18 The Effect of Harmonization of Intellectual Property
Rights on the Activities of MNCs in Developing Countries (*)
Overseas Researcher: Koichiro ONISHI(**)

In trade negotiations such as WTO and TPP, the enhancement of IP rights is one of the high-priority
issues that developed countries have been requesting developing countries to tackle. However, it has notbeen sufficiently clarified whether the strength of the IP rights in those countries would benefit thecompanies in developed countries. This paper estimates the production functions of overseas subsidiaries ofJapanese companies and thereby empirically analyzes whether the strength of the IP rights in developing
countries increase Japanese companies’ productivity. The results show that the enhancement of the patentrights in developing countries excluding China has the effect of reducing the counterfeit damage thatJapanese companies suffer in those countries and that, especially in the electric machinery industry indeveloping countries, the enhancement of patent rights and an increase in the number of patent applications
applied by Japanese companies contribute to increasing the productivity of their overseas subsidiaries.
These results suggest that the developed countries’ policy of requesting developing countries to enhancetheir IP rights has been fully achieving its goal.

Ϩ Introduction
Since the TRIPS Agreement, not only
developed countries but also developing countries
have been enhancing their IP systems. This might
have reduced the counterfeit damage suffered by
Japanese companies in other countries and thereby
increased the profitability of Japanese companies.
However, a detailed analysis has not been
conducted in order to measure how much suchmove has contributed to their profitability. In
trade negotiations at the WTO, TPP, etc., theestablishment and enhancement of IP systems is
one of the high-priority issues for which developed
countries have been requesting special attention
from developing countries. Under these circumstances,
it is an important political objective toquantitatively analyze whether the establishment
and enhancement of IP systems in developing
countries actually improve the profitability ofcompanies of developed countries.
In this paper, I estimate the production
function of the subsidiaries of Japanese companies
abroad. Since the seminal study of Griliches (1979),
there have been many studies that estimate
production functions and calculate the private rateof return of the knowledge stock acquired
through investments in R&D activities. I newly

introduce a “patent system” variable whichmeasuring the strength of patent right in eachcountry into the demand function in an attempt todistinguish the effect of the “stock of knowledge”
variable (the conventional effect of R&D activities
on profitability) from the effect of increasing
profitability through the improvement inappropriability as a result of the enhancement of apatent system.
In this paper, I use the GP Index (the “GPI”)
as a variable to measure the strength of its patent
system in each country. The GPI was created by
Ginarte and Park (1997) and was used in many
preceding studies. That index quantifies thestrength of patent rights under the patent systemof each country mainly by evaluating the text ofrelevant laws in a uniform manner. While this is avaluable indicator to measure the “formal”
change for the system, due to the nature of theindex, the index is limited for the inability toreflect unquantifiable factors of the “real”
strengthen patent rights such as the enforcementof legal system firms face. Therefore, it is notcertain whether the GPI is an ideal index for thepatent enforceability experienced by companies.
For this reason, in this paper, I first analyze
whether the GPI appropriately reflects the levelof improvement in patent enforceability before(*) This is an English translation of the summary of the report published under the Industrial Property Research
Promotion Project FY2014 entrusted by the Japan Patent Office. IIP is entirely responsible for any errors in
expression or description of the translation. When any ambiguity is found in the English translation, the original
Japanese text shall be prevailing.
(**) At Max Planck Institute for Innovation and Competition, over a period of approximately 8 months from July 30,
2014 through March 19, 2015, as Overseas Researcher under the Program for the Fiscal Year 2014.
IIP Bulletin 2015 Vol.24● 124 ●

estimating production functions. More specifically,
I use the the Survey on Counterfeit Damage
conducted by the JPO, which is now studying thecounterfeit damage suffered by Japanesecompanies in other countries, calculated thecounterfeit damage rates based on the damage
suffered by Japanese companies in other countries,
and determined the degree of correlation between
said rate and the GPI. The estimation reveal that,in developing countries excluding China, there is asignificantly negative correlation between the GPI
and the counterfeit damage rate while indeveloped countries, there is no significant
correlation between them. This result may
indicate that the GPI reflects the actual patent
enforceability to a certain extent at least in
developing countries (excluding China).
Next, I estimate the production function ofJapanese companies and obtain the following
results. In the electric machinery industry, a risein the GPI and an increase in the number ofpatent applications in developing countries appear
to contribute to the improvement of subsidiaries’
productivity. Also, in the chemistry andpharmaceutical industries, increasing of bothvariables are significantly positive associated withproductivity in developed countries. On the other
hand, in the case of the machinery industry, we
find no significant relationship between the GPI,
patent applications and firm’s productivity.
These results suggest that the strength ofpatent rights in developing countries in particularhave decreased the counterfeit damage sufferedby Japanese companies and clearly increased theirprofitability in some industries. The results
indicate that the developed countries’ policy ofrequesting developing countries to enhance their
IP systems has fully achieved its goal. However,in the case of China where counterfeit damage isextremely serious, it is necessary to devise othermeasures.

ϩ Previous Literature
In this paper, an empirical analysis isconducted by estimating the production functionof the overseas subsidiaries of Japanesecompanies in order to determine whether thestrength of the local patent systems contribute to
an increase in the productivity of those companies.
Many studies have been conducted on therelationship between IP systems in developing
countries and multinational companies’ activities(hereafter MNCs), especially focusing onexporting goods and technology licenses to local

companies and making direct investments in
those countries (Maskus and Penubarti 1995,
Maskus 1998, Smith 2001, Branstetter et al. 2006,
Javorcik 2002, Ushijima 2013, Ito and Wakasughi
2009, Ushijima 2013, etc.). Many of these studies
analyzed whether and how the enhancement of IP
systems had promoted the transfer of knowledge
through these activities of multinational companies.
The focus was placed not on the profitability of
MNCs, but on the benefits enjoyed by thecountries that had enhanced their IP systems.
While these studies support the validity of theefforts to enhance the IP systems in developing
countries, those would fail to identify the benefits
enjoyed by developed countries through MNCs.
The studies may be interpreted to indirectly
indicate the existence of the benefits enjoyed bydeveloped countries in view of the fact thatcompanies of developed countries export goods toand make direct investments in developing
countries precisely because such activities are
beneficial for them. It we take into consideration
various factors such as the lack of incentive ofgovernments of developing countries, which are
hoping to enjoy the knowledge spillover effectcaused by the export and direct investment fromdeveloped countries, to protect IP rights ofdeveloped countries, the many empirical studies
that reveal that the increasing presence of MNCs
in developing countries promotes the knowledge
spillover effect, the fact that overseas corporate
activities involve a high level of uncertainty, andthe fact that overseas subsidiaries are more likely
to withdraw from the market than local companies,
it is necessary to analyze the IP systems ofdeveloping countries and the profitability ofoverseas subsidiaries of developed countries.

Ϫ Estimation Method
In this paper, in order to determine whether
the strength of the IP systems in other countries
have a positive effect on the productivity ofJapanese companies, I made the following
evaluation by using the production function of eachof their overseas subsidiaries located in thosecountries.
First, the production function is formulated
as follows by use of the Cobb-Douglas Production
Function.

● 125 ●஑஑ ୧୨୲ ൌ  ୧୨୲ౡ ୧୨୲ౢ ሺɂ୧୨୲ ሻ     (1)IIP Bulletin 2015 Vol.24

In this formula, ୧୨୲ means the amount of
production of Overseas Subsidiary i located in
Country j during Period t.  ୧୨୲ means the capital
input necessary for production activities. ୧୨୲means labor input. ɂ୧୨୲ means the random shocks
that affect the amount of production of the company
during Period t.
However, the result obtained through such asimple estimation formula is known to be biased
because, although this formula hypothesizes allof the factors that influence the amount of
production to be random effects and indicatesሺ஗ ାଵሻȀ஗౩ ୧୨୲ ൌ  ୧୨୲౩ɘ୧୨୲ ,, which is observable by the company, but notobservable by econometricians. In this case, theproduction function may be formulated as follows.

୔୰୧ୡୣ౟ౠ౪ ୧୨୲ ൌ  ୱ୨୲ ൬

୔౩ౠ౪

஗౩

൰ ൫Ɋ୧୨୲ ൯  

‫כ‬
‫כ‬
෦
న఩୲ ൌ Ⱦ୩  ୧୨୲ ൅ Ⱦ୪ ୧୨୲ ൅ Ⱦ୯  ୧୨୲ ൅ ɘ୧୨୲ ൅ Ɋ୧୨୲ ൅  ɂ୧୨୲  (5)୔୰୧ୡୣ౟ౠ౪୔౩ౠ౪஗౩൰ ሺɊ୧୨୲ ሻ(3)function indicating the demand available to eachcompany.  ୱ୨୲ means the demand of the industry
as a whole.  ୧୨୲ means the product price ofthe company. ୱ୨୲ means the average price of theindustry as a whole. Ɋ୧୨ୡ୲ means the demand
shock.  ୧୨୲ , which means the sales of the company,
can be specified as  ୧୨୲ ൌ ୧୨୲  ୧୨୲ . If Equation (3)is substituted into this, it may be expressed as

IIP Bulletin 2015 Vol.24

the industry-level deflator, ෦న఩୲ ‫ ؠ‬୧୨୲ െ ୱ୨୲ . The
meaning of each parameter is as follows:Ⱦ୩ ൌ ሺɄୱ ൅ ͳɄୱ ൅ ͳ
ͳሻȽ୩ ǡ Ⱦ୪ ൌ ሺሻȽ୪ ǡ Ⱦ୯ ൌ ൬ ൰ ǡ
ȁɄȁ
Ʉୱ
Ʉୱ

‫כ‬
‫ ؠ‬ɘ୧୨୲ ሺɘ୧୨୲In this formula,  ୧୨୲ means the demandfollows.

Here, the sales are substantiated by using(2)

In this paper, I inset the Dixit-Stigliz typedemand function (CES type) into the production
function as a demand function. The adoption ofsuch a clear hypothesis makes it possible todisregard the lack of the product price data ofcompanies and to introduce explicit variables toindicate the demand-side effects. In this case, it
may be formulated as follows.

 ୧୨୲ ൌ  ୱ୨୲ ൬ୱ୨୲ ሺሺɊ୧୨୲ ሻሻିଵȀ஗౩   (4)Furthermore, if Equation (2) is substituted
into Equation (4), the following formula may beobtained after simplifying log expressions. Eachof the lower-case characters indicates thelogarithm of the variables.

them as ɂ୧୨୲ , the actual data would not satisfy
such hypothesis.
To solve this problem, Olley and Pakes (1996)
proposed to add the production-determining factor,

ିଵȀ஗౩

 ୱ୨୲

ͳ
Ʉୱ ൅ ͳ ‫כ‬ሻǡ Ɋ୧୨୲ ‫ ؠ‬Ɋ୧୨୲
ȁɄୱ ȁ
Ʉୱ

This formula makes it possible to avoid the
problem of being unable to obtain company-level1
price data. In this paper, in principle, thisformula will be used to make estimates. The mainfeature of this formula is the clear introduction of ୧୨୲ into the estimation formula as a variable toindicate the demand available to the company.
The effect of the enhancement of the patent
system in each country may be formulated asfollows. I specify the demand function firms faceaffected by patent rights according to Helpman(1993), in which about IP systems in developed
countries and developing countries assume thatcompanies of developed countries are incompetition with local companies in developing
countries (imitators) for goods that are
differentiated from other products and that thestrength of patent right would force local
companies to exit from the market. The exit oflocal companies means an increase in the residual
demand which companies in developed countries
face. Consequently, for the demand function usedin this paper, this can be incorporated into theestimation equation as a demand shock throughɊ୧୨୲ and may be expressed as follows.
Ɋ‫כ‬୧୨୲ ൌ Ⱦ୍୔ ୨୲ ൅ Ⱦ୮୍୔ ୧୨୲ ή ୨୲ ൅Ⱦ୮ ୧୨୲ ൅ Ɋ෤୧୲● 126 ●

(6)

This shows that the demand shock faced bycompanies may be broken down into the following
factors: the part affected by the level of patent

hypothesis was adopted based on the presumptionthat productivity is not enhanced directly by the
R&D investment of companies, but rather throughprotection ୨୲ , the number of patent applications,

uncertain routes represented as ɒ୧୨୲ . This hypothesis
4
may be compatible with the reality.
In this paper, in order to examine the effectof patent acquisition and the effect of strength ofthe patent system, the following equation isestablished by substituting Equation (6) into
Equation (5).

୧୨୲ , expressing product innovation and additional
protection effect of patent acquisition, the interaction
term between ୨୲ and ୧୨୲ , which expresses thesynergistic effect of the level of patent protection andthe effect of patent acquisition, and the independentand identically distributed, probabilistic demand2

shock Ɋ෤୧୲ .
The model where the enhanced patent
system affects residual demand can separate theproductivity enhancement effect by process
innovation from the price rising effect caused by
the exclusion of imitators. In other words, it ispossible to clearly differentiate the productivity
enhancement effect of inventions from themonopolization effect caused by patent rights.
In this paper, it assumes that the overall technicalstandard of a parent company affects productivity
through the state variable ɘ୧୨୲ . In other words, inthis paper, the productivity of a company isassumed to go in line with the Markov process
based on the results of R&D activities up to thepreceding term and the shock ɒ୧୨୲ , which is notexpected by the company. This may be expressed
as follows.

ɘ୧୨୲ ൌ ൫ɘ୧୨୲ ห ୧୨୲ିଵ ൯ൌ ൫ɘ୧୨୲ หɘ୧୨୲ିଵ ǡ ୧୨୲ିଵ ൯ ൅ ɒ୧୨୲ൌ ሺɘ୧୨୲ିଵ ǡ ୧୨୲ିଵ ሻ ൅ ɒ୧୨୲(7)୧୨୲ିଵ is the information set that determines
the productivity of the following term. ୧୨୲ିଵ isthe level of R&D investment of the company. This
indicates that productivity depends on the R&D
investments and the unexpected shock ɒ୧୨୲ , which
occurs at any time during t-1 and t. Unfortunately,in this paper, since the R&D investment data ofoverseas subsidiaries was not available, the R&D
investment data of the parent company as a whole3
was used as a variable. It may be reasonable tosay that the productivity of overseas subsidiaries
have not been achieved as a result of their R&D
investments, but rather as a result of technology
transfer from their parent companies. This෦న఩୲ ൌ Ⱦ୩  ୧୨୲ ൅ Ⱦ୪ ୧୨୲ ൅ Ⱦ୮ ୧୨୲ ൅ Ⱦ୮୍୔ ୧୨୲ ή ୨୲ ൅‫כ‬൅  ɂ෦Ⱦ୍୔ ୨୲ ൅ Ⱦ୯  ୧୨୲ ൅ ɘ୧୨୲
న఩୲ 

(8)

In this equation, ɂ෦෤ ୧୲ ൅ ɂ୧୨୲ , indicatesన఩୲ ൌ Ɋthat both of them are random shocks that are notcorrelated with any independent variable. If thenumber of patent applications itself has a positiveeffect on productivity, Ⱦ୮ would be positive. Thiseffect contains the effect of product innovation as
well as the effect of patent acquisition. On the other
hand, Ⱦ୍୔ is the measurement of the effect of ashift in the demand function, i.e., a reduction in
the number of counterfeit companies as a resultof the strength of the patent right. Eventually, theeffect of increasing productivity through theenhancement of the level of patent protection will
be measured by Ⱦ୮୍୔ୖ .
Furthermore, in the case of an overseas
subsidiary of a Japanese company, more than a
few employees are sent from Japan. These
employees are different from local employees interms of the job responsibilities and wage system(the Japanese parent company compensate wage
for employees sent from Japan). For this reason,
the labor input is divided into the local employees୎୔ୌ୧୨୲ and expatriate employees from Japan ୧୨୲ . In
this case, Equation (8) may be formulated asfollows.
୎୔ୌ෦న఩୲ ൌ Ⱦ୩  ୧୨୲ ൅ Ⱦ୪ୌ ୧୨୲ ൅ Ⱦ୪୎ ୧୨୲ ൅ Ⱦ୮ ୧୨୲ ൅‫כ‬൅  ɂ෦
Ⱦ୮୍୔ୖ ୧୨୲ ή ୨୲ ൅ Ⱦ୍୔ୖ ୨୲ ൅ Ⱦ୯  ୧୨୲ ൅ ɘ୧୨୲న఩୲ (9)In this paper, estimates are made by using
this Formula (9).
The following section explains how to handleɘ୧୨୲ , i.e., the productivity shock observable by● 127 ●IIP Bulletin 2015 Vol.24

companies. This paper adopted the methods
presented by Olley and Pakes (1996) and
Levinson and Petrin (2003). The extremely
important factor of this method is the timing of acompany’s decision of input. In this paper, it ishypothesized that companies’ capital investment
will increase their capital input during a time lagof one term. In other words, there is one-year lag
between the decision of making capital
investment and the actual use of the facilities.
This may be expressed in the following equation.

order to avoid this problem, it would make it
impossible to determine the effect of theenhancement of the patent system in eachcountry. For this reason, this paper assumes thatthe labor demand available to companies will
depend on the level of wage ୨୲ during Term t ineach country. This may be expressed as follows:ୌୌ୧୨୲ ൌ ୨୲ ሺɘ୧୨୲ ǡ  ୧୨୲ ǡ ୧୨୲ ǡ ୨୲ ǡ  ୧୨୲ ǡ ୨୲ ሻ

By making an inverse function of ɘ୧୨୲ , this ୧୨୲ ൌ ሺͳ െ Ɂሻ ୧୨୲ିଵ ൅ ୧୨୲

equation may be expressed as follows.
୧୨୲

7is the amount of investment in thecurrent term andmeans a obsolescence rate.

I assume that the company’s labor input ୧୨୲is a completely variable input. This assumptionmeans that it is possible to make a necessary
increase or decrease in labor input, or input anecessary amount of labor in each term and that
this has no effect on the future amount of
production, etc. (meaning it is not a statevariable). When a Japanese company determines
the location of an overseas production site, one of
the major determining factors is the flexibility inthe amount of labor input. The company is alsoable to change the number of expatriate
employees from Japan in accordance with thestate of production activities. It is reasonable tosay that each company determines the amount oflabor input based on ɘ୧୨୲ and other variables.
In this case, the demand function indicating
the demand for local employees may be
expressed as follows.
୎୔ୌୌ୧୨୲ ൌ ୨୲ ሺɘ୧୨୲ ǡ  ୧୨୲ ǡ ୧୨୲ ǡ ୧୨୲ ǡ ୨୲ ǡ  ୧୨୲ ሻ

In this paper, according to Levinsohn andPetrin (2003), I compute non-parametrically ɘ୧୨୲using of the factor demand function of labor5
input. It should be noted that many precedingstudies that used the factor demand function
permit time fluctuations, while assuming thateach company will face various factors such as the6same prices (labor costs). However, in somecases, such as this paper, companies having
overseas subsidiaries in multiple countries arestudied. In such cases, this assumption is
unrealistic because the level of wage differs
greatly from one country to another. On the other
hand, if a country-specific estimation is made in

IIP Bulletin 2015 Vol.24

ɘ୧୨୲ ൌ ୲୨ ሺ ୧୨୲ ǡ ୧୨୲ ǡ ୨୲ ǡ  ୧୨୲ ǡ ୨୲ ǡ ୌ୧୨୲ ሻ
Since the function form of ୲୨ is not known,a cubic polynomial function is used as a substitute.
If this equation is substituted into Equation (9),the following equation may be established.

୎୔

ୌ
෦
న఩୲ ൌ Ⱦ୩  ୧୨୲ ൅ Ⱦ୪ୌ ୧୨୲ ൅ Ⱦ୪୎ ୧୨୲ ൅ Ⱦ୮ ୧୨୲ ൅ Ⱦ୮୍୔ ୧୨୲ ή ୨୲൅ Ⱦ୍୔ ୨୲ ൅ Ⱦ୯  ୧୨୲൅୲୨ ሺ ୧୨୲ ǡ ୧୨୲ ǡ ୨୲ ǡ  ୧୨୲ ǡ ୨୲ ǡ ୌన఩୲    (10)୧୨୲ ሻ ൅  ɂ෦
When making an estimate, first, Equation (1)will be regressed by OLS. Since any variables
୎୔other than ୧୨୲ are included in the inverse function,
they are unidentifiable. Therefore, the purpose of
the OLS regression is to calculate ୌ୧୨୲ parameterand the following equation.

ɔෝ ୧୨୲ ‫ ؠ‬Ⱦ୩  ୧୨୲ ൅ Ⱦ୮ ୧୨୲ ൅ Ⱦ୮୍୔ ୧୨୲ ή ୨୲ ൅ Ⱦ୍୔ ୨୲൅ Ⱦ୯  ୧୨୲൅ ୲୨ ሺɘ୧୨୲ ǡ  ୧୨୲ ǡ ୧୨୲ ǡ ୨୲ ǡ  ୧୨୲ ǡ ୨୲ ǡ ୌ୧୨୲ ሻIn this equation, if ɔෝ ୧୨୲ is known, thefollowing equation concerning● 128 ●

ɘ
ෝ ୧୨୲

may

be

established (however, ɘෝ ୧୨୲ cannot be calculated
at this stage).
ɘෝ ୧୨୲ ൌ ɔෝ ୧୨୲ െ ሺȾ୩  ୧୨୲ ൅ Ⱦ୮ ୧୨୲ ൅ Ⱦ୮୍୔ ୧୨୲ ή ୨୲ ൅ Ⱦ୍୔ ୨୲൅ Ⱦ୯  ୧୨୲ ሻ

the patent enforceability actually experienced by
Japanese companies.
I assume that the determinant factor ofcounterfeit damage is expressed by the following
simple formula.

Equation (7) makes it possible to calculate the ൌ  Ⱦ଴ ൅ Ⱦଵ  ୨୲ ൅ Ⱦଶ   ୨୲

rest of parameters by regressing ɘෝ ୧୨୲ to the൅ Ⱦଷ  ୨୲ ൅ Ⱦସ   ୨୲previous ɘෝ ୧୨୲ିଵ and  ୧୨୲ିଵ . In this case, those൅ ൅Ⱦହ  ୨୲ ൅ ൅Ⱦ଺ ୨୲ ൅ ɂ୨୲

remaining variables and ɒ୧୨୲ need to be uncorrelated.
൛ɒ୧୨୲ ሺȾ୩ ǡ Ⱦ୮ ǡ Ⱦ୮୍୔ǡ Ⱦ୍୔ǡ Ⱦ୯ǡ Ⱦ୪ୌ ሻ൫ ୧୨୲ିଵ ǡ ୧୨୲ ǡ ୧୨୲ή ୨୲ ǡ ୨୲ ǡ  ୧୨୲ ǡ ୌ୧୨୲ିଵ ൯Ԣൟ ൌ Ͳ
The above equation makes it possible to use
GMM estimation of parameters by using thesevariables.8 Meanwhile, since the function form of൫ɘ୧୨୲ หɘ୧୨୲ିଵ ǡ  ୧୨୲ିଵ ൯ is not known, a cubic polynomial
function is used as a substitute in this formula aswell.

ϫ DataMy primary data used in my estimation i.e.,the data on overseas subsidiaries such as thesales, the number of employees, the number of
expatriate employees from Japan, the capital, andthe type of industry, was obtained from Kaigai
shinshutsu kigyou souran (Overseas Japanesecompanies) published by Toyo Keizai Inc. The
Input Output Table provided by The World
Input-Output Database (WIOD) was used as thedata on the industry-specific deflator and theindustry-specific demand in each industry.
PATSTAT published by the EPO was used toobtain data on the overseas patent applications
filed by Japanese companies. Also, the following
databases were used to obtain various data suchas the data on the countries in which overseas
subsidiaries are located. In addition, the GPI wasused in order to obtain data on the level of patent
protection in each country. The following analysis
was conducted to determine to what extent suchdata reflects the actual patent enforceability.
Before estimating production function, I firstexamine the relation between the GPI and thecounterfeit damage suffered by Japanesecompanies in other countries and thereby
determined to what extent the GPI can explain

where Imitation rate shows as dependent
variable, the rate of the companies damaged bycounterfeit country j in year t by the total numberof respondent companies. Based on the Survey on
Counterfeit Damage, compiled by the JPO. Thisvariable is in between 0 and 1.
As an independent variable, the GPI wasused as the index to measure the strength of thepatent right. The main purpose of this analysis is
to determine whether this variable decreases thedamage rate with significance. The lnGDPcapita
is the logarithmic of GDP per capita in eachcountry. Although GDP per capita might not havea direct effect on counterfeit damage, it is known
that the enhancement of the patent system itself
goes in tandem with the establishment of othersystems in an economic growth (Chen andPuttitanun 2005, Park and Lippoldt (2008)). Thisvariable is used as a variable to capture theoverall level of economic development and thechanges made in other systems.
The lnRpatent variable is a logarithmic of thenumber of domestic patent applications filed bydomestic residents. This variable is used toexpress the imitation capability of each country.
Many of the previous studies concluded that thedifference among countries in terms of imitation
capability affects companies’ choice of importdestinations and production locations (forexample Qi 2001, Ushijima 2010). In this paper,
this variable is used to determine whether suchdifference in imitation capability significantly
affects the counterfeit rate.
The lnFpatent is a logarithmic of the numberof patent applications applied by foreign residents
e.g. MNCs. for the local patent office. This is avariable to reflect foreign companies’ use of thepatent system.
FDI is a variable to express whether each of
the respondent companies has subsidiaries in a

● 129 ●IIP Bulletin 2015 Vol.24

certain country. As described above, thepossibility of recognizing counterfeit damage in acertain country depends on each company’s
capability to recognize counterfeit damage in acertain country. The rate of recognition isconsidered to be higher if the company has an
office in that country. A company that has anoverseas office is more likely to be engaged inlarge-scale production and sale in that country,
which could consequently increase the risk ofcounterfeit damage. Therefore, FDI is expected
to have a positive correlation with the rate ofcounterfeit damage.
EX is a variable that expresses whether acompany exports goods to a certain country. The
goods exported to and commercialized in a certain
country could increase counterfeit damage in thatcountry.
The estimation is made for the period from1999 to 2009 based on the unbalanced panel data.
The year 2000 was excluded from the estimation
due to the missing of the total number of
responses. First, I conducted an OLS estimationthat largely concerns a comparison between
countries, and a tobit estimation that takes data
cutoff into consideration. Then, I estimate theequation using a fixed effect model in order tocontrol for unobserved time invariant differencesamong countries such as culture, business custom
which poetically affect the damage rate.
First, I estimate with developing countries
and find that the GPI is positive and that some of
the coefficients are significant. However, if China
is excluded from the estimation, all estimation
methods, i.e., OLS, tobit, and fixed effect, showthat the coefficient of the GPI turn to be negativewith highly significance. This result indicates thatthe counterfeit damage rate of China, which isextremely high irrespective of the level of the
GPI, would be an outlier in the estimation
concerning developing countries. At least, as far
as developing countries excluding China isconcerned, the higher the GPI is in a country, theless likely companies suffer counterfeit damage inthat country. The fact that the coefficient is -0.002
suggests that one-unit increase in GPI would
decrease counterfeit damage by 0.2%. This
indicates the possibility that, in developing
countries other than China, the GPI reflects
patent enforceability to a certain extent. In
contrast, it is indicated that, in China, actual
enforceability is extremely low despite the formal
legal provisions to protect patent rights. This
result is consistent with a case study that hasrevealed that many overseas subsidiaries

IIP Bulletin 2015 Vol.24

especially suffer from counterfeiting activities in
China.
On the other hand, I was unable to obtain any
statisticallysignificant
resultconcerning
developed countries except for some exceptions.
This may be attributable to the fact thatdeveloped countries have already establishedtheir respective patent systems and have been
enforcing them with a certain level of
effectiveness and that any additional formalenhancement of their patent systems would not
make a significant contribution to decreasing
counterfeit damage.

Ϭ Results
Next, I estimate the production function
concerning some industries of developing
countries, namely, the electric machinery,machinery, chemistry, and pharmaceuticalindustries, by using various methods, i.e., OLS,
fixed effect, and the LP model. In the chemistry
and pharmaceutical industries, I use not only the
GPI but also the PIPP which are another patentindexes for pharmaceutical products establishedby Liu and La Croix (2015). First, I find that, forthe electric machinery industry, the number ofpatent applications and the GPI have astatistically-significant
positivefortheproductivity. However, the interaction term of
these two variables is significantly negative.
These suggest that, in the electric machineryindustry, the patent applications filed in adeveloping country effectively contribute toincreasing productivity. These also show that theenhancement of the patent system in a country
increases the companies’ patent appropriability inthat country. However, the interaction termshows that such effect is limited and therefore thestronger the patent system is, the weaker effectthe filing of a patent application would have interms of the effect of increasing productivity.
Also, the results reveal that the number ofpatent applications are statistically insignificant in
the machinery industry and the pharmaceuticalindustry in developing countries. This suggeststhat patent applications in a country would notincrease the productivity of the overseas
subsidiary in that country. In some estimations,
GPI and PIPP are significantly positive in themachinery industry and the pharmaceuticalindustry. In consideration of the facts that the
number of samples is small and that variation inboth indexes is also small, the enhancement of
the patent system could be contributing to● 130 ●

increasing productivity to a certain extent.
Regarding other variables, coefficient of demandis significantly negative. This variable is aninverse number of the price elasticity of demand
and my result is inconsistent with the theory.
This is probably due to the fact that market
demand measured in the two-digit category fail toaccurately match to the demand the Japanesesubsidiaries face.
In the electric machinery industry and themachinery industry in developed countries, theGPI variable are insignificant in all estimations. In
consideration of the fact that patent enforceability
is already high in developed countries, thisindicates that additional enhancement of thepatent system does not increase the productivityof companies. This result is compatible with theaforementioned analysis results produced by useof the counterfeit damage rate and also with theresults of the preceding studies that concluded
that the companies' patent appropriability in theelectric machinery industry and the machineryindustry is not high.
Inthechemistry
industryandpharmaceutical industry, I obtain the result that,
although PIPP is insignificant, GPI is statisticallysignificant and the number of patent applications
is generally significantly positive. These results
indicate that, in the chemistry industry and thepharmaceutical industry, the enhancement of thepatent system in developed countries could
increase productivity. This shows that patentappropriability in those industries is high indeveloped countries.
It should be noted that the interaction term
between the enhancement of the patent systemand the number of patent applications is
significantly negative. This indicates that, thestronger the patent system is, the weaker the
additional effect of increasing profitability would
be even if a patent application is filed.

ϭ Conclusion
This paper first examine the extent to which
the patent index designed to quantify the level ofthe strength of the IP system of each country is
related to the improvement in the actual
enforceability of IP rights by analyzing thecorrelation with the counterfeit damage sufferedby Japanese companies in that country. Then, thispaper investigate, by using the production
function and the patent index, whether theenhancement of the patent system in that country
increases the productivity of Japanese companies’

overseas subsidiaries in that country.
The results show that a rise in the patentindex has a negative correlation with thecounterfeit damage suffered by Japanesecompanies in developing countries excluding
China, whereas no statistically significant
correlation between patent index and counterfeit
damage in China and developed countries. Thisshows that, in many developing countries where
the patent system has not been sufficiently
established, the quantifiable formal enhancementof the patent system would adequately contributeto improving patent enforceability. The resultd
also suggests that China, in which counterfeit
damage is extremely serious, is an exception andthat, in the case of developed countries: in which
the patent system has already been fully
established, the formal establishment andenhancement of the patent system would not
result in additional improvement of patent
enforceability.
Based on the above-described analysis, I
estimate productivity by using the production
function as follows. First, in the electricmachinery industry in developing countries, it
reveals that both a rise in the patent index and anincrease in the number of patent applications filed
by companies increase their productivity.
However, the interaction term between these twovariables is significantly negative, which indicatesthat a high patent index would weaken an
additional effect of patent application. This may
indicate that the marginal effect of patentacquisition would decrease as the patent rightitself gets stronger.
In the chemistry industry and thepharmaceutical industry, the results show that, indeveloped countries, both the patent index andthe number of patent applications significantly
increase the productivity. As previous studies
show that the patent appropriability is high in thepharmaceutical industry, this result is consistent
with the same result from using of the production
function. It should be noted that the interaction
term is significantly negative and that a strong
patent system would decrease the additional
effect of patent acquisition.
These results described above show that thestrength of the patent system in each country
would decrease the counterfeit damage sufferedby Japanese companies and contribute toincreasing their productivity. However, such
effect would be different from one industry toanother. Such effect is clearly observableespecially in the electric machinery industry in● 131 ●IIP Bulletin 2015 Vol.24

the case of developing countries and in thechemistry industry and the pharmaceuticalindustry in the case of developed countries.
Summing up, it may be said that the request
made from developed countries including Japan todeveloping countries for enhancing their patent
system and the developed countries’ cooperationto achieve this goal are likely to have contributed
to reducing the counterfeit damage suffered bycompanies from developed countries and thenincrease their profitability.

1

It should be interpreted that technology protection bypatent rights would increase companies’ markups
through market monopolization rather than improving
their productivity. In this case, like Hall (1986) andCassiman and Vanormelingen (2013), it would benecessary to analyze the relation between parent rights
and markups. However, this analysis would require dataon labor cost share (labor costs/total production costs).
Unfortunately, such data is not used in this paper. A
further study should be conducted to make a markup
estimation.
2
Hall et al. (2005) stated that the number of patents
obtained by a company indicates the successful cases
where the company acquired new proprietary knowledge
on the presumption that the company made R&D
investments.
3
Only a small number of companies have their overseas
subsidiaries conduct R&D activities. The scale of suchactivities is just around 4.4% of the R&D costs of thosecompanies as a whole (The 43rd Survey of Overseas
Business Activities, Ministry of Economy, Trade andIndustry (2014))
4
Doraszelski and Aumandreu (2013) pointed out that thismodel is more realistic than the production
function-based estimation method that has been adopted
since the study of Griliches (1979).
5
Levinsohn and Petrin (2003) used the raw material
costs such as the electricity usage determined in thecurrent term. However, due to the lack of such data, thedemand for labor input was used to express ɘ୧୨୲ .
Doraszalski and Jaumandreu (2013) conducted an
exceptional study where they used the labor cost data ofeach company and explicitly estimated the parametriclabor demand function.
7
Please refer to De Loeker (2011), who proved that aninverse function is possible under monopolisticcompetition.
68ɒ୧୨୲ has a correlation with the number of overseas
expatriates from Japan in the current term. However,since it is hypothesized that the number of overseas
expatriates from Japan is a completely variable input,ɒ୧୨୲ has no correlation with the number of overseas
expatriates from Japan in Term t-1.

IIP Bulletin 2015 Vol.24● 132 ●