Paras Gorasia Seminar Leader: Alan Story
Intellectual Property Dissertation:
April 2002
The Impact of Article 27 of the TRIPS Agreement on Foreign Direct Investment and Transfer of Technology to Developing Countries
By Paras Gorasia
Word Count : 5002
Abstract
It is widely acknowledged that the TRIPS Agreement is the most important instrument to date concerning Intellectual Property protection. What is not clear is the impact that it will have on developing countries and whether it actually meets its objective in the,
‘…promotion of technological innovation and to the transfer and dissemination of technology…’[1]
It has been argued by the developed countries that strengthening patent protection will increase foreign direct investment in developing countries and will lead to a greater transference of technology thus ensuring that the TRIPS Agreement meets its objective stated above. However this dissertation argues that this is simply not the case and that the implementation of Art 27 of the TRIPS Agreement has actually inhibited and deprived developing countries of the opportunity to obtain additional foreign direct investment and new technologies. It will be shown that simply enhancing patent protection will not necessarily result in a corresponding increase in Foreign Direct Investment and will demonstrate that the TRIPS Agreement ensures that ‘effective’ technology transfer does not take place as a result of the provisions within Art 27.
Introduction
The Agreement on Trade Related Aspects of Intellectual Property Rights (hereafter called the “TRIPS Agreement”) establishes minimum standards of protection for a wide variety of Intellectual Property such as Patents and Industrial Designs. It is widely celebrated by industrialised countries such as the USA as being the instrument with which to stimulate innovation and inventive activity. The Developing countries on the other hand have been much more aware of the significant impact that this agreement will have on their economic development and are wondering whether there will actually be an increase of inventive activity in their respective countries.
This dissertation will look at the potential impact that Art 27 of the TRIPS Agreement will have on Foreign Direct Investment (FDI) and Transfer of Technology (TT) in developing countries.
These two factors actually constitute the entire objective of the TRIPS Agreement, as stated in Art 7 of the Agreement entitled “Objectives” which states:
“The protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare, and to a balance of rights and obligations.”
Foreign Direct Investment (FDI) is a necessity in developing countries simply because most of these countries do not have the capital to fund expensive innovations on their own. FDI has to accrue to the developing countries in order to promote technological innovation and it is clear from Art 7 of the TRIPS Agreement that this is what should happen if the substantive provisions of the TRIPS Agreement are followed.
Transfer of Technology is another aspect of innovation that TRIPS claims to stimulate. This is also important in creating an environment conducive to innovation because without new technologies being made available to Developing countries they will simply cease to compete effectively on global markets and will definitely be severely handicapped when trying to develop cutting edge technology with what may be extremely primitive tools.
Whilst it is clear that the TRIPS Agreement does not make any wild claims to make each and every country as innovative and inventive as the USA. It does state that it will contribute to the “promotion of technological innovation”. If this agreement can even bring about a marginal improvement in the areas of Foreign Direct Investment and Transfer of Technologies to developing countries, it will have proved its worth.
Unfortunately this is not happening, this Dissertation will show, the TRIPS Agreement is in fact having a detrimental impact on all of the factors[2] mentioned earlier. The end result is that Art 27 of the TRIPS Agreement is actually an antithesis to Art 7.
Foreign Direct Investment (FDI)
It is clear that one of the claims made by the proponents of the TRIPS Agreement is that by imposing patent protection on Developing Countries there will be a rise in the amount of FDI going in to these countries thus enabling the Developing Countries to create patentable products themselves and export them to the global marketplace. However, this is an overly simplistic view of the situation, as there are a number of downsides to allowing patents in Developing Countries in relation to FDI.
In determining what impact weak or strong protection of Patents has on decisions to invest abroad, it is useful to begin with a review of the economic incentives firms have for becoming multinational. The most widely accepted framework in this regard is the so-called "ownership-location- internalization theory" (OLI)[3]. The OLI approach begins by stipulating that multinational corporations (MNCs) possess ownership advantages vis-a-vis local firms in the form of intangible assets. These assets usually take the form of new technologies, informal know-how shared among employees, specific organizational skills, reputation for quality, and so forth. However, while ownership advantages are necessary, they are not sufficient for overseas investment. In fact, many firms that possess intangible assets choose to serve foreign markets by arm's-length trade relationships.
In order for firms to invest abroad, two further conditions must be met. First, the foreign country must offer location advantages that make it more profitable to locate business abroad. Location advantages are usually associated with factors such as high transportation costs and tariffs, low input prices, access to distribution networks, and local regulatory environments. Second, it must be more profitable for firms to internalize production rather than to sell or license their intellectual assets to independent local firms in the foreign country. Internalization advantages take the form of avoiding transaction costs with potential licensees, controlling inputs, and protecting quality.
As can be seen there is more to consider than mere Intellectual Property rights when a foreign corporation is looking to invest in a particular country. Merely increasing Patent protection will not by itself bring about extra FDI into a country, according to Jeong-Yeon Lee & Edwin Mansfield[4] other factors such as tax incentives, quality of infrastructure, skills availability and input prices influence foreign direct investment decisions more than the strength of Patent protection. It is clear that where corporations are looking to invest, the decision is made by referring to a whole host of macro-economic factors rather than by reference to the strength of the Patent protection available to them. Claudio Frischtak[5] concurs with this view and states that the overall investment climate of a country is more important than the strength of the patent protection regime.
It has been shown above that patent protection does not automatically increase the volume of FDI going to countries. In fact there are two effects that could justify the inference that increased Patent protection has a negative influence on foreign investment. First, stronger Patent protection provides title holders with increased market power and could, at least theoretically, cause firms to actually divest and reduce their service to foreign countries[6]. There are two reasons why this may occur, the first being that since products are being patentable and that there will be an incentive to patent inventions, the actual patent claim may be too broad. There are obvious reasons why a corporation would wish to do this, the main one being to prevent competitors from obtaining a patent on a discovery based on the peripherals of an innovation developed by the original corporation and to maximise the scope of the patent. However this has an unfortunate impact on the levels of FDI that are transferred, as a broad patent claim may prevent future research and development in a related area. This will mean that other corporations will be less likely to invest in that particular country and will also mean that there are less opportunities for that particular country to obtain extra investment from other corporations.
The second reason leads on from the first in that it is possible that only a few corporations will dominate the production of innovation in Developing countries. These are likely to be large multinational companies as they have large resources and already control most of the world’s patents. This leads to an opportunity for these large firms to engage in monopolistic and abusive tactics such as strategically using the patent to prevent other firms from investing in a related area of the patent they hold, with the end result being that Developing countries are deprived of potential FDI. In this scenario it is also obvious that the FDI that is provided from the corporations that hold the patents would be directed into areas in which the corporation sees will provide the biggest return and not necessarily in areas which are in need of FDI.
This may lead to a net decrease of innovation as only certain areas will attract FDI where patent protection is granted. As the patent is a monopoly right, the subject matter will not be able to be developed by anyone else, thus depriving FDI in areas which may have received investment had patent protection not existed. A subsidiary effect of this is that areas of innovation which have special significance to Developing Countries such as the development of pharmaceuticals to treat tropical diseases will be unlikely to be high priority areas for multinational corporations due to the limited returns that will be gained[7]. Instead development will be focused on drugs which will be beneficial to western countries[8], as a result the needs of developing countries will fall by the wayside.
Second, higher levels of protection may cause MNCs to switch their preferred mode of delivery from foreign production to licensing. Michael J. Ferrantino argues that firms prefer foreign investment over licensing in the case of weak protection because internalized foreign production helps firms to maintain direct control over their proprietary assets[9]. This is a disastrous consequence to developing countries as it will mean that the level of FDI will decrease, due to the inhibition of investment in manufacturing facilities, as more and more firms start to license the sale of their products to Developing countries. This will make these countries dependant upon imports from other countries to satisfy their domestic needs.
As a result FDI in production facilities in Developing countries will be stunted and may lead to the relocation of production from Developing countries to industrialised countries in order for the multinational corporations to benefit from economies of scale. Prior to TRIPS, countries such as India had a well developed generic drugs industry and as a result of this Multinational corporations had to invest in production facilities to ensure that they were competitive in markets such as India because licensing their products would have meant that the generic drug manufacturers could have undercut the prices that they set. By manufacturing in the foreign country, multinationals would be able to compete favourably with domestic manufacturers in countries such as India.
Now that patent protection has been introduced, generic drug manufacturers will be unable to compete with multinational corporations meaning that they are able to withdraw production totally from countries such as India and manufacture all the drugs in one country[10] and merely export them to domestic markets. As a result the level of FDI will be reduced accordingly and could lead to a potentially inefficient inter-regional allocation of resources with industrialised countries manufacturing all the products and the Developing countries importing these goods with hefty licensing fees being paid on top and the distributor’s fees adding to the price of patented products.
Of course it could be argued that as a result of patent protection, multinational corporations will be more inclined to invest abroad but there will be no incentive for them to do so. All the advantages in transferring production to a foreign country such as cheaper labour, competition and making increased profits do not apply where there is a protected market. In fact according to the ownership-location-internalization theory it will be less profitable to move production to a foreign country due to the large start up costs involved. In fact it is in the interests of multinational corporations to centralise production since there will be no reason to compete where there is a protected market, as they will be able to set prices according to what will maximise their profit margins and FDI will simply not be attractive as it will eat into their profits with little benefit accruing to the patent holding company.
It is clear that where patents are granted world wide, there is little incentive for multinational companies to increase FDI. In fact it is clear that even before the TRIPS agreement came into force there was little FDI accruing to countries which had patent protection regimes in their countries from the US. In an article by N Girvan[11], the author points out that,
“United States’ data show that most of the multinational corporations spend about 90% of their local R&D expenditure in their home country and less that 1% in the developing countries. Their R&D expenditure is confined mainly to quality control and minor adaptations”