Intellectual Property Rights and U.S. and German International Transactions in Manufacturing Industries

Author:Carsten Fink

    This chapter is adapted from a chapter published in Intellectual Property Rights, Market Structure, and Transnational Corporations in Developing Countries (Berlin: Mensch und Buch Verlag, 2000).

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I Introduction

The well-known ownership-location-internalization theory relates the formation of transnational corporations (TNCs) to the presence of knowledge-based assets (see Dunning 1979, 1981). TNCs rely extensively on the intellectual property right (IPR) system to protect their intellectual assets. For example, 50 TNCs from industrial countries accounted for 26 percent of all patents granted in the United States between 1990 and 1996 (see World Bank 1998, p. 28). Consequently, one would expect the activity of TNCs in a particular country to be sensitive to the strength or weakness of that country's IPR system.

This chapter investigates the link between IPRs and TNC activity empirically. It econometrically estimates the effect of different IPR regimes on U.S. and German international transactions in various manufacturing industries in a cross section Page 76 of industrial and developing countries. International transactions in this context are broadly considered to be foreign sales of goods that were produced with knowledge developed by domestic firms. By definition, such international transactions are dominated by TNCs. The empirical investigation focuses on both total international transactions and individual modes of delivery-exporting, foreign production, and licensing arrangements.

Both the United States and Germany are significant producers of knowledge-intensive goods and services. In 1992, the United States spent about US$165 billion on research and development (R&D), or 2.78 percent of its gross domestic product (GDP), and Germany spent about US$37 billion on R&D, or 2.48 percent of its GDP (see OECD 1997, pp. 14-16). However, the importance of R&D and, hence, the significance of knowledge-based assets differ considerably across manufacturing industries. Figure 4.1 shows industrial R&D spending as a percentage of sales in 10 manufacturing industries for Germany and the United States. It is evident that in both countries R&D activities are relatively more important for precision instruments, electrical machinery, general machinery, chemical products, and motor vehicles than for foods and beverages, textiles and apparel, rubber products, ceramics, and primary metals.

Moreover, even though R&D activities may be equally important for two industries, the importance of IPR protection in appropriating R&D outputs may not be the same for these industries. The technical properties of one industry's

Figure 4.1: The Differing Importance of R&D across Industries: Industrial R&D as a Percentage of Sales in Selected Manufacturing Industries


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typical R&D output may allow easier imitation than that of another industry. The former industry would be highly dependent on legal protection to appropriate its R&D investments compared with the latter industry, which can rely to some extent on other means of R&D appropriation. Mansfield (1986) reports survey findings across manufacturing industries on the share of inventions that would not have been commercially introduced if patent protection had not been available. Only in the pharmaceutical industry (65 percent) and chemical industry (30 percent) was patent protection found to be highly relevant. For other industries, the share of inventions that would not have been commercially introduced in the absence of patents was consistently below 20 percent and equal to zero in four industries. In view of these differences, the empirical investigation in this study focuses on international transactions at the level of individual industries (although estimates for total manufacturing are also reported).

The next section of this chapter discusses what theoretical models predict about the link between IPRs and international transactions and reviews available empirical evidence in this context. The subsequent sections explain the empirical models and present estimation results. The third section focuses on total U.S. international transactions, and the fourth section considers U.S. arm's-length exports and sales by overseas affiliates. Turning to the German data, the fifth section investigates total German exports and foreign direct investment (FDI) stocks, and the sixth section looks at German receipts from patents, inventions, and processes. The last section summarizes the chapter's main findings.

II Theoretical Predictions and Available Empirical Evidence

Fink (2000) develops a partial equilibrium model of the decisionmaking process of an IPRs-owning TNC, which points toward a positive link between IPRs and TNC activity. Intuitively, as the southern country moves to a higher level of IPR protection, the TNC's output (supplied directly through home or foreign production or indirectly through a licensee) increases as it faces increasing net demand from the displacement of pirates. The market becomes more concentrated, leading to a higher price for the TNC's product and, therefore, also to an augmented value of the TNC's output.

This unambiguously positive relationship, however, is due to the specific assumptions of the model. Maskus and Penubarti (1993) develop a model of a dominant firm with a competitive fringe industry and demonstrate that a negative "market power effect" caused by stronger IPRs may offset the positive effect Page 78 caused by increased net demand.1 Depending on the extent of the price increase, the firm's output value may rise or fall.

Predictions regarding the effects of stronger IPRs become even more ambiguous if one considers individual modes of delivery (exports, FDI, and licensing) instead of total international transactions. As illustrated in Fink (2000), a TNC may choose to switch its preferred mode of serving the foreign market once the southern country strengthens its IPR regime. The nature of such a switch depends both on the initial level of protection and on the extent to which IPRs are strengthened.

In empirical investigations of the link between IPRs and international transactions, one faces the additional problem that available data on international trade flows typically do not distinguish between intermediate goods and goods for final sale.2 Hence, it may be that trade and FDI (or licensing) are complementary to each other, instead of the substitute relationship implicitly assumed above. If the degree of IPR protection affects the way TNCs vertically integrate their activities across countries, the relationship between a country's IPR regime and international transactions gains an additional level of complexity.

Empirical evidence is available concerning the IPR-trade link. Maskus and Penubarti (1995) use an empirical specification of the Helpman-Krugman trade model of monopolistic competition to examine how a country's imports respond to the degree to which it protects intellectual property. The strength of countries' IPR regimes is represented by the patent index developed by Rapp and Rozek (1990). Maskus and Penubarti find that countries with stronger patent regimes import more than what is predicted by the Helpman-Krugman model, although this result does not hold when the estimation is confined to the most patent-sensitive industries. These results are largely confirmed by Fink and Primo Braga (chapter 2 in this book), who estimate the effects of IPRs in a gravity model of international trade using the patent index developed by Park and Ginarte (1997). Fink and Primo Braga find a significantly positive link between IPRs and total (nonfuel) trade-but, again, this link does not hold when the estimation is confined to high-technology trade.

Some empirical evidence is also available regarding the extent to which IPRs affect FDI and technology licensing. Support for a positive relationship is confirmed by survey evidence from industrial country TNCs. Mansfield (1994) collected data from patent attorneys and executives of major manufacturing firms in the United States. Most industries surveyed regard IPRs as a relevant variable in their foreign investment and technology transfer decisions. In line with existing empirical evidence, the importance of IPRs was found to be most pronounced in the chemical and pharmaceutical industries. Moreover, the survey findings indicate that IPRs are more relevant for knowledge-intensive parts of the production Page 79 process (such as R&D or technology-intensive product assembly), confirming the risk of technology leakage related to foreign production.3 Using Mansfield's survey findings as a base, Lee and Mansfield (1996) compiled an index of IPR protection for 16 developing countries and used this index to explain U.S. FDI flows in an ad hoc model of the determinants of TNCs' overseas investment decisions. Their estimation results indicate that countries whose IPR regime is perceived to be stronger generally attract significantly higher flows of FDI.4

The most comprehensive empirical investigation on the link between IPRs and international transactions to date is Ferrantino's (1993) study. This study recognizes that trade, FDI, and licensing are simultaneously determined. It explains U.S. arm's-length exports, intrafirm exports, and sales by U.S. overseas affiliates using a gravity model. The strength of IPR protection is approximated by several dummy variables on membership in international IPR conventions and on the term of patent protection. Ferrantino's results indicate a weak...

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