Intellectual Property Rights, Licensing, and Innovation
| Author | Guifang Yang, Keith E. Maskus |
| Profession | KPMG, Atlanta, DECRG, The World Bank and Department of Economics, University of Colorado at Boulder |
| Pages | WPS2973 |
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Intellectual property rights (IPRs) remain an active subject in international policy debates. Technology exporters in developed countries argue that stronger IPRs are needed in developing countries in order to provide better incentives for innovation and international technology transfer. The recent introduction of global minimum standards for IPRs, through the Agreement on Trade-Related Intellectual Property Rights (TRIPS) in the World Trade Organization, raises many questions about the relationships among IPRs, technology transfer, and economic growth.
This paper studies the effects of IPRs on innovation and technology transfer in a North-South dynamic general-equilibrium, product-cycle model with vertically differentiated products. Compared to the previous literature, in which imitation and foreign direct investment (FDI) are the channels of technology transfer, this model focuses on licensing as the means by which the South acquires advanced technology from the North. Licensing embodies features that are missing in these other channels, namely costs of contracting at arm's-length between innovators and licensees. These costs interact with IPRs in important ways.
In particular, we argue that strengthened patent rights could reduce such costs, raising returns to licensing. Indeed, according to standard internalization theory, relatively weak IPRs protection may cause MNEs to transfer technological knowledge through FDI, because there is a risk of dissipation with licensing (Rugman, 1986). Therefore, strong IPRs tend to favor licensing because a system of IPRs is necessary to the enforcement of the licensing contract (Ferrantino, 1993; Arora, 1996; Maskus, 1998).
In practice, international licensing through arm's-length contracts and joint ventures have taken on increasing importance in recent years (Maskus and Yang, 2001). For example, as a major Page 5 technology exporting country, US receipts of unaffiliated royalties and license fees were 21% of total royalties and license fees received from all the countries in the world in 1995.
Imperfections in the market for licensing, such as information asymmetry, uncertainty, imitation risk, and transaction costs, have made incorporating licensing into general-equilibrium models difficult (Caves, et. al, 1983). This paper provides one means of capturing how IPRs affect international technology transfer through licensing1. We focus on two pervasive problems in licensing: asymmetric information and imitation risk. The licensor has an incentive to convey misinformation about the true quality level of its technology and is unwilling to transfer its innovation without a payment or commitment by the licensee not to imitate. In the model, two different quality levels (high and low) of each product are sold in equilibrium due to differences in the willingness to pay of consumers for quality improvements. Multiple quality levels permit asymmetric information regarding true quality levels in setting licensing contracts.
With asymmetric information and imitation risk, the licensor is faced with the problem of designing a contractual form that signals its technological advantage while discouraging imitation (Gallini and Wright 1990). In consequence, the low-quality licensor can extract full monopoly rents from the licensee using a fixed fee. However, the high-quality licensor must share rents with the licensee due to a combination of asymmetric information and the risk of imitation. We extend this notion to show that the licensor share increases with the degree of IPRs protection in the South. By endogenizing this rent share between the licensor and the licensee, we find that stronger IPRs allow lower-cost signaling of quality levels and generate more licensing.
With two quality levels sold in equilibrium, production of low-quality goods always takes place in the South through licensing in order to take advantage of lower labor costs. However, production of Page 6 high-quality goods may either remain in the North or migrate to the South through licensing. The Northern innovative firm first chooses the intensity of effort it devotes to innovation. Once innovation is successful, the firm balances savings from lower wage costs with rent sharing in choosing whether to license. Results from the model show that the effects of IPRs in the South on innovation and licensing depend on the balance between the rents given up through licensing and lower labor costs in the South. Stronger IPRs award the high-quality licensor with a higher rent share, resulting in greater returns from licensing and innovation. Whether this change generates additional innovation and licensing in general equilibrium depends on resource constraints. Our key result is that these activities would rise if the labor force used in Northern innovation relative to that used in global production of both types of goods is sufficiently small. This condition seems consistent with reality, in that the share of research and development in gross domestic product is far smaller than the corresponding share of manufacturing output, even in developed economies.
This conclusion supports the intuition that stronger global protection of the fruits of R&D should encourage innovation. It is more optimistic about the impact of the TRIPS agreement than were the findings of prior literature. For example, Helpman (1993) found that with stronger IPRs protection the rate of innovation would fall in the long run because the North would produce more goods, taking away resources from innovation. Glass and Saggi (2002) showed similarly that a strengthening of IPRs in the South would reduce the rate of innovation because stronger IPRs would guarantee the market share of innovators. In turn, more labor would be used to produce goods in the North, providing less labor for innovation. Further, the flow and extent of FDI would decrease with a strengthening of Southern IPRs due to the increased imitation risk faced by multinationals relative to Northern firms. However, Lai Page 7 (1998) found that the effects of strengthening IPRs depend crucially on the channel of technology transfer from the North to the South. Stronger IPRs in the South would raise the rates of technology transfer and innovation if FDI is the channel of technology transfer but would have opposite effects if production is transferred through imitation.
Our focus on licensing points out that this channel of information transfer would respond positively to stronger patent rights by virtue of the ability of those rights to reduce the severity of imperfections in the licensing market. In an earlier paper (Yang and Maskus, 2001a) we found conditions under which strengthened industrial property would increase licensing and innovation, though without the contracting distortions modeled here. Indeed, limited econometric evidence suggests that, other things equal, U.S. firms license more to nations with stronger IPRs (Ferrantino, 1993; Yang and Maskus, 2001b).
The paper proceeds as follows. In Section 2 we set up a general-equilibrium model with licensing as the channel of technology transfer and with two quality levels sold in equilibrium. In Section 3 we derive solutions for steady-state equilibrium and investigate the effects of a Southern strengthening of IPRs. Concluding remarks are provided in Section 4.
The consumption side of the model is closely similar to that in Glass (1997), so we only highlight its features. Consider an economy with a continuum of goods indexed by jÎ[0,1]. Each good potentially can be improved a countably infinite number of times, indexed by qualities m = 0, 1, 2, ....
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The increments to quality are common to all products and exogenously given by a parameter l > 1.
Each good may be supplied in all discovered quality levels.
There are two types of consumers, who differ in their willingness to pay for quality improvements. They are indexed by wÎ{A,B}. High-type consumers (B) value the same quality improvement l more than low-type consumer (A): lB > lA > 1.
Each type of consumer lives forever and shares identical preference within her group. The intertemporal utility function for the representative consumer of type w is given by
Uw = ò¥ -r w
0
e t u (t)dt , (1)
where r is the subjective discount rate, and uw(t) represents instantaneous utility at time t. We specify instantaneous utility as
uw(t) = ln (lw )m w ( )
mt
m
d j dj
=
¥å
ò é
ë ê
ù
û ú
0
0
1 (2)
where dmt w(j) denotes consumption by type w consumer of quality m of good j at time t.
Every w-type consumer maximizes discounted utility subject to an intertemporal budget constraint
e -R t E t dt
¥ ò ( ) w ( )
0
= Aw(0) (3)
where R(t) is the cumulative interest factor up to time t: R(t) = r s ds
t
( )
0 ò , and Aw(0) is the value of initial
asset holdings plus the present value of factor income of type w consumers. The expenditure flow of
type w consumers at time t is given by
Ew(t) = pmt j dmt j dj
m
( ) w ( )
=
¥å
ò
0
0
1 (4)Page 9where pmt(j) is the price of a product j of quality m at time t. Define aggregate spending by all consumers as E = EA + EB. Let fw describe the exogenously given percentage of world income distributed to each type of consumer: fB is distributed to high-type consumers, while fA = 1- fB goes to low-type consumers. For simplicity, the same distribution of income applies to both countries.
The consumer's utility maximization problem can be broken into two stages. In the first stage, she optimally allocates...
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