Endogenous Research and Development and Intellectual Property Laws in Developed and Emerging Economies

[Author Affiliation]Aniruddha Bagchi, abagchi@kennesaw.eduAbhra Roy, aroy1@kennesaw.edu[Acknowledgment]This paper was presented at the International Industrial Organization Conference (May, 2008) and we thank the conference participants. We would also like to thank two anonymous referees who helped us in substantially improving the paper.1. IntroductionThere has been a recent literature (summarized in Maskus 2000) that analyzes the determinants of the intellectual property (IP) laws. This article builds on this literature by examining the incentive of a country in providing IP protection when research-and-development (R&D) effort is endogenously determined. We analyze this incentive both for a developed economy and for an emerging economy. It is natural to conjecture that in a two-country model, if one country improves its patent protection, then the other country would free ride and reduce its own level of patent protection (Scotchmer 2004a, p. 330). This conjecture generally holds if R&D effort is assumed to be exogenous. However, we show that if R&D effort is endogenized, then such a conclusion can hold only under certain circumstances. Indeed, it is possible to show that there are situations under which an improvement in IP laws in the developed economy can lead to a simultaneous improvement of such laws in the emerging economy. Our analysis can therefore be used to determine conditions under which countries can free ride on each other in framing IP laws and conditions under which they "cooperate." Interestingly, in our model such "cooperation" can be achieved by countries acting in their best interest and not because of international treaties.We also use our model to analyze conditions for convergence of IP laws between developed and emerging economies. From the perspective of IP laws, the most important differences between developed and emerging economies are that emerging economies have lower incomes and a lower level of research capability. One can conjecture that if there is a convergence between the developed and emerging economies in both of these dimensions, then there should be a convergence of their IP laws as well, but in that case it is not clear if the convergence in IP laws is because of the convergence of incomes or because of the convergence of research capabilities. However, the role of each of these dimensions can be isolated if there is a convergence in only one of these dimensions. To do so, we focus on the impact on IP laws if there is convergence in incomes without a commensurate convergence in research capabilities.1 Therefore, in our framework, the main difference between an emerging and a developed country is that the former has a domestic firm that engages in R&D, while the latter has a domestic firm that only imitates a new technology whenever possible. While we agree that there are many points of difference between an emerging economy and a developed economy, we focus on this difference since it seems to be the most relevant for the purpose of analyzing the different IP regimes that would emerge in equilibrium in either type of economy.2 Further, throughout the analysis, IP laws refer to the choice of patent length and breadth.In the model, we analyze the solution to the following questions on the structure of IP laws: (i) What is the relationship between the optimal patent length and the optimal patent breadth in a country given a fixed structure of IP laws in other countries? In other words, if a change in circumstances necessitates an improvement in the degree of patent protection in a particular country (given a fixed degree of IP protection abroad), how is this improvement achieved? (ii) What is the relationship of the patent regimes across countries? In other words, if one country strengthens its patent laws, should the other country's best response be to weaken its patent laws? …