Innovation and Patentability Requirement in a Globalized World∗

One important element of a patent regime is the non-obviousness requirement, which captures the minimum improvement to the best patented technology a new invention is required to make in order for it to be patentable. We call it the required inventive step. We explore the implications of a patenting regime based on required inventive step, by incorporating such intellectual property protection considerations in the quality-improvement model of technology, trade and growth developed by Eaton and Kortum (European Economic Review 2001). In considering whether to increase the inventive step, policy-makers trade off the benefits of a higher rate of innovation against the loss of consumer surplus as patent-holders enjoy their monopoly pricing power for a longer duration on average. We first establish that there exists an optimal binding inventive step that maximizes country welfare under certain reasonable conditions. We then proceed to formulate an open-economy model, in which countries interact through cross-border trade and firms patent internationally. We focus on the central case that domestic goods and foreign goods are highly substitutable with each other so as to contrast with earlier work of Grossman and Lai (American Economic Review 2004), who analyzed international IPR issues under an alternative regime based on patent length protection and product innovation. We find that there exists a stable Nash equilibrium of the inventive-step-setting game between national governments that features over-protection of intellectual property from a global perspective. Moreover, country governments set higher inventive steps in the open-economy relative to the closed-economy benchmark. We discuss how these results relate to Grossman and Lai (2004). Of note, globalization in the form of reduced trade frictions leads countries to raise their equilibrium inventive steps. Consequently, globalization leads to higher equilibrium research intensities in all countries.