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5
Unauthorized Use of Intellectual Property: Effects on Investment, Technology Transfer, and Innovation

EDWIN MANSFIELD

I. INTRODUCTION

This chapter addresses the issue of unauthorized use of intellectual property and its effects on the international environment for innovation, technology transfer, and economic development. More specifically, it considers the economic effects on developing countries, in terms of influencing foreign direct investment and technology transfer, and examines the economic effects on innovating firms, in terms of lost revenues and investment opportunities. The chapter also indicates what information exists and is needed to evaluate the relationships among intellectual property rights protection, unauthorized use, and technological innovation. My primary focus is on the unauthorized use of the products of research and development (R&D), rather than counterfeit consumer items.

Sections II-IV summarize briefly the rationale for the patent system, the current controversies over intellectual property rights, and the changes that often have occurred during industrialization in countries' attitudes toward such rights. After a discussion in Section V of the hypothesis that intellectual property rights protection influences the transfer of technology via foreign direct investment, Sections VI-IX present the preliminary results of a study of 94 U.S. firms that attempts to measure the perceived importance of intellectual property rights protection in this regard and to compare the perceived strength or weakness of intellectual property rights protection in 16 major countries. Sections X-XIV compare our findings with those of other studies and discuss the factors behind some of our results.



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Global Dimensions of Intellectual Property Rights in Science and Technology 5 Unauthorized Use of Intellectual Property: Effects on Investment, Technology Transfer, and Innovation EDWIN MANSFIELD I. INTRODUCTION This chapter addresses the issue of unauthorized use of intellectual property and its effects on the international environment for innovation, technology transfer, and economic development. More specifically, it considers the economic effects on developing countries, in terms of influencing foreign direct investment and technology transfer, and examines the economic effects on innovating firms, in terms of lost revenues and investment opportunities. The chapter also indicates what information exists and is needed to evaluate the relationships among intellectual property rights protection, unauthorized use, and technological innovation. My primary focus is on the unauthorized use of the products of research and development (R&D), rather than counterfeit consumer items. Sections II-IV summarize briefly the rationale for the patent system, the current controversies over intellectual property rights, and the changes that often have occurred during industrialization in countries' attitudes toward such rights. After a discussion in Section V of the hypothesis that intellectual property rights protection influences the transfer of technology via foreign direct investment, Sections VI-IX present the preliminary results of a study of 94 U.S. firms that attempts to measure the perceived importance of intellectual property rights protection in this regard and to compare the perceived strength or weakness of intellectual property rights protection in 16 major countries. Sections X-XIV compare our findings with those of other studies and discuss the factors behind some of our results.

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Global Dimensions of Intellectual Property Rights in Science and Technology In Sections XV and XVI an attempt is made to determine whether the extent of direct foreign investment is related significantly to the perceived strength or weakness of a country's intellectual property rights protection. Section XVII deals with the relationship between intellectual property rights protection, on the one hand, and the composition of direct foreign investment and the age of transferred technology, on the other. Section XVIII summarizes available evidence regarding the effects of the unauthorized use of intellectual property on the sales and profits of U.S. firms. Sections XIX-XXI discuss the results of recent studies of the effects of intellectual property rights protection on the rate of technological innovation and suggest a variety of kinds of research that might be carried out to shed new light on this very important, but inadequately explored, topic. Section XXII provides a summary and conclusions. II. RATIONALE FOR THE PATENT SYSTEM Intellectual property consists chiefly of patents, plant breeders' rights, copyrights, trademarks, and trade secrets. Economists have focused more attention on patents than other forms of intellectual property. Ever since the first U.S. patent laws were enacted about 200 years ago, the following arguments have been used to justify the existence of the patent system. First, these laws are viewed as an important incentive to get the inventor to put in the work required to produce an invention. Particularly for the individual inventor, patent protection is claimed to be a strong incentive. Second, patents are viewed as a major incentive for firms to carry out further work and make the necessary investment in pilot plants and other items that are needed to bring the invention to commercial use. If an invention became public property when made, a firm might be unwilling to incur the costs and risks involved in experimenting with a new process or product because another firm could watch, take no risks, and duplicate the process or product if it were successful. Third, it is said that patent laws result in inventions being disclosed earlier than otherwise, the result being that other inventions are facilitated by earlier dissemination of the information. Despite these arguments, not all economists believe that the patent system is beneficial. Some stress the social costs arising from the fact that a patent is a monopoly right. They point out that patents have been used to establish monopoly positions in industries such as aluminum, shoe machinery, and plate glass. Also, they say that patents are not really important as incentives for innovation because long lead times ensure that most of the profits from many types of innovations can be obtained before imitators have a chance to enter the market. Further, they argue that new knowledge is not used as widely under the patent system as it should be, from the

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Global Dimensions of Intellectual Property Rights in Science and Technology viewpoint of static efficiency. This is because the price of the information should, according to static welfare economics, be set equal to its marginal cost, which is often practically zero. However, the fly in the ointment is that this, of course, would provide no incentive for invention. In essence, a nation's patent laws must reflect a balancing of incentives for inventors and rapid diffusion of new technology. III. CHANGING POLITICAL ECONOMY OF THE PATENT SYSTEM: EFFECTS ON ECONOMIC DEVELOPMENT Countries differ greatly in their attitudes toward the patent system. A country like the United States that is a world leader in technology and that carries out huge amounts of research and development obviously stands to gain more from the patent system than a small, impoverished country with practically no scientific or technological capabilities. A country's attitude is likely to change as it industrializes, since the perceived gains and losses from the patent system are likely to be altered considerably in the course of the country's economic development. Patents often seem to be of little use in a nonindustrialized developing country, for reasons advanced several decades ago by Edith Penrose (1951): Any country must lose if it grants monopoly privileges in the domestic market which neither improve nor cheapen the goods available, develop its own productive capacity nor obtain for its producers at least equivalent privileges in other markets. No amount of talk about the "economic unity of the world" can hide the fact that some countries with little export trade in industrial goods and few, if any, inventions for sale have nothing to gain from granting patents on inventions worked and patented abroad except the avoidance of unpleasant foreign retaliation in other directions. However, when these countries industrialize, their views of the patent system may change, for reasons also pointed out by Penrose (1951): If the country is a small one, with a small internal market and fairly specialized export industries, patents in foreign markets may not only be profitable but may be an important incentive to, and protection of, invention and innovation in exporting industries .... [Also], to the extent that imitation can be eliminated in foreign markets through patents, design patents, trademarks, and copyrights, the products will be more easily able to retain their specialty character and thus their markets. Whether such a country will decide to protect foreign inventions within its own borders is a somewhat different question. As Frame (1987) has pointed out, some countries seek patent protection abroad, but offer weak protection to foreign inventors at home.

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Global Dimensions of Intellectual Property Rights in Science and Technology IV. INTELLECTUAL PROPERTY RIGHTS: INDUSTRIALIZED VERSUS DEVELOPING COUNTRIES There are well-known differences between the industrialized countries and the developing countries in their attitudes toward intellectual property rights. To the developing countries, such rights give inventors and innovators an undesirable monopoly on advanced technology that can be employed to raise prices and to impose unwarranted restrictions on the use of the technology. To them, the strong enforcement of intellectual property rights would do little to aid their own development; instead, it would tend to hinder their attempts to raise per capita income. A view commonly expressed in developing countries is that knowledge should be made available at minimal cost to everyone since it is a common property of all, and that because the development of the relatively impoverished countries of the world is a goal that benefits everyone, the technology needed by these countries should be given to them at a low cost. For these and other reasons, many developing countries have relatively weak laws to protect intellectual property and less than diligent enforcement of the laws that exist. Also, they have adopted policies with regard to direct foreign investment and licensing designed to improve the terms on which they can get foreign technology. The industrialized countries have a substantially different attitude. In their view, intellectual property rights must be respected to provide a fair return to the private investors who take the considerable risks involved in developing and commercializing a new technology. Unless such returns are available, the incentives for inventive and innovative activity will be impaired, to the detriment of all nations, rich or poor. Also, the industrialized countries sometimes assert that the establishment of stronger intellectual property rights would help to promote indigenous technological and innovative activities in the developing countries, although it is generally conceded that this is only one of many relevant factors influencing the indigenous rate of innovation.1 1   For a discussion of recent pressures on developing countries to strengthen intellectual property rights, see Mody (1990); also, see Bale (1988), Benko (1987), Chin and Grossman (1990), Clemente (1988), Cortes (1988), Evenson and Ranis (1990), Pack (1987), Richards (1988), and other references.

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Global Dimensions of Intellectual Property Rights in Science and Technology V. EFFECTS OF INTELLECTUAL PROPERTY RIGHTS PROTECTION ON THE TRANSFER OF TECHNOLOGY VIA FOREIGN DIRECT INVESTMENT Having summarized briefly some of the current controversies over intellectual property rights, and the changes that often occur during industrialization in countries' attitudes toward such rights, we turn to one of the central topics of this chapter: the relationship between intellectual property rights protection and the transfer of technology through foreign direct investment. As is well known, foreign direct investment is generally regarded as an important means of transferring technology to developing countries.2 From both policy and analytical perspectives, it is important to obtain a better understanding of the effect, if any, that a developing country's system of intellectual property rights protection has on the transfer of technology to that country through foreign direct investment. According to some observers, relatively weak intellectual property rights protection in a developing country may reduce the likelihood that multinational firms will invest there. Moreover, even if they do invest there, they may be willing (because of weak intellectual property rights protection) to invest only in wholly owned subsidiaries (not joint ventures with local partners) or to transfer only older technologies. For example, Robert Sherwood (1988) has argued that: Those who might send a leading technology to . . . a country [with weak intellectual property rights protection] would soon learn of their folly upon losing it to a competitor. There is an efficient grapevine among companies which do business internationally. If one has a bad experience in a country, all the others soon learn of it. The newer technology is not withheld to harm or abuse that country. It is kept safe at home when safeguards in a host country are defective. Although these hypotheses may be true, there is little or no evidence to support (or deny) them. With regard to licensing, an Organization for Economic Cooperation and Development (OECD) survey indicates that exchange controls, government regulations (particularly prior approval), and weak protection of intellectual property rights were the most frequently cited disincentives to licensing in developing countries (OECD, 1987: Table 40). Very little seems to be known, however, about the effects of intellectual property rights protection on the nature and amount of technology transferred to a country via direct foreign investment. Clearly, the answer may vary, depending on the industry in question and on the characteristics of the 2   For a recent study bearing on this topic, see Blomstrom and Wolff (1989).

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Global Dimensions of Intellectual Property Rights in Science and Technology developing country. Also, the answer may vary depending on the nature of the technology. VI. INTELLECTUAL PROPERTY RIGHTS PROTECTION AND DIRECT FOREIGN INVESTMENT To test the foregoing hypotheses concerning the effects of intellectual property rights protection on the transfer of technology via foreign direct investment by American firms, I chose a random sample of 100 major U.S. firms in six industries—chemicals (including drugs), transportation equipment, electrical equipment, machinery, food, and metals.3 Information was requested from each firm concerning the importance of intellectual property rights protection to whether or not the firm would make direct foreign investments of various kinds. Complete or partial data were obtained from 94 of the firms, a very high response rate. The respondents were a mixture of patent attorneys, specialists in the firm's international operations, and top executives. The limitations of survey and interview data of this kind are well known, but with proper caution, such data can be useful. In practically all of these industries, the proportion of firms indicating that intellectual property rights protection has a strong effect on their foreign direct investments depends heavily on the type of investments in question (Table 5-1). For investment in sales and distribution outlets, only about one-fifth of the firms reported that intellectual property rights protection was of importance. For investment in rudimentary production and assembly facilities, less than one-third said that such protection was important.4 However, for investment in facilities to manufacture components or complete products, about half said it was important, and for investment in R&D facilities, about four-fifths said it was important. Also, some industries, more than others, regard intellectual property rights protection as important. For all types of investments other than in sales and distribution outlets, the chemical industry (which includes pharmaceuticals) has the highest percentage of firms regarding intellectual property rights protection as important in this regard. The food and transportation equipment industries tend to have the lowest percentages, and the electrical equipment, metals, and machinery industries tend to rank in the middle. It 3   The frame for this sample was the comprehensive list of major firms in Business Week, June 15, 1990; see Mansfield (1991) for details. Note that our results pertain only to U.S. firms. Firms from other countries may have different views concerning the role and importance of intellectual property rights. 4   Rudimentary production and assembly facilities are ones involving basic technologies that are reasonably well known to all firms in the relevant industry.

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Global Dimensions of Intellectual Property Rights in Science and Technology TABLE 5-1 Percentage of Major U.S. Firms in Six Industries Where Strength or Weakness of Intellectual Property Rights Protection Reportedly Has Strong Effect on Whether Direct Investments Will Be Made Industrya Type of Investment   Sales and Distribution Outlets Rudimentary Production and Assembly Facilities Facilities to Manufacture Components Facilities to Manufacture Complete Products Research and Development Facilities Mean Chemicalsb 19 46 71 87 100 65 Transportation equipment 17 17 33 33 80 36 Electrical equipment 15 40 57 74 80 53 Food 29 29 25 43 60 37 Metals 20 40 50 50 80 48 Machinery 23 23 50 65 77 48 Mean 20 32 48 59 80 48 SOURCE: Mansfield (1991). a The number of firms in the sample in each industry is chemicals, 16; transportation equipment, 6; electrical equipment, 35; food, 8; metals, 5; machinery, 24. However, not all firms in the sample responded to all questions. b The chemical industry includes pharmaceuticals.

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Global Dimensions of Intellectual Property Rights in Science and Technology is interesting to note that there is a very high correlation between an industry's rank in this regard and its rank in previous studies with respect to rough measures of the importance of patents in the innovation process (see section XIX below). Thus, these findings seem to conform with those of earlier studies. Based on these results, it seems likely that, to the extent that foreign direct investment by U.S. firms is largely devoted to sales and distribution outlets and to rudimentary production and assembly facilities, a country's intellectual property rights protection will have little effect on the total amount invested by U.S. firms in that country. However, it may have a considerable effect on how much is invested in facilities to manufacture components and complete products, as well as R&D facilities. To see whether—and, if so, how—firms regarding intellectual property rights protection as important with respect to investment in facilities to manufacture complete products, differ from those regarding it as unimportant, we compared the sales volume and percentage of sales devoted to R&D of the firms in each group.5 The results, shown in Table 5-2, indicate that the firms regarding intellectual property rights protection as important in this respect tend to be larger (in terms of sales) and more R&D-intensive than firms that do not. However, although this is true in all industries combined and in four of the six industries, it is not true for the remaining two industries, as shown in Table 5-2. VII. INTELLECTUAL PROPERTY RIGHTS PROTECTION AND JOINT VENTURES Some countries press foreign firms to participate in joint ventures with local firms. These joint ventures generally require the foreign company to share technology with its local partner. Also, foreign firms manufacturing in developing countries may be asked to introduce relatively new technology and to use components produced locally. Coupled with weak patent protection, the foreign firm's technology may become available to local firms at relatively low cost. The U.S. firms in our sample were asked to indicate whether, in their view, any of 16 countries—Argentina, Brazil, Chile, Hong Kong, India, Indonesia, Japan, Mexico, Nigeria, Philippines, Singapore, South Korea, Spain, Taiwan, Thailand, and Venezuela—had intellectual property rights protection that was too weak in 1991 to permit them to invest in joint ventures (where they contributed advanced technology) with local partners in that country. These countries were chosen because of their size and 5   The data regarding sales and R&D expenditures pertain to 1989.

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Global Dimensions of Intellectual Property Rights in Science and Technology TABLE 5-2 Sales and R&D Expenditures of Firms, by Reported Effect of Intellectual Property Protection on Direct Foreign Investment in Facilities to Manufacture Complete Products   Industrya Firms Reporting  That Intellectual Property Rights Protection Has Chemicalsb Transportation Equipment Electrical Equipment Food Metals Machinery Total Strong effect Mean salesc 656 731 349 61 10 238 150 R&D (percentage of sales) 19.1 4.6 5.8 2.9 1.6 5.5 8.2 No strong effect Mean salesd 100 100 100 100 100 100 100 R&D (percentage of sales) 2.7 4.4 9.2 0.6 1.2 6.0 5.5 SOURCE: Mansfield (1991). a See note a, Table 5-1. b The chemical industry includes pharmaceuticals. cMean sales of firms in each industry reporting that intellectual property rights protection has a strong effect on direct foreign investment are expressed as a percentage of the mean sales of those reporting that it does not have a strong effect. d Mean sales of firms in each industry reporting that intellectual property rights protection does not have a strong effect on direct foreign investment is set equal to 100 (see note c).

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Global Dimensions of Intellectual Property Rights in Science and Technology importance, as well as the frequency with which they have been cited in connection with controversies over intellectual property rights protection. With two exceptions (Japan and Spain), these countries are major developing or newly industrialized countries. We include Japan and Spain to enable comparisons to be made to a developed country whose intellectual property rights protection has sometimes been a subject of controversy and to a relatively poor country in Western Europe. More than 30 percent of the U.S. firms felt that intellectual property rights protection in India, Nigeria, Brazil, and Thailand was too weak to permit them to invest in joint ventures there (Table 5-3). On the other hand, 10 percent or less felt that this was true in Japan or Spain. As would be expected, the proportion of firms feeling that intellectual property rights protection in these countries is, on the average, too weak to permit such investments tends to be highest in the chemical industry, where patents are relatively important, and lowest in the metals and food industries. VIII. INTELLECTUAL PROPERTY RIGHTS PROTECTION AND TECHNOLOGY TRANSFER TO SUBSIDIARIES Many firms prefer direct investment in wholly owned subsidiaries as a channel by which to transfer their technology to other countries, particularly if they believe that licensing will give away valuable know-how to foreign producers who are likely to be competitors in the future. Also, firms prefer direct investment over licensing when the technology is sophisticated and foreigners lack the know-how to assimilate it, or when a firm is concerned about protecting quality standards. For example, if a firm licenses technology to a less-than-capable foreign firm and if the foreign firm produces defective merchandise, it may reflect adversely on the firm whose technology was used. Each of the U.S. firms in our sample was asked whether, if it had a wholly owned subsidiary in one of the 16 countries listed, it would be willing to transfer its newest or most effective technology to such a subsidiary—or whether the weakness of the country's system of intellectual property rights protection would make such transfers very unlikely.6 According to Table 5-4, 30 percent or more of the firms reported that they would be very unlikely to transfer such technology to India, Thailand, or Nigeria, but less than 5 percent felt this way about Japan or Spain. Singapore seems to 6   Firms with subsidiaries (or joint ventures) in the country in question were asked this question. Firms without subsidiaries (or joint ventures) were asked whether they would be willing to transfer such technology if they had such a subsidiary. The data in Table 5-4 pertain to all firms but are highly correlated with those pertaining only to firms having such subsidiaries (or joint ventures).

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Global Dimensions of Intellectual Property Rights in Science and Technology TABLE 5-3 Percentage of Major U.S. Firms Reporting That Intellectual Property Protection Is Too Weak to Permit Them to Invest in Joint Ventures with Local Partners, by Industry and Country Country Industrya   Chemicalsb Transportation Equipment Electrical Equipment Food Metals Machinery Mean Argentina 40 0 29 12 0 27 18 Brazil 47 40 31 12 0 65 32 Chile 31 20 29 12 0 23 19 Hong Kong 21 20 38 12 0 9 17 India 80 40 39 38 20 48 44 Indonesia 50 40 29 25 0 25 28 Japan 7 40 10 0 0 0 10 Mexico 47 20 24 25 0 17 22 Nigeria 64 20 39 29 20 24 33 Philippines 43 40 31 12 0 18 24 Singapore 20 40 24 12 20 0 19 South Korea 33 20 21 12 25 26 23 Spain 0 0 10 0 0 4 2 Taiwan 27 40 41 25 20 17 28 Thailand 43 80 21 12 0 20 31 Venezuela 40 20 19 12 0 20 18 Mean 37 30 28 16 7 21 23 SOURCE: Mansfield (1991). a See note a, Table 5-1. Some firms reported they had too little information and experience regarding particular countries to provide this information. For these countries, firms of this sort are excluded. The number of firms that had to be excluded for this reason is generally very small. b The chemical industry includes pharmaceuticals.

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Global Dimensions of Intellectual Property Rights in Science and Technology socially optimal level. Given the central importance of industrial innovation for economic growth, such an eventuality would do considerable harm, both to the United States and to other countries.22 Obviously, changes in the protection of intellectual property rights are likely to have different effects in some countries than in others, and there is no simple way to determine what is in some sense best for the world as a whole. Even in the United States, we lack reliable estimates of how much the volume of inventive and innovative activity would change in response to a weakening or strengthening of intellectual property rights protection. Various kinds of research are needed, some of which are discussed in the following two sections. XX. NEEDED RESEARCH ON THE EFFECTS OF STRONGER INTELLECTUAL PROPERTY PROTECTION ON TECHNOLOGICAL CHANGE IN DEVELOPING COUNTRIES It is frequently argued that stronger protection of intellectual property rights would help to promote indigenous technological and innovative activities in the developing countries.23 This may be true, particularly in those countries that already have reached a minimal level of industrialization and have a reasonable amount of scientific and technological resources. However, there is very little information on which one can base an estimate of how large this effect may be. In this section, I sketch out three types of studies that might be helpful in this regard. First, a study might be conducted to determine the effects of stronger patent protection on the size and composition of the R&D expenditures of firms located or headquartered in selected developing countries (and the rate of commercialization of new products and processes). Although surveys of business firms have well-known limitations, it would be interesting and useful to find out what the leading executives of a sample of firms in these countries believe would be the effects of stronger patent protection on the size and composition of their firm's R&D expenditures. Findings of this sort would be rough, but nonetheless of use. 22   Of course, although a minimum degree of protection of intellectual property rights seems to be required to foster innovation in particular areas, this does not mean that increases in protection are always socially desirable. For example, see Levin et al. (1987). According to a simple model constructed by Chin and Grossman (1990), developing countries gain by protecting intellectual property if their share of the relevant market is large or if prospects for productivity gains through R&D are sufficiently bright in the industry. For substantial innovations, they find that global welfare is likely to increase with intellectual property rights protection. 23   For example, see Clemente (1988) and Haagsma (1988).

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Global Dimensions of Intellectual Property Rights in Science and Technology According to interviews carried out by Robert Sherwood, many companies in Brazil are reluctant to undertake R&D because they know that their rivals can acquire the new technology simply by hiring away their key personnel (Sherwood, 1990). Besides having relatively weak patent protection, firms in Brazil seem to have little recourse to stop loss of trade secrets to competitors in this way. His results suggest that in addition to influencing the amount spent on R&D, the relatively weak protection of intellectual property rights has reduced the productivity of the research and development that is carried out. For example, there is less cooperation among firms in research parks in Brazil and Mexico than in countries such as the United States, and foreigners are less likely to send world-class technology to Brazil (also see Tocker, 1988). The quantitative importance and frequency of occurrence of effects of this sort might be probed in a systematic survey of firms in selected developing countries. To complement, extend, and check on the results of such a survey, an econometric study might also be made of the effects of strengthened patent protection on firms' R&D expenditures. In a number of countries, patent protection has been strengthened in recent years. For example, in Japan, new chemical (and drug) products could be patented in 1975 and later years, but not before. Using standard econometric techniques, one may be able to estimate the effects of such changes on industrial R&D expenditures. Indeed, Kawaura (1988) has already taken some steps in this direction. In developing countries such as South Korea and Taiwan, it would be interesting to estimate the effects to date on industrial R&D expenditures of the recent strengthening of patent protection regarding drugs and chemicals. Although subject to obvious limitations, the results would be useful. Second, a study might be carried out to explore the costs and benefits to developing countries of modifying their patent systems. Thus, Robert Evenson (1984) has pointed out: In developing countries a relatively high proportion of time is devoted to adaptive invention, much of which is not patentable. Many of these countries have vented frustration over the terms on which technology is purchased in international forums. Few have shown imagination in designing legal systems suited to their competitive position in international invention. Most invention from these countries is adaptive. Yet they have generally not modified their patent systems to encourage adaptive invention. They have instead opted to weaken the scope of patent coverage in an attempt to discourage foreign patenting. In this the slow-growth industrialized economies and the developing economies have been successful. Unfortunately, they have also discouraged national invention in the process. A study could be carried out to determine the sorts of modifications that developing countries might consider, the potential costs and benefits of

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Global Dimensions of Intellectual Property Rights in Science and Technology each such modification, experiences in other countries with such modifications, and the practical problems in getting these modifications enacted. Third, a study might be carried out to estimate the effects of stronger intellectual property rights protection on the size and composition of R&D expenditures by multinational firms in developing countries. During the early 1980s, approximately 8 percent of the company-financed R&D of American firms was performed outside the United States. About 60 percent of this R&D was done in Germany, Britain, and Canada, but some was carried out in developing countries. Among the reasons for carrying out R&D outside the United States was the presence of environmental conditions abroad that cannot easily be matched at home, the desirability of doing R&D aimed at the special design needs of overseas markets, the availability and lower cost of skills and talents that are less readily available or more expensive at home, and the greater opportunity to monitor what is going on in relevant scientific and technical fields abroad (Mansfield et al., 1982). Some observers have suggested that if the protection of intellectual property rights were strengthened, a large amount of the overseas R&D carried out by multinational firms might be performed in developing countries. Because of external economies, this might promote technological change in these countries. Due to the limited scientific and technological resources in most developing countries, as well as other factors, it seems unlikely that a sizable increase in such R&D will occur in many parts of the Third World. Nonetheless, it would be useful to obtain information from various multinational firms as to the conditions under which they would seriously consider establishing or expanding R&D facilities in developing countries and the importance of strong intellectual property rights protection relative to other factors in making the R&D location decision. A considerable amount of research has been carried out concerning the factors influencing the location of R&D facilities. By building on that work, it may be feasible to obtain information of this sort.24 XXI. NEEDED RESEARCH ON EFFECTS OF STRONGER INTELLECTUAL PROPERTY PROTECTION IN DEVELOPING COUNTRIES ON INNOVATION IN DEVELOPED COUNTRIES Besides affecting the rate of technological change inside their own borders, the developing countries, by providing weak intellectual property rights 24   Richards (1988) has suggested that U.S. firms and government agencies might be willing to increase R&D expenditures in those developing countries that strengthened the protection of intellectual property rights. Bale (1988) has stated that Hewlett Packard's investment in R&D in Singapore and Taiwan would ''probably" increase, given the general strengthening of intellectual property rights in these countries.

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Global Dimensions of Intellectual Property Rights in Science and Technology protection, influence the rate of innovation in developed countries. Firms in the drug, chemical, and other industries in Europe, Japan, and the United States can expect to receive less profit from a particular new product or process than would otherwise be the case. Thus, it seems reasonable to believe that some R&D projects that might otherwise be profitable are not carried out, and some innovations that might otherwise be commercialized are judged not to be worthwhile. Given the fact that the private returns from industrial innovation tend to be considerably less than the social returns (Mansfield et al., 1977), this depresses innovative activity in the developed countries, which in any event may be below the socially optimal level, the result being that the world economy grows less rapidly than otherwise would have occurred. Research is badly needed to shed light on how large or small these effects are. It may be possible to estimate for a sample of firms the extent of the loss in profit from selected innovations that has been experienced due to weak intellectual property rights protection in developing countries. Using these estimates, one may be able to determine the percentage decrease in discounted profit that would be expected on this account for innovations of various kinds, and the proportion of various kinds of innovations that no longer would be profitable on this account. Rough estimates might also be made of the social losses (to developed and developing countries) resulting from the fact that these innovations are not carried out. By using data obtained from market research firms specializing in the drug, chemical, and other industries, as well as data published by various Third World countries and information from members of these industries, losses in sales due to weak patent protection might be approximated. By applying the results of various studies of cash flows from innovations in these industries, the effects on the net present value criterion of various proposed innovations could be estimated. Based on the firms' internal records, estimates might be made of the number of proposed innovations that were turned down but would have been accepted if patent protection had been stronger. Also, rough estimates might be made of how frequently new products that would be profitable with patent protection are not proposed in the first place because of the lack of patent protection in developing countries. If the relationship between estimated and actual net present value would have been the same for innovations turned down or not proposed for this reason as for those actually carried out, one might be able to estimate the private returns that were forgone. If the relationship between private and social returns would have been the same for these innovations as for those actually carried out, the social returns that were forgone might also be estimated. Of course, this analysis would be very rough, but at least it would be a beginning. To illustrate the factors involved, consider drugs to treat tropical dis-

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Global Dimensions of Intellectual Property Rights in Science and Technology eases. According to drug companies, weak patent protection in developing countries has discouraged research on such diseases. For example, Richard Furland (1988), chairman of the Squibb Corporation, has stated that "most developing nations in South America, Africa, parts of Asia, do not accept patents .... And there's very little research being done on tropical diseases because people know that if they develop a drug, the market will be immediately taken over by other people." It may be possible, based on intensive interviews with leading scientists, technologists, market researchers, and others inside and outside the relevant industries, along with statistical analysis of the available data, to shed light on the extent to which weak patent protection has discouraged R&D of various kinds, including that directed at drugs for tropical diseases. Obviously, the results would be rough, but rough results (if based on careful study and interpreted with proper caution) are better than none at all. To extend these results, it may also be possible to obtain econometric estimates of the effect of stronger patent protection in recent years in countries such as Japan, Korea, and Taiwan on R&D expenditures by U.S. firms, particularly in the pharmaceutical and chemical industries. Using standard econometric techniques, one may be able to estimate the sensitivity of industrial R&D expenditures in the United States to changes in patent protection in selected foreign countries, including some from the Third World. The available data would probably permit the disaggregation of R&D expenditures in some industries such as pharmaceuticals, which would be highly desirable. The findings might be an important check on the results of the studies suggested earlier in this section and would complement them. XXII. CONCLUSIONS At least five conclusions seem to follow from the foregoing analysis and discussion. First, the great majority of the U.S. firms in our sample report that the strength or weakness of intellectual property rights protection has an important effect on some, but not all, types of foreign direct investment decisions. Whereas about 80 percent of the firms in our sample maintained that this factor was important with regard to investments in R&D facilities, only about 20 percent said that it was important with regard to sales and distribution outlets. Also, some industries—notably, the chemical (including drugs) industry—regard intellectual property rights as much more important than others, such as the food and transportation equipment industries. In most industries, large and relatively R&D-intensive firms are more likely than other firms to regard intellectual property rights protection as important. Second, based on the views of these firms concerning whether or not intellectual property rights protection in 16 major countries allows them to

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Global Dimensions of Intellectual Property Rights in Science and Technology invest in joint ventures, transfer new technology to a subsidiary, or license new technology to each of these countries, it is possible to construct a crude index of the perceived strength or weakness of intellectual property rights in each country. In general, the countries in this sample perceived to have the weakest protection are India, Thailand, Brazil, and Nigeria; those perceived to have the strongest protection are Spain, Japan, Hong Kong, and Singapore. However, there is often little correlation between one industry's evaluation of the strength or weakness of intellectual property rights protection in a particular country and another industry's evaluation of the same country. For example, there is little agreement between the chemical industry and the transportation equipment industry. Third, there seems to be no statistically significant relationship between the perceived strength or weakness of a country's intellectual property rights protection, as measured by the above index, and the extent of U.S. direct investment in that country in the late 1980s and early 1990s. Based on our interviews with company executives, this is not surprising since they stressed the fact that intellectual property rights protection was only one of a great many relevant variables—and frequently not the most important one. Based on their responses, one might expect that the composition of U.S. direct investment would be affected by a country's perceived strength or weakness of protection, but data for 11 chemical firms show little such correlation. Preliminary results suggest that U.S. firms tend to transfer somewhat newer technology to countries with relatively strong intellectual property rights protection than to countries with weak protection. Fourth, according to estimates collected by the International Trade Commission from 167 U.S. firms, their aggregate losses in sales in 1986 due to weak intellectual property rights protection were more than $23 billion. For 45 firms, the ITC staff made crude estimates of the loss in profits on this account. The estimated aggregate loss was about $750 million, which was about 0.7 percent of sales. According to the ITC staff, this may have amounted to about a 10 percent profit reduction for these firms. Estimates of sales losses have also been made by industry trade associations, such as the National Agricultural Chemicals Association and the Pharmaceutical Manufacturers Association. Fifth, based on recent studies, it seems to be generally agreed that patents are regarded as much more important in some industries (pharmaceuticals and chemicals, in particular) than in others. Although it is frequently argued that stronger protection of intellectual property rights would help to promote indigenous technological and innovative activities in the developing countries, there is little or no information on which one can base an estimate of how large or small this effect may be. Also, whereas weak intellectual property rights protection in developing countries seems likely to depress the incentives for technological innovation in the developed countries,

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Global Dimensions of Intellectual Property Rights in Science and Technology no estimates have been made of the magnitude of this effect. Some directions in which research might be carried out to shed light on these very difficult—and centrally important—questions have been suggested. ACKNOWLEDGMENTS This chapter draws freely on preliminary findings of research I have carried out for the World Bank. Thanks go to Jacques Gorlin, Zvi Griliches, Robert Miller, Ashoka Mody, Mary Ellen Mogee, and Robert Sherwood for helpful comments on an earlier draft. REFERENCES Adikibi, A. 1988. The multinational corporation and monopoly of patents in Nigeria. World Development 16:511-526. Baldwin, R. 1979. Determinants of trade and foreign investment. Review of Economics and Statistics. Bale, Harvey. 1988. A computer and electronics industry perspective. In Intellectual Property Rights and Capital Formation in the Next Decade, C. Walker and M. Bloomfield, eds. Lanham, Md.: University Press of America. Beaumont, William. 1986-1987. The new patent law of the People's Republic of China. IDEA 27(1). Benko, Robert. 1987. Protecting Intellectual Property Rights. Washington, D.C.: American Enterprise Institute. Blomstrom, M., and E. Wolff. 1989. Multinational Corporations and Productivity Convergence in Mexico. C.V. Starr Center for Applied Economics, New York University. Chin, J., and G. Grossman. 1990. Intellectual property rights and North-South trade. In The Political Economy of International Trade, R. Jones and A. Krueger, eds. Oxford: Basil Blackwell. Chudnovsky, D. 1985. The entry into the design and production of complex capital goods: The experiences of Brazil, India, and South Korea. In Capital Goods in Economic Development, M. Fransman, ed. London: Macmillan. Clemente, C. 1988. A pharmaceutical industry perspective. In Intellectual Property Rights and Capital Formation in the Next Decade, C. Walker and M. Bloomfield, eds. Lanham, Md.: University Press of America. Cortes, Costa, M. 1988. A view from Brazil. In Intellectual Property Rights and Capital Formation in the Next Decade, C. Walker and M. Bloomfield, eds. Lanham, Md.: University Press of America. Dahlman, C., and F. Sercovich. 1984. Exports of technology from semi-industrial economies and local technological development. Journal of Development Economics 16:63-69. Dahlman, C., and F. Valadares Fonseca. 1987. From technological dependence to technological development. In Technology Generation in Latin American Manufacturing Industries, J. Katz, ed. New York: St. Martin's Press. David, Paul. 1986. Technology diffusion, public policy, and industrial competitiveness. In The Positive Sum Strategy, R. Landau and M. Rosenberg, eds. Washington, D.C.: National Academy of Sciences. Deolalikar, A., and R. Evenson. 1990. Private inventive activity in Indian manufacturing: Its extent and determinants. In Science and Technology: Lessons for Development Policy, R. Evenson and G. Ranis, eds. Boulder, Colo.: Westview Press.

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