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Journal of Economic Theory 132 (2007) 306 – 334 www.elsevier.com/locate/jet

Dynamic analysis of patent policy in an endogenous growth model
Koichi Futagamia,∗ , Tatsuro Iwaisakob
a Faculty of Economics, Osaka University, 1-7 Machikaneyama, Toyonaka, Osaka, 560-0043, Japan b Faculty of Economics, Ritsumeikan University, 1-1-1 Noji-higashi, Kusatsu, Shiga 525-8577, Japan

Received 21 October2002; final version received 28 July 2005 Available online 7 November 2005

Abstract In this paper, we explore the dynamic properties of an endogenous growth model with finite patent length. We show that there exists a unique equilibrium growth path and that this path exhibits damped oscillations in contrast to the equilibrium path of an endogenous growth model with infinite patent length. We alsoexamine the effects of patent policy on social welfare and show that infinite patent length does not maximize social welfare. Furthermore, we show that, in a growth model that does not exhibit scale effects, a finite patent length maximizes social welfare on the balanced growth path. © 2005 Elsevier Inc. All rights reserved.
JEL classification: L50; O31; O34; O41 Keywords: Patent policy; Endogenousgrowth; Innovation; Higher-order difference equations

1. Introduction Research and development (R&D) activity by private firms is an important engine of economic growth. Since the early 1990s, many researchers have proposed growth models in which private firms conduct R&D activities in search of monopoly profits. Well-known papers are Romer [26], Grossman and Helpman [16], and Aghion and Howitt[1]. These papers show that the amount of monopoly profit that the firm earns significantly affects the level of innovative activity. Higher profits induce firms to conduct higher levels of innovative activity and thus promote economic growth.
∗ Corresponding author.

E-mail addresses: futagami@econ.osaka-u.ac.jp (K. Futagami), tiwai@ec.ritsumei.ac.jp (T. Iwaisako). 0022-0531/$ - see front matter ©2005 Elsevier Inc. All rights reserved. doi:10.1016/j.jet.2005.07.009

K. Futagami, T. Iwaisako / Journal of Economic Theory 132 (2007) 306 – 334

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Various policies can affect the level of innovative activity and thus economic growth. In particular, patent policy significantly influences innovative activity by providing a firm with the monopoly right to produce a patented good. For example,venture businesses in the pharmaceutical industry need to be protected by patent law because the development of new medicine is costly, as it uses frontier knowledge of molecular biology. 1 Consequently, without patent protection for a new medicine, the money invested in its development would be wasted if other similar medicines were to emerge. In the literature on economic growth, protection bypatent law is either permanent or applies until a brand new product is invented. 2 However, in practice, the protection period is finite because permanent patents result in persistent deadweight losses for consumers due to monopoly pricing. Therefore, it is important to investigate the effects of finite patents on economic growth and welfare. Despite its importance, few papers have addressed thisissue. The seminal paper of Judd [22] used a dynamic general equilibrium framework. 3 He used an exogenous growth model to show that permanent patents maximize social welfare. By contrast, Iwaisako and Futagami [19] show that, in an endogenous growth model, the patent length that maximizes social welfare on the balanced growth path (BGP) of a decentralized economy can be finite. 4 Moreover, theyincorporate patent breadth (i.e., the licensing royalty rate) into the model and show that the patent length that maximizes the social welfare level is finite, even if the patent breadth can be controlled. However, their analysis is limited to BGPs. 5 In this paper, we explore the dynamic properties of patent policy in an endogenous growth model. We show that there exists a unique equilibrium growth...