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Article posted Aug 02 2010, 2:01 PM Category: Commentary Source: Stephan Kinsella Print

Leveraging IP

by Stephan Kinsella, Mises Economics Blog

Watch Importation, Copyright, and the First-Sale Doctrine

The "Omega Seamaster Ploprof 1200m" wristwatch.

In Cutting edges, blogger Peter Gordon relates a fascinating case where Swiss watchmaker Omega found a brilliantly evil trick using IP law to crack down on innocent market activity. Omega
sells its watches for far less money in some countries than in others, a common enough practice known to economists as “geographical price discrimination.” The U.S. market will generally bear more than the market in a Latin American republic, and so Omega offers its goods to distributors in places such as Paraguay for less than it does to American distributors.
The difference in prices creates “a tempting arbitrage opportunity in importing Omega watches from Paraguay to the U.S. It is just such watches that Costco bought from a stateside importer, allowing the warehouse store to offer an Omega Seamaster for $1,299 when the brand preferred them sold in the U.S. for $1,999.”

Omega doesn’t like this. However, they “couldn’t complain that Costco was peddling fakes--the watches were authentic goods.” And there was not trademark infringement either since the goods were genuine. So what they did was find a way to use copyright. “They fashioned a small globe logo and copyrighted the device in the U.S.” Then they sued Costco for copyright infringement–using Omega’s copyright without its permission. One would think the copyright law “First Sale Doctrine” would not permit this cause of action. The idea is that when the owner of a copyright sells a copy to a buyer, the buyer is free to resell that particular copy. The seller is said to have “exhausted” his rights in the copyright in the first sale. The buyer cannot make extra copies, but he can re-sell his copy. This is why the used book sales do not infringe the author or publisher’s copyright. But, “[t]he appeals judges decided that, since the first sale of the Omega watches in question happened outside of the U.S., America’s first-sale doctrine doesn’t apply.”

As the post observes, this is
is a small technicality that, in a global economy, could have large implications. … Constrain the first-sale doctrine and you throw a wrench into the business of used-book stores, garage sales (including the electronic garage sale that is eBay), and any and every sort of secondhand shop. And yes, even public libraries might find themselves facing the challenge of figuring out which books on the stacks were first sold in the U.S., and which were first sold abroad.
This is just an example of how IP law is insidious because it can leech into other areas of law that are not protected by copyright. Here, Omega used copyright to stop otherwise legal price arbitrage.

Printer Cartridge Patents

Other examples abound.

For example, it’s well known that Hewlett-Packard (HP) makes more money selling replacement ink cartridges for its printers, than on the printers themselves. You might say they sell printers so that they can then sell cartridges to the users. But how to prevent third parties from making cheaper or competing cartridges compatible with HP printers? Just put some kind of mechanism in the printer that requires a special mating circuit in the cartridge before the printer will function with the cartridge–and then patent the mating circuit. Even if competitors could duplicate the mating circuit so that the generic cartridge would work with the printer, this would infringe HP’s patent in the mating circuit in the cartridge. A superfluous, extra complication is added to the printer and cartridges on purpose just so that they can be patented, to prevent competition. (See HP settles inkjet cartridge patent complaints; HP sues four ink cartridge companies.) Without the mercantilist protection afforded by patent law, HP would be unable to use the law to stop owners of HP printers from buying cheaper cartridges from third parties, any more than Ford can prevent a Mustang owner from using whatever brand of gasoline he prefers. This, of course, allows a monopoly price to be charged for HP cartridges, thus gouging the consumer.

Drug Reimportation

Another example of how patent threatens free trade is found in the drug reimportation controversy. I discuss this in some posts collected at Drug Reimportation, in particular Cato on Drug Reimportation. Here’s what happens. Pharmaceutical companies charge exorbitant prices for drugs, because of the patent monopoly and also because of various FDA “exclusivity” monopolies given to them. When they sell these drugs in other countries, these governments often impose price controls. (Now normally we libertarians oppose price controls, but perhaps a limited case for them can be made in these cases–see my post Patents, Prescription Drugs, and Price Controls. But this is not relevant here.) The point is Big Pharma sells its patented drugs in Canada at a reduced price compared to sales in the US market, but obviously still at a profit. This gives rise to arbitrage opportunities, as in the Omega watch case–leading to drugs being imported into the US from Canada and sold at a cheaper price. As with copyright, the analogous “patent exhaustion” doctrine prevents the seller from claiming patent infringement: they already sold the patented pills to some buyer in Canada, so can’t claim patent infringement. “Luckily” for Big Pharma, the FDA blocks the reimportation for various made-up reasons such as consumer safety, etc. So, in 2003, a bill, H.R. 2427, was introduced in Congress, “The Pharmaceutical Market Access Act of 2003,” to force the FDA to allow so-called drug reimportation. Of course, Big Pharma fought it tooth and nail–as did, sadly, some free market advocates, primarily because of their false belief that patent rights are a legitimate type of property right. Sadly, the bill didn’t pass.

Ironically, one stated purpose of the proposed federal law was to “To reverse the perverse economics of the American pharmaceutical markets.” Ironic because the “perverse economics” comes from other federal law: patent law, the FDA, and other laws such as taxes and regulations which make things more expensive in general. A better approach would have been to repeal patent law and abolish the FDA, thus solving the problem in one stroke. Of course, Big Pharma, and pro-IP libertarians (even if they are, thankfully, a dwindling breed), would strenuously oppose patent abolition.

Trademark and Fashion

In addition to patent and copyright, trademark can also be leveraged for anticompetitive purposes. As mentioned in Johanna Blakley: Lessons from fashion's free culture, there is little IP protection in the fashion industry, which thrives despite–probably because of–this. Knockoffs of others’ fashion designs are rampant and legal. This is one reason some designers work their trademark itself into the very design of items such as purses and even some clothing. Then, a knockoff of such an item is a trademark infringement, and the designer can now sue the copier. So here we have trademark law being used to thwart otherwise-legal competition in the fashion industry.

This is also an example of how IP law–in this case, trademark law–distorts the economy and the market: who knows if this bizarre phenomenon of the trademark of the designer being plastered all over and integrated into the very appearance and style of the designer’s products would have ever arisen, absent trademark law.

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