"Competition Policy and Intellectual Property Rights in the Republic of Latvia since 1991" (the working title) Research Proposal for the Doctoral Course at the "Ostsee-Kolleg: Baltic Sea School Berlin", Humboldt University Berlin By Anna Parfjonova University of Latvia Introduction The Baltic countries of Estonia, Latvia and Lithuania have made significant progress in their transition to market economies since achieving independence in early 1990s. An important part of this economic transformation has been the development of an effective competition policy. Competition policy seeks to promote consumer welfare by removing impediments to the efficient functioning of markets. This is accomplished by preventing cartels aimed at price fixing, limiting output or otherwise restricting competition, by preventing firms from gaining market power in unjustified ways, e.g. through anticompetitive mergers with competitors, by raising the barriers to entry facing new firms, and by preventing firms with market power from abusing their dominant positions. Intellectual property rights are designed to promote the creation of innovation and thus to promote economic advance and consumer welfare. This occurs by giving an innovator an exclusive legal right to the economic exploitation of his innovation for a period of time; the reaping of profits serves both to reward the innovator for his investment and to induce others to strive to innovate in the future. A tension has arisen between the approaches espoused through intellectual property and competition policy in attempting to achieve social welfare. The intellectual property grant seeks to protect property rights and in that way limits competition. To the contrary, competition laws proceed from the assumption that consumer welfare is best served by removing impediments to competition. However, this previous short-run view of competition authorities has been replaced by a longer-run view that admits technological progress as contributing at least as much to social welfare as does the elimination of allocative inefficiencies from non-competitive prices. A growing willingness to restrict competition today in order to promote competition in new products and processes tomorrow can be observed. Hence, intellectual property rights and competition policy are seen as complementary ways of achieving efficiency in a market economy. 1 Thus, the main task of the research is to describe development of the competition policy with regard to intellectual property rights in the Republic of Latvia since 1991; to analyse the current situation in the area and to evaluate its role in economic transformations in the country that were taking place during the previous decade and occurring at present.
Background of the Research Economists recently began to deal with the problem of the interface between intellectual property rights and competition policy. Nordhaus 2 started to examine the issue of co-ordinating competition and patent policy with analysing two patent instruments: the length of the patent grant (it establishes the extent, to which firms have exclusive rights over their own inventions) and the scope of the patent (it establishes the extent, to which an innovator has property rights over related inventions). Gilbert and Shapiro 3 divided the problem in two stages. In the first stage they determine the level (or amount) of the reward to a pioneer, in the second design the structure of the patent policy (the combination of the patent length and patent scope, which provides the incentives to engage in the desired level of research). They concluded that the socially efficient way to provide the optimal reward to the pioneer is through a patent policy that entails infinite patent lives, but a narrow scope that effectively constrains a price of an innovator). Gallini 4 extended the analysis to allow for imitation responses by rivals to patent policy, where a patent grants a monopoly over the patented drug for length T. Although duplication (e.g., producing the same drug) is prevented during the patent life, firms may imitate a product or process that differentiates it in some way. Gallini acknowledges as an optimal policy conferring a broad scope patent with the patent life adjusted to achieve the desired return to the innovator. It should be underlined that competition policy is absent or is redundant given the availability of the patent scope in the models described above. Gilbert and Shapiro, for instance, present competition and the patent scope as substitutes for constraining a profit of the innovator in a certain period. They defined the patent scope as the profit that the innovator is allowed to earn in the certain period. Thus, they believe that the socially efficient profit level could be gained either through a narrow scope or a strict antitrust policy. Gallini argues that the substitutability between patent and antitrust policy is not perfect, since narrowing the scope of patent protection could control price only indirectly. Reducing price by narrowing the scope can lead to inefficient imitation, suggesting that both policies are necessary to achieve an efficient allocation of resources toward development and use of innovations. Green and Scotchmer 5 consider patent and competition policy as complimentary instruments for rewarding the innovator in the most efficient way: patent scope by preventing imitation and competition policy by effecting price through constraints on contracts for transferring technology. They claim that the incentive to research depends not only on patent policy, but also on the ability of 1 This approach is designated in the OECD report on Competition Policy and Intellectual Property Rights, Paris, 1989 2 W.Nordhaus, Invention, Growth and Welfare: a Theoretical Treatment of Technological Change, Cambridge, MIT Press, 1969 3 R.Gilbert, C.Shapiro Optimal Patent Length and Breadth, 21 (1990) Rand Journal of Economics 106 4 N.Gallini Patent Policy and Costly Imitation, 23 (1992) Rand Journal of Economics 52
firms to co-operate through licensing arrangements (ex ante licensing or ex post licensing): one determines the opportunity cost of entering into the licensing agreement and the other establishes the feasible set came of legal licensing contracts. They came to the conclusion that when innovation is sequential, competition policy that allows joint ventures and ex post licensing and patent policy that grants a broad scope to an initial innovator ensures the best allocation of resources. As the examination of the literature shows, the authors did not come far enough in elaborating socially efficient competition policy towards intellectual property (Green and Scotchmer, for instance, illuminated only price fixing and joint ventures). Gallini and Trebilcock 6 were pioneers in suggesting appropriate competition policy towards intellectual property. They started their quest by identifying three effects that competition policy can have on social surplus generated from innovation: (i) it provides ex ante incentives to innovate; (ii) it affects ex post incentives to transfer new technologies and products; (iii) it promotes price competition in product markets that use the new products and processes. 7 After giving these initial observations, Gallini and Trebilcock advise to base competition policy towards intellectual property on the following set of rules: (1) There should not be a presumption that an intellectual property right creates market power. (2) Competition policy should acknowledge the basic rights granted under patent law. (3) A licensing restriction should be permitted if it is not anticompetitive relative to the outcome that would result if that license were proscribed; otherwise, an evaluation of potential efficiency effects of the restriction on the pricing and diffusion of the intellectual property should be made. These guidelines for competition policy recognise the rights granted by patents and the benefits from diffusion from particular licensing restrictions and the possible adverse effects on prices as well, but they do not take up a question whether competition policy should evaluate the impact that the licensing restriction may have on incentives to innovate. Three general approaches towards the issue were identified by Gallini and Trebilcock so far: Approach 1: Competition policy should intervene to correct perceived excesses or deficiencies of intellectual property protection provided under patent policy. 5 J.Green, S.Scotchmer On the Division of Profits in Sequential Innovation, Spring (1995) Rand Journal of Economics 6 N.Gallini, M.Trebilcock Intellectual Property Rights and Competition Policy: A Framework for Analysis of Economic and Legal Issues in R.Anderson, N.Gallini (editors), Competition Policy and Intellectual Property Rights in the Knowledge-Base Economy, Calgary: University of Calgary Press for the Industry Canada Research Series, 1998 7 Gallini and Trebilcock assert that competition policy affects welfare through its effects on research and development, licensing and prices. Hence, competition policy as a rule deals with (iii): anticompetitive effects on prices and output. In their opinion, competition policy towards intellectual property should centre its analysis around (ii): pro-competitive effects of diffusion; the role, which competition policy should play in fostering research and development (effect (i)) is more contentious.
Approach 2: Competition policy should determine whether a license reduces competition in innovation markets. Approach 3: Competition policy should determine whether a license reduces potential competition in product and/or technology markets. 8 Lahouel and Maskus 9 continued working out the question by distinguishing three general issues, which dominate discussion over interrelationships between competition regulation and intellectual property rights: (1) Concern over monopoly pricing reflects fear of one potential abuse. In developed countries prices are rarely the focus of competition policy per se and more often the subject of price regulation for purposes of public health and nutrition. Obviously, this optimistic view may not be shared by countries in transition period, both because the number of available substitutes may be more limited (insufficient static competition) and because most innovations protected by intellectual property rights are owned by foreign interests (inadequate domestic entry in dynamic competition). (2) Most abuses of the rights inherent in intellectual property rights relate to business strategies, including selling practices and licensing restrictions (there are few concrete rules in the area because of the complicated nature of markets for information and technology). Vertical licensing agreements, for instance, may serve the purpose of ensuring downstream product quality on the part of local vendors, which aids competition. The exploitation of intellectual property rights can arouse several competitive problems: one is potential cartelisation of horizontal competitors through licensing agreements that fix prices, limit output or divide markets; the second difficulty relates exclusionary effects of licence agreements, which could exclude other firms from competing in particular markets by raising barriers to entry. (3) Problems relate to attempts to acquire market power beyond a firm s own protected technology or product by purchasing exclusive rights to competing technologies and products. Such efforts effectively are horizontal mergers, which may be analysed in terms of their impact on current and future market concentration. Although economic theory demonstrates that intellectual property rights could play either a positive or negative role in fostering growth and development, Maskus 10 suggests that the 8 Gallini and Trebilcock recommend that competition policy follows this approach. This policy has the advantage of dividing the responsibilities according to the comparative advantages of the two legal institutions: the task of patent policy is to define those rights that encourage innovation (in terms of duration and protection from imitation); the task of competition policy is to prevent anticompetitive transfer and use of technology, while respecting the basic exclusive rights as laid out by patent law. In their opinion, this policy affects an innovator s overall return, and therefore the incentive to innovate in the first place, but the decision to allow the license will be based on the ex post incentives to license, not on the ex ante incentives to innovate. 9 M.Lahouel, K.Maskus Competition Policy and Intellectual Property Rights in Developing Countries: Interests in Unilateral Initiatives and a WTO Agreement, paper for the WTO/World Bank Conference on Developing Countries in a Millennium Round, Geneva, 20-21 September 1999
relationship is positive, but dependent on other factors that help promote benefits from intellectual property protection. She regards intellectual property rights as effective and market-based mechanisms for overcoming problems that exist in markets for information creation and dissemination. Objectives of the Research The main objectives of the research are the following: - to retrace general tendencies of the development of competition policy and patent policy in Latvia since 1991; - to analyse current competition policy in Latvia, taking into consideration theory elaborated by Gallini and Trebilcock, and range of problems indicated by Maskus; - to give a brief overview of competition policy in the European Union, which is particularly important in the perspective of Latvia s accession to the European Union (Latvia is obliged to approximate substantive provisions of laws to the competition law of the European Union, as required by the Europe Agreement between the European Communities and their member states, and the Republic of Latvia); - to attempt to foresee the further development of the policy on the basis of analysing previous tendencies on one hand and Latvia s obligations towards the European Union on the other hand. Structure of the Research The research will be structured in accordance with the objectives described above. Results The result of the research supposed to be an in-depth analysis of the development of the competition policy with regard to intellectual property rights as a part of the general competition policy, what would grant an opportunity for revising modern economic theories on the interface between competition policy and intellectual property rights in a case study. The research presents the first part of my Ph.D. thesis, which should be further developed with an empirical research on a local basis. 10 K.Maskus Intellectual Property Rights and Economic Development, paper prepared for the series Beyond the Treaties: A Symposium on Compliance with International Intellectual Property Law, organised by Frederick K.Cox International Law Center at Case Western Reserve University, February 2000