Veblen, Schumpeter, and employee inventors: lessons from the US and Germany

(This article first appeared in the December 1990 issue of Managing Intellectual Property.  It remains relevant today.)

Why should bright and innovative youngsters want to enter engineering and science when the incentives are so small?

Neal Orkin, inventor of ‘Orkinomics’, looks at this question through the eyes of Veblen and Schumpeter and explains why so many US patents are now being granted to foreigners.

“Competitiveness” is the new buzzword that we Americans use to fend off those damned foreigners who “steal” our technology or trade “unfairly”.  While erudite authors and smug commentators – those Captains of Competitiveness – speak in terms of such euphemisms as better education for workers, labour-management cooperation, and new far­sighted management, we lose sight of one of the basic causes of our competitiveness problem – rewards and recognition for creative engineers and scientists.

Since the nineteenth century, corporate employers have required those who create technology to sign a contract assigning their inventions to the corporation in return for employment, or such paltry rewards as a plaque, pen and pencil set, or even $1.00. Such contracts have been upheld by the courts even though the employer might reap sizable financial gain while the employee receives an employer­ dictated wage. Meanwhile, the United States merchandise trade deficit exceeds $100 billion annually and foreigners receive almost half of all US issued patents.

Most Western European nations and Japan have outlawed these agreements and require the employer to grant compensation to the employee inventor. Compensation schemes differ within these countries, with varying degrees of fairness.

Perhaps the best drafted and administered statute is that of Germany. The original law dates to 1942 as a response by the Nazi government to stimulate invention in order to counter allied advances in such technologies as radar and bombsights. The present German law, enacted in 1957, has met with favour by both employees and industry, although management has at times complained of the required paperwork. An employee inventor will typically receive a royalty of between two to seven percent of the employer’s profits. As an example of the law’s efficacy, only 80 to 100 patent applications of 60.000 are arbitrated annually. During a conversation in 1985 with Dr. Genot Kaube, head arbitrator in the German Patent Office, I learned of one engineer who had received a royalty of $24 million DM ($13.000.000).

During the last 20 years, attempts in the U.S. Congress to emulate the German legislation have met with dismal failure. With virtually no lobbying efforts by engineers and scientists fearful of employer reprisal, lukewarm support from the AFL-CIO, and extreme hidebound pressure from the corporate sector, no bill has yet reached the floor of either the House or Senate. The last such effort in 1984 resulted in a congressional approval of $250,000 (reduced from a House authorized $1,000,000) to fund a National Commission on Innovation and Productivity to study the problem of employee compensation. President Reagan, approving a more expansive statute containing this funding, had the following comments:

I am disappointed that the Congress chose to include in this bill a new National Commission on Innovation and Productivity. This Commission would be established to study the productivity of inventors employed by private companies and, more generally, to make recommendations for changes in U.S. laws to better foster innovation and productivity. Employed inventors have contributed greatly to our country’s competitiveness in high technology areas. Nevertheless, I believe that the private sector rather than the Federal Government is best able to decide on methods to stimulate increased productivity on the part of employed inventors. My administration will oppose any appropriation for the National Commission on Innovation and Productivity authorized by HR 6286.

Since 1970 six federal productivity units, piloted by the Captains of Competitiveness, have studied the American innovation recession with myopically limited focus on the employed inventor. Advocacy for progressive reform has been limited to but a few patent attorneys and academics such as myself.

Veblen

Thorstein Veblen – social critic, economist, technocrat, and apostate – through his mordant pen viewed early Twentieth Century industrial America as wasteful and damnably inhuman. The resulting inequities could only be solved by a “Soviet of Technicians”, capable of running the nation as an efficient well-oiled machine. He waxed poetic in The Engineers and the Price System as he described “those one-eyed captains of industry that brought the regime of the captains (the earlier inventors and innovators) to an inglorious close, by shifting the initiative and discretion in this domain out of their hands into those of the investment bankers”.  ”…[i]f the country’s productive industry were completely organized as a systematic whole, and  were managed by  competent technicians with an eye single to maximum production of  goods and  services; instead of, as now (1919), being managed by ignorant businessmen  with an eye single to maximum profits; the resulting output of goods and  services would doubtless exceed the current output by several hundred percent” (emphasis added). Perhaps he foresaw the hordes of well paid, brash MBAs that run rampant through American industry.

Veblen felt that management was as capable of sabotage as were employees. As a remedy for corporate inefficiency, he proposed that the engineers execute a general strike:…”such a thing as a general strike of the technological specialists in industry need involve no more than a minute fraction of one percent of the  population; yet it would swiftly bring a collapse of the old order and sweep the timeworn fabric of finance and absentee sabotage into the discard for good  and all” (emphasis  added). This could very well prove an efficient means for engineers and scientists to facilitate change in the current system of administering their invention rights. Moreover, the present low patenting rates of American employee inventors may well be a direct result of employee sabotage.

Veblen’s tenet on innovation as a means for change also proves worthy of note. In The Theory of the Leisure Class he expressed a view of both conservatism and innovation: “Conservatism, being an upper-class characteristic, is decorous; innovation, being a lower-class phenomenon, is vulgar. The first and most unreflected element in that instinctive revulsion and reprobation with which we turn from all social innovators is this sense of the essential vulgarity of the thing. So that even in cases where one recognizes the substantial merits of the case for which the innovator is spokesman – as may easily happen if the evils which he seeks to remedy are sufficiently remote in point time or space or personal contact – still  one cannot but with whom it is at least distasteful to be associated, and from whose social contact one must shirk. Innovation is bad form.” (emphasis added)

Veblen’s view of the American inventor also reflects a mordant perspective as he states in The Higher Education in America: “American inventors are bold and resourceful, perhaps beyond the common run of their class elsewhere, but it has become a commonplace that American inventors habitually die poor; and one does not find them represented on the boards in question. American engineers and technologists are as good and efficient as their kind in other countries; but they do not as a class accumulate wealth enough to entitle them to sit on the directive board of any self-respecting university, nor can they claim even a moderate rank as ‘safe and sane’ men of business.”

Incentives

Schumpeter

Joseph Alois Schumpeter – conservative, dapper, and somewhat iconoclastic toward the established ec­ onomic order – theorized an economic system based on innovation, propelled by constant change. Though he would advocate comparable rewards to the technological innovator as did Veblen, the two would remain adversaries. Whereas Veblen defined the “entrepreneur” as one who merely handles the financial end of business, Schumpeter provided a more extant description in his Capitalism, Socialism, and Democracy:

We have seen that the function of entrepreneurs is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way …To undertake such new things is difficult and constitutes a distinct economic function, because they lie outside of the routine tasks which everybody understands. To act with confidence beyond the range of familiar beacons and to overcome that resistance requires aptitudes that are present in only a  small fraction of the population and  that define the entrepreneurial type as well as the entrepreneurial function. This function does not essentially consist in either inventing anything or otherwise creating the conditions which the enterprise exploits. It consists in getting things done. (emphasis added)

Schumpeter in his later years became somewhat Veblenistic when in the same work he described the modem corporate executive who had by this time become a sedentary bureaucrat similar to Veblen’s Captain of Industry:

… the modern businessman, whether entrepreneur or mere managing administrator, is of the executive type. From the logic of his position he acquires something of the psychology of the salaried employee working in a bureaucratic organization. Whether a stockholder or not, his will to fight and to hold on is not and cannot be what it was with the man who knew ownership and its responsibilities in the full-blooded sense of those words. His system of values and his conception of duty undergo a profound change.

One realizes that the end product of Schumpeter’s “Modem Corporate Executive” and Veblen’s “Captain of Industry” of a generation earlier is one and the same. To Veblen, the technocrat would guide industrial progress, while Schumpeter’s entrepreneur – who could very well be an engineer or scientist -would be the one to allow industry to be competitive.

Orkinomics

Although the German inventor compensation scheme seems fair to both employer and employee, it does not appear to be the most equitable solution to the problem. Rewarding the individual/s statutorily named as the “inventor /s”, could easily result in an imbalance of equities.  Consider the situation in which an employee invents and patents a light bulb, that at this time would cost $1,000 each to produce.  Another employee or team of employees invents a non-patentable method to reduce unit costs to $10, making wide scale production feasible. Thus, while the “inventor” may reap sizable royalties, the “innovatorIs”receive nothing under this plan.

To remedy this situation I have formulated a method, eponymously named Orkinomics, to reward all parties necessary for commercial success: the inventor, the innovator, and the employer.

• Income Tax Incentives and Royalties for Employee Inventors: A method similar to the German scheme, but allowing a portion of the employee’s royalty to be tax free would provide an equitable result for the employee. For example, if the employee received a $10,000 royalty, 20 percent of that amount would not be taxed for the first two of a possible 17 years of royalties.

• Income Tax Incentives for Employers:  This would allow the employer a tax credit in excess of the employee’s remuneration. For example, if the employer paid a $10,000 royalty, it could deduct $12,000 from its income taxes. Thus, there would be an incentive for the corporation not to attempt to lessen the amount due the inventor.

• Bonuses and Tax Incentives for the Innovators: The employer would pay a bonus to the innovators in the above example, and would also receive a tax advantage for this payment.  The statute would require a strict definition of “innovator’” so that in a true Schumpeterian fashion the proper individuals would receive compensation.

Orkinomics would reward all the sources of innovation, and only for those products that are commercially successful. One must compare this scheme to the present research and development tax credits described in the next section to determine the efficacy of both.

Captains of Competitiveness

During the last decade one of the major responses of the executive and legislative branches, in coordination with the Captains of Competitiveness, to stimulate American productivity was a 25% (now 20%) tax credit for increases in research and  development expenditures. Thus, if a firm had R&D expenditures of $1 million and increased this to $2 million the next year, it could deduct the $2 million from its income taxes and receive an additional $250,000 for the increase.  The result of this gov­ ernmental grant to industry proved a boondoggle at the expense of the American taxpayer.  Without strict controls on who was entitled to the credit, more than half of all businesses taking the credit were  non-manufacturing  firms  - including stockbrokers, fast food restaurants, hairdressers, banks, and movie producers.  Unfortunately, the sizable increases reported in manufacturing R&D was also a result of corporate “creative accounting” – the shuffling of resources to now magically be research and development. The present tax credits reward accounting and finance, whereas Orkinomics would reward true innovation.

We must ask ourselves whether these are types of rewards we as a nation wish to grant. Does this largess truly represent a stimulus to competitiveness? These Captains of Competitiveness have proposed that America will be competitive when our national savings rate increases, when our chidl­ ren  are better educated, when our R&D expenditures are increased, when engineering and science is given greater emphasis, and when we have an industrial policy that selects winners and losers. Yet we have lost sight of rewarding our current technologists who are needed to produce competitive products.

Commentary

In retrospect, Veblen misunderstood the engineering psyche. Most of these technologists have always been, and remain staunchly conservative, hoping only to maintain their middle class social status in an atmosphere of employment insecurity. That engineers would execute a general strike to take the reins of industry seems as likely as President Bush joining the Industrial Workers of the World. Schumpeter’s policies toward the innovator have also met with little more than euphemistic lip service from business and governmental leaders more interested in gaining status as Captains of Competitiveness. Can America attract its brightest young people into engineering and science when remuneration is greater in other fields that merely recirculate our steadily depleting resources? Can these Captains of Competitiveness lead our nation from its present technological malaise? Would Veblen and Schumpeter agree with these gurus who emanate from both the left and right? Let the reader and history be the judges.

© Neal Orkin 1990. The author is a Retired Associate Professor of Legal Studies at Drexel University in Philadelphia, where he taught courses in IP and Labour & Employment Law. He has published extensively on the rights of employee inventors since 1974.

* The views expressed in this article are exclusively those of Professor Neal Orkin.