Intellectual Property Rights, Licensing, and Innovation

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org. There is considerable debate in the economics literature about whether a decision by developing countries to strengthen their protection of intellectual property rights (IPRs) will increase or reduce their access to modern technologies invented by developed countries. This access can be achieved through technology transfer of various kinds, including foreign direct investment and licensing, the latter of which is the focus of this paper. To the extent that inventing firms choose to act more monopolistically and offer fewer technologies on the market, stronger IPRs could reduce international technology flows. However, to the extent that IPRs raise the returns to innovation and licensing, these flows would expand. In theory, the outcome depends on how IPRs affect several variables, including the costs of, and returns to, international licensing, the wage advantage of workers in poor countries, the innovation process in developed countries, and the amount of labor available for innovation and production. This paper develops a theoretical model in which firms in the North (developed nations) innovate products of higher quality levels and decide whether to produce in the North or transfer production rights to the South (developing nations) through licensing. Different quality levels of each product are sold in equilibrium due to differences in the willingness to pay of consumers for quality improvements. Contracting problems exist because the inventors in the North must indicate to licensees in the South whether their product is of higher or lower quality and also prevent the licensees from copying the technology. Thus, constraints in the model ensure that the equilibrium flow of licensing higher-quality goods meets these objectives. When the South strengthens its patent rights, copying by licensees is made costlier but the returns to licensing are increased. This change affects the dynamic decisions regarding innovation and technology transfer, which could rise or fall depending on …