As discussed above, effects of patent rights are defined in early empirical studies are market expansion and market power. In principle, market power and expansion effects can be briefly explained in two aspects – demand and supply in economics. The market expansion effect can be defined that market shares of patent holders will rise when the patent rights protection in importing countries is improved. The advanced rights of patent generate higher costs of imitation to competitors and encourage, promote and attract more foreign technology to importing countries.
In other words, less imitation not only implies an increased demand for exports because of lower costs, but also infers an increased supply. It is because exporters save anti-imitative costs such as monitor costs, enforcement costs and costs to prevent copying and imitation. In a standard demand and supply model, cost reduction leads a right shift both in demand and supply line. On the other hand, improved patent rights protection might produce monopolistic market power and contribute to a more concentrated market because of higher technical and cost barriers to entry.
From the standard monopoly model, it can be seen that the sold quantity of monopolistic enterprises would be always less than the society optimum quantity in order to sell products at prices plus monopoly mark up. There is a monopolistic tactics to maximize firms profit is to beat selling quantity down in order to raise price. Hence, market power effect will confer more market power on the patent holders and then result in a reduction of the amount of export.
In this article, we collect data sets from US exports and study three forms of bilateral trade equations to test three hypotheses about the relationship between exports and patent rights in relation to income development, imitative abilities, and threat of imitation, respectively. The first hypothesis which examines the relation between patent rights and country development is based on Maskus and Penubarti’s research (1995) and Smith’s research (1999). The other two hypotheses are based on Smith’s research (1999) to take the degree of threat of imitation and imitative abilities into account.
Hypothesis 1- interaction between exports and patent rights with relation to country’s level of development In this section, I suppose a country’s development of patent rights positively respond to its economic development. We assume that countries with higher economic development would pay more attention on patent reform. In addition, higher-income developed countries possess much financial resources than lower-income countries. As imagined, higher-income developed nations are likely to control up great majority expenditure and performance on research and development in the world.
Otherwise, developing countries take ambiguous attitudes towards the world’s patent reform. As discussed above, a fierce debate originates in some doubts with regard to effects of patent protection from developing countries. A patent reform in developing countries might attract foreign investment and international trade, but it might restrain economic development in local industry as well. Besides, lower income economies seem to relatively lack non natural resources such as financial and technological resources.
It is said that higher income countries possess some degree of market power because of these unique competitive advantages such as patent, financial resources or higher technical capacities. Hence, referring to above assumptions, higher income developed nations pose stronger patent protection than lower income countries have. Based on this notion, I group the selected countries into four categories – high income (H), upper-middle income (UM), lower-middle income (LM) and low income (L) according to the income standard of World Bank in 2005.
The World Bank defines that high income group is country’s gross national income (GNI) per capita over $10,726 or more; the upper middle income group is country’s GNI per capita range of $3,466 to $10,725; the lower middle income group is the economies with a GNI per capital of more than $876 and less than $3,465; and the low income group is the economies with a GNI per capita of more than $875 in 2005 (The World Bank, 2006). The further detail information refers to Table 3 in 4. 2 Method and data. The flowchart of hypothesis 1 is illustrated in Figure 1 below.
The expectation derived from assumptions above that patent rights systems in countries with higher income are more mature than the systems in countries with lower income because rich countries possess significantly more resources and the patent confers market power in the world’s market. Moreover, we further suppose that imitative risks in countries with high income and upper-middle income might be lesser than in countries with lower-middle income. The lack of substitutes and lesser imitative activities in the market results in weaker risks of imitation and imply that patent owners might possess market power in the market.
If a reform of patent rights system is driven in countries with weaker imitative risks at this moment, the competition in the market would become less fierce. Therefore, the market power of patent owners would more concentrate owing to reshaping and reforming the patent rights law. In conclusion, market power effect would occur in those countries with high income and upper-middle income has relatively low risk of imitation when the patent rights protections are improved. And the effect in high income countries would be more significant that the effect in upper-middle income countries.
On the contrary, patent systems in low-middle income countries are likely to be weaker than in higher income countries. Rampant imitative activities but weak patent protection would distract foreign investment and international trade. Exporters need to increase anti-imitative costs by using special techniques when they ship products to those importing countries in order to avoid imitation through reverse engineering (Catherine, Y. C. , 2004) which imitators figure out product’s functions and layout from analyzing its software and hardware.
Hence, an improvement in the patent system causes a reduction of anti-imitative costs. In a competitive market, market share of patent holders would be increasing as a result of cost reduction. Market expansion effect occurs when patent holder have increased competition. However, in low-income developing countries, people have lower consumption abilities. Lower demands lead to a limited number of exports. Even patent rights are enhanced in low income economies; there is insignificant but negative influence to exporters.
Hypothesis 2- interaction between exports and patent rights with relation to country’s level of imitative abilities In hypothesis 2, by following Smith’s research which takes country’s imitative abilities into account, we attempt to examine how sensitive are US exports to country’s patent right with relation to country’s level of technical skill. It is assumed that countries with higher technical capacities imply that they pose stronger imitative abilities and diffusion and imitation are rampant in these nations.
Thus, exporters confront a higher (lower) but potential imitative risks if importing countries own strong (weaker) level of technical capacities to imitation. Figure 3 above illustrates what kind of interactive influences between levels of technical capacities in a country and international trade occur. This study expects that exports will reduce to respond to an improvement of patent rights protection if the importing country is grouped into weak R&D ability. An ambiguous effect would happen in countries with middle level of imitative abilities.
Therefore, if an improvement of patent right happens to a country with higher levels of technical skill, the effect would be positive link with exports. For further explanatory, the effect has to depend on the degree of imitative risks. In first situation, when patent holders, which pose more market advantages, import their patented products into countries with weak imitative capacities, exporters gain higher level of market power because of less competition in local market due to the improvement in patent rights protection.
Local firms might have insufficient abilities to imitation through reverse engineering and might need to spend much to imitation. Patent rights provide its holders with a relative an advantageous position and leading market power. Thus, after a patent rights system reform, patent holders pose larger market power. In second situation which countries have moderate R&D abilities, effects will depend on the relatively dominance of market power and expansion when exporters confront moderate imitative risks, ceteris paribus.
In addition, market expansion effect occurs in the last situation. When exporting firms face strong risks of imitation, importing countries have high levels of imitative abilities, an improvement of patent right would provide legal protection to exporting firms and tend to expand its market. The reason is that countries with strong imitative abilities imply fierce imitation activities in a competitive market. Through an improvement of patent system, exporters can spend less anti-imitative costs but rivals must pay more to imitate products.
Thus, the amount of imitation would be decrease to respond to patent reforms and might increase demand and supply as a result of cost reduction. Parts of market demand will retreat to the patent holders; indeed, parts of supply from exports will increase. That is the reason why we assume that market expansion effect occurs in countries within strong imitative abilities with respect to the improvement in patent rights. Based on the reason, we sort those selected countries into three groups by the level of imitative abilities – strong (Sk), middle (Mk) and weak (Lk).
The rule to segment countries into three groups is based on the number of utility patent applications filed in US from 1995 to 2005. We further define that importing countries are grouping into the strong imitative abilities group (Sk) when their number of utility patent applications filed in US from 1995 to 2005 is more than 50,000 items; the middle imitative abilities group is country’s utility patent application range of 1,000 to 50,000 items; the weak imitative abilities group is country’s utility patent application less than 1,000 items. For more detailed information about this grouping refer to Figure 9 in 4.
2 Method and data. Hypothesis 3- interaction between exports and patent rights with relation to country’s level of threat of imitation In this section, we examine effects of market expansion and market power by considering country’s threat of imitation. We adopt imitative risks measured by country’s technical capacities in hypothesis 2; however, in hypothesis 3, we emphasize a more detailed grouping which displays mutual influences between the existing degree of patent rights protection and imitative abilities (the same as the hypothesis 2) in importing countries.
In short, to further understanding the effect of patent reform in importing countries, it is necessary to consider the existing patent system. Based on the notion, we sort countries into four groups by degree of imitative threats, which can be classified as four groups – strong (T1), moderate (T2 and T3) and weak (T4) in this paper. If nations have strong imitative technical skill and abilities, the number of utility patent application in US from 1995 to 2005 less than 10,000 items, but powerless patent protection, which the index of patent rights bigger than 4, can be defined as countries with strong threat of imitation (Group 1).
On the contrary, when a country has high level of technical skill (utility patent application more than 10,000 items) but powerless patent laws (the index of patent right small than 4) can be defined as countries with weak threat of imitation (Group 4). The remaining countries have both strong/weak patent systems and imitative abilities (utility patent application more than 10,000 items and the index of patent right larger than 4 / application number less than 10,000 items and the patent index smaller than 4).
The former is Group 3 and the latter is Group 2. Hence, market power effect is expected to occur in countries with low threat to imitation (Group 1) if importing countries proceed with patent reform. It would lead to reduce exports because of higher concentrated market power of patent holders. Market expansion effect will occur in countries with high threat of imitation and exports would increase to respond to an improvement of patent rights.
In addition, if countries have both strong and weak patent protection and imitative abilities, degree of imitative threat in countries should be moderate. The link between patent rights and exports is somehow unclear. The flowchart of hypothesis 3 is illustrated in Figure 4 below. As described, the purpose of three hypotheses testing is to observe the determinants of market expansion and power effect related to patent rights protection.
To be clear, I assume that levels of economic development, imitative abilities, and threat of imitation are the main explanatory dummy variables in this paper. Through above assumptions, this study attempts to figure out coefficients between the strength of patent rights protection and exports. In addition, the relation among these three determinants – development, R&D ability and threat of imitation further analyze in 4. 2 Method and data.