This paper examines the role of business method patents in the context of the broader literature on the subject: theories of patents, empirical evidence, and policy implications. It offers a nice review of recent developments in this area.

In the U.S., small numbers of patents have been granted on business methods since the mid-nineteenth century. However, it was long believed that statutory restrictions excluded such practices as valid subjects for patents. Then, in 1998, in the famous case of State Street Bank and Trust v. Signature Financial Corporation,* the Court of Appeals for the Federal Circuit decided, as the opinion put it, to “lay this ill-conceived exception to rest.” As Hall documents, a flood of business method patents soon followed.

To explore the impact of this development, Hall reviews both the theoretical and the more recent empirical literature on the effect of patents. Theory holds that patents have both positive and negative effects on innovation and competition. Patents create incentives for firms to invest in R&D and they may encourage the disclosure of inventions, but they also raise transaction costs for follow-on innovation, which creates a trade-off. In terms of competition, patents may encourage the entry of small firms by facilitating venture financing, but they also impose monopolies, which may become long-term monopolies in industries where standards are important. In the end, theory alone cannot inform us whether the wholesale extension of patent coverage to business methods is socially beneficial or not; we must turn to the empirical evidence.

Despite the frequency with which patents have been declared essential to innovation, Hall finds the empirical evidence that would support such a claim remarkably limited. She concludes: “First, introducing or strengthening a patent system (lengthening the patent term, broadening subject matter coverage, etc.) unambiguously results in an increase in patenting and in the strategic uses of patents. It is much less clear that these changes result in an increase in innovative activity, although they may redirect such activity toward things that are patentable and/or are not subject to being kept secret within the firm. If there is an increase in innovation due to patents, it is likely to be centered in the pharmaceutical and biotechnology areas, and possibly specialty chemicals. Patents in these areas are relatively easy to define, because they are based on molecular formulas, and therefore also relatively easy to enforce.” She also notes that the patent system may affect the organization of an industry.

Given ambiguous results on the role of patents in both theory and practice, Hall is reluctant to draw strong conclusions about the role of business method patents in general. Instead, she focuses on one related issue—the “quality” of these patents, meaning the standards for novelty and non-obviousness used to examine patent applications. Hall finds a widespread agreement in the literature that the courts and patent office have reduced these standards, especially for software and business method patents. Hence, even if business method patents are not a problem in and of themselves, low standards for such patents may still have negative effects.

The policy literature recommends a variety of solutions, including some calls to reinstate the rules that excluded software and business methods as valid subjects of patents. Hall also discusses the use of a European-style opposition system, where patent grants may be challenged in an administrative hearing, which would allow competitors to present prior art that the patent office may have overlooked (See Post-Issue Patent “Quality Control”: A Comparative Study of US Patent Re-examinations and European Patent Oppositions ). Hall suggests that it may be too late to reinstate the related subject matter exclusion for software patents, but that the subject matter exclusion for business method patents may be necessary if the U.S. patent system is to be in harmony with the rest of the world.

* This case concerned a patent for a method for calculating the asset value of multiple mutual funds by multiplying a matrix of fund stock holdings by a vector of stock prices.