It’s something of a mystery in the IP literature why small, developing countries would ever enforce intellectual property rules. The standard tradeoff is higher prices in exchange for more innovation. But the innovation is useful no matter where it comes from. So unless you are a relatively large, prosperous country, it’s unlikely to be worthwhile trading off higher prices within your country due to the limited monopoly of IP for a tiny increase in inventive activity. Indeed, the US did not enforce foreign copyrights, for example, until the 20th century, much to the consternation of Charles Dickens. Of course, in practice many nations strengthen IP laws because they are coerced into doing so in exchange for other beneficial trade liberalization – see the TRIPS agreement. But outside of trades of this type, might there be another reason for strengthening IP in the developing world?
L. Kamran Bilir argues that there might be in a new working paper which she presented here earlier this week. Multinationals make up the bulk of international trade (and international technology transfer) and have many options of where to place their new plants. But they are worried that if they locate in a region with weak IP, there is a strong incentive for some local company in that region to rip off their product. Assume that such imitation can only happen if a plant or affiliate plant of the MNC is located in the foreign country. Assume also that figuring out how to imitate involves some stochastic investment by a would-be imitator. A simple model gives the following predictions. First, products whose commercial usefulness is very short don’t worry about imitators: by the time the iPhone is knocked off, Apple has a new model ready to go. These industries will always produce overseas in order to access cheap labor, regardless of formal IP laws. Second, products whose commercial usefulness is of moderate length might be coerced to locate overseas earlier in the product lifecycle if, at the margin, IP laws strengthen. The idea is that, with relatively stronger IP, the incentive to imitate will be weaker because stronger IP lessens the expected profits the imitator can expect to make; you might imagine “stronger IP” as “higher probability that the government will shut you down for selling products that violate a foreign patent.” Third, products with long commercial lifecycles spend less of the product lifecycle producing overseas after an IP strengthening than the marginal intermediate-length products. The response of MNC offshoring to IP changes, then, is nonmonotonic in the product lifecycle length.
Bilir then uses data, in a number of different specifications, from dozens of countries and over 30 years. She finds precisely this nonmonotonic effect. The measure of “average product lifecycle” (or, in another specification, 90th percentile product lifecycle) is constructed from forward citations in the US patent database by industry, and of course you might question this portion of the methodology, but it’s not ridiculous on face; you might also not like the measure of IP strength used, though it is pretty standard in this literature for better or worse. The nonmonotonic effect of stronger third world patents is seen not just in affiliate sales, but also in affiliate size and in the number of affiliates employed. A sensible interpretation is that third world countries can use stronger IP protection to attract MNC investment, but that policies will be unsuccessful for firms like software with short lifecycles and will be relatively unsuccessful with products like machine tools that have long lifecycles. What’s nice here is that the impact of IP on MNC location is identified in and of itself: IP changes often happen concurrently with other liberalizations in a nation’s economy. The identifying power here is that year and country fixed effects will pick up those other liberalizations while the differential impact of the IP strengthening across sectors with different product lifecycles (presumably affected in similar ways by non-IP reforms) let us isolate IP.
Two more things I would like to see. First, the formal tradeoff between reliance on secrecy and reliance on patents seems important here. This is related both to the ease of knocking off a product (drugs, for example, are easy to reverse engineer) and the importance of local legal systems in maintaining non-patent contracts like “do not disclose” policies. Perhaps this should enter the model? Second, I have an idiosyncratic preference for welfare estimates in policy-related papers, even if such estimates are only back-of-the-envelope. In this case, assuming standard learning-by-doing and technology transfer to affiliates, is it worth it for, say, China or Nigeria to increase their enforcement of IP (raising domestic prices) in exchange for some new jobs and tech transfer for the new MNC affiliates? A rigorous discussion here would lengthen the paper too much – it is already quite a monster – but a two page rough-and-dirty estimate would be useful indeed.
http://www.stanford.edu/~kbilir/Bilir_IP_and_MNCs.pdf (July 2011 Working Paper)
A Fine Theorem 
The post makes a strong point for why IP protection should worldwide. Twain & Dickens both argued the lack of copyright protection kept local authors from being published. Worldwide patent protection would increase investment in new technologies, which are the only way to increase real per capita incomes.
If countries do not adopt patent protection then they never develop their own inventive skills. Most third world countries can increase their standard of living by just adopting non-patented technology. They are not third world countries because patented technology is too expensive. They are third world countries because they have policies that discourage investment in technologies developed by others and policies that discourage creating new technologies locally. Note “IP changes often happen concurrently with other liberalizations in a nation’s economy.” The reason this occurs is that patents are consistent with property rights, which are necessary for economic growth.