Editor’s Introduction

1

Editor’s Introduction

R IAN MCEWIN

I. Background

Innovation is the main driving factor in economic growth. Innovation includes the generation, diffusion, absorption and application of new ideas, knowledge and technologies, which leads to new or better goods and services, production processes, marketing methods (distribution, etc) and better forms of business organisation. Innovation is a major source of economic growth for both developed and developing countries.

Asia has experienced rapid economic growth and development since the end of the Second World War. To begin with, many Asian countries industrialised by developing import-substituting industries such as food processing, textiles, footwear, etc that built on their agricultural strengths. South Korea and India also focused on developing medium and heavy industries. Japan concentrated on rebuilding its industries through exports and by opening, to a degree, its economy to trade and investment. The Japanese approach was followed by China, South Korea, Singapore, Taiwan and Hong Kong. Later, Indonesia, Malaysia, Thailand and the Philippines introduced similar export-oriented policies that led to their rapid growth from the 1980s.

Technology was important, to varying degrees, in Asia’s export success. Growth was fueled mainly by technology derived from imported capital equipment. As Brahmbhatt and Wu in a World Bank Report pointed out:

While the econometric evidence is mixed, a rich body of case study literature argues that East Asian firms may have derived significant technological benefits from exports under longer term Original Equipment Manufacturing (OEM) contracts, as part of the global production networks of foreign multinationals … Here evidence for technology transfers through ‘vertical’ relationships between local firms and MNC affiliates (another form of supplier–oriented upgrading) is more convincing than for other channels that have been suggested.[1]

Almost 80 per cent of the world’s research and development (R&D) is carried out in the developed world. For most countries, innovation means catching up with developed countries. However, even developed countries rely on imported technology for growth. Eaton and Kortum have estimated that foreign sources of technology account for at least 80 per cent of domestic productivity growth in most Organisation for Economic Co-operation and Development (OECD) countries—except for the United States and Japan.[2]

However, the ability to introduce technology from abroad depends on a country’s ability to learn and absorb the technology, which depends on scientific and technical skills within the country in universities, public and private research bodies, and the willingness of multinational companies to invest in training local staff.

Weak intellectual property rights (IPRs) reduce the returns from domestic R&D. However, for countries at an early stage of economic development, with little local R&D, there is little to protect. Copying allows local industries to grow—at least in markets where easy copying is possible. As a country develops and starts to develop its own indigenous research, IPR protection becomes more important. For example, new products increasingly come from innovation in large, fast-growing developing countries such as China, India and Brazil. Initially these new products were developed for domestic consumers but now increasingly they are for export to developed countries.[3] Industries engaged in indigenous research will argue for better local intellectual property (IP) protection and will clash with domestic industries that thrive on copying.

IP laws are mainly concerned with innovation. As Schumpeter puts it ‘… to survive in capitalist competition, incumbents must withstand a perennial gale of competition in the form of the new consumer goods, the new methods of production or transportation, the new markets, the new forms of industrial organization.’[4]

IPRs provide an economic incentive to innovate but they differ in their importance across industries. Mansfield[5] concluded in 1985 that patents were only essential in chemical industries and pharmaceuticals, but more recent work by Maskus[6] finds that patents are also important in newer technologies such as biotechnology and plant genetics.

IPRs do not exist in a policy vacuum. For example, the importance of IPRs in promoting innovation is affected by a country’s complementary endowments and policies. Government commitment to education and skills training is more likely to lead to greater innovation—and so IPR protection becomes more important when combined with a policy emphasis on education. Similarly, the relationship between competition law and IPRs does not exist in a vacuum. Countries that are closed to trade, and so face little import competition, will find IPRs create greater market power than they would in an open economy. Thus, competition regulators may need to play a greater role.

IPRs promote innovation by allowing firms to protect their ideas or expression—so leading to new products or new forms of expression for which consumers are willing to pay. IPRs do not necessarily confer market power but they might. Where IPRs designed to promote innovation create substantial market power, they may conflict with competition law that tries to ensure new ideas and expression are disseminated at least cost as widely as possible. Put more technically, there may be a clash between IPRs, designed to encourage optimal innovation over time (dynamic efficiency) and competition law, designed primarily to promote efficient short-term resource allocation (static or allocative efficiency where goods and services are supplied at least cost to consumers prepared to pay for them). Countries may face difficult policy choices in trading off conflicts between these two kinds of efficiency (ie optimal innovation over time versus the cost-justified use of innovation).

Many believe dynamic competition to be more important than short-term price competition. For example, McKenzie and Lee argue that economic models of price competition (ie static models) ‘exaggerate the economic harm done by real-world monopolies in real-world markets’ and that ‘some degree of monopoly is good because without some monopoly presence no economy can ever hope to maximize human welfare over time’.[7]

Yet, modern competition law enforcement around the world (following the United States) continues to be concerned, mainly, with short-term economic efficiency and to apply economic models of short-term price competition. So, for example, in defining markets for competition law purposes, the focus is on price competition by using a price elevation test that looks at the extent to which consumers switch product as a result of an increase in price. However, competition in new product or process markets is often on the basis of product characteristics, not price. So markets defined for competition law purposes solely on the basis of price competition may not reflect competitive realities in either developed or developing countries.

II. Intersection between IPRs and Competition Law

Over the last 20 years, the United States has been at the forefront of the development of the policy and jurisprudence of the intersection between competition law and IP law. Typically, the United States has focused on the trade-off between domestic innovation (in the United States) and domestic dissemination of ideas and expression (again in the United States). The policy debate has been concerned with whether the traditional approach to competition law enforcement, with its focus on price competition, should be changed to accommodate situations where innovation and IPRs are important.

US regulators started to seriously consider the importance of dynamic competition from the early 1990s. For example, in their joint 1995 ‘Antitrust Guidelines for the Licensing of Intellectual Property’, the Department of Justice and the Federal Trade Commission (FTC) stressed that: the common purpose of intellectual and competition laws; intellectual property was like any other type of property; IPRs did not necessarily create market power; and that licensing is generally pro-competitive.[8] The 1995 Guidelines also said that while licensing was pro-competitive, a licensor could limit a licensee’s use of its technology in the same way that the licensor could if it exploited the IPR itself. So there is no obligation to promote competition in licensing one’s own IPR.

The 1995 Guidelines also identified three kinds of markets relevant to dynamic competition. First, an innovation market that involves R&D aimed at improving products or processes. Second, a technology market where the IPRs themselves are bought and sold (eg IPR licenses and the competing technologies that constrain any market power the licensor/licensee may have). Finally, the goods market which consists of the goods and services comprising the IPRs.[9] This characterisation has been questioned. For example, Hay and others wonder whether innovation markets are new or simply a new name for potential competition from new technologies.[10]

Most in the United States now agree that competition laws should incorporate dynamic competition into the existing approach. For example, in 2007, the US Antitrust Modernization Committee concluded that ‘[c]urrent antitrust analysis has a sufficient grounding in economics and is sufficiently flexible to reach appropriate conclusions in matters involving industries in which innovation, intellectual property, and technological change are central features’.[11]

The US approach to the intersection of IP and competition laws has been largely followed in Europe, Australia, etc. Competition law guidelines dealing with the intersection have largely followed the United States. However, is this approach appropriate to other countries, with different business practices, legal systems and levels of innovation, IPR regimes and stages of development? This book provides an overview of the relationship between IPRs, competition law and policies in Asian countries. The goal was to consider their intersection within a broader economic and legal context than just a domestic trade-off between innovation and static efficiency as in the United States. For example, for countries with little or no innovation there is no trade-off.

III. Competition, Innovation and Welfare

In the short-term, competition improves consumer welfare and contributes to economic growth by forcing firms to work in consumer’s interests. Firms that fail to serve customers with the products they want at the lowest price lose out to firms that do. Competition drives price down towards cost promoting efficient resource allocation. However, to be competitive firms must be internally efficient. So competition also forces internal efficiency. As Holmes and Schmitz pointed out in a recent survey of competition and productivity:

We have reviewed a new literature that has examined industries experiencing dramatic changes in their competitive environment. Nearly all the studies found that increases in competition led to increases in industry productivity. Plants that survived these increases in competition were typically found to have large productivity gains, and these gains often accounted for the majority of overall industry gains.[12]

While competition seems to improve what economists call X-efficiency or internal or within-plant efficiency, some argue that too much competition might also reduce dynamic efficiency and so longer-term economic growth. Schumpeter argued that economic change depends on innovation, entrepreneurship, but also on market power. Market power is beneficial, he said, if it is derived from innovation and provides better outcomes for consumers than price competition. While innovation may create monopoly power, rivals and imitators soon compete away these monopoly profits. Temporary monopolies, he argued, were necessary to provide the important incentives necessary for firms to develop new products and processes. Competition that reduces a firm’s ability to capture monopoly profits discourages innovation and so long-term growth.

Evidence on the relationship between competition and innovation is mixed. For example, Blundell, Griffith and Van Reenen found a strong positive relationship between product market competition (eg the number of competitors) and productivity growth and innovation.[13] Others, like Michael Porter, argue that product market competition promotes growth because firms are forced to innovate or go out of business.[14] Factors that limit competition such as barriers to entry are also important—if there are barriers to firms introducing new technology then there is a reduced incentive to innovate.

Firms innovate because they believe they can make profits from R&D. This depends on the economic environment and the market conditions in which a firm operates. A firm is more likely to invest in R&D if it believes it can develop a major innovation that limits post-innovation competition (by making competitors’ products obsolete or too costly). If an innovation is relatively trivial (and so only slightly differentiates the product from others) then it is likely that monopoly profits will be negligible. So, the likely level of post-innovation competition will be an important factor in deciding whether to engage in R&D.

However, innovation might be driven, also, by an attempt to pre-empt the R&D of a competitor or possible new entrant. R&D decisions also need to take into account the impact of any innovation on any existing monopoly profits (ie where innovation ‘replaces’ existing products). To the extent that new innovation cannibalises existing profits, the incentive to innovate will be diminished.[15] So, the dynamics of competition are more complicated than Schumpeter believed.

In 2007, Richard Gilbert surveyed the theoretical and empirical literature on competition and innovation[16] and stressed that there are many factors that affect the relationship between incentives to innovate and market power.[17] These factors include:

— Property rights system. How much protection is there? Are IPRs easy to invent around? Can innovation be protected outside the IP system?

— Nature of the invention—does it involve a new product or process innovation that reduces production costs? Is it a minor advance or does it replace existing products?

— Extent of competition pre and post-innovation—is a highly competitive situation before the innovation likely to be replaced by less competition afterwards, etc? Is competition mainly on the basis of price or product? Are there significant barriers to R&D? Is the inventor also the innovator, or does the inventor expect to license the innovation to someone else?

— The dynamics of R&D competition. Are outcomes of R&D predictable? Can firms collaborate to avoid duplication of R&D?

Gilbert went on to conclude that:

The large body of economic theory and empirical studies on the relationship between competition and innovation fails to provide general support for the Schumpeterian hypothesis that monopoly promotes either investment in R&D or the output of innovation. The theoretical and empirical evidence also does not support a strong conclusion that competition is uniformly a stimulus to innovation.[18]

Studies by Blundell, Griffith and Van Reenen,[19] Greenhalgh and Rogers[20] provide some evidence that oligopoly may provide better innovation outcomes than more competition. Aghion and Griffith have empirical evidence supporting their argument that there is an inverted U-shaped relationship between competition and innovation.[21] That is, patents rise as competition increases but then a point is reached at which increased competition leads to a falling off in patent rates.

The complex factors that affect the relationship between competition and innovation are likely to differ not only across markets in a single country but more so across countries. Countries need a range of capabilities to allow firms to successfully exploit innovation. Teece first stressed the importance of complementary assets.[22] Assets such as skilled labour, information, financing opportunities, ability to use IPRs, the availability of sophisticated legal and accounting services are all important—and particularly important for an innovative firm in a developing country whose innovation is to be exploited in a developed country.

Given the uncertainties in the relationship between competition and the incentives for innovation, it seems likely that the relationship between competition law and IP will differ between countries.

Not only will the impact of one law on the other be different due to local economic circumstances, but countries may have different policy objectives towards both laws. National interests become important to any trade-off. For example, a country might use compulsory licensing to force overseas technology transfer to a local monopoly and then either regulate the price or protect it against imports as part of an industrial policy aimed at developing local industry or local vested interests rather than promoting domestic competition. Competitor collaboration in setting standards may also be directed at protecting an indigenous technology rather than promoting consumer interests.

IV. Asian Legal Systems

Of course, the way IP and competition laws are enforced and their effectiveness depends on a country’s legal system. Even where substantive laws are the same, different legal systems may enforce IP or competition laws differently. This may be due to differences in policy goals or procedural differences (the way or sophistication in which economic evidence is dealt with by regulators or courts for example). Asian legal systems vary but, in general, law in Asia is not as important as it is in the West. Glenn describes Asian legal systems in the following way:

It is law which is secular in origin, yet greatly limited by its formal version, by its reach and effect. In China the limits are the secular ones of Confucianism; elsewhere, Asian religions have done the same work of limiting the role of the lawyers. Everywhere in the Asian tradition … there is denial of the primary role of secular law-makers and denial of the idea of a sweeping religious law. In short there is denial everywhere of a primary role for what is usually known as law. It is a secular, largely informal, legal tradition, though informed by great learning.[23]

Still, Asian law has been greatly influenced by the West. Japan looked to Europe in the early twentieth century. China followed. However, the US occupation after the Second World War impacted Japanese law and led to a US style competition law in 1947. Dutch, English and French law initially influenced law in South East Asia, but its influence declined in Cambodia, Laos and Vietnam post-independence. Common law is still important in Brunei, Hong Kong, Malaysia and Singapore.

V. Why Should Countries Introduce Competition and IPLaws?

Countries will only introduce (or enforce if forced on them) competition law and IPlaws when they yield tangible, positive, benefits. Both IP laws and competition law are highly technical, particularly where complex issues involving innovation and dynamic competition are concerned. Their successful introduction requires the kinds of skills that are limited or non-existent in developing countries. So some time may be needed to develop the necessary skills and expertise to identify whether a patent application is novel or whether business conduct is anti-competitive—and whether an anti-competitive practice can be realistically improved by intervening

Governments may give a low priority to protecting IPRs to ensure their citizens have low-price access to patented or copyrighted products. For example, a number of developing countries allow the importation or domestic production of generic drugs despite patent protection. Preventing anti-competitive practices may be also given a low priority by governments. Well organised groups such as wealthy families who control legislatures may benefit considerably from government-protected cartels. Competition laws may threaten that wealth and so they may wield their political influence to prevent the introduction of competition laws. Or, a government may believe there are greater benefits from focusing on general competition policies such as reducing tariffs or opening up markets by reducing government-imposed entry barriers than introducing a competition law.[24] Domestic competition may be restricted as part of an export-oriented industrial policy. For example, local collaboration between competing firms may be allowed in order to develop sophisticated products for export in the longer term.

However, countries in Asia have increasingly introduced competition and IP laws. Sometimes they have been forced on them as part of a financial bail-out from the International Monetary Fund (IMF) or World Bank or introduced as a quid pro quo or for access to developed country markets (under Trade-Related Aspects of Intellectual Property Rights (TRIPS) or free-trade agreements). Sometimes this has been resented—particularly as sometimes the terms imposed have been more onerous than for similar recent assistance to developed countries in Europe.

VI. IP Laws, Competition Law and Economic Growth

How important are intellectual and competition laws to economic growth? This is a difficult issue to resolve both theoretically and empirically. Also, the evidence of the effect of both is mixed. A recent study by Falvey, Foster and Greenaway examined the relationship between IPRs and economic growth. They concluded: