Intellectual property rights (IPR) are legal entitlements granted by governments within their respective sovereignties that provide patent, trademark, and copyright owners the exclusive right to exploit their intellectual property (IP) for a certain period. The basic rationale for IPR protection is to provide an incentive for innovation by granting IP owners an opportunity to recover their costs of research and development.
While many countries have some form of IPR protection, the degree to which IPR is protected varies greatly. For economists, IPR protection represents a tradeoff between the benefits of innovation and the costs of exclusivity. Property rights encourage the development of new technologies, products, music, and other creative output. Exclusivity, however, protects IP owners from competition and, in some cases, can grant monopoly power. For this reason, IPR protection is always limited in either the length or scope of protection. After expiration, for example, the knowledge embodied by a patent enters the public domain.
The U.S. has a relatively well-defined IPR policy that is enforced and protected by its applicable laws. However, this is not the case for many of its trading partners around the world. In particular, developing countries often lack any substantial IPR protection. In a recent report, the Organization for Economic Co-operation and Development (OECD) estimated that "international trade in counterfeit and pirated goods could account for up to US$200 billion in 2005." (OECD 2007) This amount does not include any counterfeit products produced and consumed in the same country or counterfeit digital products sold over the Internet. Consequently, the U.S. and other developed countries have called on other, often less-developed, nations to adopt IPR protection or increase its current protection in order to stop counterfeiting and piracy.
Countries with weak IPR protection, however, stand to realize an immediate benefit to lower-priced products or technologies. Cheaper DVDs, access to AIDS drugs, or other types of imitation can represent increases in consumer welfare when compared to the higher prices that would prevail with stronger IPR protection. In addition to the potential benefits to consumers, existing commercial operations in developing countries may already be set up and may be significant contributors to a country’s economic growth. Countries with weak IPR protection must therefore weigh these gains with the loss of international incentives to invest resources or develop products, as well as reduced innovative output within the country.
The net economic impact on less-developed nations from implementing and protecting IPR is not clear. Some have argued that increasing IPR protection will improve economic growth and welfare in less-developed nations, and others claim it will be of no help or even a detriment, thereby decreasing overall welfare.
In this paper, we review economic research investigating the impact of IPR protection on less-developed countries with regard to the primary measures of economic well-being—economic growth, technological innovation, and welfare—as well as foreign direct investment and international trade. The literature reflects that under some circumstances and model assumptions IPR protection has a positive effect for some countries, while under other circumstances it has a negative effect. The lack of any uniform result may suggest that a case-by-case analysis must be performed to determine how IPR protection will affect a country’s economic growth and welfare.
II. Review of Relevant Literature
The economic literature on the relationship between IPR protection and economic development falls into two broad strands—one theoretical and one empirical. The theoretical literature focuses on identifying the potential avenues by which a developing country’s IPR protection regime affects economic welfare. Economic welfare is typically defined as the sum of consumer and producer surplus (i.e., the combined net benefits to consumers and industry). The empirical literature attempts to quantify the effect of IPR protection on various measures of economic performance, such as gross domestic product (GDP) growth, total factor productivity (TFP), foreign direct investment (FDI), innovation, and international trade.
The theoretical literature considers the costs and benefits of introducing or increasing IPR protection. Among the potential costs of this type of policy are decreased revenues in industries that rely on imitating the products of developed nations and the associated increases in the prices of protected goods. The potential benefits include increases in FDI, foreign technology transfer, local innovation, and research and development (R&D). The fundamental questions asked in the theoretical literature are whether these costs and benefits are in fact present, and, more importantly, what the net effect of increased IPR protection is on economic growth and consumer welfare. Following are the findings of nine theoretical papers that examine these aspects of the relationship between IPR protection and economic welfare and growth in developing nations.
Some of the theoretical literature considers a stylized world with a technologically developed "North" and a less technologically developed "South." These models are based on the premise set forth in Chin and Grossman (1988) where the North innovates and the South imitates the Northern technologies. The main finding of Chin and Grossman (1988) was that a persistent tension exists between the North and the South—while the North innovates, the South chooses low levels of IPR protection because it benefits from the innovative output of the North. Whereas these models may capture the dichotomous incentives between the North and the South in the short run, they may ignore other dynamic incentives of the South to increase IPR protection in the long run. For instance, increasing IPR protection in the South can prompt innovation in the South, thereby increasing investment in R&D and thus possibly positively contributing to economic growth.
Studying the effects of tighter IPR protection in a less technologically developed South on welfare in both the North and the South, Diwan and Rodrik (1991) found that net-innovation-consuming countries (the South) were only motivated to safeguard IPR if the type of innovation demanded was different from the type demanded in the net-innovation-producing countries (the North). Their model, a theoretical model of trade and technology transfer, was based on the premises of Chin and Grossman (1988)—in particular, the fact that the South had strong incentives to free ride at the North’s expense. Diwan and Rodrik arrived at their main conclusion by noting that demand for innovation in the South differed from that of the North. They used the example that the North might prefer to develop drugs for cancer and heart disease, while the South might prefer drugs to fight tropical diseases like malaria. The greater the difference between the type of innovation demanded by the South and that demanded by the North, the more incentive the South had to increase its IPR protection, which induced greater innovation by the North focused toward the South’s needs.
Diwan and Rodrik noted two other specific conclusions related to determining the right level of IPR protection for developed and less-developed nations. The first was that if the South were given a greater weight in the welfare calculation, overall welfare could be maximized by setting greater IPR protection in the North than in the South. Diwan and Rodrik found that differential weights could be justified using the assumption that increasing welfare in less-developed countries was more important than increasing welfare in developed countries. The second was that, as the market size in the South increased, both the South and the North would choose to reduce IPR protection. This counterintuitive result comes from modeling how the North and the South set their optimal levels of IPR protection in a Nash Equilibrium.1 As the size of the market in the South increases, the scope of innovation increases beyond the optimal level, and the North will reduce its level of IPR protection. At the same time, the larger the Southern market, the greater its incentives are to free ride, all else being equal. The South will then have an incentive to reduce its IPR protection. Diwan and Rodrik differed from Chin and Grossman (1988) in that they assumed that the two regions had varying needs and tastes. This difference in assumptions challenged the result that free riding by less-developed countries increased their welfare.
Helpman (1993) evaluated the effect of tighter IPR protection in the South on welfare in the South and the North. He based his study on the premise that weak IPR laws in the South reduced innovation in the North, which in turn reduced the benefits from innovation in both regions. Helpman’s study commenced with a model that had a constant (and exogenous) rate of innovation. Helpman found that two factors affect welfare. First, strengthening IPR protection in the South shifted the terms of trade in favor of developed countries, making the South worse off. Second, production resources moved from the low-wage South to the high-wage North, which made both regions worse off. In Helpman’s initial model, the South was always worse off, while the effects on the North were ambiguous. The key factor in Helpman’s model was the rate of imitation by the South—the higher the rate of imitation, the more valuable IPR protection became to the North.
Helpman then made two additions to his initial model. First, he assumed that innovation was endogenous, which simply implied that as IPR protection increased in the South, the rate of innovation in the North increased. In this context, Helpman found that while the rate of innovation in the North initially increased in response to tighter IPR protection in the South, it eventually fell. This was because increased protection augmented the availability of products in the short run, but decreased it in the long run. Trading the temporary increase in innovation with this long-run effect, the net effect was a decrease in the availability of products, hurting both regions with regard to this factor. Thus, Helpman concluded that even with this change in the model, tighter IPR protection in the South decreased welfare in the South and still yielded ambiguous results for the North.
Second, Helpman included FDI in his model, which assumed that a Northern company could establish a manufacturing subsidiary in the South, taking advantage of relatively low wage rates. Helpman acknowledged that this model greatly oversimplified the role of FDI. As before, even with this additional assumption, Helpman found that an increase in IPR protection in the South only benefited the North, although the model yielded one new finding. Without FDI, an increase in IPR protection in the South lowered welfare in Northern countries with low levels of imitation. With FDI and low levels of imitation in the South, this result was reversed—increased IPR protection raised welfare in the North. In all of his models, Helpman found that strengthening Southern IPR protection did not benefit the South, but produced ambiguous results in the North. This result was different from other papers (e.g., Chin and Grossman 1988) in that, for low levels of imitation, the incentives of the two regions could be aligned. That is, weaker IPR protection in the South can benefit the South and the North.
Lai (1998) compared the long-term effects of IPR protection on the rate of product innovation, assuming that international production transfer took place through imitation or FDI. Lai modified previous models from Grossman and Helpman (1991) and Helpman (1993) and relaxed the assumption that the South could only acquire new technology by imitating products produced in the North. Rather, Lai assumed that Northern firms undertook FDI in the South—a process he called "multinationalization," and he assumed that, in the multinationalization regime, Southern firms imitated only after Northern firms transferred production to the South. Lai’s treatment of FDI differed from Helpman’s in that it assumed the rate of innovation to be endogenous.
Using his revised model, Lai found that the effects of tighter IPR protection in the South crucially depended on whether imitation or multinationalization was the channel of international production transfer from the North to the South. If imitation was the channel of production transfer, stronger IPR protection lowered the rate of innovation, rate of production transfer, and wages in the South relative to the North. Under this scenario, stronger IPR protection in the South had two counteracting effects. First, it lowered the rate of imitation, thus prolonging the expected duration of monopoly for the Northern innovators, which raised the returns to innovation. Second, the prolonged duration of monopoly for the Northern firms also increased the demand for Northern labor and Northern wages. This raised the cost of innovation, thus lowering the return to innovation. Lai showed that the second effect dominated the first, and therefore the rate of innovation declined. Conversely, if multinationalization was the channel of production transfer, strengthening IPR protection had the opposite effect. Under this scenario, Northern firms moved production to the South using FDI. This process had two effects on Northern firms: (1) they could take advantage of the lower wage in the South; and, (2) they faced a higher probability that they would lose their monopolies to imitators in the South. In addition, stronger IPR protection in the South increased the rate of innovation in two stages. First, it increased the expected lives of the monopolies. However, because the resulting increase in the demand for labor took place entirely in the South, the return to innovation rose without a corresponding rise in cost. Second, since the return to multinationalization increased, firms moved more quickly to the South, increasing the return to innovation further. Lai further showed that the latter effects held even when both imitation and multinationalization coexisted, as long as the rate of multinationalization was sufficiently large.
Markusen (1998) studied a specific aspect of the correlation between IPR protection and growth. The previous literature in this area primarily considered the effects of IPR protection on equilibrium rates of innovation in the North, imitation rates in the South, and welfare in the South. Markusen took a slightly different, but complementary, approach and examined strategic behavior at the firm level. Specifically, Markusen examined the effects of contract enforcement and IPR protection on the flow of FDI and host-country (the South) welfare. In his model, a "multinational" firm hired a local manager in the host country. The local manager learned the necessary technology in order to produce the good in the first period of a two-period product cycle. The local manager had the option to defect and to start a rival firm in the second period. The multinational was able to similarly dismiss the manager at the beginning of the second period and hire a new manager. The ability of the multinational to fire the manager was crucial to some of the interesting results in this paper. This assumption also appears unique to this paper.
The results from this study showed that both multinational profits and host-country welfare were improved by the institution of contract enforcement if it led to a mode shift such that the multinational firm started producing in the host country instead of exporting to that country. Exports dissipated rents and resulted in a higher product price in the host country.2 Domestic production, on the other hand, resulted in a consumer surplus gain and could result in rent capture by the local manager. Contract enforcement, however, led to either no change or to a fall in the host-country welfare if the multinational established a subsidiary prior to the policy change. In the latter case, there was a rent transfer from the local manager to the multinational, the scenario feared by many developing countries.
Yang and Maskus (2001) analyzed the effects of IPR protection in the South on the incentives of firms in the North to innovate and to license state-of-the-art technologies to the South. They found that the previous literature had focused on technology transfer, imitation, and FDI as sources through which the South could gain access to the North’s advanced technology. Licensing had been largely ignored. The authors focused on licensing as the means by which the South obtained advanced technology. They considered licensing important for a number of reasons. First, in some situations, imitation was sufficiently difficult such that it was not profitable. Second, government policies in some technology-importing countries supported licensing rather than equity investment as the mode of technology transfer. In this model, the Northern innovative firm first selected the intensity of effort it would devote to innovation. Once the innovative effort was successful, the firm decided whether to license it. Results from this model showed that stronger IPR protection in the South generated a higher rate of innovation in the North and a higher rate of licensing in the South.
The intuition for the above results is as follows. First, as licensing costs decrease, economic returns to innovation, and therefore licensing, increases as well, providing firms more incentive to license and innovate. Second, at a given level of licensing costs, stronger IPR protection in the South enhances a licensor’s share of licensing rents, thereby encouraging licensing and innovation. Third, since licensing requires fewer resources, more labor becomes free for innovation in the North. Furthermore, when more production is transferred to the South, additional resources are freed in the North for innovation. However, Yang and Maskus found that stronger IPR protection had an ambiguous effect on the relative wages of the regions. If stronger IPR protection led to substantial technology transfer, the Southern relative wage rose. If a small amount of production moved, the Southern relative wage fell.
Starting with the general model from Grossman and Helpman (1991), Glass and Saggi (2002) constructed an oligopoly model that examined the relationship between increased IPR protection in the South on innovation, imitation, and FDI. An important contribution of this paper was that it developed a product-cycle model in which innovation, imitation, and FDI were all endogenous. Glass and Saggi found that stronger IPR protection resulted in an increase in the cost of production because of stricter uniqueness requirements. This, in turn, provided increased IPR protection for multinational Northern firms. However, it also provided increased protection for firms operating only in the North. Thus, stronger IPR protection did not alter the expected profit stream for a multinational Northern firm relative to a pure Northern firm. Consequently, Glass and Saggi concluded that even though stronger IPR provided more protection, it did not generate any additional incentives for FDI.
Furthermore, Glass and Saggi argued that by making imitation more costly, stronger IPR protection forced the South to spend more resources for a given probability of imitation success, leaving fewer resources for production. This caused FDI to contract—a resource wasting effect that acted as a reduction in the Southern labor supply. As resources were drawn into production in the North due to less FDI, fewer resources remained for innovation, causing innovation to contract as well. There was also an imitation disincentive effect that acted like a tax on imitation by making imitation more costly. The imitation disincentive effect and the resource wasting effect reinforced each other to reduce FDI and innovation. Thus, Glass and Saggi predicted that strengthening Southern IPR protection would cause a decrease in FDI and innovation.
Expanding on his previous work, Lai and Qiu (2003) reexamined the long-term effects of IPR protection. In this paper, they assumed that both the North and the South had innovative capabilities. Previous papers, including Lai (1998), Chin and Grossman (1990), Deardorff (1992), Diwan and Rodrik (1991), and Helpman (1993), all assumed no innovative capabilities in the South. Based on their modified model, Lai and Qiu concluded that increasing IPR protection in the South had a negative welfare effect in the South and a positive effect in the North. However, they also found that unlike Lai’s previous result, the global net effect on welfare was positive. He concluded that in order to align the incentives of a stronger IPR protection regime in the South, the benefiting North must compensate the South with measures such as lower trade barriers for imports of traditional goods from the South.
Grossman and Lai (2004) studied the impact of harmonization of IPR between the North and the South. They found that stronger IPR protection tended to be efficient (i.e., welfare maximizing) in countries with larger markets for innovative products and relatively strong human capital endowment. Consequently, they argued that national policy should be the result of a country’s characteristics rather than a global harmonized policy. Furthermore, harmonized IPR tended to benefit the North but had the potential to harm the South.
Much like the theoretical literature, the empirical literature we reviewed examines this all-important international trade question, seeking to validate and expand on the theoretical models. In the following, we present a review of ten such studies. In these studies, the authors seek the answers to many issues regarding IPR protection such as: Are high-technology imports relevant in explaining domestic innovation in both developed and developing countries? Does IPR protection affect the innovation rate, and, if it does, is it more significant for developed countries? What is the relationship between FDI and IPR?
Gould and Gruben (1996) examined the relationship between IPR and economic growth. They used a benchmark growth model—a regression of per-capita GDP growth for 95 countries on a standard set of variables from 1960, including GDP per capita (since growth rates may depend on the beginning level of GDP), physical capital savings, and secondary school enrollment rates (a proxy for human capital savings). For the strength of IPR protection, they used a measure of patent protection developed by Rapp and Rozek (1990) that scores countries on a range from one to six, with one being no IPR protection and six being consistent with U.S. law. Gould and Gruben noted that this measure was positively correlated with economic growth. Adding this measure of patent protection to their benchmark model, they found a positive but not significant relationship. After using instrumental variables to correct for possible measurement errors and endogeneity issues, this relationship became significant; that is, increased IPR protection yielded increased economic growth.
Gould and Gruben then examined the correlation between IPR protection and whether the country had a relatively open or closed trade regime. They tested three measures of trade openness: black-market exchange rate premiums, real exchange rate distortions, and a composite trade regime index. They generally found a negative but insignificant effect. While this suggested that a differential effect did not exist for closed trade regimes, controlling for this factor (closed economy interacting with IPR) increased the effect of IPR protection on the growth of open regimes. For one specification in which the interaction between IPR protection and closed trade was significant, the results suggested that IPR protection had a smaller effect in closed regimes than in open ones. This specification implied that an open-trade country with a moderate level of IPR protection would grow about 1.4 percent faster than a closed economy with the same level of patent protection.
Lee and Mansfield (1996) studied the degree to which firms’ perceptions of a country’s patent protection regime affected their investment strategies. The authors answered two questions: Did weak IPR protection lower a U.S. firm’s FDI in a country? Did weak IPR protection make it more likely that U.S. companies would only transfer older or less-effective technologies? Lee and Mansfield surveyed 94 U.S. firms about their perception of 14 developing countries and analyzed the resulting data using two regression models. The results of these regressions revealed that patent protection made it more likely that firms would increase their investments in foreign countries. The specification of the second regression suggested that IPR affected firms’ investments differentially, protecting new or more effective technologies that were more highly valued by the firm. This suggested that as countries increased their IPR protection there would be a gradual shift of technologies to the developing countries. Lee and Mansfield also stated that passage of stronger patent laws alone might not result in higher investment because a country’s cultural and legal framework could be important determinants of whether new laws were likely to have their intended effect. If a change in the law does not translate into stronger enforcement, U.S. firms’ perceptions of IPR protection will be unlikely to change and their incentives to invest in the country will not increase.
Park and Ginarte (1997) created an IPR index for a panel of 60 countries from 1960–1990 and estimated a system of equations to identify the effect of IPR protection and other national characteristics on economic growth. The authors simultaneously estimated the effect of IPR protection directly on the factors that drive growth, such as R&D activity, investment, and education. Park and Ginarte’s paper differed from previous research in that the authors constructed their own quantitative index of IPR protection, which incorporated five measures related to national patent laws: (1) the extent of coverage (types of inventions), (2) membership in international agreements, (3) provisions for loss protection, (4) enforcement mechanisms, and (5) duration of IPR protection. Previous studies (Gould and Gruben 1996) had used measures of IPR protection, such as that developed by Rapp and Rozek (1990), which exhibited less variability and therefore had potentially less explanatory power. Other studies had evaluated the link between property rights generally and economic growth (Tortensson 1994, Svensson 1998, Sachs-Warner 1995), but had not isolated IPR protection.
Park and Ginarte found that a broader measure of market freedom (which included property rights related to land, wealth, and earnings) did contribute positively to economic growth, while IPR protection separately did not. However, they found that IPR protection was a significant determinant of both physical capital accumulation (investment) and R&D capital accumulation, even after controlling for general market freedom. Thus, they concluded that IPR protection could affect growth through the encouragement of capital accumulation, both tangible and intangible. Park and Ginarte uncovered an interesting result when splitting the sample by level of development. They found that the benefit of IPR protection with respect to investment and R&D occurred only in the top 30 economies. The effect was not statistically significant in less-developed nations. They concluded that this was likely because R&D in developing countries was largely imitative—as opposed to innovative—and therefore nonresponsive to IPR protection.
Park and Ginarte identified several implications of their findings. First, they noted that their findings provided an explanation for why IPR protection became increasingly important for countries as they developed: there is little benefit to IPR protection when those benefits accrue to firms located outside the home country. However, the authors also noted the interdependence of IPR protection and research activity. Expanding the research base in developing countries gave those countries an incentive to develop IPR protection, which then benefited both domestic and foreign firms.
Thompson and Rushing (1999) examined the factors influencing a country’s level of patent protection. In their analysis, they tested the effects of free trade openness, R&D infrastructure, political stability, and educational attainment on the level of patent protection (measured by the Rapp and Rozek index). Estimating a system of three equations (GDP growth rate, TFP, and patent protection), they found that stronger patent protection and enforcement had a positive and significant effect on the growth of TFP, a measure of the technological improvements in the productivity of labor and capital over time, and therefore on the level of output for a given level of capital and labor.
In determining the effects of patent protection on TFP, Thompson and Rushing found a positive and significant effect for countries with GDP per capita greater than US$4,000 (in 1985 dollars), but a negative and insignificant effect for countries with GDP per capita less than US$4,000. Thompson and Rushing also found a positive correlation between the likelihood of stronger IPR protection and the relative openness of an economy. Similarly, countries without active R&D were unlikely to pursue IPR protection, although the authors did not measure R&D activity directly. Instead, they used per capita GDP as a proxy for this hypothesis. The result was statistically significant (again) only for countries with per capita GDP above US$4,000. Thompson and Rushing concluded that countries without a significant R&D infrastructure (low-income countries) were less likely to increase IPR protection. Their study found no correlation between the likelihood of adopting increased patent protection and political instability. However, as expected, low-income countries with low educational attainment did not have high levels of IPR protection. This study was consistent with the findings of Gould and Gruben (1996) in that countries with open trade policies had higher levels of IPR protection. Interestingly, Thompson and Rushing rejected their own hypothesis from a previous paper (1996) that found political instability affected patent protection rights in a developing country. Finally, the US$4,000 threshold per capita GDP level was consistent with the authors’ previous study (1996) in which they found that the effects of stronger IPR protection began to occur at a level of $3,400 in GDP per capita (in 1980 dollars).
Braga and Fink (2000) reviewed and discussed previous research on the effects of IPR protection on trade, FDI, technology licensing, and international transfer of knowledge. On the relationship of IPR protection with trade, research results from Ferrantino (1993), Maskus and Penubarti (1995), Braga and Fink (1997), and Fink and Braga (1999) indicated that IPR protection had a positive influence on overall trade flows. In addition, Fink and Braga (1999) found this positive link to be very weak in high-technology products, which confirmed Maskus and Penubarti’s (1995) result that the most patent-sensitive industries, on average, were unaffected by the IPR protection. On the relationship of IPR protection with FDI, a few research studies based on survey data collected from U.S. manufacturing firms, including Mansfield (1994), Frischtak (1993), and Lee and Mansfield (1996), inferred a positive IPR protection-FDI link. However, more recent regression analyses based on research by Ferrantino (1993) and Fink (1997) found no significant link between IPR protection and FDI. The reason for the difference in results, according to the authors, is that the research using the survey data overstates the influence on FDI that can be directly attributed to IPR protection, since the surveyed IPR protection index implicitly includes firms’ perceptions about other factors influencing FDI, such as the presence of potential imitators. On the relationship of IPR protection with technology licensing, both Mansfield (1994) and Fink (1997) found the link to be weakly positive. On the relationship of IPR protection with knowledge transfer, the authors pointed out that only limited anecdotal evidence was available for this topic and opined that the overall usefulness of IPR protection in transferring knowledge to developing countries was controversial. If knowledge is excludable without legal protection, IPR protection titles define legal instruments on which to base the transfer of technologies and IPR protection may reduce the risk to foreign titleholders of losing proprietary knowledge after it has been transferred. Regarding the relationship of IPR protection and economic growth, Braga and Fink briefly reviewed Helpman’s (1993) theoretical work and mentioned that very little empirical research had been done in this area because of the difficulty of incorporating an endogenous and imperfectly competitive market structure into a dynamic general equilibrium model.
Kanwar and Evenson (2003) examined the relationship between IPR protection and the rate of technological change. This study differed from the others in that it did not examine the relationship between economic growth and IPR protection. Kanwar and Evenson’s reason for ignoring the relationship between economic growth and IPR protection was that an insignificant relationship between the strength of protection and economic growth could be due to the fact that innovation accounted for an insignificant part of economic growth. Furthermore, they cited literature that discussed the effect of technological change on economic growth and agreed with the general finding that there was a positive relationship between those two variables, which could be small or large depending on the particular economy or time period in question.
Kanwar and Evenson used a random effects model and time series data from 1981 through 1995 to estimate the relationship between technological change and IPR protection. Their empirical model specified R&D investment (measured as a proportion of GNP) as a function of various IPR protection indices, gross domestic savings as a proportion of GDP, change in per capita GDP, the Barro-Lee (2000) human capital variable, a political instability index, and a black market exchange rate premium dummy variable. Fitting this model revealed evidence supporting their claim that IPR protection (proxied by an index of patent rights) had a strong, positive influence on technological change (proxied by R&D investment expenditure).
Chaudhuri, Goldberg, and Jia (2003) estimated the effects of global patent protection on pharmaceutical products in India. They stated that only a few empirical studies examined this particular relationship, and concluded that increased IPR protection had a negative impact on welfare in developing countries. Chaudhuri et al. cited Challu (1991), Fink (2000), Maskus and Konan (1994), Nogues (1993), Subramanian (1995), and Wattal (2000) as support. As in these other studies, Chaudhuri et al. found that IPR enforcement had an adverse welfare effect in developing nations. They drew this conclusion by studying the effects of patent enforcement for a certain type of antibiotic in India.
Rather than focusing on economic growth, Javorcik (2004) focused on factors affecting FDI. Specifically, Javorcik examined firm-level decisions to invest in Eastern European countries after liberalization in 1989 using a survey conducted in 1995 of more than 1,000 firms from around the world. She analyzed two binary decisions: (1) whether to engage in FDI in a particular country, and (2) whether to invest in a manufacturing project or a solely distribution-related project. She tested whether two measures of IPR protection affected these decisions. The first was similar to the IPR index created by Ginarte and Park (1997). She then added a second index that focused on the enforcement of laws (as opposed to the strength of the laws on the books) and also on trademark and copyright protection, as opposed to the Ginarte-Park measure, which focused on patents. Javorcik allowed for differential effects in sectors deemed sensitive to IPR protection, such as pharmaceuticals, electronics, and chemicals.
Her study differed from previous analyses that assessed only aggregate FDI flows, as opposed to firm-level decisions. Javorcik also took advantage of the natural experiment of the opening of Eastern Europe, which represented an improvement relative to earlier studies that did not control for changes in policy and investment variables over time in countries that were relatively open throughout the period analyzed. Javorcik noted that the theoretical relationship between IPR strength and FDI might be ambiguous: Weak IPR protection reduced the advantages of a foreign producer by subjecting it to expropriation, however, strong IPR protection encouraged licensing as an alternative to FDI. Javorcik noted mixed conclusions found in the prior literature. For example, Ferrantino (1993) found no statistically significant relationship between U.S. affiliate sales in a foreign country and that country’s membership in an international IPR convention—the same finding as Maskus and Konan (1994) and Primo Braga and Fink (2000). Lee and Mansfield (1996) and Smith (2001), however, did find positive correlation between U.S. affiliate sales and IPR protection. Javorcik noted other studies that found IPR protection could vary in importance across industries.
Javorcik found support for both hypotheses. She found that the strength of IPR protection, as measured by the Ginarte-Park index, positively affected the probability that a firm in an IPR-sensitive sector would engage in FDI, but it did not affect firms in other sectors. Interestingly, she also found modest evidence that her second index of IPR enforcement affected the decision across all sectors. She concluded that firms were more likely to engage in manufacturing-related FDI, as opposed to focusing solely on distribution, when the IPR protection regime was strong. She found this effect prevailed across all sectors.
Schneider (2005) tested the impact of international trade, IPR protection, and FDI on innovation and economic growth. She measured innovation as the number of U.S. patent applications by residents of each country. Schneider controlled for a number of domestic factors, including the strength of IPR protection, and she used the Ginarte-Park (1997) index as a proxy for the strength of IPR protection. She noted the benefit of this index over previous ones, such as Rapp and Rozek (1990) and Mansfield (1994), in that it varied substantially over time. With respect to IPR, Schneider found that increased protection had a positive affect on innovation across the whole sample. However, the difference between developed and developing countries was strong. IPR protection had a zero or even negative correlation with innovation in the developing country component of the sample. This finding was similar to that of Ginarte and Park (1997). Schneider reported mixed results from the regression examining the relationship between IPR protection and economic growth, although IPR protection appeared to have a positive effect on economic growth. This result was generally consistent with Gould and Gruben (1996), and the implications were similar to those identified by Ginarte and Park (1997). Schneider concluded that R&D in developing countries was largely imitative, rather than innovative, and therefore was generally not affected by IPR protection. She stated that in such countries providing strong IPR protection benefited foreign firms at the expense of local ones. The policy implication is that developed countries benefit by supporting R&D in developing countries, so that developing countries eventually have the incentive to strengthen IPR, which benefits both foreign and domestic firms.
Branstetter, Fisman, and Foley (2006) studied the relationship between increased IPR protection and U.S. multinational firms’ technology transfer to developing countries and found a positive and significant relationship. This result, in itself, did not seem sufficient to demonstrate that increased IPR protection was welfare enhancing or contributed positively to economic growth in developing nations as it did not consider the local effects of firms displaced after the IPR reform. In this paper, Branstetter et al. used affiliate-level data on U.S. multinational firms and aggregate patent data to test whether legal reforms that strengthen IPR increased the transfer of technology to multinational affiliates operating in reforming countries throughout the 1980s and 1990s. They found that royalty payments for the use or sale of intangible assets made by affiliates to parent firms, which reflected the value of technology transfer, increased in the wake of strengthened patent regimes. This increase was concentrated among the affiliates of firms that made extensive use of U.S. patents prior to reform and was more than 30 percent for this subsample.
Falvey, Foster, and Greenaway (2006) conducted a study designed to assess the effect of IPR protection on economic growth. Falvey et al. noted that, from a theoretical perspective, the strength of IPR protection had an ambiguous effect on growth. Strong IPR could adversely affect domestic industries that rely on pirated technologies. On the other hand, creativity and risk taking could be enhanced by strong IPR protection, even in developing economies. The relationship between IPR protection and factors that drive growth, such as trade and inbound FDI, was similarly ambiguous. Falvey et al. noted that Gould and Gruben (1996) found a positive link, although statistically not significant. Thompson and Rushing (1996) found a nonlinear relationship: a positive relationship between IPR protection and growth in countries with per capita GDP above US$3,400 (in 1980 dollars), but no relationship for countries with lower income levels. They also mentioned Kanwar and Evenson (2003), who found a positive relationship between IPR protection and R&D.
To test these arguments empirically, Falvey et al. relied on panel data of 79 countries from 1975 to 1989. They used the Ginarte-Park index as a measure for IPR protection strength and controlled for other factors, such as trade, inflation, and education. Their initial model found that IPR protection had a positive affect on growth, although this effect was stronger for high-income countries. This was consistent with Thompson and Rushing (1996) and much of the other literature. Furthermore, very low-income countries (less than approximately US$700 per capita, in 1995 dollars) exhibited a positive relationship between IPR protection and economic growth, while middle-income countries (up to US$10,000 per capita) showed no relationship. The authors interpreted these results as follows. In very low-income countries, where there is little or no domestic R&D or innovation and very few firms have the resources to imitate products from advanced countries, IPR protection serves to encourage imports and inbound FDI by protecting the property rights of multinationals. The finding for middle-income countries reflected two countervailing factors: the positive effect on trade and FDI can be balanced by the negative effect on knowledge diffusion and discouraging imitators. Falvey et al. emphasized that they did not find that IPR protection reduced growth even in the middle-income countries. Rather, there was no consistent positive effect.
The studies reviewed consistently used the Ginarte-Park IPR index, a numerical score compiled from various characteristics of national patent laws. However, this index appears to suffer from a weakness—the relative importance of the various categories considered may not, in reality, reflect the arbitrary scoring imposed by Ginarte-Park. On the other hand, the consistent results appear to demonstrate a real effect. Apparently, earlier studies used an index by Rapp and Rozek, which did not vary over time. Javorcik adds another index related to the enforcement of the laws on the books. This seems to be a useful addition to the literature. Further research to develop an index reflecting the actual effect of statutory protections combined with enforcement measures would be even better.
II. Conclusions and Implications for Public Policy
The theoretical literature primarily focuses on technology transfer, imitation, and FDI as sources through which the South could gain access to the North’s advanced technology. Much of the literature emphasizes Southern economies’ incentives not to adopt strong IPR protection; they receive the benefits of innovation through imitation without incurring the costs of exclusivity granted by IPR protection. In general, strengthening Southern IPR protection does not benefit the South and produces ambiguous results in the North. Helpman suggested that the South benefited from weak IPR protection and, accounting for such factors such as wage rates, weak Southern IPR protection may even benefit the North. Grossman and Lai explored the effects of harmonization, but found it benefits the North and potentially harms the South. Lai and Qiu affirmed this result, noting that the net effect on global welfare increases with weaker IPR protection in the South. Glass and Saggi found that increased IPR protection in the South decreases FDI and innovation. Diwan and Rodrik provided an important counterpoint to these studies. Their model recognized the differences in technological needs—the South may have to increase IPR protection if it wants to attract innovation tailored to its preferences.
Other papers examined more specific effects of IPR protection. These papers show that the effect of IPR protection is likely to depend on the channels of international transfers (Lai), contractual enforcement (Markusen), and the existence licensing options (Yang and Maskus).
The empirical literature confirms the complexity of the issue found in the theoretical literature; growth and welfare depend on many factors. There is some disagreement about whether in lower- and middle-income countries the correlation between IPR protection and innovation and/or growth is negative or zero. This is an important issue because it addresses the question of whether developing countries should adopt stronger IPR protection or whether developed nations need to provide additional incentives to compensate for the adverse effects of stronger IPR protection on developing countries.
While Gould and Gruben found that growth rates increased as IPR protection increased, some model specifications suggested this depended on the openness of the trade regime. Many of the papers tested for a threshold level upon which IPR protection affected growth. Park and Ginarte, Thompson and Rushing, and the Schneider paper all suggest a differential effect for developed and developing countries, finding no effect of IPR protection on growth for lower-income countries. Falvey et al. also failed to find an effect of IPR protection on growth rates below a certain income threshold, but found an interesting result that the poorest countries might benefit from increased IPR protection. Chaudhuri et al. found that increased IPR protection is actually detrimental to overall welfare.
A second strain in the empirical literature examines the effect of IPR protection on factors that may drive growth. Lee and Mansfield found that the perceived level of IPR protection influenced the amount and type of FDI a country was likely to receive, a result confirmed by Javorcik. Park and Ginarte found that IPR protection corresponded to capital and R&D investment accumulation. Similarly, Branstetter et al. found increased technology transfer among U.S. multinational firms while Kanwar and Evenson found a strong relationship between IPR protection and technological change. Falvey, Foster, and Greenaway, however, found no relationship between IPR protection and factors that drive growth, such as trade and inbound FDI. The Braga and Fink review also noted the ambiguous effect of IPR protection on many of these measures. While some of these results suggest a positive relationship between IPR protection and these factors, it is not possible to determine their aggregate effect without measuring the costs of increased IPR protection.
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1. A Nash equilibrium occurs when holding the strategies of all other market participants constant, a firm cannot achieve a higher profit by changing its own strategy unilaterally. Hence, in a Nash equilibrium no market participant wants to change its strategy.
2. Economic rent is the difference between what a factor of production (i.e., land, labor, capital, and enterprise) is paid and how much it would need to be paid to remain in its current use. In a perfectly competitive market there are no economic rents.
2. Economic rent is the difference between what a factor of production (i.e., land, labor, capital, and enterprise) is paid and how much it would need to be paid to remain in its current use. In a perfectly competitive market there are no economic rents.
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