9. Intellectual Property Protection, Foreign Direct Investment, and Technology Transfer DISCUSSION PAPER. Edwin Mansfield

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Intellectual Property Protection, Foreign Direct Investment, and Technology Transfer

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DISCUSSION PAPER

Edwin Mansfield

INTERNATIONAL FINANCE CORPORATION

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INTERNATIONAL FINANCE CORPORATION

DISCUSSION PAPER NUMBER 19

Intellectual Property Protection, Foreign Direct Investment, and Technology Transfer

Edwin Mansfield

The World Bank Washington, D.C.

Copyrighti 1994 The World Bank and International Finance Corporation 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing February 1994 The International Finance Corporation (IFC), an affiliate of the World Bank, promotes the economic development of its member countries through investment in the private sector. It is the world's largest multilateral organization providing financial assistance directly in the form of loan and equity to private enterprises in developing countries. To present the results of research with the least possible delay, the typescript of this paper has not been prepared in accordance with the procedures appropriate to formal printed texts, and the IFC and the World Bank accept no responsibility for errors. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the IFC or the World Bank or to members of their Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. Some sources cited in this paper may be informal documents that are not readily available. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to Director, Economics Department, IFC, at the address shown in the copyright notice above. The IFC encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. The complete backlist of publications from the World Bank, including those of the IFC, is shown in the annual Index of Publications,which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Iena, 75116 Paris, France. ISSN: 1012-8069 Library of Congress Cataloging-in-Publication Data Mansfield, Edwin. Intellectual property protection, foreign direct investment, and technology transfer / Edwin Mansfield. p. cm. - (IFC discussion papers, ISSN 1012-8069 ; no. 19) Includes bibliographical references (p. ). ISBN 0-8213-2759-3 1. Investments, American. 2. Corporations, American-Finance. 3. International business enterprises-Finance. 4. Intellectual property. 5. Technology transfer-Developing countries. I. Title. II. Series: Discussion paper (International Finance Corporation) no. 19. HG4538.M354 1994 332.6'7373-dc2O 93-49386 CIP

Contents Introduction

1

Effects of IntellectualProperty Protection: A Survey of U.S. Firms 1 Perceived IntellectualProperty Protection in SixteenCountries 2 Measuresof Perceived IntellectualProperty Protection 5 The Estimatesof the U.S. InternationalTrade Commission 6 Why Protection Is Regarded as Inadequateand Why PerceptionsVary amongIndustries 9 Responses and Views of Individual U.S. Firms Regardingthe Effects of IntellectualProperty Rights Protection 11 Firms' Reactionsto Changesin Laws in Republicof Korea, Mexicoand Taiwan, China 12 Changes During 1991-93in the Evaluationsof Mexico, Republic of Korea, India and Taiwan, China 14 StatisticalRelationshipsbetweenProtectionand the Amountand Compositionof Foreign Direct Investment 15 Size of Market and the SpecialCase of Mexico 15 A Simple StatisticalAnalysis 16 The Compositionof Direct Foreign Investment 17 Age of Transferred Technologies 18 Sununary and Conclusions Appendix I

19

23

Firms That Rule Out SubstantialInvestmentsin CountriesAffordingWeak Protection 23 Firms ConsideringIntellectualProperty Protectionas One of Several ImportantFactors in the InvestmentDecision 25 Firms Regarding IntellectualProperty Protection as Relatively Unimportant in the Investment Decision 27 IntellectualProperty Protection and TechnologyTransfer TechnologiesWithheldBecauseof Weak Protection Appendix II

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iii

30

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Usl of Tabl. Tablk I - Major U.S. Firms in Six Industries Where Strength or Weakness of Intellectual Property Rights Protection Has Strong Effect on WhetherDirect Investments Will Be Made, 1991 3 Tabe 2 - Major U.S. Finns Reporting That IntellectualPropertyProtectionIs Too Weak to PermitInvestmentin Joint Ventureswith Local Partners, by Industry and Country, 1991 4 Table 3- Major U.S. FYnnsReporting That IntellectualPropernyProtectionIs Too Weak to Permit Transferof Their Newestor Most EffectiveTechnologyto WhollyOwnedSubsidiaries,by Industry and Country, 1991 7 Table 4 - Mojor U.S. Firms Reporting That IntellectualPropertyProtectionIs Too Weak to PermitLicensingof TheirNewestor Most EffectiveTechnologyto UnrelatedFirms, by Industry and Country, 1991 8 Table 5 - Estimated Regression Coefficientsin Equation (1) and Their Standard Errors (in Parentheses). All Manufacturing,Japan and both Japan and Spain Excluded. 34 Table 6 - Estmated RegressionCoefficientof Weakness-of-Protection Variablein Equation(1), Six ManufacturingIndustries,Japan and both Japan and Spain Excluded. 35 Referenec

37

iv

Foreword

ThisDiscussionPaper presentsthe first empiricalevidenceto my knowledgeon the relationship between, on one hand, respect/disrespectfor patents and other forms of intellectualproperty rights on the part of developingcountries,and, on the other hand, foreigndirect investmentflows which are being attracted to these developing countries. The research project on which the findings are based was initiatedby the IFC's EconomicsDepartment. Edwin Mansfieldis director of the Center for Economics and Technologyand Professor of Economics at the Universityof Pennsylvania.

Guy P. Pfeffermann Director, EconomicsDepartment & EconomicAdviser of the Corporation

v

Abstract Policy makersand analystsrequirea better understandingof the effect, if any, that a developing country's systemof intellectualpropertyrights protectionhas on the transfer of technologyto that country through foreigndirect investment. It is frequentlyarguedthat relativelyweak intellectualproperty rights protection in a developingcountry may lower the probabilitythat multinationalfirms will invest there, and that, even if they do invest there, they may be willing (because of weak intellectual property protection) to invest only in wholly owned subsidiaries (not joint ventures with local partners) or to transfer only older technologies. But this and other hypotheseshave been challenged,and there is very little evidenceone way or the other. This paper is an attemptto help fill this importantgap. Based on a combinationof survey data, interviewstudies, and statisticalanalysis,we find that the strengthor weaknessof a country's system of intellectual property protection seems to have a substantial effect, particularly in high-technology industries,on the kinds of technologytransferred by many U.S. firms to that country. Also, this factor seems to influencethe compositionand extent of U.S. direct investmentthere, althoughthe size of the effectsseems to differ from industryto industry. While we believe that this study sheds substantialnew light on this topic, much more needs to be done. For one thing, the statisticalanalysis is only a beginning; further efforts should be made to refine and extend the results. Also, our findingspertain entirelyto U.S. direct investment;it would be worthwhileto extendthe coverageto Japaneseand Europeaninvestment. We are currently startingsome work in these and other directions.

vii

I

Acknowledgments

Apreliminarydescriptionof someof the resultsderived in this paper was presented earlier in my 1993 article (cited below on page 43) publishedby the NationalAcademyPress. I am indebtedto Jacques Gorlin, Zvi Griliches, Robert Miller, Ashoka Mody, Mary Ellen Mogee, and RobertSherwood who commentedon this earlier paper. Also, thanks go to Gary Hufbauer, Leonard Lederman, Guy Pfeffermann,and others who took part in a seminar at the World Bank that I gave on this topic, and to AshokaMody and Brian Pinto for their commentson the presentpaper. Financialsupport was received from the ResearchCommitteeof the World Bank.

ix

Introducdon Foreign direct investmentcan be an importantmeansof transferringtechnologyto developing countries.1' It is widelyrecognizedthat both policy makers and analystsrequire a better understanding of the effect, if any, that a developingcountry's system of intellectualproperty rights protectionhas on the transfer of technologyto that country through foreign direct investment. Some observersv have arguedthat relatively weak intellectualproperty rights protectionin a developingcountrymay lower the probabilitythat multinationalfirms will investthere, and that, even if they do investthere, they may be willing(becauseof weak intellectualpropertyprotection)to investonly in whollyownedsubsidiaries(not joint ventures with local partners) or to transfer only older technologies. Other ol'servers' have challengedthis hypothesis. Unfortunately,there is very little evidenceto support or deny many of the hypothesesthat have been put forth. The purpose of this paper is to help fill this importantgap. Based on a combinationof survey data, interview studies, and statisticalanalysis, we find that the strength or weakness of a country's system of intellectual property protection seems to have a substantialeffect, particularly in high-technologyindustries, on the kinds of technologytransferred by manyU.S. firms to that country. Also, this factorseems to influencethe compositionand extent of U.S. direct investmentthere, althoughthe size of the effectsseems to differ greatly from industryto industry. This paper begins with a descriptionof our survey data, after which the interview studies are taken up, and some preliminarystatisticalanalysisis discussed.

Effects of InteUlectualProperlyProtection: A Survey of U.S. Ftnns In 1991, I chose a random sample of 100 major U.S. firms in six manufacturingindustries chemicals(includingdrugs), transportationequipment,electricalequipment,machinery,food and metals. The frame for this samplewas the comprehensivelist of major firms in BusinessWeek,June 15, 1990. Each firm was asked to provide informationregardingthe importanceof intellectualproperty protection in influencingwhetheror not the firm wouldmakedirect foreigninvestmentsof varioustypes. Complete or partial informationwas obtained from 94 of the firms, a very high responserate. The respondents generally were patent attorneys, specialistsin firms' internationaloperations, and top executives. The limitationsof survey data of this kind are well known, but interpretedwith proper caution, they can be helpful. The percentageof firms indicatingthat intellectualpropertyprotectionhas a major effect on their foreigndirect investmentdecisionsdependsgreatlyon the type of investmentsin question(Table 1). For investmentin sales and distributionoutlets, only about20 percent of the firms reported that intellectual property protection was of importance. For investment in rudimentary production and assembly facilities,4'about 30 percent said that such protection was important. For investmentin facilities to manufacture componentsor complete products, about 50-60 percent said it was important, and for

I/For example, see Blomstromand Wolff (1989). 2/Sherwood(1988). _/United Nations(1993). I/Rudimentaryproductionand assemblyfacilitiesare ones involvingbasic technologiesthat are reasonablywell knownto all firms in the relevant industry.

investmentin R and D facilities,about 80 percent said it was important. Thus, to the extent that fbreign direct investmentby U.S. firms is focused heavily on sales and distributionoutlets and on rudimentary production and assembly facilities, it appears that a country's intellectualproperty protection has a relatively small impacton the total amountinvestedby U.S. firms in that country. But it may have a much bigger impact on the amountinvested in facilitiesto make componentsand completeproducts, as well as to do R and D. For all types of investmentsother than in sales and distribution outlets, the chemical industry (which includes pharmaceuticals)has the largest percentage of firms regarding intellectual property protectionas importantin this regard. The food and transportationequipmentindustriestend to havethe smallest percentage, and the electrical equipment,metals, and machineryindustriestend to rank in the middle. As mightbe expected,there is a very high correlationbetweenan industry's rank in this regard and its rank in previous studies with respect to rough measures of the importance of patents in the innovationprocess. (Intellectualpropertyconsists chieflyof patents, plant breeders' rights, copyrights, trademarks, and trade secrets.) Perceived Intellectual Properly Protection in Sixteen CountiEes Each of the firms in our samplewas asked to indicatewhether, in its view, any of 16 countriesArgentina,Brazil, Chile, HongKong, India, Indonesia,Japan, Mexico,Nigeria, Philippines,Singapore, Republicof Korea, Spain, Thailand, Venezuelaand Taiwan, China-had intellectualproperty protection that was too weak in 1991 to allow it to invest in joint ventures (where it contributed advanced technology)with local partners in that country. These countrieswere selectedbecauseof their size and importance,as well as the frequencywith which they have been cited in connectionwith controversies over intellectualpropertyprotection. Except for Japan and Spain, these countriesare major developing or newly industrializedcountriesin Asia, Latin America, or Africa. Japan and Spain were includedso comparisonscould be made to a developedcountrywhose intellectualpropertyprotectionhas sometimes been a subject of controversyand to a relativelypoor Western Europeancountry. Over 30 percent of the U.S. firms felt that intellectualproperty protection in India, Nigeria, Brazil, and Thailand was too weak to permit them to invest in joint venturesthere (Table 2), while 10 percent or less felt that this was true in Japan or Spain. The proportionof firms feelingthat intellectual propertyrights protectionin these countriesis, on the average,too weak to permit such investmentstends to be highest in the chemical industry, where patents are relatively important,and lowest in the metals industry. Each of the firms was also asked whether, if it had a wholly ownedsubsidiary in one of the 16 countries listed, it would be willing to transfer its newest or most effective technology to such a subsidiary-or whether the weaknessof the country's system of intellectualproperty protectionwould make such transfers very unlikely.Y Thirty percent or more of the firms reported that they would be very unlikely to transfer such technologyto India, Thailand, or Nigeria, but less than 5 percent felt this way aboutJapan or Spain (Table 3). Singaporeseems to be regarded reasonablywell, with only about

I/Finxnswith subsidiaries(or joint ventures)in the country in questionwere askedthis question. Firms withoutsubsidiaries (or joint ventures)there were asked whetherthey wouldbe willing to transfer such technologyif they had such a subsidiary. The data in Table 3 pertain to all firms but are highly correlatedwith those pertainingonly to firms having such subsidiarie (or joint ventures).

2

Table 1 - Major U.S. Firms in Six Industries Where Strength or Weaknessof IntellectualProperty Rights Protection Has Strong Effect on Whether Direct InvestmentsWill Be Made, 1991 (percent)

Industrr

Sales and Distribution Outlets

Rudimentary Production and Assembly Facilities

Facilities to Manufacture Components

Facilities to Manufacture Complete Products

Research and Development Facilities

Mean

Chemicalb Transportation equipment Electrical equipment Food Metals Machinery Mean

19 17 15 29 20 23 20

46 17 40 29 40 23 32

71 33 57 25 50 50 48

87 33 74 43 50 65 59

100 80 80 60 80 77 80

65 36 53 37 48 48 48

* The numberof firms in the sample in each industry is chemical, 16; transportationequipment,6; electricalequipment, 35; food, 8; metals, 5; machinery,24. However, not all firms in the sample respondedto all questions. ' The chemicalindustry includespharmaceuticals.

Table 2 - Major U.S. Firms ReportingThat IntellectualProperty Protection Is Too Weak to Permit Investmentin Joint Ventures with Local Partners, by Industry and Country, 1991i (parcent) Country

Chemicalb

Argentina Brazil Chile HongKong India Indonesia Japan Mexico Nigeria Philippines Singapore Rep. of Korea Spain Taiwan,China Thailand Venezuela Mean

46

40 47 31 21 80 50 7 47 64 43 20 33 0 27 43 40 37

Transportation Equipment 0 40 20 20 40 40 40 20 20 40 40 20 0 40 80 20 30

Electrical Equipment

Food

Metals

Machinery

Mean

29 31 29 38 39 29 10 30 39 31 24 21 10 41 32 19 28

12 12 12 12 38 25 0 25 29 12 12 12 0 25 12 12 16

0 0 0 0 20 0 0 0 20 0 20 25 0 20 0 0 7

27 65 23 9 48 25 0 17 24 18 0 26 4 17 20 20 21

18 32 19 17 44 28 10 22 33 24 19 23 2 28 31 18 23

* See Table 1. Some firms reported they had too little informationand experienceregardingparticular countriesto providethis information. For these countries,firms of this sort are excluded. The numberof firms that had to be excludedfor this reason is generallyvery small. i

See note b, Table 1.

14 percentof the firms beingunwillingto transfersuch technologythere. The percentageof firms feeling that intellectual property protection in these countries is, on the average, too weak to permit such technologytransfer is relativelyhigh in the chemicalindustry and relatively low in the metals industry; the industryranking is much the same as in Table 2. In addition, each firm was askedto indicatewhetherthe protectionof intellectualproperty in each of 16 countries listed was too weak to permit it to license its newest or most effective technologyto unrelatedfirms in that country. Over 30 percent of the firms said that this was the case for India, Brazil, Thailand,Nigeria, Indonesiaand Taiwan, China (lTable4), whileunder 10 percent said this was the case for Spain and Japan. (More than two-thirds of the chemical firms reported that intellectualproperty protectionin India, Indonesia, Nigeria, Thailand, and Brazil was too weak to permit licensing of their newest or most effective technologythere.) The percentageof firms feeling that intellectualproperty protectionin these countrieswas, on the average, too weak to permit licensing is relativelyhigh in the chemicalindustry and relatively low in the metals industry, the industry rankingbeing similarto Tables 2 and 3. Measures of Perceived Intellectual Property Protection Tables 2-4 providedthree crude measuresof the perceivedstrength or weaknessof intellectual property protectionin 16 countries: (1)

the percentageof firms believingthat protectionthere is too weak to allowthem to investin joint ventures with local partners;

(2)

the percentage believingthat protection is too weak to warrant the transfer of their newest or most effectivetechnologyto a wholly owned subsidiaryin that country;

(3)

the percentagebelievingthat protectionis too weak to allowthem to licensetheir newest or most effectivetechnologyto unrelatedfirms in that country.

While the roughnessof thesemeasuresshouldbe stressed, theynonethelessshouldbe of interest. A country's standingbased on one of these measurestends to be highlycorrelatedwith its standingbased on another of them. The coefficient of determinationbetween the first two of the above measures averagesabout .73; the coefficientof determinationbetweenthe first and third measuresaveragesabout .85; and the coefficientof determinationbetweenthe second and third measures averagesabout .82. Because these three measures are so highly correlated, which one we employ makes relatively little difference for many purposes. In the analysisbelow, we often will use (in each industry) the mean of these three measuresfor a particular country as a rough index of the perceivedstrengthor weaknessof intellectualproperty rights protectionin that country(for this industry). There is little correlation between one industry's evaluation of the strength or weakness of intellectualproperty protectionin a particular countryand another industry's evaluationof the strength or weaknessof intellectualpropertyrights protectionin the same country. To illustrate,considerour first measure of the strength or weaknessof a country's protectionsystem--thepercentageof firms reporting that a country's protection is too weak to allow them to invest in joint ventures with local partners. While there generally is a moderateamount of correlation(r2 greater than or equal to .40) among the evaluationsby the chemical, food, machinery,and electrical equipmentindustries, there is little or no correlationbetweenthese four industriesand the transportationequipmentindustryor betweenthesefour 5

industriesand the metals industry. Reasonsfor this low level of correlationare discussedon pages 10-11 below.Y When we compare our findings in Tables 2-4 with the Pharmaceutical Manufacturers Association's (PMA) list of countrieswith very weak intellectualproperty protection,1 ' we find both a reasonabledegree of correlationand significantdifferences. AlthoughNigeria and Taiwan, China tend to have relatively weak protection based on our measures, they are not on the PMA list; and while Argentina, Chile, Mexico, the Philippines,and Venezuelaare on the PMA list, they are not amongthe weakest based on our measures. However, this seems to be due in large part to our more extensive industrial coverage. If we focus solely on our results for the chemical industry (which includes pharmaceuticalfirms), our measures agree almost exactly with the PMA list, Nigeria being the only exception.Y If we compare our measureswith those of Rapp and Rozek (1990),who used a procedurebased on Gadbaw and Richards (1988) to construct an index of patent protection measuring the extent of conformityof a country's patent laws to the minimumstandardsproposed in the GuidelinesforStandards for the Protectionand Enforcementof Patentsof the U.S. Chamberof CommerceIntellectualProperty Task Force, we find that there is considerablecorrelationbetween their index and ours. (heir index ranks the extent of patent protectionon a scale from 0 to 5, where a country with no patent protection at all receiveda 0 and a nation whose laws are fully consistentwith these minimumstandards receives a 5.) Sincetheir index is based solelyon the laws on the books, not on the waysthese laws are enforced, their results would be expectedto differ somewhatfrom ours. Also, their results lump all industries together. For many purposes, interindustry differences are important, as we have seen, and it is necessaryto formulatea separate indexfor each industry, as we have done in Tables 2-4.

TheEstimates of the U.S. Internatonal Trade Commission In 1988, the U.S. InternationalTrade Commission(ITC)publisheda studywhich ranked countries in the approximateorder of negative marketplaceimpact ... that resulted from inadequate intellectual property protection. In assessing negative marketplace impact, the following factors were considered-market size, share of market lost, export market losses in third countries,reductionin marginsthroughprice competitionand price controls set by reference to the price of infringing material, goods, or services;use of confidentialtest data by others, withoutthe respondent's authorization, in securing government approvals; lost manufacturing efficiencybecauseof reducedvolume; lossof reputationand diminished

6/Note that the percentageof firms in the metalsand transportationequipmentindustrieswith foreignsubsidiariesor joint venturesin at least one of these countriesis as large as it is in the electricalequipmentand machineryindustries; so differences in this regard are not responsiblefor the lack of correlation. I/See Mogee (1989)and Rozek (1990) for this list. /Prame (1987) has constructedan index basedon the PMA list and the InternationalTrade Commissiondata discussedin the following ection.

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Table 3 -- Major U.S. Firms ReportingThat IntellectualProperty ProtectionIs Too Weakto Permit Transferof Their Newestor Most Effective Technologyto Wholly OwnedSubsidiaries,by Industryand Country, 1991' (percent)

|

Country Argentina Brazil Chile Hong Kong India Indonesia Japan Mexico Nigeria Philippines Singapore Rep. of Korea Spain Taiwan, China Thailand Venezuela Mean

See Table 2. b

See Table 1.

Chemicalb 44 50 47 21 81 40 0 31 67 47 12 31 0 19 60 50 38

Transportation

Electrical

Equipment

Equipment

20 40 20 20 40 20 0 20 20 40 40 20 0 40 80 20 28

21 24 21 38 38 31 14 21 25 28 21 28 7 41 31 18 25

Food

Metals

Machinery

Mean

12 12 12 12 38 25 0 25 25 12 12 12 0 25 12 12 15

0 0 0 0 20 0 0 0 20 0 0 40 0 0 0 0 5

14 39 27 14 41 23 0 22 23 17 0 22 13 35 14 18 20

18 28 21l 18 43 23 2 20 30 24 14 26 3 27 33 20 22

Table 4 -- Major U.S. Firms ReportingThat IntellectualProperty ProtectionIs Too Weakto Pernit Licensingof Their Newestor Most Effective Technologyto UnrelatedFirms, by Industryand Country, 1991a (nerl ent) Country Argentina Brazil Chile Hong Y,-ng India Indonesia Japan Mexico Nigeria Philippines Singapore Rep. of Korea Spain Taiwan, China Thailand Venezuela Mean

b

See Table 2. See Table 1.

ChemicaPb 62 69 47 33 81 73 12 56 73 47 25 38 6 44 73 62 50

Transportation Equipment

Electrical Equipment

Food

Metals

Machinery

Mean

0 40 20 20 40 20 20 20 20 40 40 20 0 40 80 20 28

26 29 22 38 38 33 17 28 32 34 24 34 14 55 36 21 30

12 25 12 12 38 25 0 25 38 12 12 12 0 25 12 12

0

29 73 25 14 50 37 0 36 25 24 0 29 14 36 25 26 28

22 39 21 20 44 31 8 28 35 26 20 29 6 37 38 24 27

0 0 0 20 0 0 0 20 0 20 40 0 20 0 0 8

value for the companyname becauseof counterfeitingor other infringingactivity; and increasedproduct liability costs; the added costs of intellectualproperty enforcementattempts; the difficulty of doing business in a straightforward, efficient manner; and opportunity losses where inadequate intellectual property protectionacted as a deterrentto business activity. The ITC's rankings were based on 1986 data receivedfrom 161 Americanfirms in a variety of manufacturingand nonmanufacturingindustries. For the 16 countriesin Tables 2-4, the rankings(from largest to smallestlossesto U.S. respondents)are (1) Taiwan, China (2) Mexico, (3) Republicof Korea, (4) Brazil, (5) India, (6) Japan, (7) Nigeria, (8) Hong Kong, (9) Indonesia,(10) Spain, (11) Singapore, (12) the Philippines, (13) Thailand, (14) Venezuela, (15) Argentina, and (16) Chile. The correlation betweenthese rankings and our own is relatively low (about .33). Mexico, Republicof Korea, Japan, and Spain seemto rank higher on the ITC's list of countries(basedon negativemarketplaceimpact)than on our list, whileIndia, Nigeria, Indonesia, and Thailandseem to rank lower on the ITC's list than on ours. To a substantial extent, this low correlationseems to reflect the fact that the two rankings are measuringdifferent things. The ITC is measuringthe reduction in profits imposedby a country's firms on U.S. firms, whereas the present study focuses on the willingnessof U.S. firms to engage in joint venturesor to licenseor utilize advancedtechnologyin a country. Even if the profit reductionsimposed on them by a particular country's firms are small (perhaps because this country's firms are not very adept), U.S. firms may not be willingto engagein such activities in that country. Yet U.S. firms may be willingto engage in these activities in another countryeven if the profit reductionsare large, because they nonethelessfind these activities profitablethere. Also, the ITC's rankings are influencedheavily by counterfeiting,not taken up here, and by the entertainmentindustry, not includedhere. The ITC's study shows the numberof times that the firms in its samplereported inadequaciesin a country's patent protection regime and inadequaciesin remedies and enforcement in 1986. The correlationbetweenthis numberand our results in Tables 2-4 is very low, which may reflectthe fact that the ITC questionnaireasked firms to list countries "in approximateorder of importanceto you, which you would most like to see adopt fully adequateand effective intellectualproperty protection:" (U.S. InternationalTrade Commission,1988: D-22). The countriesthat are cited most often are those where U.S. firms felt that their reductions in profit due to weak intellectualproperty rights protectionwere biggest, not those in which U.S. firms would be least likely to license or utilize advancedtechnology. To repeat, these may not be the same thing.2'

WhyProtectionIs Regardedas Inadequateand WhyPerceptionsVaryamong Industries Interviews with officials of many of the companies in our sample indicate that, in deciding whether a particular country's system of protection is too weak, they are especiallyinterested in the answers to three broad questions. (1) Can the country's laws protect their technology? (As an illustration, some countries do not allow chemical or drug products to be patented.) (2) Is there an adequate legal infrastructurein the country? (Some countries contain few patent attorneys or other specialistsin this area of expertise.) (3) Do the relevantgovernmentagenciesin the countryenforcethe

29Also, countries like the Republic of Korea acted to strengthen their system of intellectual property protection after 1986. This too may help to explain the low correlation.

9

laws and provide prompt and equitabletreatmentto foreignfirms? (In some countries,there are reports of corruption and of discriminationagainstforeign firms.) In some of the 16 countries in Tables 2-4, a substantialnumber of U.S. firms seem to feel that the answer to at least some of these questionsis no. In India, products patents are not issued for drugs, chemicals, alloys, opticalglass, semiconductors,and intermetalliccompounds. In Thailand,firms have objected to the lack of patent protection for chemicals, drugs, food and beverages, and agricultural machinery, as well as the weak protectionof trademarksand copyrights.L' In Brazil, there is no patent protectionfor chemicals,drugs, and foodstuffs,and complaintshave been made about weak trade secret protection.l' In Taiwan, China, foreign firms have claimed that patent protection for chemicalsand pharmaceuticalshas been inadequateand that there has been no unfair competitionlaw dealingwith false advertising, imitativeproduct packaging, and inaccuratemarks of origin. In 1986, a revisedpatent law was passed that extends full patent protection to chemical and pharmaceuticalproducts, but many problems are said to remain.2 If a countrygrants patent protection,this does not mean that the length of the patent is the same as in the U.S. (17 years). In India, those patents that are permitted in the food, medicine, and drug industriesextend for seven years. In some countries, the patent holder must work the inventionwithin one to three years after the patent is issued; if they do not do so, the patent is subject to compulsory licensingor may lapse. Firms argue that they cannot make their products in every country where they expect patent protection. When compulsorylicenses are granted, the royalty rate is often set at 0.5 percent or less of sales, which firms regard as very low. In India and the Philippines,drug patents are subjectto compulsorylicense on demand, even if the inventionis worked there by the patent holder.13 ' Tables 2-4 have indicated that industriesdiffer considerablyin their evaluationof intellectual property rights protectionin particular countries. Interviewswith firms show that intellectualproperty protection does not play the same role for each industry. In some industries like metals and transportationequipment,competitorsfrequentlycannotmakeeffectiveuse of a firm's technologywithout many expensiveand complex complementaryinputs. In other industriessuch as chemicals,local firms can imitate an innovator'snew productsrelativelyeasily. Differencesof this sort help to accountfor the lack of correlation between the chemical industry's evaluationsof specific countriesand the metals or transportationequipmentindustry's evaluationsof these same countries. Since these industriesdo not face the same problems, they often evaluatea specific countryquite differently.

10/SeeSen (1990) on India and Schumann (1990) on Thailand. In the May 25, 1989 report of the U.S. Trade Representative on "Special 301," Thailand and India were leading on its "priority watch list," followed by the Republic of Korea, Taiwan, and the People's Republic of China. 11/See Frischtak (1990) and Sherwood (1988). Also, metallic admixtures and alloys are not patentable unless they have "specific intrinsic qualities precisely characterized by the nature and proportions of their ingredients or by special treatment." NoneLheless,as shown in Tables 2 to 4, this seems to have had little or no effect in discouraging U.S. metals firms, illustrating once again the importance of an industry-by-industry analysis. According to some U.S. metals firms, they often can incorporatc sensitive technologies in "black boxes" that can be protected. 12/See Schumann (1990) and references in note 13. 13/See Goans (1986), Hill (1985), Matthews (1988), and the President's Commission on International Competitivencss (1985).

10

A country's laws often affect different industriesin quite different ways. Countriesthat do not extendpatent protectionto drugs and chemicalsobviouslyare likely to receivelow evaluationsfrom the chemical industry, even though other industries--oftenones in which patent protection is of less importancein any event--donot regard these countriesvery negatively. Thus, Argentina(whichdenies patent protectionto drug products) and Venezuela(whichhas deniedpatent protectionto drug products or chemicalpreparations, reactions, or compounds)get poor evaluationsfrom chemicalfirms. (Almost two-thirdsof U.S. chemicalfirms said protectionin both of these countrieswas too weak to permit them to licensetheir newestor most effectivetechnologythere.) But outsidethe chemicalindustry,U.S. firms give both of these countries relativelygood evaluations. (Only about 15 percent of U.S. nonchemical firms said protection in these countries was so weak they could not license such technologythere.) Interindustryvariationin the evaluationof protectionin any specificcountrymay also reflectthe fact that local firms in one industry in this countrymay be more aggressivein exploitingweak laws and enforcementthan local firms in another industry. While intellectualproperty protectionmay not vary between thesetwo industries,U.S. firms may perceiveit to be weakerin the former industrythan in the latter. Some observershave suggestedthat this helps to explainour results regardingArgentina;in their view, Argentina's drug firms have been much more aggressive in this regard than other parts of Argentineanindustry. Responses and Views of Individual U.S. Firns Regarding the Effects of Intellectual Property Rights Protection In previous parts of this report, datahave beenpresentedthat summarizethe responsesof 94 U.S. firms to a numberof centralquestionswe asked them regardingthe effects of intellectualpropertyrights protectionon their decisionsconcerningforeigndirect investmentand the transfer of technology. While summarydata of this sort are of great value in delineatingthe overall contours of their responses,they cannot conveymany of the nuances. Havingspent over two years communicatingwith these firms, and probing their responses, I can testify that the viewpointsof U.S. top managerson this topic constitutea rich, variegated, and complex mosaic. To conveythe spirit and range of their views, direct quotations of their responsesto key questions are provided in AppendixI of this paper. These quotationscome almost entirely from written statementsto us, so there is no chance of misquotation. Abouttwo dozen major firms are included, so a reasonablediversityof viewpointscanbe encompassed. The only editing of the responseswas to delete names or phrases that would identify the firm or executive.X Some firms, particularly research-intensivefirms with products(or processes)that are relatively easy to imitate assert that they will not make substantialinvestmentsor transfer advancedtechnologyto countries with weak intellectualproperty protection. But most such firms we contacted, particularly outsidethe chemical (includingdrugs) industry, regard such protectionas an importantfactor, but only one of a number of factors, influencingtheir investmentdecisions. As would be expected, many firms with limited R and D investmentsconsider intellectualproperty protectionto be relatively unimportant in the investmentdecision. The firms in our sample tend to regard strong intellectualproperty protection as being more important in decisions regarding the transfer of advanced technology than in investmentdecisions.

14/Not all of the firms included in this part of the report were members of the sample underlying Tables 1-4. To supplement this sample, 12 additional firms were drawn at random from these industries. 11

Although some high-technologyfirms avoid transferring advancedtechnology even to countries with strongprotection, this is not true of most firms we studied; But research-intensivefirms, particularlyin the chemical (includingdrugs) industry, often will not transfer advanced technologyto countries with weak protection. Accordingto the statementsof the executives, who were a mix of chief executive officers, vice presidents, patent attorneys, and others, the technologieswithheld because of weak protectionwouldhave benefittedthesecountriesconsiderably. For direct quotationsfrom their responses, see AppendixI. Flrms' Reactions to Recent Changes in Laws in Republic of Korea, Mexico and Taiwan, China Each firm in our samplewas asked to evaluatethe significanceof recent changesin intellectual property rights in countries like Republic of Korea, Mexico and Taiwan, China. Most felt that the changeswere important. For example,a computerindustry executivesaid: We believethat the new trade secret and copyright laws in Republicof Korea, the [developments]....that should lead to a new copyrightlaw in Taiwan, and the new patent, trademark,and copyrightlaws (as modified by the NAFTA draft agreement)in Mexico, are significantintellectual property law changesthat will encourageinvestment. Accordingto the chairmanof a chemicalfirm, fhere is no question that intellectual property rights protection has improved in countries like Republic of Korea, Taiwan, and Mexico. This is particularlytrue of Mexicowhere the new proposalscan serve as a role model for many other countries. Many firms seemed to regard the changesin Mexico as particularly important to them. For example, a patent attorney at a food companysaid: The changes in Mexico are probably the most significantto [us]. The changes in Republic of Korea and Taiwan appear to relate primarilyto other aspectsof intellectualpropertyprotectionor other technologies,in particular pharmaceuticals in the case of Republic of Korea, and copyrightsin the case of Taiwan. Even so, much of the changeappears, from what we have read, to be windowdressing rather than based on a real desire to implement a more favorable and effective intellectual property system. A chemical R and D executivesaid: The 1991 Mexican intellectual property law dramatically improved technology rights in that country. Of the three countries (Mexico, Republic of Korea, Taiwan), only Mexicomade substantialchanges in their laws. Since the law was not effective until August 1991, it is prematureto make a judgment on enforcement.

12

Many of the respondentsstressedthat it wouldtake a long time to determinewhetherthe recent legal changeswould be enforced. For example,the chairmanof a chemicalfirm said: [My firm] has been encouragedby the recent changesin the intellectual property laws in Mexico and Taiwan. These changes appear to add significantprotectionfor our types of technology;however, it is still too early for us to determinewhether the courts in these countries will be able to effectivelytranslate the legal changesinto real protection. The managing counselof a chemicalfirm commentedas follows: The awakeningof Taiwan and Republicof Korea to the need to protect intellectualproperty rights has given comfort to plans to build plants there in conjunctionwith serving these markets. We are also freer to introduce new, even copiableproducts into these countries. The same is true of Mexico. This expandedbusinessopportunityis only one side of the coin. The other side is that copyingof our proprietaryproducts, e.g., agrichemicals,does not exist. Prior to the new Taiwan patent law, Taiwan manufacturerscopiedand exportedour proprietaryagrichemicals whichwere not patent-protectablein Taiwan; this does not happentoday. At the time of the new Koreanpatent law in 1987and the accompanying protectionprovided by administrativeguidance, we had informationof at least one of our most important proprietary agrichemicals being developed for copyingin Republic of Korea; this stopped. So, the law changes and the accompanyingconsciousnessof the need to protect intellectualproperty, or trade pressureby the U.S. government,or all of the above has been helpful in sparing our agrichemicalbusiness from piracy on an internationalscale. As to countriesmaking substantialchanges in laws and enforcement,I am more familiar with laws than enforcement, in the sense that enforcement questions are often not reached until after a period of operating under new laws. An exceptionis Mexico, which legislated criminal penalty, understood to include jail time, for infringementof intellectual property rights; that certainly gets people's attention. Mexico, Republicof Korea, and Taiwan have all legislatedsubstantial improvements at least in their patent laws ... Indonesia has its first patent

law. The vice president of a pharmaceuticalfirm said: The recently strengthened intellectual property rights of Republic of Korea and Mexico, as well as the newly reformed countries of Eastern Europe, are a welcomechange. Republicof Korea, like Mexico,is now a country where serious investment by [us] in marketing and manufacturingis now possible. We must cautionthough, that the full significanceof their improvementscan't be judged until we see how vigorously those countries intend to enforce their laws. Finally, those 13

developingcountriesthat comprisemajor pharmaceuticalmarkets, such as Taiwan, India and Brazil, have not actually made any significant improvementsin their intellectualpropertylaws. The followingstatementwas made by a chemicalexecutive: The changes have indeed been significant for the chemical and pharmaceuticalindustry, because the products and sometimeseven the processes of these industrieswere not protectedunder the former laws. Of particular importanceare Korea, Taiwan, Mexico, the countries of Eastern Europe, and Spain. However, good laws mean nothing unless they can be enforced and enforcementis something that can only be judged by observingthe system over a periodof time. In our judgment it is too early to know whether the patents we are beginningto receive will indeed be enforceable. A new drug or agrochemicaldiscovered today and patented in Taiwan will not be approved by health and environmentalauthoritiesfor 5 to 10 years. Then they will have to be introducedto the market and the businessbuilt up to an interestinglevel. It is only at that point that a patent pirate will come into the market with an infringing product. So on chemical and pharmaceuticalproduct patents we will not have a good idea of enforceabilityuntil late in this decade, if then. In the meantime we can draw some conclusionsfrom enforcementin other areas such as copyright and trademark cases. In this connection, we understandthat enforcementin Taiwan is still a serious problem, and that Korea is not muchbetter. While most firms seemedto welcomethese legal changes,some stressed their limitations. For example, the chairmanof an electronicsfirm stated: "I can certainlysay that in the case of Republic of Korea there is absolutely no intellectual property rights protection. There has been no change Accordingto a chemicalexecutive, Many of the changes in the intellectualproperty laws in these countries will benefit industry segments other than the commodity chemicals business. Our concern still resides in being able to procure a quick injunctionagainsta confidantwho is in a positionto disclose :onfidential informationto third parties. Changes During 1991-93 in the Evaluations of Mexico, Republic of Korea, India and Taiwan, China Given the legal changesthat have occurred in Mexico, Republicof Korea, and Taiwan, China, it is importantto determinehow manyof the firms in Tables2-4 that were unwillingin 1991to transfer advanced technologyto each of these countrieswould now (late 1993)be willing to do so. To obtain such information,a randomsample of 50 percent of these firms was selected, and the relevantofficials of each firm (or their successors)were re-interviewed. The results indicatethat Mexicois the only one of these countriesthat has experienceda substantialincrease in the proportionof firms willing to send it advanced technology. About 30 percent of the firms in Table 3 that said in 1991 that they were 14

unwilling to transfer their newest and most effectivetechnologyeven to a wholly owned subsidiary in Mexico now say that they are willingto considerseriously such technologytransfer. On the other hand, despitethe interest in the changesin Republicof Korea and Taiwan, China, there seems to be a wait-and-seeattitude in many U.S. firms toward these countries. Only about 10 percent of the firms in Table 3 that said in 1991 that they were unwillingto transfer their newest and most effectivetechnology even to a wholly-ownedsubsidiary in these countries now say that they are willing to considerseriously such technologytransfer. For the sake of comparison,we obtainedthe same sort of data for India as for Republicof Korea and Taiwan, China. The results suggestthat attitudestoward Republicof Korea or Taiwan, Chinahave not changedsubstantiallymore than toward India. About 10percent of the firms in Table 3 that said in 1991that they were unwillingto transfer their newest and most effectivetechnologyeven to a whollyowned subsidiaryin India now say that they are willing to considerseriously such technologytransfer. In considerablepart, the limitedchangein attitudestoward Republicof Korea and Taiwan, China,Is due to unresolvedquestionsconcerningenforcementof laws, discussedin the previous section. Also, some executivesare frank in admittingthat they have only a general knowledgeof what changeshave occurred in Republic of Korea and Taiwan, China.

StatisticalRelationshipsbetween Protectionand the Amount and Composiion qf ForeignDirect Investnent We turn now to some statistical tests to determinewhether the perceivedstrength or weakness of intellectualproperty protectionin a countryis relatedto the size and compositionof direct investment by U.S. firms in that country. These tests utilize the measures of the strength or weakness of such protection described earlier; these measures are based on the data we obtained from 94 firms. Our previous results have indicatedthat there has been no significantcorrelationbetweenthe extent of direct investmentby U.S. firms in a country and the perceivedstrength or weaknessof intellectualproperty protectionin that country. (See Mansfield(1993).) But whether or not such a correlation exists when other major determinantsof U.S. direct investmentsare held constantis unknown. The purposeof the analysisdescribedbelow is to see whether this is the case.

Size of Market and the Special Case of Mexico Many economistshave pointed out that direct investmentin a particular country is likely to be influencedby the size of its market. For example, according to Anthony Scaperlandaand Laurence Mauer, "The size-of-markethypothesis,as generallystated, is based on the assumptionthat an inadequate market size has retarded the specializationof productivefactors. The argumentholds that the size of the market has been insufficientto absorb efficiently the technology which the direct investor desires to introduce. Basedon this and relatedunderlyingassumptions,the size-of-markethypothesisis that foreign investmentwill take place as soon as the market is large enoughto permit the capturingof economiesof scale."i' In their study of U.S. direct investmentin the European Community,Scaperlandaand Mauer

15/Scaperlanda and Mauer (1969), p. 560.

15

used gross nationalproduct as a measure of size of markets. So have many studies of investmentin developingcountries. Robert Stobaugh has indicated some drawbacks in the use of gross national product for this purpose. "The problem in using gross nationalproduct(or gross domesticproduct) is its failure to show for some countriesthat a large number of people have very low incomes. Hence, a seemingly sizable GNP might neverthelessrepresent a small market for many U.S. goods. This measure suggests, for example, that India's market is about the same size as Canada's. But, for most U.S. manufacturers interested in foreign investment, India, of course, is not nearly as large a market as Canada."Iw Nonetheless,Scaperlandaand Mauer found that size of market, as measuredby gross nationalproduct, was directlyrelatedto U.S. direct investmentin the EuropeanCommunity,whereasthe other independent variables included in their analyseswere not statisticallysignificant. Anotherfactor that has been cited in this regard is the special case of Mexico. The UnitedStates has establishedmany programsto encouragedirect investmentin Mexico, its neighborto the south, long beforethe creationof the North AmericanFree Trade Agreement. Thus, there seemsto be good reason to expectthat U.S. direct investmentin Mexico will be relativelylarge. The fact that the UnitedStates and Mexicoare neighbors also may play a role by itself. For example, Nankani,in his investigationof the foreign direct investmentsof the leading industrialnationsin variousdevelopingcountries,found that an industrial nation's investmentin a developing country is generally greater if the two countriesare located close to one another."' One reason that is given is that communicationsand transactionscosts go up with distance. A Simple Stadsdcal Analysis To see whetherthe change in U.S. direct investmentpositionin a particularcountry is related to the perceived strength or weaknessof its intellectualproperty rights protection when the effects of market size and the special case of Mexicoare taken into account, Jeong-YeonLee (1993) carried out a statistical analysis,described in AppendixII. Over the four years 1989-92,regardlessof whetherthe changein U.S. investmentpositionor capitaloutflowis the dependentvariable,and regardlessof whether both Spain and Japan or only Japan is excluded, his results indicate that the perceived weakness of protectionis inverselyrelatedto U.S. direct investmentin all manufacturingwhen these other variables are held constant. Taken at face value, the difference in protectionbetween Indonesiaor Republicof Korea and Hong Kong or Singaporeseems to be associatedwith a difference in U.S. direct investment of about$170 millionper year. At the level of individualmanufacturingindustries,his results are often more blurred, which is not surprisingdue to data limitations. Of course, market size and the special case of Mexico are not the only factors other than inte]lectual property rights protection that may influence foreign direct investment. For example, Schneiderand Frey (1985)found that a nation's level of wage costsand secondaryschoolenrollmentratio are relevant. Lee has added these variables, as well as the nation's economicgrowth rate, per capita electricityconsumption,and per capitanumberof telephonelines, to his analysis,and has foundthus far

16/Stobaugh(1969), p. 131. 17/Nankani (1979).

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that the effect of intellectualproperty rights protectiontends to remain significantwhen they are added. However, since his analysisis continuing,this finding must be regarded as tentative.!!' It is almost impossibleto separate a country's system of intellectualproperty protectionfrom its attitudes(andprocedures)toward protectingall forms of private property-- and the propertyof foreigners in particular. I suspect that Lee's results are due in part to a tendency for countrieswith very weak intellectualpropertyprotectionto have a variety of otherproblems(from the point of view of U.S. firms) that discourageU.S. direct investment. As stressed in a previous section, the mere passage of a patent or copyrightlaw is unlikelyby itselfto elicitsubstantialincreasesin direct foreigninvestmentif the entire legal system and enforcementmechanismsare judged to be inadequate. T7heComposition of Direct Foreign Investment The governmentsof developingcountriesrealize that the amountof technologytransfer to their citizens and firms depends on the types of investmentsmade by foreign firms, not just on the dollar volume of such investments. Specifically,investmentsin facilities to make componentsor complete products are likely to increasethe country's technologicalcompetenceto a greater extent than investments in sales and distributionoutlets or in rudimentaryproductionand assemblyplants. Becausefirms tend to be much morelikely to regard intellectualpropertyprotectionas importantfor the former than for the latter types of investment, a country's system of intellectualproperty protection may influence the compositionof direct foreign investment. While U.S. firms may be quite willingto invest considerable amountsin sales and distributionoutlets and in rudimentaryproductionand assemblyfacilitiesin countries with weak protection,their investmentsin R and D facilitiesor in facilitiesto manufacturecomponents or completeproducts may be more likely to go to countrieswith stronger protectionsystems.!' To see whethera relationshipof this sort exists, Jeong-YeonLee obtaineddetaileddata from 14 major U.S. chemical firms regarding the compositionof their investmentposition at the end of 1992in each of the countries (excludingJapan and Spain) included in the previous section. For each firm, he determined the percent of its total investment in each of these countries (where it had substantial investments)L'devotedto either sales and distributionoutletsor to rudimentaryproductionand assembly facilities. This figure was obtainedfor (1) all investmentswhere the firm had over 10 percentownership in the venture, (2) all investmentswhere the firm had over 50 percent ownershipin the venture, and (3) the firm's wholly owned subsidiaries. Whetheror not the perceivedweaknessof intellectualpropertyprotectionseemsto have an effect on the compositionof a U.S. chemical firm's investmentposition in a particular developing country

18/For details, see Appendix 11. 19/Of course, when the firm can defend the new technology through incorporation in "black boxes" or other means, such technology may be sent to countries with weak protection, but such defensive mechanisms are often unavailable or ineffective. 20/Only countries where a firm had invested at least St million were included in the analysis.

17

depends on how much ownershipthe U.S. firm has in the venture. Only for wholly ownedsubsidiaries is the estimatedeffect statisticallysignificant.' Basedon the interviews,manychemicalfirms are reluctantto transferrelativelynew or advanced technology to other than wholly owned subsidiaries;thus, for present purposes, only wholly owned subsidiariesmay be relevant. The aboveevidenceindicatesthat, in countrieswhere intellectualproperty protection has been perceived to be weak, a larger proportionof these chemical firms' investmentin wholly owned subsidiaries may be devoted to either sales and distribution outlets or to rudimentary productionand assemblyfacilitiesthan in countrieswhere protectionis perceivedto be stronger. Age of Transferred Technologies Accordingto a numberof executivesin our sample, some of whom are quoted in AppendixI, their firms transferolder technologiesto countrieswith weak intellectualpropertyprotectionthanto those with strong protection. For a few chemicalfirms, it has been possible to estimatethe age of a small sample of technologiestransferred via foreign investmentin these countries. (The age of a technology is defined here as the difference between the year the technology was transferred and the year the technologywas first used by this firm.) Accordingto the results, U.S. firms seem to transfer somewhat newer technologyto countrieswith relativelystrong intellectualpropertyprotectionthan to countrieswith weak protection,but the sample is so small that the results should be regardedonly as suggestive. There is similar evidencein the machineryindustry, but it, like the chemicaldata, is fragmentaryA'

21/The index in Table 3 (that is, the percent of major chemical firms reporting that protection is too weak to permit them to transfer their newest or most effective technologies to wholly owned subsidiaries in the country) is used here. It seems preferable to those in Tables 2 and 4 because the latter are concerned with whether or not to invest or with whether or not to license; what concerns us here is the sorts of technologies that will be transferred. 22/These data are old and pertain to only a few firms. Unfortunately, data of this sort are extremely scarce, which explains why these fragments seem to be worth presenting at all.

18

Summary and Conclusions 1. The bulk of the 94 U.S. firms in our sample report that the strength or weakness of intellectual property protection has an importanteffect on some, but not all, types of foreign direct investmentdecisions. Whereas about 80 percent of the firms in our sample maintainedthat this factor was important with regard to investmentsin R and D facilities, only about 20 percent said that it was important with regard to sales and distributionoutlets. Also, some industries--notably,the chemical (includingdrugs) industry--regardintellectualproperty as muchmore importantthan others, such as the food and transportationequipmentindustries. 2. Based on the evaluationsby these firms of whetheror not intellectualpropertyprotection in 16 major countriespermits them to investin joint ventures, transfer new techno!ogyto a subsidiary, or license new technology to each of these countries, it is possible to formulate a crude index of the perceived strength or weaknessof intellectualproperty protectionin each country. Averagedover all included industries, the countries perceivedto have the weakestprotection are India, Thailand, Brazil, and Nigeria; those perceived to have the strongest protection are Spain, Japan, Hong Kong, and Singapore. Our index seems to agree reasonablywell with those of others, but there is little correlation between our results and those of the InternationalTrade Commission. This seems to be because the commissionis measuringthe reduction in profits imposedby a country's firms on U.S. firms, whereas we are looking at the willingnessof U.S. firms to invest in, or transfer advanced technology to, a country. 3. There is often little correlation between one industry's evaluation of the strength or weakness of intellectual property rights protection in a particular country and another industry's evaluationof the samecountry. For example,there is little agreementbetweenthe chemicalindustryand the transportationequipmentindustry. In part, this is because a country's laws may be different for one industry than for another. For example, in some countries, patents can be obtained for some products but not others (such as drugs). In addition, because industriesface different problems,they tend to see a particularcountry in a different light. In some industriessuch as metals and transportationequipment, it is relatively difficult for competitorsto make effective use of a firm's technology without many expensiveand complexcomplementaryinputs, whilein other industries,such as chemicals,it is relatively easy for local firms to imitate an innovator's new products. Also, local firms in one industry in a particular country may be more aggressivein exploitingweak laws and enforcementthan local firms in another industry. 4. Communicationswith executivesin the chemical(includingdrugs), electricalequipment, transportationequipment,machinery,metals,and food industriesprovidefurther evidenceof the diversity of viewpointsin this area. Some firms, particularlyresearch-intensivefirms with products (or processes) that are relatively easy to imitate, assert that they will not make substantial investmentsor transfer advancedtechnology to countries with weak intellectualproperty protection. But most such firms we contacted, particularly outside the chemical (including drugs) industry, regard such protection as an importantfactor, but only one of a numberof factors, influencingtheir investmentdecisions. As would be expected, many firms with limited R and D investmentsconsider intellectualproperty protectionto be relativelyunimportantin the investmentdecision. 5. The firms in our sample tend to regard strong intellectualproperty protectionas being more importantin decisionsregardingthe transferof advancedtechnologythan in investmentdecisions. 19

Although some high-technologyfirms avoid transferring advanced technology even to countries with strong protection,this is not true of most firms we studied. But research-intensivefirms, particularlyin the chemical (including drugs) industry, often will not transfer advancedtechnologyto countrieswith weak protection. Accordingto the statementsof the executives,who were a mix of chief executive officers, vice presidents, patent attorneys, and others, the technologies withheld because of weak protectionwouldhave benefittedthese countriesconsiderably. 6. Most of the executivesstated that the recent changes in intellectualproperty laws in Republicof Korea, Mexico, and Taiwan, China have been important,but the changesin Mexicowere often regarded as muchmore significantthan those in the other two countries. About 30 percent of the firms that said in 1991 that they were unwillingto transfer their newest and most effective technology even to a .;holly owned subsidiary in Mexico now say they are willing to consider seriously such technologytransfer. Practicallyall of them stressedthat it wouldtake a long time to determinewhether these recent legal changeswouldbe enforced. Withregard to chemicaland pharmaceuticalpatents,some believe that it will take until late in this decade, if then, for them to knowhow vigorouslythese countries intendto enforce their laws. 7. Accordingto Lee's findings, if one holds a country's gross domesticproductconstantand recognizesthe special position of Mexico, there is a statisticallysignificantrelationshipbetween U.S. direct investmentin manufacturingin a country in 1989-92and our index of the perceivedweaknessof intellectualproperty protection. Taken at face value, a 10-pointincrease in our index seems to be associatedwith a decrease in U.S. direct investmentin manufacturingof about $200 millionper year. In interpretingthis result, one shouldrecognizethat a country's systemof intellectualpropertyprotection is inextricablyboundup with its entire legal and social system and its attitudestoward private property; it involvesmuch more than the passage of a patent or copyrightlaw. Also, the tentativenessof these statisticalfindingsshouldbe emphasized;further effortsshouldbe made to refineand extendthe analysis. 8. Based on the results of our survey as well as the interviewsand correspondencewith major executives,the compositionof U.S. direct investmentin a countrywouldbe expectedto be related to the strength or weaknessof the country's intellectualproperty protection. Whereas U.S. high-tech firms may be quite willing to invest considerableamounts in sales and distribution outlets and in rudimentaryproductionand assemblyfacilitiesin countrieswith weak protection,they may be muchless inclinedto invest in R and D facilities or in facilitiesto manufacturecomponentsor completeproducts. Detailed data obtained from 14 major U.S. chemical firms show no such correlation for their entire investment, but when only their investment in wholly-owned subsidiaries is considered, there is statisticallysignificantevidencesupportingthis hypothesis. 9. Accordingto a numberof the interviews,technologiestransferredto countrieswith weak intellectualpropertyprotectiontend to be older than those transferredto countrieswith strong protection. Data obtained from a few chemical firms seem to bear this out. Fragmentary data in the machinery industry suggest the same thing, but they, like the chemical data, are too limited to be more than suggestive. 10. In conclusion,the strength or weakness of a country's system of intellectualproperty protectionseems to have a substantialeffect, particularlyin high-technologyindustries,on the kinds of technology transferred by many U.S. firms to that country. Also, this factor seems to influencethe compositionand extent of U.S. direct investmentthere, althoughthe size of the effects seems to differ greatly from industry to industry. We believethat this study sheds substantialnew light on this topic, 20

which is both importantand relativelyunexploredfrom an empiricalstandpoint. But much more needs to be done. For example,our results pertain entirelyto U.S. direct investment. It wouldbe worthwhile to extend the coverage to Japaneseand European investment. We are currently beginning some work along this line.

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Appendix I This appendix provides direct quotations from the responses of various executives to our questions. We beginwith firms that say they rule out substantialinvestmentsin countriesaffordingweak protection, then take up firms considering intellectualproperty protectionto be one of a number of important factors in the investmentdecision, and next consider firms regarding intellectualproperty protectionas relativelyunimportantin the investmentdecision. Finally, we look at technologytransfer, rather than investment decisions, and consider the types of technologieswithheld because of weak protection. Finns That Rule Out Substantial Investments in Countries Affording Weak Protection Some firms, particularlyresearch-intensivefirms with products (or processes)that are relatively easy to imitate, maintainthat they will not make substantialinvestmentsor transfer advancedtechnology to countrieswith weak intellectualpropertyprotection. Accordingto a major executiveof one such firm, Intellectual property is absolutely essential to [our] willingnessto make substantial research investmentsin a countryor to transferadvancedtechnologythere. It has played an important, and in some instancesdeciding, role in our decision to either reduce or limit our investmentsin such countriesas the Republicof Korea, the People's Republic of China, and India. As you know, muchof [our] advancedtechnologyis wrapped up in a very simple package ... As a result, they can be reproducedand disseminatedin a countryeven by personswho do not have additionalknow-howfrom us and do not have accessto advancedfacilitiesor equipment. Thus, we are basicallyat the mercy of three componentsin a recipientcountry: First, a cultural ethic for fairness and integrity. We have limited resources to pursue infringers of our rights. Further, once such a violation has occurred, much of the damage has been done. Thus, it is importantto us that the numberof violators be few and the number of violations be occasional. An acceptance and recognition of the concept of private property is essential, too. Second, a legal or statutory framework which provides us with appropriate rights providing sufficient protection for our intellectualproperty ... Third, a legal infrastructurewhich is capableof supportingboth the grant of rights in appropriatecircumstances,and the enforcementof rights when violationsoccur. Thus, for example, the existenceof a patent statute without a Patent Office is of no value to us. Likewise, the existenceof a patent system without a developed court system which provides for redress of private wrongs such as patent infringementis of no value to us. The chief executiveofficer of another firm stated flatly that "we are a high-technologycompany and would not considersetting up a subsidiaryin a countrywithout such protection." Perhaps for this reason, this firm has establishedonly one foreign subsidiary, and it is not in a developingcountry. The presidentof a large chemicalfirm said the following:

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Our investmentin building a chemical facility or entering into a joint venture is a long term strategic decision. When we make such a decision, we consider many factors including whether the laws of the host countrycan effectivelyprotect the technologywe are designingthe plantto operate with today, as well as the improvedtechnologieswe will want to add to the plant in the future to maintain our competitive position. Intellectualpropertyprotectionis especiallyimportantfor those proprietaryadvancedtechnologieswe have spent millionsto develop and which we feel provide the basis of our global competitiveadvantage. The strength or weaknessof a particular country's intellectualproperty rights protectionis, therefore, an importantfactor in [our] decisionsto invest in a country. The weaker we perceive a country's system for protecting intellectual property to be, the more likely we are not to transfer any leading-edgetechnologywhetherthrough direct investment, joint venture or license. The risk that the laws will not be able to effectivelydeter or remedy a theft of our technologyhas led us to defer from investingin certain countries, to limit the technologywe transfer, and has even factored into our decisionsto withdrawfrom operating in other countries. For example,we closed a manufacturingfacility in [a majordevelopingcountry]because,amongother things, [its] intellectual propertyprotectionlaws did not adequatelyprotectthe technologyneeded to maintainour competitiveposition. We also are reluctantto provide certain state-or-the-arttechnologyto a joint venture in [another major developing country] because of our uncertaintyof the effectivenessof their intellectualpropertyprotectionsystem. The chief patent attorneyof another big chemicalfirm stated as follows: Inadequateor ineffectiveprotectionof intellectualpropertyworks against introductionof the product into such country, wherebythe businesscan never grow sufficientlyto even reach questionsof direct investmentor licensing to subsidiaries. Thus, inadequateor ineffectiveprotectionof intellectual property in a country weighs heavily against ... the natural

progression of events which could lead to the question of foreign investment... Another manifestationof concern and reluctance is the assurance we need, when business needs indicate the desirability of foreign manufacturinginvestment,that the technologywill remain proprietary. To some extent, this assurance arises from our subsidiary being the manufacturer. We generally would not transfer leading-edgetechnology operated by [us] or a subsidiary, where such technology is likely to be pirated. Having said that, I am unawareof an investmentdecisionbeingrejected on that basis. I believethe investmentproposal comes with reasonable assuranceof proprietary position. 24

Finms Considering Intelectual Property Protection as One of Several Important Factors In the Investment Dedslon While some R and D-intensivefirms rule out substantialinvestmentsin countriesaffordingweak intellectual property protection, this does not seem to be true of most such firms we contacted (particularly outside the chemical industry). Instead, most R and D-intensivefirms seem to regard intellectualproperty rights protection as an important factor, but only one of a number of important factors, influencingtheir investmentdecisions. For example, the vice president of a major medical products firm stated that: Intellectualpropertyrights protectionin a particularcountryis important to [us] and is a considerationin deciding whether to invest or transfer technologyto a joint ventureor subsidiary. But it is only one factor and each case must be evaluatedon its own merits. Other importantfactors to [us] are: (A) size of the market for our key products; (B) desire of the local customersto have products made locally versus imported; (C) health care reimbursementpolicies of the country in question; and (D) the need for a technical presence in the country to support sales effort and educatekey opinion leaders/customersin the use of our products. All of these factors must be weighedand contrastedagainst the risk of loss of proprietary technical informationin each case. Similarly,the vice presidentof a major pharmaceuticalfirm said that: [It] has always been difficultto ascertain precise measurementson the relation between intellectual property and investments, and it would certainly be disingenuous to suggest that pharmaceutical patents by themselveswill determineour investmentin a country. Pricinglevels for pharmaceuticals, the ability to register products with local health authorities,and assessmentof growth opportunitiesin a countryrelated to demographicfactors, serve alongwith pharmaceuticalpatents as chief determinantsin our decision-makingprocess. The director of internationalmarketingof a chemicalfirm stated that: The strengthor a particularcountry's protectionof intellectualproperty rights is one of the considerationswe would have in expanding or investingin the transfer of any of our technologyto that country. The vice president of an office equipmentfirm said: While [my firm] has never refused to sell or service its products in any foreign country due to the lack of intellectualproperty protection, it is certainly a factor in our considerationfor future investmentsin foreign countries.

25

Similarly,the vice presidentof a pharmaceuticalfirm stated that: A given country's intellectualproperty laws do, however, influencethe extent to which we will invest in an actual physical presence in that country,includingmarketingforces,branchstructuresand manufacturing and packaging facilities. For example, [my firm] divested all of its assets in [a major developingcountry] some years ago when [its] law gave us virtually no protection, although [our] products remained available to patients there. However, with the recent changes in [this country's] intellectualpropertylaws, re-establishmentof a presencethere is once again feasible. The director of internationalaffairs of a chemicalfirm said the following: Whether one invests in the usual developing country is a complex equation which involvesissues like size of market, ability to serve by importing into the country, etc. To over-simplify, if the market is substantial and you are required (usuallyby the local government) to manufacturethere in order to sell, you may very well invest. Lack of intellectualproperty protectionis a factor, but it can be handled ... If the investmentquestioninvolvesa countrywithvery strong intellectual property protectionand, in order to protect a patent the patent must be "worked' by local manufacture,the intellectualproperty considerations can be the primary reason for the investment. For example, in some countries in Europe, if you had a patent on a drug, or agrochemical,you had to manufacturethem locally to insure that you could enforce the product patent. In those cases we built small local plants for last step manufacture(just enoughto satisfy local "working' requirements). This of course has changedsomewhatwith the EEC. The vice president for research and developmentof a chemicalfirm said: The strength or weaknessof a particular country's intellectualproperty laws is only one factor in a decisionon whether or not to investin that country. We have no situation where we decided not to transfer advancedtechnologyto a countryhavingweak intellectualpropertylaws solely becauseof such laws. However, to date we have transferred our advancedtechnologyonly to overseas affiliates or joint ventures where we have a substantialequity position, and therefore a strong voice in management. The vice presidentof a major metals firm stated: [The] major focus of our activity in recent times has either been in countrieswhere such protectiondoes existor, where such protectionhas been questionable,in ventureswhere the factor of intellectualproperty protection has not been a major consideration. Since we seek out 26

potential investments on a continuing basis, this could, of course, change. I think it is fair to say that where a potential investment involved intellectual property rights as an important element and was targeted for a country with a reputationfor minimumprotectionin that field, we would give serious considerationto these factors in arriving at an investmentdecision. A computer executivesaid: The strengthor weaknessof a particular country's intellectualproperty laws is of importanceto us in determiningwhetherwe will investin that country or transfer advancedtechnologyto that country. For example, althoughwe have made investmentsin [a large developingcountry],we havenot implementedmanufacturingoperationstherethat use our highest level of technology due to uncertainty over adequacy of trade secret protection. Likewise,we limited the types of softwarebeing developed [there] due, in part, to the lack of adequatecopyrightprotection. Finns Regarding Intellectual Property Protection as Relatively Unimportant in the Investment Decision The bulk of the firms in many low-technologyindustries--andsome in high-technologyindustries like electrical equipment(and even chemicals)--regardintellectualproperty rights protection as being relatively unimportant in the investmentdecision. For example, an R and D executiveat one of the nation's largest firms said that there was no correlationbetweenhow muchmoneyhis firm was investing in particular countries and the strength of the country's intellectualproperty rights protection. In his view, the correlation, if any, was negative! A patent attorney for a major machineryproducer stated that: Over the past nine years I can recall no case where intellectualproperty laws affectedour investmentor technologytransfer decisionfor foreign countries. Further, I can recall no case where we felt victimizedor disadvantagedby the intellectualproperty laws or lack thereof in any foreign country. We do business in over 130 countries, including Republicof Korea, Taiwan and Mexico. It is not clear to me that investment or technology decisions have anythingto do in most instanceswith problemsof unauthorizedcopying. Nor is it clear that "stronger"laws will realisticallyresolvethe problems that are most prevalent. The current controversymostlyconcernsproductsthat are easily copied, e.g., audioor VCR tapes,applicationsoftwarefor "personal"computers, pharmaceuticals or the like. The original products and related informationin U.S. patents and other publicationsare readily available in the U.S. and elsewhere. The products at issue are thus freely ableto 27

be copied in a foreign countryeven though no investmentor technology transfer has occurred there. In manycases, the copyingand marketingare beingdone by fly-by-night operators. Even "strong" intellectualproperty laws may not stop this. For example,in New York City clone "Rolex"watchesare now for sale on many street corners. The presidentof a firm makingmachinetools stated that: In our particularcase, the strengthor weaknessof a particularcountry's intellectualproperty rights does not particularlyinfluenceus. We have a manufacturing facility in [a developed country] and one in [a developingcountry], and we are not hesitant about passing information back and forth. Of course, we have wholly owned subsidiariesand this might make a difference. It is importantto note in this regard that patents are of much less importancein many industries than in pharmaceuticalsand chemicals. In some industries,it is relativelyeasy to inventaround patents. In other industries, it is very difficult for rivals to imitate a new product or utilize a new technology without complementaryinputs that are hard to obtain; thus, patents are of secondary importance. In industrieslike these, it is not surprisingthat intellectualproperty rights protectionis not a major factor in investmentdecisions. InteUectual Property Protection and Technology Transfer Many firms regard strong intellectualproperty protectionas being more importantin decisions regardingtechnologytransfer than in decisionsregardinginvestment. Some companieshave a policy of minimizingthe transfer of technologyto other countries. The director of technologyof a biotechnology firm said: It has been [my firm's] policy to keep to a minimumthe transfer of its technologyto other companiesin both developedand developingnations. Therefore, the relative strength or weaknessor a country's intellectual property laws generally has little or no impact on whether we will transfer advancedtechnologyto another company. Also, the vice president of a leadingdrug firm said: [This firm] does not transfer leading-edgetechnologyin its usual course of business. Whensuch transactionshave occurred, intellectualproperty laws have not been a critical factor in decidingwhetherwe will transfer leading-edgetechnology to a foreign country. Thus, we cannot cite specific cases where [we] would not transfer these technologiesto a country on the basis of weak intellectualproperty laws. However, it should be pointed out that the decision not to transfer a leading-edge technologyto such countries is made simply becausethey generallydo not have the technologicalinfrastructurein place to put the technology 28

to work, and therefore couldnot benefit from it. Most [of our] products require an extraordinarilyhigh degreeof scientifictalentand engineering resources to manufacture. We have found that such resources are generallyinsufficientin the type of developingcountriesthat also happen to lack strong intellectualproperty laws. And the internationalmarketingdirector of a chemicalfirm said: As a general rule, we are reluctant to do any straight transfer of technology deals unless the informationis coded or the technologyis older technology. If we do send technology to one of our foreign subsidiaries,it is codedwith very limitedaccessto the codedinformation by an expatriatemanager or a well-knownnational. Whereas some high-tech firms avoid transferring advanced technologyeven to countries with strong protection,this does not seem true of most firms we studied. However,research-intensivefirms, particularly in the chemical (including drugs) industry, often will not transfer advanced technologyto countries with weak protection. For example,the chairmanof a major chemicalcompanysaid: There is no questionthat we will not put good product technologyin a country where we cannotprotect it. You ask for specific cases, and the most obviousones are [a major Asian developingcountry] where there is no meaningfulprotection of intellectualproperty, and some of the Latin American countries like [a major developingcountry] where we and others have withheld some [products] because of the inability to protect them. Another chemicalexecutivestated the following: [We] will not expose technologyof any significantvalue in countries where it is not safe. Where there is a total lack of any protection and rampant piracy, such as in [a major Asian developing country] you provideno technologyof valueperiod. In [that country]you are assured that pirate competitors will steal anything you send in and use it to competewith you in [that country]and through exports. Combinethis with the fact that government red tape makes it almost impossibleto make any real money [there] and you will understandwhy that country operates on technologywhich is 15 to 30 years old. While the rest of Asia has taken off like a rocket, [it] remains in the post WW II era. In countries where some protectionexists, but it is very questionable, such as [a major Latin American country], you tend to use your older technology. For example,you may develop a chemicalprocess to make a product. Over the years you will makeprocess improvementsand may even develop totally different, new processes which are much more efficient. If the technologyis extremelyvaluable,you may decide to use one of your older processesin [that country]. Here again, the decision is not that simple. What is dte value of the efficienciesof the newer 29

process? Are there likely local pirate competitors? Do they have the capital and technical capabilityto duplicateyour technology if they get their hands on it? Accordingto managing counselof still anotherchemical firm, The technology embodied in new, but copiable products like highly successfulagrichemicals,are withheldfrom countrieswhere intellectual property is inadequatelyprotected, and thus from subsidiariesand joint ventures. And according to the chairman of a firm in the informationprocessing industry, 'We would transfer to Republicof Korea and Taiwan, China, only low tech processes." But some firms are much less impressedby the potentialproblemsin this area than other firms. Thus, the vice presidentof an instrumentsfirms said: So far, to my knowledge,[my firm] has not decided againsttransferring technology to a particular country where other factors were favorable, but the strength of the patent system there was suspect. We have not been confrontedwith that scenarioto date. Also, the chief patent counselof a chemicalfirm stated: The technology advantage that we enjoy over our competitors often results from catalystcompositionsand process know-how. Knowledge of the compositionand manufactureof catalysts and process know-how need not be transferred to licensees or subsidiariesoutside the United States in order for the productionof the commoditychemicalto occur. With our major commoditychemicallicensingprograms, the strengthor weaknessof a country's intellectualproperty rights have relatively little bearing on our decisionto license technology. Other barriers to market entry exist which are oftenmore foreboding. We typicallyminimizethe risk to our intellectual property by not disclosing critical catalyst or process know-how information to the licensee. In short, the best protectionof informationis to avoid divulgingthe information. Technologies Withheld Because of Weak Protection We asked each firm in our sample to cite cases, if they existed, where advancedtechnologies were withheldfrom particular countriesbecauseof weak protectionof intellectualproperty. Manyfirms which said such cases existed seemedreluctantto discussthem in detail, apparentlybecausethey did not want to provide details of instances where they were withholdingtechnology from poor countries. However, they sometimeswere willing to make general statements. For example, one firm's patent attorney stated as follows:

30

In many cases, potentialrecipient countriesare amongthe poorest in the world. Much of their economy is dependent upon agriculture and its productivity. The products [my firm] has to offer, including our advanced technology, provide for significant increases in agricultural productivityand efficiency. Because[my firm] is unwillingto send its most elite materials to those countries, they lose out on the benefits of increased agricultural productivity and efficiency gains and the consequent enhancement of their standard of living and overall improvementof their agricultural-basedeconomywhich these materials would have provided. Also, another firm's chief patent counselsaid: We have had several instances in which we decided not to transfer information to another country due to the weak intellectual property protection. In one instance, equipmentembodyingvaluabletechnology to practice a process was not providedto Republicof Korea since there was no effectivemeans to prevent a Korean employeewho developsa knowledgeof the equipment,from using that informationin a subsequent employment.Althoughthis is a problem faced in virtuallyevery country of the world, the concernsin Korea were highlightedby the risk that the courts may view the confidentialityprovisionsas againstpublic policyin Korea and therefore null and void ... the loss of gross incometo Korea was a minimumof $5 to $10 millionper year. Another case was cited by the chairmanof a chemicalfirm, who said: [My firm] is a world leader in [an important]technology. Wehave been constantlyimprovingthis technologyover the past twenty-fiveyears, and we are unwilling to transfer this advanced technology to developing countrieswith weak intellectualpropertyprotectionsystems. We believe that these countrieswould greatly benefit from manufacturingproducts using this technology in their country rather than having to import products from abroad. Accordingto another chemicalexecutive,the situation is as follows: It is usually a questionof when a weak IP countrygets the product. For example, agrochemicals require extensive and expensive registration work beforethey can be made and sold and farmerswill try nothingnew withouta substantialmarketingeffort. You normallydevote your money and effortto countrieswith significantmarketsand decent protectionand leave the less attractive, weak IP countries to last. They lose the economicefficienciesof newtechnology. In agrochemicals,the farmers of the country will have lower yields at higher cost, resulting in higher than necessaryfood costs and less competitivenesson world markets. You can add this up for the 6 to 10 years a significantnew productis not marketed. The FMC Corporationdid a study of this some years ago in 31

Mexico and the results were dramatic. With respect to processes, if a new process can reduce the cost of producing a basic conunodity chemical by 10% - for example sulfuric acid - you can easily calculate

the costs to a country which does not have access to the new process. Ihe manager of intellectualproperty of a computermaker said: We will not place high technologymanufacturingplants or development operations, either via subsidiariesor joint ventures,in foreigncountries that have weak intellectualpropertyprotection. I do not wish to identify particular technologiesthat we have restricted or the potential benefits that foreign countries would have derived therefrom. However, I will note that the level and availabilityof technologywithin a given country can have a direct effect on advancementof the country's infrastructure, includingsupportcompanies,local suppliers, and its educationalsystem.

32

Appendix 11 To see whetherU.S. direct investmentin a particularcountry is relatedto the perceivedstrength or weaknessof its intellectualproperty rights protectionwhen the effects of market size and the special case of Mexico are taken into account, Jeong-YeonLee (1993)has carried out a statisticalinvestigation using data obtainedfrom the U.S. Departmentof Commercefor 1989-1992. While his study includes a variety of other independentvariables, the basic features of his results can be illustratedby assuming that I=AO + AGj + A2

+ A3 Pj + Zl''

(1)

where Ij is the change in U.S. investmentposition in (or capital outflow to D) the j' country during 1992, Gj is the gross domesticproduct (in 1989) in the j' country, Mj is a dummy variablethat equals I for Mexicoand zero otherwise,Pj is the meanvalue of the three measures(in the last columnof Tables 2-4) of the weakness of intellectual property protection in the jp country, and ZV is a random error term.23 Of course, this model is highly simplifiedbut it illustratesthe sorts of results he has obtained. Using least-squares,he estimatedthe A's in equation (1), based on data for all manufacturing. Regardlessof whetherthe changein U.S. investmentpositionor capitaloutflowis the dependentvariable, and regardlessof whether Spain is excludedor included,the results, shown in Table 5, indicatethat the effect of Pj always has the expectedsign, and is statisticallysignificantin every case.2y Holding GJand M constant, a 10-pointincrease in P; seemedto be associatedwith abouta $200milliondecrease in U.S. direct investmentper year. To interpretthis finding, it may help to recall that the difference between Indonesia's or Republic of Korea's value of P, and that of Hong Kong or Singaporewas about 8 or 9 points. Thus, taken at face value, the sort of differencein perceivedprotectionbetweenthese countries seems to be associatedwith a differencein U.S. direct investmentof about $170 millionper year. Also, the effect of P; is about the same, and remain statisticallysignificant,if data for 1990, 1991, and 1992 are pooled, and the numberof degreesof freedom is about40. Data by industry concerning U.S. direct investmentin each of these countries are not always available, but all available data (from the U.S. Departmentof Commerce)were used to estimate the regression coefficientsof the model in equation (1), as well as more complex models, at the level of individualindustries: (1) chemicals,(2) transportationequipment,(3) electricalequipment,(4) food, (5) 2/For obviousreasons, Lee is more interestedin the total investmentby the U.S. asa wholethanthatof oursamplefirms only. Since our sampleis a randomsample,it shouldbe possibleto use Pj for this purpose,althoughthe resultsmay be biued toward zero becauseof samplingerrors. Accordingto the U.S. Departmentof Commerce,the directinvestmentpositionis the bookvalue of U.S. investors' equity in, and net outstandingloans to, their foreignaffiliates. (A foreignaffiliateis a foreign businessenterprise in which a singleU.S. investor owns at least 10 percent of the voting securitiesor the equivalent.) The change in direct investmentpositionequals capital outflowsplumthe valuationadjustment.Capitaloutflowsequal reinvsted earningsplus intercompanydebt outflowsplus equityoutflows. See Scholl (1990), 24/Notethat the effectof Mj will includethe effectof the re-evaluationof intellectualpropertyprotectionin Mexicosince 1991, as wcll as the other effectsdiscussedin a previous section. Also, note that, becausethere is a delay bctweenthedecision to investandthe investmentitself, GDPshould be lagged. It is assumedhere that GDP in 1989 is relevant,but tho resuhsin TableS vary only in detail if GDP in 1991is used instead. Each estimateof A, remains negativeandof about the samesize as in Table 5. 2SlOne-tailedtests are appropriatehere because the hypothesisstipulatesthe sign of the regresion coefficient.

33

metals, (6) machinery. Becausethese data for individualindustriesseem to contain considerablenoise and have often been revised substantiallyin the past, it is not surprisingto find that the estimatedeffect of the mean (calledP.) of the three measures (in Tables 2-4) of the perceivedwealness of intellectual propertyprotectionin the iPindustryin thepj countryis frequentlynot statisticallysignificant. However, if both Japan and Spain are excluded, there is substantialevidencethat the coefficientof Pi is negative in the machinery,food, chemical, and metals industries(Table 6).2W Taken at face value, intellectualproperty rights protectionseems to have a particularly strong effect on U.S. direct investmentin the machineryindustry. This is quite consistentwith our interview and survey results, sincemany machineryfirms emphasizedthe importanceof such protection. The fact that Pi seems to have a smaller effect in the chemicalindustry, where intellectualpropertyprotectionhas been such a major issue, may be due to the small numberof observationsand the large revisionsoften made in the chemicalinvestmentdata. More surprisingis the significanteffectof Pi in the food industry, which seemed in Tables 14 to regard such protection as less important than many other industries. Perhapsour results in Tables 14, based on a small sample,tend to underestimatethe importanceof such protectionto food firms. But it is also importantto recognizeonce more the obvious limitationsof the model. As indicatedabove, Lee has addedother independentvariablesto his analysis, and has included investmentdata for the years 1989-91as well as 1992. In particular, he has addedmany variablesthat Schneiderand Frey (1985)found to be significant,such as a nation's level of wage costs and secondary school enrollmentratio. Also, he has includedthe nation's economicgrowth rate, per capita electricity consumption,and per capita number of telephonelines, amongother variables. Thus far, the effect of Pj tends to remain significantwhen each of these variables is added. But he is continuingthe statistical analysis, and, for obvious reasons, his results must be regardedas tentative. Table 5- EstimatedRegressionCoefficientsin Equation(1) and Their StandardErrors (in Parentheses). All Manufacturing,Japan and both Japan and Spain Excluded CountrioaExcluded

Intercept

Weakness of Protection IGross Domestic Product

I Mexico Dummy |R

Change in U.S. Investment Position

Japan Japan and Spain

445 694

(153) (185)

-11.1 "(5.5) -22.3 (7.5)

.0001

.0007

(.0004) (.0004)

U.S.Capital

1458 (264)

Japan

Japan and Spain

757

(349)

-19.0 -

j -32.5

1 0023

(9.4) (14.1)

0030

290' (200) 180 (187)

62

.55

Outflow

(.0004)

(.0008)

1207 (344)

.79

74 (351)

.61

ouc:Lee MOT3.

Significantat .10 probabilitylevel (one-tailedtest except for intercept). Significantat .05 probabilitylevel (one-tailedtest except for intercept). Significantat .01 probabilitylevel (one-tailedtest except for intercept).

2t§Me revisionsof the Commercedata can have a substantialeffect on the estimatedeffectsof PNj.For exmnple,in the chemical industry, there is a rather low correlation (r2 = .43) between the original catimatesof changesin U.S. invaetment position and the revised estats three years later. 34

Table 6 - Estimated Regression Coefficientof Weakness-of-ProtectionVariable in Equation (1), Six ManufacturingIndustries, Japan and both Japan and Spain Excluded Japan

Japan and Spain

Excluded

Excluded

Industry l

______________________

Changein U.S. Investment Position, 1991-92

Machinery Food Chemicals Metals

TransportationEquipment ElectricalEquipment

0.3 2.1 -0.2 -0.7 -4.1 2.8

(4.5) (3.5) (0.8)

-12.6 -4.9 - 1.4-

(5.0) (1.6) (0.8)

(0.5)

- 0.7

(0.6)

(3.3) (4.5)

0.2 2.8

(1.6) (6.6)

U.S. Capital Outflow, 1992 Machinery Food

-1.3 (3.2) 0.0 (2.7)

Chemicals

0.1

Metals TransportationEquipment ElectricalEquipment __________

Sourc:

_________

(1.2)

-0.8 (0.5) -5.4 (5.1) 2.1

-9.5~ -4.9 - 1.8 -1.10.7 0.2

(4.1) (1.9) (1.3)

(0.4) (3.2) (6.4)

(4.4)

Lee (1993).

Significantat .10 probabilitylevel (one-tailedtest except for intercept). Significantat .05 probabilitylevel (one-tailedtest except for intercept). Significantat .01 probabilitylevel (one-tailedtest except for intercept).

35

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