Why Openness Leads To Greater Innovation: The Friction Of The Hold Up Problem

from the the-hold-up-problem dept

There's an article over at GigaOm that's discussing some of the economics of open source software, specifically in relation to the development of Flash, and as a way to explain why Apple is so anti-Flash. But the key point of the article, a reminder of the so-called "hold-up problem" in economics, which basically shows the additional transaction costs associated with having to rely on another party:

The reason is based on what economists call "the hold up problem." When a business relies on assets owned by another party, it may become dependent on that party's cooperation in the future. In this situation, the party with ownership of a key resource may gain the ability to "hold up" its partner, demanding an unreasonably high price. Hold up becomes a problem especially when a business needs to make large capital investments that assume future cooperation from the owner of a complementary asset.

While the article goes on to explain why the problem is particularly an issue in IT, and why that explains why so many companies rely on open source software (to avoid the hold up problem), it actually is a good explanation for the friction and higher transaction costs involved in all sorts of innovation that relies on solutions that are locked up either via copyright or patents.

The biggest conceptual mistake that people have in thinking that copyright and patents lead to greater output or innovation is that they have trouble understanding the nature of dynamic creativity or innovation. It's tough to realize that innovation and creativity are both ongoing processes. There is no beginning, middle and end. They just keep going, and a single "flash of genius" is meaningless if it does not become a part of that dynamic flow. But the "hold up problem" described above gets in the way nearly every time if you have to rely on some other party -- such as a copyright holder or a patent holder -- to give their approval. It's why we so fear a permission-based culture that doesn't let such things move forward. Each time that it happens, it not only slows down both creativity and innovation, but adds additional wasteful transaction costs that are a dead weight loss to society.

These cases are the norm. Research has shown time and time again that it's the ongoing process that matters, not any particular element of it. And to make that ongoing process keep moving forward, you need less friction, not more. The hold-up problem shows how friction decreases a market from functioning properly, and in many, many cases, both patents and copyright serve to do one main thing: to add a hold-up problem where none need exist. In other words, they serve to add friction to the processes of creativity and innovation, rather than to take away friction. That should be seen as a serious problem.

Filed Under: copyright, economics, friction, hold up problem, innovation, open source, openness, patents