Innovation rents

Innovation may improve products, and the new features of product enables a higher price. Innovation may also improve processes which will reduce costs, and this will increase profit as long as the prices are primarily related to “old” business processes. For these reasons innovation can be a source of rents, and such rents are functional as they incentivize investments in more innovation.

Innovation rents are sometimes called Schumpeterian rents, because it was Joseph Schumpeter who described innovative entrepreneurs as the engine of economic development, and such entrepreneurs were the champions of the capitalist system. Neoclassical economic theory is all about equilibrium, but for Schumpeter capitalism is dynamic and is about ‘creative destruction’.

However, Schumpeter also analyzed that innovation rents are temporary when innovations diffuse, when they are copied by other suppliers or when they are superseded by even better innovations: creative destruction.

The original intention of patents was to protect entrepreneurs to have a return for their investments, and the idea behind this was to promote innovation. There has always been discussion if patents are a good instrument for this, and the extreme growth of patents in recent times has added fuel to this discussion. A good summary of this discussion is in the book by Jaffe and Lerner (2004): “Innovation and its discontents. How our broken patent system is endangering innovation and progress, and what to do about it”.