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Trying to maintain investor-state dispute mechanisms is merely a political gamble that might put China at a disadvantage. (Qilai Shen/Bloomberg)
Trying to maintain investor-state dispute mechanisms is merely a political gamble that might put China at a disadvantage. (Qilai Shen/Bloomberg)

DAN BREZNITZ

Trans-Pacific Partnership is a wonderful idea – for China Add to ...

The website of the Office of the U.S. Trade Representative proudly describes the Trans-Pacific Partnership as “Made in America.” It does so to position this treaty, made up of a motley crew of allies, as a bulwark of free competitive markets against China. It is only fair, then, to judge the TPP on these merits: Will it lead to freer, more competitive markets and more rapid economic growth? Does it offer a better future for the U.S. and Canadian middle classes?

Worryingly to those of us who believe that entrepreneurship is crucial for economic growth, the TPP is failing on its declared goals. Once ratified, the agreement will make our markets less free and less competitive, and it will particularly hurt innovation-based entrepreneurship. This could not come at a worse time for our future economic growth, since, as The Economist has just reported, we are already at historic lows in the formation and growth of new companies and historically high levels of concentration across many industries.

The United States, which sees itself as the champion of entrepreneurship, has devised a deal that seems designed to make it harder for new high-tech businesses to start, scale up and succeed. Instead of “Made in America,” the U.S. Trade Representative should describe the deal for what it truly is: “The delight of Beijing.” A careful reading of the agreement shows that it is Chinese economic officials who should be opening their best champagne in celebration.

The only explanation for this outcome is that, in the secrecy under which the TPP was negotiated, interests representing a very narrow slice of U.S. society were allowed in, and the public interest was blocked at the door.

Limits information

Let’s start by acknowledging that the TPP is a laudable attempt at free trade in services that are now blocked by high non-tariff barriers. If this was the only aspect of the deal, we should all rush to ratify it. But most of its two million words concern how markets need to be regulated. Deciding how to regulate markets is also deciding winners and losers. And no matter what the intentions of the writers of this complex legal document may have been, it is written in a way that runs counter to its declared goals.

The TPP harms all the requisites of efficient competitive markets, innovation and entrepreneurship. Above all, it puts limits on information, in terms of both access and usage.

First, it adds another layer of intellectual property protections, which means broader, longer and deeper limitations on access to, and use of, information. In doing so, the TPP will hurt the ability of consumers and entrepreneurs to make informed decisions, and then to act on them. This will lead to less efficient resource allocation by markets.

It is not enough for consumers to be well informed. They also need to have the ability to make choices, either by using information or by being offered real choices about whatever they might want to purchase. Any regulation that: 1) prevents consumers from using information and/or grants monopoly/oligopoly rents; 2) stifles new competition by creating artificial barriers to entry for new competitors; and 3) creates different classes of actors in front of the law (creating both moral hazards and incentives for “gaming”) should be treated with the utmost suspicion.

Second, the TPP increases both uncertainty and risk for individuals and companies who want to launch new products and services, which is the essence of innovation. Any act of innovation, especially research and development directed at the creation of new products and services, is both risky and uncertain. Entrepreneurs are never certain that their investment in research and development (R&D) will result in anything useful, or that consumers would actually buy the new products or services they offer. And there is always uncertainty about whether or not they will even be allowed to sell them.

The TPP significantly increases both risk and uncertainty. It strengthens and adds rigidity to the current U.S. system of intellectual property rights, which economists have repeatedly found to slow down innovation. It adds several badly written, ambiguous trade-secret propositions to the law, and it makes some supposed intellectual property rights infringements into criminal offences. This perfect pincer manoeuvre would not only make it more expensive for entrepreneurs to bring new products and services to market, but it would also increase the personal risk they face (from financial bankruptcy to prison) to levels that deter even the hardiest from attempting to innovate.

Finally, the TPP continues to enshrine the very questionable usage of investor-state dispute-settlement mechanisms – special courts in which foreign investors can sue countries, states and local authorities but cannot be sued back. This elevates one economic actor (investors) to a status above all others in an economic transaction, and induces strategic behaviour by investors that aims to influence regulatory decisions, instead of letting consumers make their choices known through the market. There is no economic rationale for these mechanisms, only a very questionable (and extremely inefficient, in cost terms) political gamble that some time in the future, they might put China at a disadvantage. It’s time that we put these mechanisms in their proper place – the trash bin of history.

Chilling effects

All this extra cost, risk and uncertainty will have chilling effects that will stifle market experimentation. This leads to yet another problematic “benefit” of the TPP: Decreasing the Hayekian (as in Friedrich Hayek) efficiency of the market. That is, the ability of the markets to act as the best-learning and constantly improving system mankind has ever developed.

Let me elaborate on a few of these points.

First, rather than modernize intellectual property rights for the 21st century, the TPP authors appear keen to return us to the era of 19th-century trade secrets.

Modern intellectual property rights, such as patents and copyrights, are premised on a social bargain. The side that wishes to be granted a patent needs to disclose new and useful information to society at large, and in return we (the people) give it an exclusive right for a limited time, preventing others from using it without permission. In other words, we grant it a temporary monopoly.

This is the opposite of trade secrets, where we (the people) give rights to prevent others from using any information without any disclosure and without any time limitation or otherwise – as long as it remains undisclosed (in other words, secret). In so doing, we give a quid that covers potentially wide-ranging types of information, without receiving any quo in return.

For these reasons, the law has evolved to provide much more limited remedies for the disclosure of undisclosed information in a limited set of circumstances, such as breach of contract not to disclose, or breach of trust. Currently, the remedy is available only against those who breached the contract or trust, but not against others who obtained the information. Once the information has been disclosed publicly, the person who disclosed it might be held liable, but everyone else is free to use it.

There are many good reasons for this narrow scope of protection. The broader the scope of what could be considered trade secret and the broader the scope of the remedies and the type of persons who could be liable, the further the protection gets from its limited rationale, and the more it becomes a quo without a quid. At the extremes, trade secrets have been used to make sure that skilled labour is never allowed to work again for any other company, or to start another business.

Since the TPP is “Made in America,” its authors might do well to study the history of Samuel Slater, the man whom 19th-century U.S. president Andrew Jackson called the Father of the American Industrial Revolution.

When the young Mr. Slater decided that his future lay in emigrating to the United States, he faced such draconian trade-secrets laws in his native Britain (which tried to enforce them in a failed attempt to prevent new technology from arriving to the United States) that he had to keep his travel plans secret from family and friends, and disguise himself as a farm labourer. While modern law recognizes certain circumstances that justify limitations on the disclosure of information, it weighs heavily in favour of the rights of individuals to apply their skills and the interest of the public in free and competitive markets.

The TPP breaks with this tradition in ways that can seriously restrict entrepreneurship, diminish competition and limit the basic economic freedom of individuals. Article 18.78 adopts a potentially very broad concept of a trade secret, a very wide range of activities that might constitute a breach and a very broad potential class of persons who might be liable. Worse, it also calls for criminalization. The potential risk for would-be entrepreneurs to start a business in anything that even remotely relates to their past job are now enormous.

The resulting chill in entrepreneurship alone would cost the U.S. and Canadian economies significantly higher orders of magnitude in terms of lost growth, jobs and welfare than any positive benefits that the TPP might bring. Even more disturbing, Articles 18.74 and 18.75 profoundly expand the enforcement measures, including significant provisional ex parte proceedings, and narrow the discretion of the courts. Those provisions apply to all intellectual property rights, including trade secrets. These extra-potent tools would be used not only where they are appropriate, but also where they aren’t – such as to stifle competition and innovation.

If you are now sipping eggnog and wondering whether these provisions are really so important, you need look no further than the duelling economic fortunes of California and Michigan.

Michigan, following a similar logic behind the TPP view of trade secrets, historically enforced non-compete covenants that prevented people who worked for company A from leaving and starting to work for company B, or from opening their own businesses. This doctrine was used by Detroit automobile companies to reduce labour mobility and stifle innovation. California did not follow this route and is now home to Silicon Valley, the engine of U.S. innovation prosperity. Michigan instead is the home of Detroit, also a shining case of innovation – in how to handle the bankruptcy of a large municipality.

Extreme regime

The TPP holds even more nasty surprises. Strangely, the sad truth about our patent system has hardly been discussed in the news media. If there is one single thing that economists who study innovation have clearly shown in the past decade, it’s that the current U.S. patent system is detrimental to innovation. Extensive research has demonstrated that the more patents are issued in a technological area, the less innovation results. This is in direct contradiction of the basic rationale for having a patent system, which is the granting of a limited monopoly in exchange for higher rates of innovation and faster diffusion of new knowledge.

The one area where we were led to believe patents might still induce innovation is in health and drug discovery. Yet one of the most recent MacArthur “Genius Grants” was given to Heidi Williams of the Massachusetts Institute of Technology for research clearly showing that even in the health sector, the U.S. patent system distorts innovation instead of incentivizing it. Indeed, recognition that the patent system is broken (to paraphrase a wonderful book by Josh Lerner) is so widespread that the U.S. Congress has already acknowledged it and a reasonable law change has been in the works for three years.

The TPP completely disregards this understanding by taking the most extreme version of the current U.S. intellectual property regime (actually stronger than what is currently in force) and forces all signatories to apply it as the minimum baseline. It then goes further still, ensuring that this collective intellectual hara-kiri is permanent by making it impossible for any country to improve it without approval of all other TPP signatories for the life of the agreement.

Since the competitive edge of the United States has been to excel in novel product innovation, and new industries have been the engine of growth, it is clear that the TPP should make policy makers in Beijing giddy with delight. Slightly freer trade in services might be achieved with this trade agreement, but in exchange for significantly lower rates of innovation and economic growth.

Dan Breznitz holds the Munk Chair of Innovation Studies and is a co-director of the innovation policy lab at the Munk School of Global Affairs at the University of Toronto. He is the author or co-author of several books on innovation-based growth.

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