Sunday, January 9, 2011

Intellectual Property and the Market Economy

Intellectual property results in monopoly prices and concomitant shortages, thereby harming the interests of consumers (all the members of society).  To demonstrate that, I present here a catallactic analysis of the function of ideas (recipes) in market production.

Recipes and Labor

As an act of production on the market, to formulate ideas (or recipes, in Misesian terminology) is to labor.  To formulate a recipe is to expend personal energy.  What the formulator directly gives up for the sake of formulating his ideas (his opportunity cost) is either his leisure, or the wages he might have otherwise earned had he not expended the personal energy to formulate the recipe.  It cannot be characterized as the performance of any other economic (catallactic) function.1  

It obviously cannot be characterized as a performance of the landowner function.  Neither can it be characterized as the performance of the capitalist function.  The formulator does not expend saved capital to directly formulate the recipe.  He may expend his savings on supporting his formulation of an idea (like, for instance, purchasing drafting materials). But supporting the thinking process is not itself thinking.  The act of thinking up an idea is itself labor, not the expenditure of saved capital.

Finally, it cannot be characterized as a performance of the entrepreneurial function, for the following reasons.

Entrepreneurs are uncertainty bearers. To truly bear uncertainty, one must be exposed to its downside, as well as its upside: to loss, as well as profit.  As Murray N. Rothbard pointed out, workers can in a sense be called entrepreneurs, because they are, like all humans, perpetually faced with uncertainty.  However, they cannot be said to incur entrepreneurial losses, since they cannot...
 “suffer negative incomes in production. Even if a laborer emigrates to a nation where pay turns out to be lower than expected, he ab­sorbs only a differential, or “opportunity,” loss from what he might have earned elsewhere. But he still earns a positive wage in production. Even in the unlikely event of a labor surplus vis-à-vis land, the laborer earns zero and not negative wages. But the capitalist-entrepreneur, the man who hires the other factors, can and does incur actual monetary losses from his entrepreneurial effort.”2
Because workers cannot be said to truly be subject to monetary loss, they cannot be said, in a strict sense, to fill the role of the entrepreneur in the Misesian framework of the market; a role which is by definition characterized by exposure to both profit and loss.  As Peter Klein has stressed in his work, the entrepreneurial function is predominantly filled by the capitalist-entrepreneur.3

Recipes and Economic Goods

For something to attain a price on the market, it must be an economic good, which is to say it must be scarce and rivalrous.  Recipes, in themselves, can never be scarce, and thus can never be rivalrous; recipes can never be economic goods.  Through enforcement, however, the privilege to utilize recipes, can be made scarce, and thus rivalrous.  Also through enforcement, the privilege to grant use-privileges for recipes can also be made scarce, and thus rivalrous.

Under most copyright and patent regimes, this usually entails the privilege to grant use-privileges for recipes being created, and granted solely to the formulator of the recipe.  This granting privilege is not created by the formulator-worker.  It is produced by whatever agency enforces the privilege, and granted to formulator, effectively, in exchange for his labor.  Thus, catallactically, the copyright/patent-holding formulator-worker can only be considered a hireling of the enforcing agency (generally the state) who is paid in privileges.

Again a recipe cannot ever be an economic good.  Only a marketable expression of the recipe (or a privilege to utilize it) can be.  Since the marketable expression can only be produced with saved, scarce means, it can only be produced by a capitalist, with the hired assistance of workers.  And in the real world of uncertainty, all capitalists are capitalist-entrepreneurs.

Recipes and Capitalist-Entrepreneurs.

Regardless of who originates a recipe, it must be adopted and acted upon by an capitalist-entrepreneur who gives the idea a marketable embodiment.  It is the capitalist-entrepreneur (whose own savings are on the line) who is the one who bears the uncertainty with regard to the scarce means invested in the physical expression of the recipe.  The person who, as a capitalist-entrepreneur, gave the recipe a marketable expression with saved scarce means may be the same person who, as a worker, formulated the recipe, but this need not necessarily be the case.  Thus the distinguishing characteristic of the functional concept of the capitalist-entrepreneur is not creativity per se, but judgment.4

Capitalist-entrepreneurs, by hiring labor and investing their savings, arrange and deploy the factors of production in order to better satisfy consumers in the future than they otherwise would be. An entrepreneur's way of arranging and deploying factors of production is a "how to" idea; it is a recipe.   Let us term such recipes "entrepreneurial recipes".  The capitalist-entrepreneur does not need to originally formulate a recipe; he need only judge it worthy of implementing, using his scarce means.  For example, an entrepreneurial recipe may be formulated by a hired middle manager.  But it can only be given expression by saved scarce means if it is adopted by the shareholders, as capitalist-entrepreneurs.  Even if the shareholders do not sign off on the plan (or even if they do not know about it), it is still their ultimate judgment which commits the saved scarce means to it, because they decided to put their capital under the revocable stewardship of the middle manager.

The better a capitalist-entrepreneur anticipates the future state of consumer tastes and desires, the more efficaciously, from the consumers' perspective, will he arrange and deploy the factors of production; in other words, the better will be the entrepreneurial recipe he adopted prove to have been. If his plan for arranging and deploying factors of production serves the consumers better than that of his competing entrepreneurs, he will make profits. If it serves the consumers poorly, he will incur losses. Profits put yet more of the factors of production in the hands of the entrepreneur who adopts an effective entrepreneurial recipe. So much the better for the consumers his judgment has served so well. Losses remove factors of production from the hands of the entrepreneur who adopts an ineffective entrepreneurial recipe. So much the better for the consumers he failed to satisfy.

Profits attract other capitalist-entrepreneurs to emulate the already-successful one. To emulate a successful entrepreneur is to copy key parts of his entrepreneurial recipe. The competition brought on by this emulation eliminates profits, but only gradually so. Early adopters of the key parts of the efficacious entrepreneurial recipe get high profits in direct correlation with how quick they were in arranging and deploying yet more factors of production according to the new and improved modus operandi. Consumer goods thus get cheaper, and entrepreneurs are thus impelled to move on to finding their next profit-lavishing, consumer-satisfying, and game-changing entrepreneurial recipe.

This is the way the market process works to continually transform the structure of production for the benefit of all (since we are all consumers).  Its functioning depends on the freedom of capitalist-entrepreneurs to adopt entrepreneurial recipes formulated by hired managers, and of other capitalist-entrepreneurs to emulated the successful entrepreneurial recipes of competitors.  Were formulators or first-adopters given sole privileges in the granting of use-privileges for entrepreneurial recipes, those use-privileges would command monopoly prices.  (Monopoly prices are discussed further below.)  This would result in drastic shortages of the entrepreneurial recipe use-privileges.  Since entrepreneurial recipes are present in almost every market event, this would cripple the market process.  Adoption and emulation would be entirely stymied, productivity would crash, and consumers (all the members of society) would suffer immensely.  Actually, a great portion of human population would die.

The above is important for the matter of intellectual property, because the chief catallactic importance of creative works is their role as entrepreneurial recipes. Remember, an entrepreneurial recipe is simply a way of arranging and deploying factors of production in anticipation of what will satisfy consumers better in the future. What is a vocal song? It is a way of arranging and deploying a human's vocal chords (which are factors of production) in order to please consumers of music better than they would have been had they not heard the song. What is a book? It is a way of arranging and deploying any digital or physical printing technology (which are factors of production) in order to please consumers of information, arguments, or stories better than they would have been had they not read the book.  It is the songwriter or author who, via his labor, originates a song or book.  But a marketable expression of his song or book requires scarce, saved means; it requires investment from a capitalist-entrepreneur (again, whether or not that capitalist-entrepreneur is the same person as the creator-laborer).

Moreover, the chief catallactic importance of technical inventions is their role as entrepreneurial recipes too. What makes a "more efficient" new design for a machine potentially useful is not the bare fact that it uses up certain resources less (like time, space, energy, coal, aluminum etc.). What makes it potentially useful is the anticipation that consumers will consider themselves better served if the resources saved by the new design are used instead for other purposes, and that they will not be too concerned about the machine perhaps using up certain other resources more prolifically. Thus, the efficient new design of a machine is also a way of arranging and deploying factors of production in anticipation of what will satisfy consumers better in the future.  It is the inventor who, via his labor, originates the design.  But a marketable expression of the design requires scarce, saved means; it requires investment from a capitalist-entrepreneur (whether or not the capitalist-entrepreneur is the same person as the inventor).

To make their case, advocates of patent and copyright law who base their advocacy on economic analysis, and who do not advocate intellectual property over entrepreneurial recipes, must explain how creative works and technical designs are different in their catallactic function from any other entrepreneurial recipe.

Recipes and Monopoly Prices

Some advocates of patent and copyright law have argued that monopoly prices do not necessarily harm consumer interests.  Below, I aim to demonstrate why the usual argument for this position is faulty.  First let us consider what monopoly prices are, why they are prejudicial to consumer satisfaction, and how they can arise due to intellectual property laws.

Monopoly prices occur when a monopolist is able to achieve higher net revenues by simply restricting supply, not so as to reallocate scarce means toward other consumers' goods more urgently demanded, but solely so as to raise his selling prices.  With monopoly prices (which are almost always brought about by government intervention), the consumer-oriented character of the market, and thus the harmony of interests that is characteristic of a capitalist society, breaks down to an extent.  Between consumers and producers, "with regard to monopoly prices there is not harmony, but conflict of interests."5

And, as Mises clearly states,
"recipes are as a rule free goods as their ability to produce definite effects is unlimited. They can become economic goods only if they are monopolized and their use is restricted. Any price paid for the services rendered by a recipe is always a monopoly price."6  
Sole ownership over the right to grant recipe use-privileges leads to monopoly prices for those use-privileges, because the sole owner can increase his net returns by restricting the supply of use-privileges, not for the sake of reallocating the privilege toward production more urgently demanded by consumers, but simply for the sake of increasing his selling price.  This results in use-privilege shortages, and thus shortages of the goods whose production requires them.  Therefore, sole ownership over the right to grant recipe use-privileges (in other words, intellectual property rights) harms the interests of consumers.

However, Mises did not take an unequivocal stand against copyrights and patents, for he admitted a possible exception:
"Yet there is an exception to this general rule that monopoly prices benefit the seller and harm the buyer and infringe the supremacy of the consumers' interests. If on a competitive market one of the complementary factors, namely f, needed for the production of the consumers' good g, does not attain any price at all, although the production of f requires various expenditures and consumers are ready to pay for the consumers' good g a price which makes its production profitable on a competitive market, the monopoly price for f becomes a necessary requirement for the production of g. It is this idea that people advance in favor of patent and copyright legislation. If inventors and authors were not in a position to make money by inventing and writing, they would be prevented from devoting their time to these activities and from defraying the costs involved. The public would not derive any advantage from the absence of monopoly prices for f. It would, on the contrary, miss the satisfaction it could derive from the acquisition of g."7
The advocate of copyright and patent law might say that often, creative works and technical designs are indeed needed for the production of goods that are potentially profitable (and thus serviceable to consumers); but, without copyright and patent laws, those creative works and technical designs would not attain any price at all.  They might argue that patents and copyrights are necessary to create monopoly prices for recipes (like the information content of a song or a blueprint), and that such monopoly prices are necessary to incentivize their creation, thereby making possible the wonderful consumer goods (like song recordings and physical machines) that depend on them.

Now in the case of f being a creative work or technical designs, it is actually impossible for a capitalist-entrepreneur to purchase f on the market, because, again, recipes cannot in themselves be marketable goods (see above).  The capitalist-entrepreneur who wants to produce g can only purchase the privilege to use f.

Yet, even if they accept this formulation, advocates of copyright and patent law might still take recourse to the above argument.  They might say that copyright and patent laws are necessary to create monopoly prices for privileges to use a recipe, by granting the sole privilege to grant use-privileges to the formulator of a recipe, and that such monopoly prices are necessary to incentive the creation of recipes, thereby making possible the wonderful consumer goods that depend on them.

However, the whole hypothetical scenario (presented in the block quote above) of any monopoly price for any kind of f benefiting consumers by resulting in g is faulty.  The core issue is the fact that complementary factors do not need to command prices on the market to be produced.  The production of the complementary factor can simply be hired as labor, as is done with all in-house talent.

The value of higher order goods is derived from the lower order goods they help to produce.  If, as is assumed in the hypothetical scenario, the production of f really is necessary to produce profitable good g, then a would-be capitalist-entrepreneurial vendor of g would have every incentive to acquire f.  And if he cannot purchase f on the market, he can simply hire somebody to produce f "in-house".

There are several upsides of producing something "in-house", perhaps foremost among which is avoiding transaction costs, as was pointed out by Ronald Coase.  There are also several downsides; for instance, as Rothbard noted, if a firm “vertically integrates” to the extent that it starts to completely subsume whole markets for its factors, it will start to suffer from calculation problems with regard to those factors.  The "make or buy" decision (as it is known in theory of the firm literature), like all decisions regarding capital on the market, are made by capitalist-entrepreneurs, with the aim of maximizing profits, by way of serving consumers better than their competitors.  Thus, in a market economy, "make or buy" decisions are ultimately under the sway of the sovereign consumers.  By not supporting a market price for f, the consumers are in effect supporting the "make" option with their dollars.  Anyone, including advocates of copyrights and patents, who insist that f be granted a monopoly price so as to make it saleable on the market, is essentially insisting on the "buy" option, in direct contravention to consumer preferences.


The formulation of recipes is labor.  The marketable expression of recipes can only be accomplished by capitalist-entrepreneurs, with the hired help of workers.  The market process depends on the fluid adoption and emulation of non-priced recipes.  The possession of sole privilege to grant recipe use-privileges by recipe formulators (or anybody else) results in monopoly prices, and thus shortages that harm the interests of consumers (all members of society).  Intellectual property, therefore, is prejudicial to the well being of all members of society.

1"The entrepreneurs, capitalists, landowners, workers, and consumers of economic theory are not living men as one meets them in the reality of life and history. They are the embodiment of distinct functions in the market operations." (Ludwig von Mises, Human Action, chapter 14, section 7.)

2Murray N. Rothbard, Man, Economy, and State, Chapter 9.

3Peter G. Klein, The Capitalist and the Entrepreneur.


5Mises, Human Action, chapter 24, section 3.

6Mises, Human Action, chapter 16, section 6.

7Note that Mises does not say whether patents and copyrights generally, or even ever, meet the criteria for a hypothetical case of a monopoly price actually serving the interests of the consumers.  He merely states that that is what "people advance" to make the case for patents and copyrights.

8Klein, The Capitalist and the Entrepreneur.


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