Intellectual property rights, political risk and economic growth in developing countries

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1 Journal of Economics and International Finance Vol. 1(6), pp , November, 2009 Available online at ISSN Academic Journals Full Length Research Paper Intellectual property rights, political risk and economic growth in developing countries Samuel Adams Ghana Institute of Management and Public Administration P. O. Box AH 50 Achimota Accra, Ghana. Accepted 7 September, 2009 This paper examines the impact of intellectual property rights (IPRs) on economic growth for a cross section of 73 developing countries over a period of 19 years ( ). The results of the study indicate that: 1) strengthening IPRs has a negative effect on economic growth; 2) the impact of patent protection on economic growth after the TRIPS agreement is far and above that of the pre TRIPS era; 3) domestic investment and good economic and political institutional infrastructure are positively correlated with economic growth. Key words: Intellectual property rights, innovation, economic growth, domestic investment, technology transfer, developing countries. INTRODUCTION Over the past decade, the development and use of products embodying intellectual property rights have increased considerably. Indeed, one of the most dramatic changes with respect to the global economy is the development of international economic law (Yueh, 2007). Intellectual property refers to creations of the mind: inventions, literary and artistic works and symbols, names, images, and designs used in commerce (World Intellectual Property Organization (WIPO), 2003). Almost everyone in society is a user and potential creator of intellectual property and its protection, through a system of national and international rules is called Intellectual Property Rights (IPRs). IPRs can therefore be defined as the rules on how to protect patents, copyrights, trademarks and trade secrets that have become a standard component of international trade agreements (Fink and Maskus, 2005). IPRs protection is necessary to provide incentives and financing for innovation, which in turn lead to economic, cultural and social progress. In the last twenty years, the protection of IPRs has moved from an arcane area of legal analysis to the fore front of global economic policymaking (Maskus, 2000a). This in no small measure has been motivated by the successful completion of the World Trade Organization s (WTO) Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) in 1994, which sets strong minimum standards in each of the areas commonly associated with IPRs (Maskus, 2000b).The protection of IPRs has therefore gained prominence in economic development literature because it motivates technological change, which is essential for economic growth (Mondal and Gupta, 2006). For instance, the Deputy Direct or General of the World Intellectual Property Organization (WIPO), Rita Hayes (2003) claimed that in the 21 st century, intellectual property provides a powerful engine for the economic development of nations. Growing numbers of experts, however, question the positive effect of IPRs on economic performance in the context of developing countries and argue that IPRs do little to stimulate innovation in these countries because the research and development (R&D) needed for innovation is absent (Commission on Intellectual property Rights (CIPR), 2002; Maskus, 2000a). Leger (2006) observed that the very low innovative capabilities of the less developed countries limit the potential of IPRs to support local innovation. Others also indicate that strengthening IPRs may result in job losses; drive up prices due to monopoly created by the intellectual property protection and reduce access to technology needed for development (Hillery, 2006; Kumar, 2002). In recent times, many empirical studies have been done to ascertain the impact of IPRs on economic growth in both the developed and developing countries, however, most of the studies have pooled together both developed and developing countries. The generalizability of such studies, however, is limited as the developing and

2 128 J. Econ. Int. Financ. developed countries differ in their political, socio-cultural and scientific and technical capacities (CIPR, 2002). For instance, Schneider (2005) found distinct effects of IPRs on the developed and developing country groupings and suggested that pooling together developed and developing countries might lead to misleading conclusions and hence inadequate policy recommendations. To reduce the bias in the regression estimates, this study examines the impact of IPRs on economic growth in the context of developing countries. Specifically, it analyzes how patent protection affects economic growth for a panel data set of 73 developing countries. Additionally, the study examines whether there is a differential effect of patent protection on economic growth after coming into effect of the TRIPS agreement. The rest of the paper is organized as follows: Section two reviews the literature on the IPRs economic growth relationship. Section three describes the data and methodology and section four presents and analyzes the results. Section five presents the implications, directions for future research and offers concluding remarks. LITERATURE REVIEW There are many studies that suggest that strengthening IPRs could have a positive impact on economic growth (WIPO, 2004; Kumar, 2002). Three of the ways in which IPRs affect growth are highlighted here. First, intellectual property rights have been recognized as part of the infrastructure supporting investments in R&D leading to innovation and subsequent economic growth (Grossman and Helpman, 1991; Kanwar, 2006). Obviously, if agents innovate to capture or hold a share of the market they would not retain otherwise, then protection of property right might boost long - run growth. A WIPO (2003) report describes intellectual property as a "power tool" for economic growth and wealth creation that is not yet being used to optimal effect in all countries, particularly in the developing world. The report notes that intangible assets - such as knowledge, creativity and inventiveness are rapidly replacing traditional and tangible assets - such as land labour and capital - as the driving forces of economic development. Second, there is abundance of research that indicates that strengthening the IPRs system in developing countries directly encourages technology transfer from more advanced countries through foreign direct investment (FDI) and high technology imports, which could lead to total factor productivity improvements (Shapiro and Hassett, 2005; Taylor, 1993, 1994). The CIPR (2002) report noted that in the poorest regions of the world, strengthening IPRs could help to stimulate invention and new technologies, thereby leading to an increase in agricultural or industrial production, domestic investment and FDI, which are key determinants of economic growth. Third, by granting temporary exclusive rights on inventions, IPRs allow the right-holders to price their products above marginal cost and hence recoup their initial research investment. Such exclusive right creates incentives for the conduct of R&D, which contributes to the promotion of technological innovation and to the transfer and dissemination of technology, in a manner conducive to social and economic welfare (Leger, 2006). As noted by Greenspan (2004) and Boldrin and Levine (2002), market economies require rule of law and that no economic agent exercises productive effort, without the certainty of controlling its fruits. The strengthening of IPRs will therefore ensure that a country s resources are allocated to the most valuable uses. This is consistent with the International Chamber of Commerce s (2005) observation that since everyone in society is a user and potential creator of intellectual property, its protection, through a system of national and international rules is necessary to provide incentives for innovation and knowledge creation. According to the World Economic Forum Global Competitive Report ( ), 20 of the 27 countries with the highest growth competitive index had the most stringent property rights regime, while 20 of the 36 countries with very low growth competitive index had the weakest property rights protection in The World Bank (2005) also reported that since the 1980s, the world s greatest economic gains have been achieved by developing countries that aggressively opened their economies to foreign technologies and business methods and had strong IPRs regimes. Other studies, however, suggest that strong IPRs may have a negative effect on developing countries because of the little, if any, R&D and technological development (CIPR, 2002; Shapiro and Hassett, 2005). Shapiro and Hassett (2005) observed that even if strong IPRs promote innovation, the benefits go primarily to those who develop them. Additionally, Horii and Iwaisako (2007) claimed that strengthening IPRs lowers growth in technologically deficient economies especially when it lowers imitation. The result is that a strong patent regime would act only to transfer profits to firms outside the country rather than encouraging domestic innovative activity. Also, Horii and Iwaisako (2007) argued that IPRs provide patent owners, on average, with long monopoly periods and therefore tend to increase the number of monopolistic sectors within the economy as a whole. Furthermore, it is possible that some corporations will focus their resources on defending their original innovations rather than developing new products and therefore limiting their output below socially desirable levels leading to negative consequences on consumer welfare (Shapiro and Hassett, 2005). Conversely, Horii and Iwaisako (2007) asserted that IPRs may have three main effects on economic growth. First, it raises the expected profit from R & D, which is a positive effect. Second, it gradually reduces the number of competitive sectors where R & D is more active, a

3 Adams 129 negative effect. Third, it lowers the market wage and therefore increases the number of R & D researchers employed in each competitive sector, a positive effect. The overall effect of stronger IPRs on economic growth is therefore determined by the relative magnitude of these three effects. Similarly, Maskus (2000a) argued that IPRs have both positive and negative effects on economic growth and noted that the potential gains and losses depend on the competitive structure of markets and the efficiency of related business regulation. Consequently, the scope, depth and enforcement of IPRs are likely to differ across countries according to their economic and political institutions and ability to engage in and disseminate the fruits of R & D (La Croix and Konan, 2006). Finally, from an efficiency perspective, Fink and Maskus (2005) claimed that patents are only a second best means of encouraging invention, as the market exclusivity conferred by IPRs reduces competition and therefore distortions in the allocation of resources. This view is supported by Levin et al. (1987), Arundel s (2001) observation that patents may not be the most appropriate way for firms to appropriate the benefits of their innovative efforts. Arundel s (2001) study of over nearly 2850 firms in the European community showed that a higher percentage of firms rated secrecy as more valuable than patents. In a similar study in the US context of 650 respondents from 130 industries, Levin et al. (1987) reported that secrecy, lead time, moving down the learning curve and sales efforts were more effective than patents in protecting firms processes of production. In light of the conflicting theoretical views, many empirical studies have been conducted to examine the relationship between IPRs and economic growth. Like the theoretical studies, however, the results of the empirical studies are not conclusive. For example, Gould and Gruben (1996) examined the impact of IPRs on economic growth for a cross section of 95 developed and developing countries from 1960 to 1988 and found only a marginal effect of IPR on economic growth. Nonetheless, they showed that the effect of IPRs on economic growth to be stronger in more open economies (about 0.66% points higher per year). On the other hand, Kim, Lee and park (2007) employed a GMM estimation technique to examine the impact of IPRs on economic growth and found differential effects of IPRs on the sample of countries studied. Their study involved 96 developed and developing countries over six time periods of five - year intervals ( ) and indicated that IPRs had a positive significant positive, negative and no effect on the high, middle and low income countries respectively. Similarly, Park and Ginarte (1997), in a study of 60 developing and developed countries that showed that strengthening IPRs seem to matter for the R & D activities of the developed economies and not the less developed economies. Falvey et al. (2006) built on prior literature to examine the effect of IPRs on three groups of countries (low, middle and high income) and reported that IPRs protection had significant positive effects in low and high income countries but not in middle - income countries. Using threshold regression analysis, the authors demonstrated that though IPRs protection was dependent on the initial level of development, IPRs protection promoted innovation in low and high - income countries but not in middle - income countries because of offsetting losses from imitation. La Croix and Konan (2006), however, indicated that middle - income countries should be the greatest beneficiaries from IPRs protection due to their ability to absorb technologies efficiently compared to low - income countries and lower investments costs in R & D compared to high - income countries. In view of the inconsistencies in the empirical studies, Park and Ginarte (1997) argued that it is important to examine the effect of IPRs on economic growth in developed and developing countries separately. This study therefore contributes to the literature by examining the effect of patent protection on economic growth for 73 developing countries. The data and methodology are discussed next. DATA AND METHODOLOGY The study examined the impact of patent protection on economic growth for a cross section of 73 developing countries between 1985 and 2003 (Table 1). The empirical analysis is based on a panel data set consisting of four separate 5 year periods (the last period is 4 years), , , and The empirical analysis for the study is based on prior IPRs and economic growth literature (Leger, 2006; Falvey et al., 2006; Chen and Puttitanum, 2005) and the regression model for analysis is specified as follows: Y = 0 + 1LGCAP it + 2 OPEN it + 3DI it + 4 FDI it + 5GOV it + 6LGINF it + 7POL it + 8IPR it + 9IPRSQ it + 10TRIPS*IPR it + i + it where Y is the Real GDP per capita growth rate for country i in year t; 0 is the constant term; is are the coefficients to be estimated; LGCAP is the log transformation of the GDP per capita, which is a measure of the level of development; the degree of openness of the economy (OPEN) is measured as the share of trade (exports plus imports) in GDP; DI represents domestic investment share in GDP and FDI is the foreign direct investment share in GDP. GOV is government consumption share in GDP and LGINF is the log transformation of the inflation rate; Political risk is an indication of the political and institutional or governance infrastructure and is rated on a scale of zero (0) to 100, with high scores indicating high levels of political stability and low scores indicating low levels of political stability. The political risk is a composite measure of 12 factors and it includes factors like law and order, government stability, bureaucratic quality, corruption and democratic accounttability. IPR is the intellectual property rights variable. i represents the country-specific effect, which is assumed to be time invariant and it is the classical disturbance error component. We first differenced the data to eliminate the country-specific effects and employed the Seemingly Unrelated Regressions(SUR) for the parameter estimation. SUR allows for different error variances in each of the four equations and correlation of these errors across equations (Makki and Somwaru, 2004). The strength of intellectual property protection is measured by the Ginarte Park index of laws: (1) extent of coverage, (2) membership in international patent agreements, (3) provisions for loss of protection, (4) enforcement mechanism and (5) duration of protection. Each of these categories (per country, per time period)

4 130 J. Econ. Int. Financ. Table 1. Average Patent Protection Index ( ). Country IPR Country IPR Algeria 3.42 Madagascar 0.63 Angola 0.86 Malawi 0.59 Argentina 2.60 Malaysia 4.15 Bangladesh 2.28 Mali 1.69 Benin 2.86 Mauritania 3.18 Bolivia 2.17 Mauritius 1.11 Botswana 1.99 Mexico 2.11 Brazil 2.18 Morocco 1.96 Burkina Faso 2.40 Mozambique 3.19 Burundi 2.94 Nepal 0.07 Cameroon 2.65 Nicaragua 2.15 Central African Rep 2.65 Niger 0.52 Chad 2.80 Nigeria 3.36 Chile 2.82 Pakistan Colombia 1.98 Panama 2.68 Congo 2.69 Papua New Guinea 3.31 Congo DR 2.86 Paraguay 1.20 Costa Rica 1.79 Peru 2.18 Cote d Ivoire 2.69 Philippines 1.56 Dom Rep 2.61 Rwanda 0.37 Ecuador 2.11 Senegal 0.97 Egypt 2.11 Sierra Leone El Salvador 2.73 South Africa 0.76 Ethiopia 0.25 Sri Lanka 1.03 Fiji 2.10 Sudan 1.44 Gabon Swaziland 5.72 Ghana 1.38 Syria 2.36 Grenada 8.07 Tanzania 1.69 Guatemala 1.20 Thailand 2.10 Guyana 7.71 Togo 1.61 Haiti 0.19 Tunisia 2.13 Honduras 2.01 Uganda 1.55 India 0.38 Uruguay 0.79 Indonesia 0.25 Venezuela 2.05 Jamaica 3.55 Zambia 3.45 Jordan 1.60 Zimbabwe 0.98 Kenya 0.37 Source: Ginarte and Park (1997). is scored a value ranging from 0 to 1 and the unweighted sum of these five values constitutes the overall value of the patent rights index. The index therefore ranges from 0 to 5, with higher numbers indicating stronger protection. IPRSQ is the square of IPR and is included to capture any nonlinear relationship between IPR and economic growth. TRIPS*IPR is the interaction of the TRIPS dummy (1 for the post TRIPS era and 0 for pre TRIPS era) and the patent protection variable (IPR) to identify any differential effects of IPR before and after the coming into effect of the TRIPS agreement in The net FDI are the net inflows of investment to acquire a lasting management interest (10% or more of voting stock) in an enterprise other than that of the investor. This is the sum of equity capital, reinvestment of earnings, other long-term capital and short-term capital as shown in the balance of payments. Data on INF and OPEN were obtained from the Global Development Network Growth Data on Real GDP per capita growth rate and real GDP per capita, were obtained from World Economic Outlook (2000) and Global Development Network Growth Database and data on the government consumption and gross fixed investment were obtained from the World Development Indicators CD - ROM (2006). We used the initial IPRs values of the sub - periods, but used the average values of the period s growth rate to control for the fact that it takes time for IPRs to have an effect on the growth rate.

5 Adams 131 Table 2. Regression coefficients for the impact of IPRs on economic growth. DI 0.097*** (0.020) *** 0.156*** 0.158*** 0.181*** (0.018) (0.030) (0.035) (0.030) 0.157*** (0.024) FDI 0.160*** (0.034) 0.181*** (0.024) 0.194*** (0.035) 0.192*** (0.038) 0.214*** (0.038) 0.120*** (0.036) GOV *** (0.033) *** (0.026) *** (0.037) *** (0.037) *** (0.043) *** (0.038) LGCAP *** ( *** (1.747) *** (1.968) *** (2.351) *** (2.140) *** (1.735) OPEN (0.005) (0.006) LGINF *** (0. 115) 0.423** (0.177) * ** ** (0.175) ** (0.175) POL 0.001*** 0.001*** 0.001*** 0.001*** 0.001*** IPR * (0.300) (0.848) ** (0.424) ** (0.377) IPRSQ (0.175) TRIPS 0.707*** (0.251) TRIPS*IPR 0.287*** (0.095) N R 2 adjusted Note. t statistics in parentheses: * Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% RESULTS AND DISCUSSION The regression results are reported in Table 2. We see that the coefficients of most of the standard variables have the expected sign in most of the model specifications. The IPR variable is negative and significantly correlated with economic growth (Column 3 through 6). This finding suggests that strengthening IPRs on average is associated with a negative growth effect in developing countries, suggesting that strengthening IPR of developing countries may worsen their economic condition. As noted by Park and Ginarte (1997), countries not conducting innovative research or conducting a limited amount would enjoy a few, if any, of the benefits of intellectual property protection because an innovation sector through which IPRs affect economic growth is absent. Park and Ginarte (1997, p. 51) describe the effect of strong IPRs in developing with an analogy, which goes as follows: Consider a town with few, if any vehicles. If the town passes a law against lead emissions, the law is likely to have no effect on lowering pollution. The discussion above is consistent with the assertion of Helpman (1993) that if anyone benefits from patent protection, it is certainly not the South. It should be noted patent rights, which is based on five categories of patent that the main argument of the advocates of anti - WTO and TRIPS agreement for a uniform patent regime is the fact that strong IPRs system affects developing countries negatively because of the power over markets and the price advantages it confers on patent owners (WIPO, 2003). The IPR and IPRSQ variables are both negative and insignificantly correlated with economic growth (Column 4), which suggests the lack of a nonlinear relationship between IPR and economic growth. We also tested for any differential effects of IPRs on economic growth before and after the passage of TRIPS agreement and the results reported in Column 6. The results show a

6 132 J. Econ. Int. Financ. significant positive effect of the TRIPS*IPR interaction variable, which implies the effect of IPR on economic growth after 1995 is far and above the pre period. This indicates that the TRIPs agreement could have generated some positive effects on the economy of developing countries. This positive effect, however, could be related to many other factors associated with overall economy, as most of the countries in the developing countries also implemented other social, economic and institutional reforms to promote economic growth. The study s results also show that domestic investment, foreign direct investment and lower levels of political risk are positive and significantly correlated with economic growth at the 1% level, which suggests that these variables are key determinants of economic growth. The initial real GDP per capita is negative and significantly correlated with growth in all the model specifications (Columns 1 through 6), providing support to the thesis that countries at a lower of level of development grow faster and over time catch up with countries at a higher level of development. Similarly, the government consumption variable is negative and significantly correlated with economic growth in all the model specifications and therefore increasing government consumption, on average is likely to have a negative effect on economic growth (Folster and Henrekson, 1999). Openness is negative but never significantly correlated with economic, which contradicts other studies that report that integration into the world economy promotes growth (Dollar and Kraay, 2002; Sarel, 1997). Like Easterly and Levine (2002), however, Rodrik (2006) argued that the evidence that trade openness has predictable, robust and systematic effects on national growth rates is quite weak. Similarly, Zagha et al. (2006) asserted trade is an opportunity, not a guarantee and that it is overly naive to expect that simply opening one s economy would automatically increase growth. The implications of the findings of the study are discussed next. POLICY IMPLICATIONS AND CONCLUDING REMARKS The first and most important finding of the study is that strengthening IPRs was associated with negative growth in developing countries. The study found DI, FDI and conducive investment climate to be important determinants of economic growth. These findings have important implications for developing countries. First, the negative effect of IPRs on economic growth might suggest that most innovation in developing countries may be imitative or adaptive in nature. Therefore, providing stronger IPRs may protect foreign firms at the expense of domestic firms. Developing countries must promote patent policies that are intrinsically related to their economic development. The WIPO (2003) report indicated that Singapore and Korea, for example, adopted a proactive approach to patent policy such that it promoted patent licensing joint ventures and strategic alliances to encourage local inventions as well as foreign direct investment. Apparently, an increase in the level of local inventions will hasten the rate of technology innovation and hence higher level of economic growth. The implication is that developing countries need to focus on implementing IPRs policy such that it plays a positive role in inducing technology acquisition and creation, but even more important local business development. This view is supported by Braga et al. (2000), who claimed that developing countries can maximize the benefits of the IPRs system by specifically targeting local entrepreneurs and facilitate the dissemination of domestic and foreign knowledge. Second, to enhance local inventions and business development, governments in the region will also need to stimulate R & D in universities and other research centers to jump start the local knowledge development process and help in the diffusion of the findings of higher centers of learning. As the WIPO (2003) report emphasizes; patents are efficient drivers of national or indigenous innovation, R & D, product creation and business transactions that have beneficial macro and micro economic effects when handled properly. Furthermore, government policy must be directed at reducing market concentration to ensure adequate availability of protected products through price controls and possibly compulsory licenses and the control of anti competitive practices (Braga et al., 2000). Third, the effectiveness of the IPRs system is dependent on how it impacts on technology transfer (Naghavi, 2005) and hence the need to enhance the absorptive capacity of domestic firms in improving their productivity. Even more important is the need to invest in information and communications technology to enhance the entrepreneurial capability of both individuals and firms in the production of goods and services. Another strategy for compensating for any negative effects of strengthening of IPRs on developing countries is to provide increased technical assistance and international R & D funding to local enterprises to help them build local capabilities (Hayes, 2003; Kumar, 2002). One possibility is for developed countries to donate a substantial portion of technology license fees collected from developing countries to fund creative activities of domestic enterprises in the developing countries. Finally, IPRs is just one of the essential elements required to promote growth. Consequently, to realize its full potential, it has to be supported by other country specific characteristics including sound economic management, institutional environment, regulatory and judicial reforms. It is also important to note that some studies have shown that universally imposed standards for patent protection are not likely to contribute to increased growth in countries below a certain threshold of develop-

7 Adams 133 ment (Thompson, 1996; Schneider, 2005). It has also been argued the developed and those developing countries that have achieved substantial growth rates have all fine tuned their IPRs system to match their development needs, rather than blindly implementing a wholesale IPRs policy (Dolfsma, 2006; Kumar, 2002; Maskus, 200a; CIPR, 2002). These studies suggest that there has generally been an association with weak rather than strong forms of patent protection in the formative period of economic development and the IPRs regimes strengthened as countries became significant producers of innovations and new technology as seen in Korea and India. The studies reviewed and the findings of the study indicate that strengthening IPRs could result in more international economic activity and greater indigenous innovation, but that such effects would be conditional on the country - specific conditions, for example, an efficient market system. 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