CHAPTER 2 : LITERATURE REVIEW: PATENT AND TRADE SECRET
2.3 Policy Issues and Current Debates 24
2.3.2 Current Policy Debates: Trade Secrets 31
Trade secrets face many of the same debates as patents. Given their inherent secrecy, trade secrets can be particularly challenging when faced with demands for knowledge diffusion. Additionally, trade secrecy protection is not
internationally homogenous, which leads to the discussion of harmonization.
Knowledge Diffusion: The Loss of Trade Secrets
Trade secrecy protection, as noted earlier, is less well defined as patent
protection. Trade secrecy protection can be lost once the secret becomes public; this is the primary means of knowledge diffusion with trade secrets. Loss of trade secrecy occurs through two main channels: competitors and employees.
Competitors can obtain trade secrets through independent research, espionage and negotiations. Conducting R&D to either reverse engineer or discover an innovation independently are legitimate channels of independent research that can uncover trade secrets. Industrial espionage provides another, illegal, means of spying on another competitor in order to gain access to confidential
information and uncover trade secrets. As Risch (2007) notes, a common
example of industrial espionage is the 1964 DuPont case29, in which a competitor
hired a photographer to take aerial photos of a DuPont plant being built. DuPont argued successfully that this was a violation of their trade secrets as the plant construction revealed their methane-‐treating process, as noted in Friedman, et al (1991). Finally, trade secrets can be disclosed legitimately in interactions with potential business partners etc.; while this disclosure is lawful, the owner of the trade secret often has the right to prevent the other party from using the trade secret in practice through contracts (Dessemontet, 1998.)
Perhaps the most common form of trade secrecy loss is through employees, as noted in Almeling et al (2009.) Employees, particularly former employees, may
29 Posner (1983) also cites this DuPont example as an example of the economic benefit of having
commercial privacy. In the absence of the right to privacy, DuPont would be induced to expend resources to conceal the building of the plant. Commercial privacy, in this case, reduces the wasteful use of resources.
disclose trade secrets to others or new employers. While the disclosure of trade secrets by employees is illegal, this is a grey area as the right of the employee to work is important and can override the right to trade secrecy. Coleman (1992) notes this difficulty:
… too tight a control on the right of employees and ex-‐employees to use or disclose information could have a detrimental effect on the employment market … On the other hand, without some form of post-‐employment protection to ensure that valuable developments or improvements remain in the exclusive control of employers, there would be less incentive to carry out research and development.30
Thus, policy makers face a delicate balance of taking into account the rights of employees to work, versus the rights of employers to maintain trade secrets.
Trade Secret Law Harmonization
The international harmonization of trade secrecy laws is also an issue as differing legal and cultural attitudes towards trade secrets pose problems for international business (Bone, 1998; Lemley, 2008.) In contrast to patents, trade secrecy has much more heterogeneous protection internationally and may fall under a variety of legal jurisdictions (e.g. tort law, criminal law and contract law, as noted in Bone, 1998; and Samuelson and Scotchmer, 2002.) This lack of consistency obfuscates the legal protection of trade secrets, particularly for firms operating in multiple countries. The public status of court proceedings can also have an impact on the protection of trade secrets, as firms will be reluctant to seek legal recourse if court proceedings are made public (Nasheri, 2005.) These public proceedings could result in the disclosure of the trade secret, as noted in Lerner (2006.)
Recent changes in the U.S. law, with the enactment of the Economic Espionage Act (EEA) of 1996, have highlighted the issue of harmonization. The EEA and the data associated with it form a central part of this thesis. The enactment of the EEA lead to significant harmonization of trade secret laws at the state level in the U.S. Authors such as Poolely et al (1997), Carr et al (2000) and Uhrich (2001) have examined the new law and its legal implications. As these authors note, the
EEA has some extraterritorial provisions that are given particular attention in Effron (2003.) Chapter 3 of this thesis will develop these issues further.
Trade Secrets in Cumulative Innovation
One particular doctrine that varies internationally is the application of prior user rights, which allows an owner of a trade secret to continue to use the trade secret if another entity develops and patents the trade secret independently. Prior user rights also figure into the cumulative innovation debate as they allow for two independent innovators to incur the costs of developing the innovation and reap a portion of the rewards (Shapiro, 2006.) More precisely, Magri (1997, p. 4) defines them as, “Prior user rights allows one who is practicing the
invention prior to the filing of a patent application by a later user to continue to practice the invention, even if a patent issues to the later user on the technology.” Denicolo and Franzoni (2004) examine the economic effects of prior user rights and conclude that prior user rights increase incentives for innovation but
decrease the first innovator’s propensity to patent. As they argue that patenting is social surplus increasing, they argue that prior user rights are not socially beneficial. Prior user rights are not internationally harmonized, as noted in Menell and Scotchmer (2005.)
Given the discordance of international IP regimes, harmonization of trade secret laws internationally could prove beneficial to firms operating internationally. Magri (1997, p. 2) recounts an example of how this discordance affected the decisions of Coca-‐Cola. In 1977, Coca-‐Cola ceased its operations in India in order to protect its secret formula. At the time, the Indian government, by law, was demanding that Coca-‐Cola turn over 60% of its Indian operations to Indian-‐ controlled enterprises. With this 60%, Coca-‐Cola was expected to hand over technological information, including the secret formula; Coca-‐Cola refused and chose to leave India. As the laws changed, Coca-‐Cola returned to the Indian market in 1993.31 Harmonization of international trade secrecy laws could avoid
costly situations such as the 1977 Coca-‐Cola case.
31 According to the Coca-‐Cola India website: http://www.coca-‐colaindia.com/about_us/coca-‐
Collectively, patents and trade secrets face similar policy and current debates, as discussed in Friedman et al (1990.) Knowledge diffusion, cumulative innovation and harmonization all factor into current academic and political topics. These debates will shape the future of policy and are thus central to academic
investigations into theoretical models and empirical evidence. The next two sections of this chapter develop the theoretical and empirical themes in their academic context.
2.4
Theoretical Models in Economics
In addressing the policy issues and current debates surrounding IP systems, the economics literature has responded with economic models. These theoretical models weigh the relative merits of policy options and examine the impact of policy changes at various levels, including the firm and market levels. This section presents an overview of current models in IP with a focus on theoretical models incorporating trade secrets.
2.4.1
Patents
The literature developing theoretical models of patenting is vast and provides the foundations for later work in trade secrets. This section of the literature review will describe recent scholarship in patenting with particular attention to those models that are deemed relevant to trade secrets and the topic of this thesis.
Models of Cumulative Innovation and Disclosure
As noted in the previous section, a current debate surrounding patent policy is the appropriate rewards for cumulative innovation (e.g. Scotchmer, 1991; Chang, 1995; Choi, 2004; and Scotchmer, 2005.) Many authors note that, without
adequate models for protecting cumulative innovations, the innovator of the first innovation may ultimately suffer from the success of the second innovation (as in Scotchmer, 1991; Green and Scotchmer, 1995; and Chang, 1995.) Erkal (2005) models cumulative innovation as a Bertrand competition between firms over