Kristian Niemietz Blog

Published in “Know I.P.”, August 2007

At a first glance, and peculiarly, arguments both for and against intellectual property rights can sound intuitively convincing. The theoretical case for protecting knowledge-creations from imitation is clear: Nobody would till a field if he expected his neighbours to reap the harvest. Why should the incentive structure be different when it comes to the production of intangible goods?

But there are differences between physical and intellectual property. Whether or not somebody is trespassing on somebody else’s estate can be found out relatively easily. Whether or not an invention borrows from another one, or is to be considered as an invention in its own right, is seldom as obvious as this. While borders around property in, say, land, are clear-cut and observable, the same is not true for borders in the idea space. Therefore, some have argued that in a system of IPRs inventors must constantly ensure their ideas do not violate ideas already reserved by others. Critics of IPRs have likened them to a minefield, in which every step holds the danger of a costly patent suit. IPRs would therefore not stimulate innovation but stifle it, by imposing large costs on potential innovators.

Where theory gives ambiguous answers, because both innovation-enhancing and innovation-hindering effects exist, empirical studies can help in assessing which of these effects are stronger. The Rapp-Rozek-Index, the first statistical measure of IPR-strength for cross-country comparison, revealed a close correlation between IPR-strength and economic development (and obviously, developed economies produce more innovation). But correlation alone says nothing about causality. Developed countries tend to have more sophisticated legal systems in general, IPRs being only one of multiple layers. So it could well be that strongly defined IPRs are simply a companion phenomenon of economic development, not a causal factor. There could even be a reverse causality: When knowledge-based industries emerge, their actors acquire the ability to voice their economic interests and push legislation in their favour. In other words, perhaps it is the growth of knowledge-based industries that causes the protection of IPRs, not IPRs that cause the growth of knowledge-based industries.

In an econometric panel data study, Sunil Kanwar tries to adjust for these two error sources. The author measures the link between innovation and IPR, but corrects for other factors associated with innovation, such as general economic conditions, human capital, domestic capital funds and the cost of borrowing. As these are abstract concepts, Kanwar expresses ‘innovation’ as the share of R&D-expenditure in GDP, ‘IPR’ as the Ginarte-Park-Index of patent protection, ‘economic conditions’ as the growth in GDP per capita, ‘human capital’ as the average number of schooling years, ‘domestic funds’ as last year’s savings rate, and the ‘cost of borrowing’ as the real interest rate. To correct for a potential reverse causality, Kanwar adjusts for the dependency of IPRs on the level of economic development, human capital, a governments’ ability to protect IPR, the institutional climate, and the openness of the economy to trade. Again, this involves abstract concepts. The author approximates ‘economic development’ by GDP per capita, ‘government’s strength’ by the weight of tax revenue, the ‘overall climate’ by the Fraser Institute’s Index of Economic Freedom, and ‘openness’ by the difference between the official and the black market exchange rate. Having thus accounted for sources of biases, Kanwar estimates the impact of IPR for a data set comprising 44 countries and 20 years (1981-2000). He finds a strong positive impact of IPRstrength on R&D-investment.

It might be objected that even if such a relationship exists, it merely describes an average for a large sample of countries. An overall positive average could conceal large losses to individual countries within a sample. Indeed, this is the point made by critics such as Carlos Correa and Frederick Abbott. According to them, developed countries depend on innovation and therefore benefit from IPRs. Developing countries, in turn, depend on imitation. They should therefore introduce IPRs only very gradually. But there are factors pointing in the opposite direction. Without reasonable protection of their IP, technology-intensive companies could be reluctant to invest in or trade with a specific country. Therefore, the flow of technology and the subsequent sharing of knowledge between developed and developing countries could be impeded, resulting in a widening of the technological gap. Just as above, where the theoretical debate is ambiguous, empirics may be useful. Andreanne Leger (2006) has conducted a study similar to the above, but with a separate estimation including developing countries only. The author estimates the connection between innovation and IPR, and corrects for other main determinants of innovation such as market demand, past innovative activities, economic conditions, political stability, human capital, financial capital and openness to trade. Most of these abstract concepts are measured in a similar manner to Kanwar’s study. ‘Past innovative activities’ are approximated by last year’s R&D-investment, ‘political stability’ describes a distinction between countries with and without a coup d’état in a specific year and a measure for ‘openness to trade’ is derived from the Penn World Tables. Comprising observations from 36 developing countries and 26 years (1970-1995), a strong positive impact of IPR on innovation can be observed. Leger’s study confirms the intuition that IPRs encourage the transmission of technology to developing countries and thereby boost innovation there. It does not, however, show in which precise way this impact is exerted. Technological knowledge from outside can infiltrate an economy via three channels: Foreign technology-intensive companies can export to that economy, set up production facilities there, or sell the right to employ a protected technology to a local company. Douglas Lippoldt and Walter Park have attempted to assess the effect of IPRs on all three channels, also disaggregating countries according to economic development. They find that the impact of IPR on FDI is stronger in the subgroup of the developing countries than in the sample as a whole, and greatest in the sub-subgroup of the LDCs. Of course, there are large variations between economic sectors. Some sectors are more IP-intensive than others, and some are more able than others to rely on self-help measures such as trade secrets. But other things being equal, FDI is the main channel by which IPRs exert their impact on innovation in developing countries. To summarise, an adequate system of IPRs may not be the single most influential factor for economic growth, but there is reasonable empirical evidence that the gains from IPRs more than outweigh the costs. That is true both in high- and low-income nations. In the latter, the most important channel via which IP affects innovation is FDI. Econometric models are always subject to rough simplifications and can legitimately be criticised. But it should be up to the opponents of IPRs to prove their cause using a more fine-tuned model. Emotional arguments may be fashionable but they provide little help for economic development.