- This chapter is adapted from a chapter published in Owen Lippert (ed.), Competitive Strategies for Intellectual Property Protection, (Vancouver, B.C., Canada: Fraser Institute, 2000). It was prepared for the two conferences on Competitive Strategies for Intellectual Property Protection, organized by the Fraser Institute and held in Santiago, Chile, on April 19, 1999 and in Buenos Aires, Argentina, on April 22, 1999. I gratefully acknowledge helpful comments by Octavio Espinosa and Jayashree Watal.
The exhaustion doctrine related to the protection of intellectual property rights (IPRs) is one of the most complicated regulations of international business. It defines the territorial rights of intellectual property owners after the first sale of their protected products. Under a system of national exhaustion, a title holder can prevent parallel importation of his or her product from a foreign country, where it is sold either by the IPR owner or by an authorized dealer. In contrast, if rights exhaust internationally, the title holder loses his or her exclusive privilege after the first distribution of the product, thus allowing parallel imports from abroad. A hybrid between national and international exhaustion is regional exhaustion, whereby parallel trading is allowed within a particular group of countries, but parallel imports from countries outside the region are banned.
Parallel trade refers to trade in genuine products outside official channels of distribution; it should not be confused with trade in counterfeit goods, which refers to trade in products that infringe on an IPR. If unrestricted, parallel trading activities can generally take two forms. The most common form is passive parallel imports, whereby arbitrageurs buy goods in a foreign country and sell them in the domestic market. Active parallel imports occur when a foreign licensee (or distributor) of the IPR holder enters the domestic market to compete with the IPR holder or his or her official domestic licensee. Regardless of the form that parallel imports take, they are subject to the same border measures as regular imports are, including tariffs, quantitative restrictions, and technical standards.
The economic significance of the exhaustion doctrine is difficult to evaluate. The potential size of the market that could be subject to parallel trading activities, if unrestricted, is undoubtedly significant, because most tradable goods (besides commodities) and services are protected by at least one form of IPR (for example, trademarks).1Virtually no statistics are available on this so-called gray market segment of international trade. In addition, if intellectual property owners and their licensees respond to the threat of parallel imports by pricing more uniformly across national markets- thereby eroding international arbitrage opportunities-trade statistics would give an insufficient indication of the economic effect of parallel import policies.
The significance of the exhaustion doctrine depends also on the extent to which private contractual means can substitute for territorial rights exhaustion in restricting parallel imports. Territorial restraints in licensing agreements and restrictive purchasing contracts can limit active and passive parallel imports, respectively, even though IPRs may exhaust internationally. The extent to which such private contractual means can be used depends, in turn, on whether they are considered to be anticompetitive by prevailing competition laws.
Current exhaustion regimes differ widely among countries and across the different forms of IPRs. Although most industrial countries maintain significant restrictions on parallel imports, recent initiatives by policymakers in several Organisation for Economic Co-operation and Development (OECD) countries have been favorable to international exhaustion. It would be premature, however, to interpret these initiatives as a fundamental shift in the regulations that govern parallel imports. Parallel import policies have also received increasing attention in proposals for promoting differential pricing structures for pharmaceutical products; these structures may entail substantial price discounts of essential medicines in poor countries.2 Finally, as intellectual property rules have become part of international trade agreements, future trade negotiations at the bilateral, regional, and multilateral levels may seek to develop obligations with regard to IPR exhaustion.
The effects of national or international exhaustion are complex and have been subject to extensive debate among economists, lawyers, lobbyists, and policymakers.
This chapter offers an introduction into this "jungle" of intellectual property exhaustion by focusing on the economic aspects of the debate. It starts by outlining the current state of national and international regulations that govern parallel imports. The subsequent two sections discuss the pros and cons of national versus international exhaustion and review the (limited) empirical evidence. The chapter concludes by pointing to some issues that may be relevant in the context of international trade negotiations covering exhaustion rules.
Unless bound by an international agreement, countries are free to adopt their preferred exhaustion regime for each form of IPR. So far, no international convention or multilateral agreement on IPRs has mandated a particular regime. The only provision in the various multilateral and plurilateral agreements of the World Trade Organization (WTO) that explicitly addresses the exhaustion issue is article 6 of the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), which states:
For the purposes of dispute settlement under this Agreement, subject to the provisions of Articles 3 and 4 above nothing in this Agreement shall be used to address the issue of the exhaustion of intellectual property rights.3
Article 6 of TRIPS is widely interpreted as an agreement to disagree, giving WTO members the freedom to opt for national, regional, or international exhaustion.4 It reflects the negotiating history of TRIPS, in which, although the exhaustion issue was raised, member countries could not form consensus on a multilateral statute.
At the regional level, the European Union (EU) applies a system of regional exhaustion that denies parallel imports from outside the EU territories but does not restrict parallel trading within those territories. This system has emerged from jurisprudence by the European Court of Justice (ECJ). In the early 1970s, the ECJ ruled that national exhaustion would be inconsistent with the Treaty of Rome, which aims at "[uniting] national markets into a single market."5 The regional exhaustion regime applies to all forms of intellectual property. However, in the past, the European Commission has considered the revision of the EU trademark directive, so as to free parallel imports from outside the EU (see NERA 1999).
Other regional trade agreements largely remain silent on the exhaustion issue. The North American Free Trade Agreement (NAFTA), for example, has no explicit provision on the exhaustion question, and the substantive provisions of NAFTA's chapter 17 on IPRs can be interpreted as giving member countries freedom to determine their preferred exhaustion regime. The Treaty of Asunción, which established the Southern Cone Common Market (Mercado Común del Sur, or MERCOSUR) between Argentina, Brazil, Paraguay, and Uruguay, also does not address the question of parallel imports.6
At the national level, the United States applies (with few exceptions) a system of national exhaustion for all forms of IPRs.7 The exhaustion regimes of other OECD countries also lean toward national exhaustion, although there are important cases in which IPRs exhaust internationally. In Japan, for example, a recent decision by the Supreme Court confirmed the lawfulness of parallel imports of patented products unless restrictions are clearly displayed on the products.8 In 1998, New Zealand became the first OECD country to adopt a system of international exhaustion with respect to copyright.9 After the removal of parallel import restrictions on compact discs (CDs) in 1998, the Australian government considered expanding the international exhaustion rule in the area of copyright to books and computer software ("Australia Presses for Liberalization" 1999).
In non-OECD countries, regulations regarding parallel imports differ widely. According to a survey on parallel import protection in the area of copyright, for example, 25 non-OECD countries were classified as providing such protection and 21 non-OECD countries were classified as allowing parallel imports (the regime was unclear in 33 non-OECD countries).10 Recent decisions by New Zealand and Australia to open their markets for parallel imports in copyright-protected products as well as the current initiative on reforming the EU trademark directive on this issue have brought increased attention to the parallel import question.11
Finally, exhaustion rules may be subject to future trade negotiations. For the foreseeable future, further negotiation is unlikely for TRIPS (although proposals for an exhaustion obligation were made before the launch of the Doha Round), but it may well happen in the context of bilateral or regional trade agreements. Indeed, the 2003 free trade agreement between the United States and Singapore has an implicit obligation to curtail parallel importation of pharmaceutical products.12
Before turning to the various arguments...