Selling some of the most highly anticipated inventions, like an AIDS vaccine or method for carbon sequestration, might not make anyone rich.  In order to change the world, they have to be inexpensive and widely accessible. They might be difficult or even impossible to protect with traditional patents.

This worries economists like UCI’s Linda Cohen, who wonders how we can incentivize individuals or companies to invest millions of dollars in research and development to create these much-needed innovations.

In a recent working paper “Forward Markets to Spur Innovation,” Cohen and co-author Amihai Glazer, economics professor and director of UCI’s Program on Corporate Welfare, propose a new use for so-called "future contracts" that would enable innovators to financially benefit from developing some of these game-changing inventions.

Patent shortfalls

Historically, patents granted by the government have been the best way to ensure an inventor benefits from his or her innovation, but patents have had shortfalls from the beginning. Take for example the cotton gin. After its creation in 1794, cotton became the leading U.S. export and made Southern landowners and Northern textile mills rich—while dramatically expanding the institution of slavery in America.  One would assume that Eli Whitney, who received one of the first U.S. patents for the invention, had hit the jackpot.  But he did not.  Once the idea for his machine was out, the cotton gin was easily replicated and Whitney made virtually no money off it. 

“Eli Whitney’s invention changed the course of human history,” explains Cohen, who holds a joint appointment in the School of Law. “But all that patent did was give him a right to sue others.”

Incentivizing environmental innovation

This problem with patents especially vexes Cohen, whose 30-year academic career focuses on environmental economics, including regulatory politics of nuclear power. She wants to leverage the power of economic forces to encourage environmental breakthroughs – breakthroughs that will likely be expensive to develop yet should be inexpensive and widespread in their use.

Today, one of environmentalists’ burning questions is how can carbon dioxide—a primary culprit of global warming—be pulled from the earth’s atmosphere and stored, as a solid or liquid, underground?

“The challenge with something like carbon emissions is how do we encourage innovation?” she explains. “We need the invention to be cheap because it would be in the public’s interest to have this new technology used all around the globe. But there has to be a way for inventors to make money other than through sales of their invention.”

Cohen’s idea for using futures contracts to incentivize innovation could be especially impactful in the area of environment.  One possibility occurs if cap-and-trade laws, similar to California’s pioneering regulations, become more widespread.

Here’s how it works: cap and trade regulations set limits for how much carbon dioxide can be emitted, and require companies to hold permits for each ton of emissions they produce.  If a company lowers its emissions through, say, some investment in new pollution-reducing technology, it can buy fewer permits or can sell its existing permits to another company.  If a new technology could cheaply lower pollution, demand for permits would sink, as would their price.

“The key to the innovation mechanism is that a successful, cheap, widely used innovation lowers the price of carbon permits in an open market,” Cohen explains.  “We propose that the inventor profits from that price reduction.”

Betting on our future

If a robust cap-and-trade market was in place, Cohen says, potential innovators could bring together a consortium of companies that produce carbon emissions, and need to purchase permits. The innovator would then sign a “futures contract” with the consortium,  offering to sell them carbon permits for a price lower than the current value, but higher than what the permits would cost in the future if the new carbon sequestration technology becomes available. 

“So if a carbon permit costs $14 per unit, I might offer to sell you some number of permits for $10 in 10 years,” explains Cohen. “In return, you give me money to fund my R&D now.” Ten years later, if permits actually trade at $8.00 thanks to the invention, the inventor will make money. At that point, firms pay less than $14 for the contracted permits (although they could purchase them on the open market at that point for even less). 

On the other hand, if the invention fails, and 10 years from now permits continue trading at $14, then firms benefit from their futures contract, by paying only $10. The key is that, in general, both the firms and the inventor want to sign the contract because without it the R&D won’t happen and firms expect to keep paying $14 for all their permits in the future.

Alternatively, inventors could sign contracts with fossil fuel producers, offering to pay a higher price for coal in the future than its current value. In this case, the innovator is betting that their invention will so dramatically reduce pollution that the demand for coal will increase in the future, and so too will the value of coal.

The inventor, if successful, makes money from the difference between what he paid for the coal (the futures price) and what he sells it for (the market price).  The coal company makes money because had it not funded the innovation, the price of coal would still be low.

Cohen points out that California’s current price floor on carbon permits creates problems for her proposed mechanism. The floor means permit prices don’t fall, even when demand is very weak. This is just one of several challenges that Cohen and Glazer discuss in their paper, and they propose a number of variations to their method in order to deal with particular cases. 

Ultimately, Cohen believes that if economists and policy makers work together, they can leverage the power of economic forces for good. “We need everyone to think more creatively about incentivizing environmental innovation,” says Cohen. “Doing so will not only be good for business, but also for humanity.”

- Christine Byrd, UCI


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