Rewards versus intellectual property rights when commitment is limited

This paper compares the performance of a variety of innovation policy instruments when the government cannot commit to transfer cash rewards to an innovator and has the option to divert resources to alternative investments. In a dynamic environment in which government’s investment opportunities evolve stochastically, we provide conditions under which the optimal mechanism is a price regulation system where the inventor owns intellectual property and receives a cash transfer when price equals marginal cost. We illustrate how a dynamic complementarity between cash rewards and intellectual property may arises when the government’s budget is limited and monopoly distortions are not too severe. We discuss how other forms of complementarity between cash transfers and intellectual property may emerge, with patent rights serving as a discipline device that ensures the payment of the reward.