Intellectual property rights affect the pattern of trade

Jenny Lin, William Lincoln

Disagreements over intellectual property rights policies have been a major roadblock in recent trade agreement talks, and the issue has also been a pillar of critiques of globalisation. This column discusses new research that matches confidential, comprehensive data on firm patenting and trade behaviour for the first time. It shows that, all else equal, firms who hold patents in the US are significantly more likely to export to countries that better protect intellectual property rights.

In 1999, protestors famously disrupted the Ministerial Conference of WTO, raising a number of issues. Central to their concerns was the implementation of the WTO’s Trade Related Aspects of Intellectual Property Rights agreement. This issue has long been controversial, with Charles Dickens even travelling to the US to lobby Congress over copyright policy in the 1800s. More recently, it became a source of controversy in the talks over the Trans-Pacific Partnership.

The effect of intellectual property rights (IPR) policies on the pattern of trade remains contested in the academic literature. While some papers have found substantial effects (e.g. Maskus and Penubarti 1995, Ivus 2010, 2015), earlier papers found no effects (e.g. Smith 1999) or even negative effects of IPR protections on the level of trade (e.g. Ferrantino 1993). In recent research, we construct the first comprehensive matched firm-level data set combining information on firms’ trade and patenting behaviour to look at this idea (Lin and Lincoln 2017). We show that, all else equal, firms with patents tend to export more often to countries with better IPR policies. This is supported theoretically in a companion working paper (Lin and Lincoln 2018). As intellectual property becomes increasingly central to modern production, our results promise to inform an issue that is only likely to grow in importance over time.

New facts

As we are the first to match information on patenting and trade at the firm level, we begin by simply documenting a number of new facts. In this, we see our work as combining two different but very important literatures. In particular, our results follow in the footsteps of the pioneering work by Bernard and Jensen (1995) describing producer-level trade behaviour for the first time and the results of Balasubramanian and Sivadasan (2011), who match comprehensive information on patents to firms for the first time.

Our data construction begins with the confidential Longitudinal Business Database (LBD), which is maintained by the US Census Bureau. It contains information on the employment and payroll of every legally operating firm in the US. Onto this backbone, we merge on patent data from the US Patent and Trademark Office and trade data from US Customs and Border Protection first analysed by Bernard et al. (2009). We then limit the analysis to the manufacturing sector where these issues are the most central; manufacturing firms account for roughly 70% of all patents issued in the US.

We establish a number of new stylised facts regarding trade and innovation for our sample:

while less than 10% of firms hold a patent, they account for nearly 90% of all exports;

82% of firms with a patent sell abroad, compared to 24% of other firms;

25% of firms that export hold a patent, compared to 2% of other firms;

amongst firms that export, firms with a patent tend to sell to more countries;

amongst firms with a patent, exporters tend to hold more patents;

employment, payroll, and the share of non-production workers all increase with exporting and patenting, with the set of firms that engage in both being disproportionately large in size.

The last stylised fact in particular demonstrates that the size effect separately found for exporters and for businesses who patent is driven primarily by firms who engage in both activities. As shown in the figure, patenting firms are especially important for exports in the Great Lakes region and in the Northwest of the US. Exporting behaviour is also found to increase sharply around the time of a firm’s first patent.

Figure 1 Percentage of exports from patenting firms

Gravity with patenting

We next turn to looking at how IPR policies in foreign countries affect the pattern of where US firms sell their goods. To do so, we appeal to a modified version of the workhorse gravity model in international trade. Firms with patents are disproportionally shown to export to countries with better protection of IPRs. Interestingly, these effects are primarily found on arm’s-length transactions with other firms; we find dramatically smaller effects of IPRs on related party transactions with firms’ subsidiaries abroad. While we did not expect these related party effects to be zero, since IPRs could affect where firms have subsidiaries in the first place, they are consistent with firms altering their exporting behaviour due to concerns over their technology being pirated by other businesses.

As this is the first work to incorporate patenting in a firm-level gravity model, the coefficients on other interaction terms are also of interest. Larger firms and those with a more skilled workforce are also more likely to sell to countries that better protect IPRs. Firms with a patent are more likely to sell to countries that are more developed, that share a common language with the US, that had a colonial relationship with the US, and that are farther away. An important exception to this last result is that firms with a patent are substantially more likely to export to a country that borders the US. This effect remains even when dropping Canada from the analysis. Exchange rates do not seem to have a disproportionate effect on patenting firms, at least in the cross section. Differences in time zones also do not have a disproportionate effect on patenting firms after controlling for market distance.

Evidence from six IPR reforms

Another way to look at the effect of IPRs is to consider how US firms changed their behaviour in response to a strengthening of protections abroad. Despite the fact that in the gravity implementation above we employ a measure of IPR protection that is well regarded and that has been widely used, this additional exercise helps address concerns over measurement error in this index. It also will allow us to look at the effects of reforms in very different political environments as well as in countries with different market structures.

We look at how US firms changed their exporting behaviour in response to six large-scale IPR reforms that happened during our sample period in Argentina, Brazil, Colombia, the Philippines, Turkey, and Venezuela. We use a propensity score matching differences in differences estimation approach as in Heckman et al. (1997) to see if US firms with patents disproportionately began to export to these countries after the reforms were enacted. This allows us to compare how firms that are otherwise similar, with the exception of holding a patent, responded to the reforms. This is particularly important in ensuring that the firms that we compare were not on fundamentally different growth trajectories prior to the reform.

We find statistically and economically significant responses to five out of six of these reforms. Like in our gravity estimations, the effects are primarily found to be on arm’s-length export transactions. Effects on related party exports are found to be substantially smaller and are often statistically insignificant.

The one reform for which we find no effect was in Venezuela. The end year of our sample for this country saw substantial policy uncertainty with the election of Hugo Chávez, who had previously been involved in a coup attempt, and the beginning of what has been termed the ‘Bolivarian Revolution’. Policy uncertainty has been found to significantly affect firm trade behaviour (e.g. Handley and Limão 2014, 2017) and we believe this likely drove our findings here. Informal discussions with economists from Venezuela reaffirmed this view.

Conclusion

Our work has a number of implications. With respect to the policy debate over IPRs, our results certainly support the view that stronger IPR policies in developing countries would lead to greater import variety. This is particularly important since developing economies are often heavily reliant on imports to obtain the latest technologies. We should emphasise, however, that these results only speak to one aspect of the debate over IPR policies. The diffusion of technologies from innovative, wealthier countries to others is often sped along by the weak protection of intellectual property rights and this learning can be crucial for economic growth. Allowing the pirating of foreign technologies can also lower prices for domestic consumers. The trade-off between these concerns is therefore a question of first order importance for raising living standards worldwide and is still a subject we are only beginning to understand.

Authors' note: Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed.

References

Balasubramanian, N and J Sivadasan (2011), “What happens when firms patent? New evidence from U.S. Economic census data”, Review of Economics and Statistics 93: 126–146.

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Ivus, O (2015), “Does stronger patent protection increase export variety? Evidence from U.S. product-level data”, Journal of International Business Studies 46: 724–731.

Lin, J and W F Lincoln (2017), “Pirate's treasure”, Journal of International Economics 109: 235-245.

Lin, J and W F Lincoln (2018), “Trade composition and intellectual property rights”, Claremont McKenna College Working paper.

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Smith, P (1999), “Are weak patent rights a barrier to U.S. exports?”, Journal of International Economics 48: 151–177.