Strengthening IP protections will bolster investment and the U.S. economy

Raymond Keating Chief Economist, Small Business & Entrepreneurship Council
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Despite what many people seem to believe — including more than a few prominent politicians — capitalism cannot happen without capitalists. Put another way: the enormous benefits that come from free enterprise and free markets are not possible without those who have accumulated capital and are willing to place that capital at risk.

Of course, invention and innovation need investment. While inventors, innovators, and entrepreneurs usually are celebrated by elected officials — as they should be — investors often are dismissed or even demonized by politicians. Just consider that the returns gained by investors — such as capital gains and dividends — are labeled as “unearned income.” In reality, nothing could be further from economic reality. Investing in new ideas and expanding businesses are risky endeavors, and the returns from such ventures most assuredly are “earned income.”

But why would investors risk their resources without strong protections for intellectual property? A central duty of government is to protect property as matters of justice, economic growth and development — and that most assuredly includes intellectual property. Most certainly, in the 21st century, knowledge-driven economy, venture capital and angel investment need strong patent and copyright protections in order to fully flourish.

Mario Cardullo, former counselor on technology and entrepreneurship to the U.S. Department of Commerce, provided a valuable reminder of this economic reality in an analysis for the World Intellectual Property Organization titled “Intellectual Property — The Basis for Venture Capital Investments.” (The full article can be read here.)

Cardullo correctly observed: “While technology has been seen as one of the engines for the dramatic economic growth and productivity the United States has experienced over the last several decades an underlying factor has been the strength of the intellectual property developed during that period. Intellectual property provided the basis for investors to place their resources at risk. Intellectual property is an integral part of value creation in a technology-based enterprise and as such is a critical element in obtaining venture capital for SMEs [small and medium-sized enterprises].”

He added that “venture capitalists want to maximize returns and minimize risks.” In turn, it follows: “Without the strength of the intellectual property and its protection, little if any investments would be made into new or growing enterprises.” The economics are anything but mysterious. As Cardullo explained: “Exclusive rights offered by the intellectual property system are often the main assets from which an SME technology-based enterprise can benefit. The appropriate use of the intellectual property system may contribute to bring high rates of return on capital, which is crucial in order to attract venture capital investors to an SME.”

Let’s be clear: Given how critical and elusive capital is for start-up and small businesses, strong and clear IP protections arguably are more crucial to the well being — indeed, the very survival — of smaller firms than for large businesses.

As for the impact of venture capital on the overall economy, according to the National Venture Capital Association’s most recent analysis (“Venture Impact: The Economic Importance of Venture Capital-Backed Companies to the U.S. Economy,” Fifth Edition): “In 2008, venture capital-backed companies employed more than 12 million people and generated nearly $3 trillion in revenue. Respectively, these figures accounted for 11 percent of private sector employment and represented the equivalent of 21 percent of U.S. GDP during that same year.” In terms of job growth, from 2006 to 2008, while private sector employment growth registered 0.2%, among venture-backed companies, it was 1.6%.

The NVCA report brought the importance of VC investment back to IP rights: “For decades, the U.S. venture capital industry has garnered the envy of the world. It has spurred the development of many high-tech industries … and has helped to build innovative powerhouse companies that are now household names: Amazon, Google, Apple, Cisco, Staples and eBay. These successes have made the U.S. a magnet for the globe’s best and brightest scientists and entrepreneurs. Today, countries around the world have begun to emulate the U.S. model by adjusting their tax and regulatory policies and by strengthening intellectual property protection.”

The United States, other developed nations, and developing or emerging economies all benefit from intellectual property protections. Patent and copyright enforcement plays a central role, as it boosts investment, and spurs on greater innovation and IP development. Strong intellectual property protections provide the foundation for, and create a mutually reinforcing relationship between IP development, investment, and economic growth. The new Congress and Obama administration need to take note; strengthening IP protection at home and around the world will bolster our investment and job creation at a time when both are desperately needed.

Raymond J. Keating serves as chief economist for the Small Business & Entrepreneurship Council.