A few years ago debate about the impact of sovereign wealth funds was all the rage in foreign- and economic-policy circles.  We were warned that these funds were anti-competitive and market distorting, that they would create a protectionist backlash, and that they were “black boxes” with little or no transparency.

Only a few years later, many of these concerns now seem overblown. At the same time, we’re now seeing significant debate – along with a healthy amount of criticism – focusing on a new type of state-sponsored fund: sovereign patent funds. The potential advantages of establishing such an entity in Canada have been discussed here at the DEEP Centre by Dan Herman and myself, and are increasingly being engaged with elsewhere.

In light of the similarities of both sovereign wealth and sovereign patent funds and the arguments deployed against them by critics, I thought it would be worth taking a look at some of these arguments in greater detail. In particular, I’m interested in three elements of the SPF debate – that these funds are anti-competitive, that they will lead to protectionism, and that they lack transparency.

Argument #1: These Funds are Anti-Competitive

One of the major criticisms levied against sovereign wealth funds is that they are market distorting and anti-competitive. According to critics, sovereign wealth funds undermine competition by “propping up” firms which would otherwise fail, often for political motives.  Going further, Larry Summers, the former US Treasury Secretary, argued in 2007 that these funds have the potential to disrupt the core logic of capitalism. Summers argued that:

The logic of the capitalist system depends on shareholders causing companies to act so as to maximize the value of their shares. It is far from obvious that this will over time be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence.”

Similar concerns are now being raised about the activities of sovereign patent funds. In October Stephen DeMaura argued that:

Government-sponsored patent-assertion entities, such as Innovation Network Corporation of Japan and France Brevets, promote an anti-competitive precedent across industries where patents are essential. The market should remain the driver of innovation and competition, not governments with funding for aggressive behavior. Their activities complicate global cooperation efforts on trade-related matters, which are becoming more and more important.

More than sovereign wealth funds, patent funds are explicitly intended to serve the needs and interests of domestic firms. At the same time, it is difficult to argue that these funds are any more “anti-competitive” than the patent system itself. In a number of areas existing private entities already provide similar services to those offered by sovereign patent funds. A number of these services –such as providing financing to small entrepreneurs, purchasing and aggregating dormant patents, and helping to reduce the costs associated with navigating the patent system, appear likely to enhance, rather than limit, competition.

Just as with sovereign wealth funds, the true impact of state-sponsored patent funds on competition and innovation will become much clearer over time. If these funds become aggressively and offensively litigious, they may indeed act as an anti-competitive roadblock to innovation. At the moment, however, there is little evidence of such a trend.

Argument 2: These Funds Will Lead to Protectionism

One of the most consistent criticisms levied against sovereign wealth funds is that their operations will spur financial protectionism among countries within which they attempt to invest.  According to this argument, states which are fearful of investment by sovereign wealth funds – resulting from concerns about national competitiveness or national security – are likely to raise barriers to foreign investment. In 2008 the Economist argued that, “although the risk that the funds may abuse companies and markets is theoretical, the danger of financial protectionism is all too real.”

In this case, the argument about sovereign patent funds is subtly different. Critics have now begun to argue that patent funds are themselves a protectionist scheme. As with classic cases of protectionism, concerns have also been raised that the creation of these funds will generate a cascade of beggar-thy-neighbour type policies. As David Balto argues:

State-sponsored PAEs set a dangerous precedent that could lead to a “race to the bottom” as countries establish their own PAEs. This race would be exacerbated by political conflicts caused by overzealous enforcement against foreign companies and entities. States would be pressured to form PAEs of their own to protect their domestic companies from foreign patent assertions.

In the case of both sovereign wealth and patent funds, however, there is little evidence that their activities have sparked anything approaching a widespread protectionist backlash. Further, in the case of patent funds, it is difficult to argue that these constitute a clear case of protectionism. Nor has there been much support presented for the assertion that these funds are illegal under international trade law.

Argument #3: These Funds Lack Sufficient Transparency

Both sovereign wealth funds and sovereign patent funds can rightly be accused of lacking sufficient transparency. In 2007 the International Monetary Fund’s then-Chief Economist, Simon Johnson, noted growing unease about the “black box” nature of sovereign wealth funds.

These criticisms of sovereign wealth funds led to the creation of the (entirely voluntary) Santiago Principles intended to enhance transparency. Though progress in the direction of greater transparency has been made as a result of the principles, concerns persist.

Transparency is also a legitimate concern when it comes to sovereign patent funds. Despite growing debate, we still know relatively little about what goes on inside these organizations. This fact alone likely explains the negative reaction visible in some quarters to the emergence of SPFs.

Of the three arguments common to both sovereign wealth funds and sovereign patent funds, the argument in favour of greater transparency is the most compelling. If the proliferation of national patent funds continues, it may be worth considering the creation of transparency principles similar to those established for sovereign wealth funds. Though greater transparency is unlikely to fully satisfy the most vociferous critics of sovereign patent funds, greater public knowledge about what these organizations do and how they do it may temper broader suspicion about the operations of these bodies.

Regardless of the international context, we in Canada need a better understanding of what these patent funds are, what they do, and what they mean for our national competitiveness. Recent litigation undertaken by France Brevets – the French SPF – further highlights the potential costs of inaction in this space.