Senator LONG. The first witness today will be Prof. Daniel Hamberg, of the University of Maryland.

Mr. HAMBERG. Thank you, Mr. Chairman.

STATEMENT OF DANIEL HAMBERG, UNIVERSITY OF MARYLAND, COLLEGE PARK, MD.

Senator LONG. Dr. Hamberg, I believe you have been informed that our procedure will be in accordance with the Legislative Reorganization Act, wherein you are requested to bring a prepared statement, which I would like to put in full in the record, and then to summarize your statement in your testimony today.

Mr. HAMBERG. The Senate Small Business Committee is to be warmly congratulated for its investigation of the patent policies of Federal agencies. Especially crying for study is the policy of virtually all Federal agencies (with the exception, I believe, of the Atomic Energy Commission, the Department of Agriculture, and the Tennessee Valley Authority) of permitting private corporations to secure patent rights to inventions developed by the corporations under Federal financial sponsorship. This policy possesses all the inherent and potential disadvantages of the patent system and none of the latter's alleged advantages.

Whatever their merits, it is undeniable that patent rights confer monopoly powers on the patentee. Patents enable their owners to restrict the use of inventions, thereby restricting the contributions to the national product that the patented inventions could make, in the hope that the resulting higher market prices will make possible (monopoly) profits in excess of what could be earned under competitive conditions. To deny this feature of the patent system would be tantamount to denial of any usefulness of the patent system.

Implicit in this essential characteristic of the patent system is a retardation in the rate of diffusion of inventions. Why has society erected a legal institution that impedes the diffusion of technological knowledge? The answer lies in the belief that the monopoly profits made possible (if not guaranteed) by the patent system will act as an inducement to further, and even raise the rate of, invention and innovation. In a word, the patent system was conceived in the paradoxical expectation that by slowing down the rate of diffusion of inventions, there will be more inventions to diffuse.

What is the argument for the patent system and what is its relevance to the problem at hand, namely, the granting of patent rights to corporations conducting research under the financial sponsorship of the Federal Government?

Basically, the argument for a patent system, as such, is an incentive argument.

The profit expectations connected with the hope for a patent monopoly may induce inventors to exert their inventive efforts, or, in the modern scheme, induce corporations to maintain expert staffs of scientists and engineers and expensive research laboratories; the same profit prospects may induce venturesome capitalists, or their modern counterparts, the great corporations, to risk their money on uncertain and expensive development projects and pilot plants, and on the equally and uncertainty-laden tasks of building up markets. It may

be granted that patent-monopoly profits stem from output restrictions, and are thus inherently associated with underutilization of a recently developed piece of technology. But it is argued that this is the price we must pay for a system that fosters the development of new technologies and thereby ultimately permits a more rapid growth in total production than would be possible in its absence.

Without pausing to examine the validity of this argument, and there are many grounds for questioning it, let us scrutinize its applicability to the case of Government-financed research carried on in the private sector of the economy. Perhaps the most notable feature of such activity is the total absence of all financial risk on the part of firms conducting the research and development. Virtually all R. & D. contracts let by Federal agencies and departments are on one sort of "cost plus" basis or another. No results are guaranteed, nor can they be, of course. But no mater how difficult or expensive a project turns out to be, the costs are covered by the Government. The contracting firm pays not 1 cent from its own pockets. Not only is it renumerated for the basic invention for which it is responsible, but the Government bears all the costs of development work attached to it. Furthermore, there is no market to be developed. The market is there, waiting eagerly, in the form of the Federal agency or department for whom the R. & D. has been performed. In short, the whole thing is virtually a riskless venture for the contracting corporation. If there is a possible risk, it is that of contract cancellation. But even this can hardly be described as a risk, for it remains true that the firms have invested none of their own funds, and are always granted a return well in excess of costs, to boot.

What becomes of the "incentive" argument in this case? The answer, of course, is that it collapses completely. If there are no risks there is no justification for a monopoly profit such as might accrue from patent rights. But since the patent rights are clearly not needed to serve as an inducement to invent and innovate, while they simultaneously impede the diffusion of technological knowledge uncovered at public expense, the granting of patent privileges to the contracting firms clearly gives society none of the alleged advantages of the patent system while foisting upon us one of its decisive disadvantages.

It is undeniable that the whole basis of a patent system is the power inherent in the monopoly position that the patent grants, that is, the power to slow down, retard the rate of diffusion of inventions, so that the patent owner may receive a higher profit thereby.

Consequently, while there might be an argument for accepting this cost of a patent system as the price we pay in order to induce more invention and innovation at private expense, in the case at hand where the Government covers all the financial costs, bears all the financial risks of invention and innovation, we are clearly receiving no advantage here, while accepting the decisive disadvantage or one of the decisive disadvantages of the patent system, namely, the retardation of the diffusion of invention.

Lest the committee infer that the withdrawal of patent privileges from firms performing R. & D. for the Government at the latter's expense will remove all competitive advantage accruing to such firms, let me hasten to caution against any such inference. There are inherent advantages in performing such work that exist quite apart from patent privileges.

Where there is fortuitously direct and immediate commercial applications, or where the contracting firms will take contracts, as they often do, only when the R. & D. is relevant to technical and, hence, commercial problems already confronting the firm, the result is in either case that although the firm may provide the Government with a sought-for "product," the firm in the process gets its R. & D. costs financed by the Government.

A second important advantage is that the finance that the contracting firm receives from the Government enables the firm to acquire scientific personnel that it ordinarily might be unable to do.

This is certainly one of the paradoxes, I think, of the present system of having the Government finance R. & D. in the private sector, because, unquestionably, the contracting firms are thereby enabled w bid up the prices, the wages and salaries, of scientific and technical personnel.

In the process they compete away such personnel from the Government sector, from Government research and development laboratories. The Government is, thereby, deprived of its own highly qualified personnel, and in the end winds up paying more for R. & D. than it otherwise would because it now must pay the higher costs involved as a result of the bidding away of scientific personnel from the Gov

ernment.

So the Government finds itself not only, I think, spending more on R. & D. as a result of this situation, but also finds itself confronted with a shortage of scientific personnel that it itself has created.

Thirdly, we should note that the performing firm, ipso facto, acquires a considerably body of information relating to the invention, information that is unpatentable, but possession of which is often indispensable to the proper use of the invention.

This information is known colloquially as "know-how."

In the case of a new product or material, this know-how includes the relevant experience accumulated in the early stages of production, during which many minor modifications may be made in the design or production process. Similarly, invaluable information is often accumulated during the trial runs or pilot plant testings of new processes. Such information is typically unpublished and remains as confidential information in the possession of the firm's operating personnel. The withdrawal of patent rights from performing firms would not and could not deprive them of this often priceless know-how.

In concluding this opening statement, I should like to draw the committee's attention to one other problem created by the present pattern of the Government-research expenditures. Whether by design, or chance, or more likely, administrative expediency, Government R. & D. contracts have been let primarly to the giant corporations, to the virtual exclusion of small- and medium-size firms. As we have noted above, either with or, in view of the know-how that automatically accrues to the performing firms, even without patent rights, this practice automatically confers great competitive advantages on the giant firms vis-a-vis their smaller competitors, thereby promoting already extant monopolistic tendencies. The withdrawal of patent privileges from the giant firms would only reduce this effect; it would fall far short of eliminating it. The enhancement of monopolistic tendencies is an intrinsic characteristic of the present practice

of concentrating R. & D. contracts in the hands of the giant corporations. The committee would do well to look into ways of getting Federal agencies and departments to distribute R. & D. contracts on a very much broader basis than is now done-in the interests of fostering more competition in the economy generally and, more specifically, in the new industries arising under the spur of new discoveries associated with Government-sponsored R. & D.

I would like to implement that last point with a suggestion for spreading R. & D. contracts on a broader basis by substituting a fixedfee contract for the presently widely used cost-plus contracts.

The reason is that too often the small firm cannot make anything in the way of a profit, because it may be able to put to work, let us say, only 10 or 15 or 20 men compared with the 500 or so men, let us say, that the large corporation can put on it.

So the cost base is much smaller for the smaller firm than it is for the larger firm and, hence, the percentage it gets in the plus part of the cost-plus contract, winds up as a very small figure that makes it quite impractical for the small firm to undertake these contracts.

On the other hand, the mere fact that the large firms can often put these huge teams of workers on a Government R. & D. contract does not necessarily mean that the large firm will necessarily do any better.

Certainly, as one examines the pattern of inventions in the past, even when conducted within the research laboratories of the giant corporation, one of the outstanding features discernable is that although there may be many, many people at work, usually there are only one or two key personnel involved, very able men, who spark the project, if I may put it so crudely, with the rest largely hanging around or performing more or less menial tasks.

I would suggest that in view of this fact that very often the small firms can do just as well, by putting four or five men to work, with one key operator at the crucial position.

I think it is also commonly, fairly commonly, known that the large firms, in getting these contracts, in putting these large teams to work, frequently throw their least able men on Government contracts because of the cost-plus nature of the contract, and retain some of their best personnel for their own commercial work.

Thank you, Mr. Chairman.

Senator LONG. Professor Hamberg, could you just give a little of your background in this field. Have you taught patent law or economics in this field?

Mr. HAMBERG. My field is economics, Mr. Chairman, and recently I have been concentrating my research in the economics of invention and innovation.

Senator LONG. Do you know, in general, how the British system works?

Mr. HAMBERG. Well, vaguely. I know that the contracting firm is required to pay something like 712 percent of its sales revenues back to the Government in the case of products that reach the commercial market where the research for them has been conducted under the aegis of the British Government's financial sponsorship, and where they do not market such products commercially, but grant licenses, there is some higher fee they pay, I believe something like 12 percent, 13 percent.

Senator LONG. I believe the figure is 333 percent.

Mr. HAMBERG. I would like to say, Mr. Chairman

Senator LONG. My understanding is that if the British firm licenses another firm to use its invention developed with Government funds, 333 percent of the royalty goes to the Government.

Mr. HAMBERG. I see.

Senator LONG. I believe that if the company itself markets the product, the Government gets 72 percent of the selling price. Mr. HAMBERG. Right.

Senator LONG. What do you think of the British system?

Mr. HAMBERG. I think that sweetens a bad system, and nothing

more.

One advantage, of course, is that it enables, it provides a vehicle whereby the Government can recover some of its outlays on R. & D. or perhaps all. But to me, this is a minor consideration in a system of granting patent rights to private corporations where they perform R. & D. at Government expense.

The major consideration, it seems to me, is that the patents are inherently a monopoly right, and they enable the firm, as I have said in my opening statement, to reduce the rate of diffusion of inventions and, therefore, the rate of diffusion of technological knowledge.

This is inherent. If this were not true, there would not be any advantage to the patent system. By reducing the use of the invention, they are enabled to increase their prices, and their revenues and, therefore, earn a profit in excess of what they could receive under competitive conditions.

But the important thing is that they do reduce the rate of diffusion of technological knowledge, and, in addition, they receive potentially broad monopoly powers, which have significant overtones for the efficient operation of the economic system.

It seems to me this is the thing on which we ought to keep our eyes focused, and not a rather minor consideration of recovering some of the R. & D. outlays.

Senator LONG. Your thought, then, is that there is no point in giving a firm a monopoly on what they develop on Government contract because there is plenty of incentive already in the fact that you are paying them to do this research?

Mr. HAMBERG. That is right.

Senator LONG. In addition, you contend that they also gain by doing the research. They gain the know-how which gives them an advantage in getting a production contract on which they also make a profit?

Mr. HAMBERG. Unquestionably.

The argument for a patent system is an incentive argument, a risk argument.

Senator LONG. Yes.

Mr. HAMBERG. Where the firms are being paid to undertake R. & D., there are no financial risks or, at least, negligible risks, negligible financial risks.

Senator LONG. It has been suggested that in view of the shortage of competent research personnel a patent monopoly might be needed as a bonus to induce corporations to devote their best scientific brains to Government research and development. What is your reaction to that suggestion?