarding ideas and knowledge. First, there is a wide body of historical and contemporary evidence that, at least for some types of ideas such as scientific knowledge, ideas producers explicitly value the dissemination and future use of that knowledge over the monetization of the idea. Consider the famous words of Benjamin Franklin, a noted Enlightenment inventor and ideas producer:
… as we enjoy great advantages from the inventions of others, we should be glad of an opportunity to serve others by any invention of ours; and this we should do freely and generously. (Franklin, 2003, p.117-118.)
Though expressions of the value of free exchange by suppliers of ideas and knowledge are pervasive – from scientists to journalists to advocates for diverse religious expression – there are very few analyses that take on the consequences of such sentiments for the incentives to produce knowledge or the impact on the design of efficient institutions for the exchange and dissemination of that knowledge. Second, it is useful to distinguish repugnance (at least initially) from the simple desire to “pay
less” or offer a “discount.” Instead, we observe a bimodal structure to transactions in the ideas market. On the one hand, some ideas are associated with either bilateral or multilateral exchanges, and there are significant premiums placed on successful innovations (e.g., potential drug candidates, promising software algorithms, etc). At the other extreme, there is a wide body of knowledge that is distributed at a price of exactly zero. There are few transactions that take place at a low but positive price (particularly for goods that are themselves considered pure “knowledge” or “ideas”). Not simply a reflection of transaction costs (which would not explain why so much knowledge is simply diffused for free), we raise the hypothesis that, for the class of ideas where both buyers and sellers believe that trade is repugnant at any price, the equilibrium that emerges is that only a small number of (very valuable) ideas will have a high and positive price (and be criticized for that monopolistic pricing) while a larger number of ideas will effectively be sold at a price of zero.
Sources of repugnance
The origins of repugnance over ideas trading are likely diverse and subtle, and our examination here is necessarily incomplete; instead, as in our earlier discussions, we highlight what we think may be the most important drivers of repugnance while fully acknowledging that we are in no way completing a comprehensive survey. With that disclaimer, we examine three drivers in particular. First, as emphasized by Arrow, there appears to be a complicated set of essentially psychological intrinsic drivers:
It seems to me that that there is a motive for action not taken account of in standard economic models. It is a motive that operates in a social context and cannot fully be discussed in the terms standard in “methodological individualism.” I refer to what appears to me to be a tendency for individuals to exchange information, to engage in gossip at all levels. There is some form of satisfaction not only in receiving information but also in conveying it. Currently, this is exemplified by the curious phenomenon of Wikepedia [sic], where individuals spend time and effort to convey information without pay and without fame. Probably, there is even an evolutionary basis for this phenomenon, though explanations of social traits (other than those involving kin) on the basis of natural selection have proved to be difficult. (Arrow, 2008, p.2)
In other words, disclosure is fundamental to human communication. The dividing line between social communication and the disclosure of knowledge is often blurry, particularly in the context of embryonic ideas. An important component of human creativity is the communication of that novelty
to others, both in the desire to impress and to share (Amabile, 1983, 1996). Simply put, while economists have essentially abstracted away from the joy and excitement of discovery in the study of innovation, discovery and creativity are nonetheless important stimuli that are shared through communication (requiring disclosure that most theory suggests agents will keep to a minimum). A second potential driver is grounded in the sociology of collective sharing and gift exchange (Gouldner, 1960; Iannaccone, 1992).12 While the conditions in which communities establish free exchange norm are subtle (and we discuss below), it is possible that the willingness of suppliers to provide ideas and knowledge at a zero price is grounded in their membership within a community in which they also receive ideas and knowledge at a zero price. Indeed, this form of communal sharing flips the challenge arising from the low costs of user reproducibility on its head; rather than serving as a deterrent to an organized market, an entire community acts as both suppliers and demanders, and enforces an equilibrium norm in which exchange takes place at a zero price. Of course, as we discuss in more detail below, the precise set-up of institutions supporting communal norms will vary by context (e.g., the rules governing open science are distinct from the “magician code of conduct”). However, from a broad market design perspective, this collective (equilibrium) choice to exclude monetary exchange and other forms of profit manifests itself in the form of repugnance for cash transactions. Finally, it is possible that the origin of repugnance might be due to an aversion to complex contracting over the uses and applications of intangible goods. One of the distinctive properties of information is that potential buyers may not be able to anticipate precisely how they might use a particular idea or new technology once it is acquired. Consequently, buyers may be extremely averse to negotiating contracts (particularly contracts in which they are in an informational disadvantaged position) about how they might use or exploit an idea once it is exchanged. In such an environment, potential buyers would have an extreme control-rights preference against paying for an idea in a way that involved significant ex post monitoring regarding the use of that idea. For example, there would be significant aversion to contract terms that involved metering of restrictions on the scope of application. From a market design perspective, an inability to charge a positive price on the use of an
This is similar to the emotional commitments described by Frank (1994).
idea (even when that may be “efficient” from the perspective of traditional economic theory) can be interpreted as a repugnance-based constraint on certain types of licensing and intellectual exchange arrangements.
Transaction Costs versus Repugnance
Before turning to the impact of institutions that seem to account for repugnance in ideas markets, it is useful to consider whether the lack of exchange of ideas at a positive price is simply the result of transaction costs. While transaction costs certainly mitigate the ability to viability of certain types of opportunistic transactions that might involve considerable negotiation (even in the absence of the types of challenges we described earlier), the dynamics of markets for technology or ideas with positive prices versus zero prices are strikingly different:
From the consumer’s perspective, though, there is a huge difference between cheap and free. Give a product away and it can go viral. Charge a single cent for it and you’re in an entirely different business, one of clawing and scratching for every customer. The psychology of “free” is powerful indeed, as any marketer will tell you. This difference between cheap and free is what venture capitalist Josh Kopelman calls the “penny gap.” People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that's the difference between a great market and none at all. The huge psychological gap between “almost zero” and “zero” is why micropayments failed. It’s why Google doesn’t show up on your credit card. It’s why modern Web companies don't charge their users anything. And it's why Yahoo gives away disk drive space. The question of infinite storage was not if but when. The winners made their stuff free first. (Anderson, 2008)
To an economist, what Anderson is implying is that not only is the cost of information replication low, but the demand curve for information goods becomes highly elastic at a zero price (and relatively inelastic at any positive price). In other words, even a very small monetary cost can engender a dramatic shift in realized demand. While certain types of “micro-payments” have emerged in certain contexts (e.g., iTunes 99 cents pricing), participants in many ideas transactions seem willing to negotiate over whether and when knowledge will be exchanged (incurring significant transaction costs) but there seems to be significant aversion to transactions at low but positive monetary prices. In other words, even where transaction costs have fallen dramatically (e.g., news delivery), this has not translated into the emergence of monetary payments.
28 The Design of Markets for Free Ideas
Roth emphasizes that repugnance need not be a fundamental constraint on efficient exchanges (though of course it does raise some difficult challenges). When Roth confronted repugnance in the market for kidney donation, he began to design markets that involved exchanges among voluntary donor pairs, essentially allowing for exchanges across families. Working within the repugnance constraint, Roth has organized an emerging set of markets for kidney exchange that operate without monetary payments but do indeed save lives through effective market design. In the market for ideas, there are a striking number of real-world institutions that are premised on a price of zero.13 Consider Wikipedia (Tapscott and Williams, 2008; Greenstein and Devereux, 2006). The traditional encyclopedias such as Encyclopedia Britannica involved the solicitation of articles by leading scholars along with a modest monetary payment, and the encyclopedias themselves were sold at extremely high margins (e.g., the 1980s-era Encyclopedia Britannica sold for about $3000 and was produced for a marginal cost of about $300) (Devereux and Greenstein, 2006). Wikipedia, on the other hand, is organized according to very different principle. Both the provision of content and the use of the online encyclopedia are not only free but open to debate and interpretation by the user community. Rather than soliciting articles from leading “experts,” Wikipedia allows any user to also serve as a contributor and has developed subtle protocols to adjudicate debates when different user/contributors hold different perspectives. Once an entry or contribution is submitted, individuals do not even have an absolute right of “control” over their own prior contributions; not only are there no prices, there are no property rights. Despite this quite idiosyncratic “design” for an encyclopedia, Wikipedia has quickly emerged as the single most utilized reference source in the world. In less than a decade, Wikipedia has essentially supplanted the expert-based system with positive prices that had existed for nearly 200 years. Of course, the reliance on mere users and free contributors has raised concerns about quality and accuracy; perhaps surprisingly, most independent tests suggest that the overall rate of error across free, user-based system and expert-based systems with positive prices (and, along some dimensions, Wikipedia is in fact superior) (Giles, 2005).
It is interesting to note that while Roth’s examples usually involve a law or regulation that prohibits monetary transfers, institutions for free ideas tend to operate according to (strongly enforced) informal norms and practices.
Intriguingly, given the complexity and need for debate and adjudication within the Wikipedia user and contributor community, the decisive issue for Wikipedia is not a lack of “transaction costs” (indeed, there are significant transaction costs to make a contribution and understand the information upon which individual entries are based); instead, the key issue seems to be the complete transparency of the process by which information is provided, the ability to debate alternative ways of organizing a particular set of facts, and the ability of the worldwide user community to access that information for free (Tapscott and Williams, 2008). Put simply, the ‘wiki’ model (which now extends well beyond Wikipedia) has emerged as a market for free ideas that simultaneously involves significant investment on the part of ideas contributors but also relies on free exchange. Whereas Wikipedia is a quite recent phenomena, the development of institutions involving the free exchange of ideas is, of course, much older, and realized most durably and strikingly in the context of the Open Science (Merton, 1973; Dasgupta and David, 1994; Stern, 2004; David, 2008). Open Science is a complex system in which researchers participate within a scientific community by drawing upon and advancing a specialized field of knowledge by pursuing research directions of their own interest. The hallmark of this system is the priority-based reward system: to receive credit for their discoveries, scientists publicize their findings as quickly as possible and retain no formal intellectual property rights over their ideas (Merton, 1957; Dasgupta and David, 1994). In turn, the institutions supporting scientific research – from universities to public funding agencies to non-profit foundations – offer status-based rewards such as tenure and prizes to recognize significant achievements that are also publicly disclosed. The priority-based reward system not only serves to provide incentives for scientists, but also provides an system of efficient disclosure that (at least in principle) minimizes the duplication of research efforts among scientists (assuming that scientists can access and replicate each other’s work at relatively low cost) and enhances the growth in the stock of knowledge within the boundaries of particular scientific disciplines (Dasgupta and David, 1994). While the origins of open science are grounded in a complex set of motives and incentives facing researchers and funders (David, 2008), the norms of open science have evolved to ensure a high level of participation (allowing researchers to build on ideas in an unstructured way over time), allow for multiple researchers to both collaborate and compete with each other in a (relatively) transparent way,
and, strikingly, provide status-based rewards to those that can credibly claim to have initially made a discovery (rather than those that simply learn about it and diffuse it to others). In other words, as a market design, open science overcomes the challenges arising from ideas complementarity, value rivalry, and user reproducibility, respectively.14 It is of course feasible to consider a wide range of institutions that support markets for free ideas, and examine each from the perspective of market design. Without claiming to provide a comprehensive list, such institutions range from enduring arrangements such as the freedom of the press and religion, to more contemporary phenomena such as the open source software movement, the blogosphere, and YouTube. In each case, ideas that are costly to develop are nonetheless offered at essentially a zero price. One dramatic consequence of a zero price is that, conditional on participation by ideas suppliers, it is relatively easy to ensure market thickness and to take advantage of the nonrivalry of ideas among users. Market safety is likely to be more of an issue, particularly when ideas can be used or manipulated in ways that are adverse to the interests of the ideas supplier. To take but one example, the ubiquity of video coverage of politicians along with the YouTube platform have likely made politicians and public intellectuals more reticent and scripted in their public activities, lest their words be taken out of context or misconstrued by particular viewers or listeners. More generally, while each of these institutions supports both the production and diffusion of free ideas – ranging from political rhetoric to well-defined technological innovation – it is striking to us that there has been little systematic analysis of the institutional requirements for such institutions to exist, the role that repugnance plays in shaping these institutions, and the contribution of these idiosyncratic and eclectic institutions to economic and social well-being. Market Design and the Limits of Repugnance One of the most striking aspects of repugnant markets is that the constraints on pricing are rarely comprehensive and often emerge in relatively subtle ways. For example, while there are sharp
Indeed, it is precisely the violation of these norms that are at the heart of contemporary policy debates about the limits of open science when knowledge traditionally maintained within the public domain is also protected by formal intellectual property protection. As emphasized by Murray (2009) and Murray and Stern (2008), patents in particular seem to have emerged as an alternative non-monetary “currency” that has been adapted by the scientific community to promote the underlying norms of the open science system.
constraints on organ trading a positive price, there is certainly no expectation that physicians involved in kidney exchange should operate for free, nor are there constraints on charging for other human parts such as hair. How do the limitations and nature of repugnance impact the pricing of ideas and knowledge? Consider the emergence of online two-sided markets such as Internet search. From a theoretical perspective, it is possible that, for technologies such as Google web search, the equilibrium involves (a) consumers paying for web search and access to advertisers, (b) advertisers paying for access to consumers who are able to search for free and (c) a mixture of payments on both sides of this technology platform. However, if consumers have a deep aversion to paying for “information,” it becomes much more likely that the equilibrium will involve free consumer search alongside paid advertising content. It is useful to compare this model with the pricing of physical newspapers. Even for a newspaper in which the marginal cost was positive, consumers have traditionally paid a nominal charge and the bulk of newspaper revenues have been through the advertising channel. In other words, the existence of repugnance did not necessitate public funding in order to achieve a positive level of supply; instead, media and advertising have evolved to complement each other in order to overcome some of the key constraints that would arise if newspapers or other media could only be accessed at a high price. Examining markets for ideas that involve significant limitations on the use of those ideas highlight a second type of nuanced constraint on pricing. For example, while the market for prerecorded magnetic videotape was by and large served in the form of a rental market (placing significant time limitations on use, opening up users to the potential for late fees, etc), the pricing of DVDs and CDs is in the form of a flat fee for unlimited private exploitation.15 More generally, different technologies and types of knowledge are associated with very different pricing schedules, and there has been little detailed examination of the conditions under which different arrangements
As well, except for media that have been protected by digital rights management software, it is also possible to share these materials with others in violation of the license agreement imposed on buyers. Indeed, Boldrin and Levine (2008) suggest that fixed fee pricing with no limitations on use (including resale and replication) can be optimal. Their analysis captures the idea that if you allow idea buyers to re-sell the idea, you are able to charge a premium to early buyers and so avoid the costs imposed by the restrictions. When imitation is not immediate, first-mover advantages may allow ideas sellers to appropriate rents even in the absence of intellectual property protection. See also Gans and King (2007).
are effective, and, in particular, what role repugnance over certain types of monetary transactions plays in the emergence of different types of pricing structures. This can be seen perhaps most dramatically in the case of fixed fee versus subscription services. While some types of information products can be sold through a subscription service (from newspapers to cable television), attempts to establish subscription services have failed in a wide range of settings, including software. While most consumers (and particularly business consumers) are fully aware that upgrades are likely to occur on a regular schedule, and that they are likely to purchase such upgrades (either as the result of enhanced quality or to ensure interoperability), software companies such as Microsoft and Intuit have largely failed in their efforts to establish subscription services for their products. In the absence of repugnance, this is surprising, since the availability of a subscription service likely reduces the riskiness of expenditures of a potential buyer and most subscription services have been offered in a way that made them an attractive option for those who were likely to upgrade anyway (which turns out to be most consumers). However, if buyers have a preference for control over the decision (even one that likely involves paying a premium ex post), the repugnance associated with subscription pricing likely undermines the market viability of what would otherwise be an efficient pricing mechanism. Taken together, these examples suggest that understanding the form in which repugnance takes in particular circumstances, and considering how that particular form of repugnance impacts the broader challenge of designing an effective market for ideas, can deepen our analysis of repugnance.
In this paper, we have tried to develop an agenda and framework for understanding the
apparent lack of formal markets for ideas. In so doing we have combined insights from the economic literature on market design and the literature on markets for technology. We have noted that the latter has mostly studied bilateral exchange of ideas rather than “markets” as characterized by large numbers of buyers and sellers engaging on large numbers of transactions. Those markets enable participants to better evaluate options for combining ideas with each other and with other assets in a
timely and stable manner. Consequently, they can both enhance the useful application of ideas and also harness the force of competition to ensure creators of ideas earn an appropriate return. Several conclusions emerge from this exercise. First, ideas possess particular characteristics that make the efficient design of markets challenging. The fact that many ideas require access and perhaps ownership of other, complementary ideas to be of value makes it difficult to coordinate transactions so that participants can evaluate their choices over different bundles of ideas. The fact that, for some ideas, the value of them to a given user falls if other users should have access to them creates incentives for pre-emptive signing of exclusionary deals. This diminishes the potential for participants to evaluate options at a given point of time. Finally, the fact that ideas might be easily reproduced by users or expropriated by them through pre-contractual disclosures, can make sales of an idea to many buyers unsafe; driving bilateral exchange. Second, formal intellectual property protection can assist in alleviating these challenges to the design of efficient markets for ideas. It can make intangible ideas into assets that can be easily traded and understood. Policy-makers to increase transparency and reduce issues of market congestion can adjust the terms of disclosures in intellectual property protection. Finally, by protecting against reproduction and expropriation, intellectual property protection can make idea selling safe. Third, we have identified idea exchange for money as an activity that can be understood as being constrained by repugnance. We noted that the resistance to selling certain ideas comes from sellers as much as buyers and that it also appears to generate a desire for extreme control rights in the use of ideas. The constraint of repugnance is something we argue that has constrained the development of markets for ideas (at least with positive prices) but can also assist researchers in understanding various practices and non-practices in selling ideas. Finally, because in so many situations and creative communities, the sellers of ideas use ideas, and gain value from the use of their own ideas by others, the most market-like areas of the exchange of ideas have occurred precisely where by norms or repugnance, the price of ideas has been constrained to be zero. In this situation, the lack of monetary flows can itself be seen as a means of generating market thickness, avoiding congestion, making exchange safe and adhering to repugnance. We believe that the analysis we have provided and the issues we have identified are critical
for the study of idea dissemination and the returns to innovators; in particular, understanding the efforts of business and government to facilitate these objectives. The details and exploration are, however, something we leave for future research.
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