Patent Valuation under Fragile Institutional Enforcement: A Continuous-Time Markov Approach

We build a tractable model that links institutional dynamics with the private value of innovation. Our approach differs from much of the existing literature in that an inventor does not retain a perpetual monopoly over its use, and the cash flows generated from a new idea are uncertain. In our framework the relevant dimension of institutional quality is enforcement strength. We model institutional strength as a two-state continuous-time Markov chain. This makes the cash flows from innovation stochastic and state-dependent, and hence the incentive to innovate varies with the strength of enforcement regime. Countries alternate between periods of strong and weak enforce-ment, reflecting irregular political and legal events such as reforms, leadership changes, or crises. Our model shows how institutional fragility can alter the incentive to innovate and connects institutional dynamics with cross-country differences in standard of living.