This paper assesses the importance of intellectual property (IP) for innovation and welfare in the context of a model of industry dynamics where innovations are generated by financially constrained entrepreneurs. The increase in IP protection and the development of alternatives for the financing of high-tech start-ups (most notably, venture capital) are in the list of factors that may have facilitated the unprecedented prosperity of innovative entrepreneurial activities since the early 1990s, which also includes the opportunities and technological changes associated with the information technology (IT) revolution, the reduction in setup costs and other barriers to the creation and development of new firms, and the emergence of a new “entrepreneurial culture” that has increased the social recognition and other rents associated with being and succeeding as an entrepreneur.

Regarding IP protection, it is commonly understood that, in the United States, the creation of a unique Court of Appeals of the Federal Circuit in 1982 strengthened the position of patent holders against potential infringers. Other legislative changes, such as the 1984’s Semiconductors Act or the extension of patent duration to 20 years, has contributed to this increase in protection. However, there is considerable empirical and theoretical controversy on whether these reforms actually promote innovation. Some quantitative assessments based on US data conclude that higher protection would induce more innovation (Denicol`o (2007)), while others suggest that the greater protection brought about by recent reforms may have actually reduced innovation (Levin et al. (1985), Hall and Ziedonis (2001)). Practitioners express their doubts regarding the role of IP protection by referring to issues such as the “tragedy of the anti-commons” that deems strategic patenting and patent stacking as obstacles to innovation (Heller and Eisenberg (1998)). At a theoretical level, advice against excessive IP protection can be found in papers such as Boldrin and Levine (2002), Hunt (2004) or Bessen and Maskin (2006). None of these papers, however, makes explicit reference to the innovators’ financing problem and the direction in which financial constraints might change their normative prescriptions.