International Intellectual Property Rights Protection and the Rate of Product InnovationProduct Cycle Models Lacked FDIFDI ImportantFDI in Product Cycle (Helpman 1993)FDI with Endogenous InnovationIPRs MatterFDI MattersIPRs Encourage FDIModifications Needed to Add FDILai’s ModelProfit Maximization by MNCsExogenous ImitationProfit Maximization by Southern firmsIPRs and ImitationMNCs More ProfitableProfit StreamsValuation ConditionsMNCs and Imitation RiskProfit ExpressionsLabor ConstraintsSystem of EquationsRelative WagesMain resultsEffects of Southern IPR ProtectionInternational Intellectual Property Rights Protection and the Rate of Product InnovationEdwin L.C. LaiJournal of Development Economics 55 (February 1998):133-153.Product Cycle Models Lacked FDIIn standard product cycles models, for production to be shifted to the South, Southern firms must expend effort to imitate production technologies.Why don’t Northern firm shift their production to the South instead?Build a plant in the South to reap cost savings.FDI ImportantGreater and greater shares of world output are being produced and traded by multinational firms.Need some product cycle models with foreign direct investment (FDI) to understand the role of multinational in innovation, international technology transfer, and imitation.Possible that results found in standard product cycle models might be differ if FDI occurs.FDI in Product Cycle (Helpman 1993)First effort to add FDI to a product cycle model less than satisfying.Purpose of model was to examine effects of IPRs on Southern welfare.Stronger Southern IPR protection captured as an exogenous reduction in imitation intensity.Two models: one with endogenous innovation but no FDI, and the other with FDI but innovation exogenous.FDI with Endogenous InnovationLai saw need for a model with FDI and endogenous innovation to properly assess effects of IPRs.What Helpman should have done was add FDI keeping innovation endogenous, but likely that welfare analysis (including transitional dynamics) would have been too complex.If willing to stick to steady-state analysis, FDI with endogenous innovation can be done, as Lai shows.IPRs MatterHelpman found that reducing the imitation intensity:Reduced rate of innovation in the base case without FDI, Reduced FDI in the version with exogenous FDI.Remained unknown what reducing imitation intensity would do to FDI and innovation in a model with FDI and endogenous innovation.Lai finds FDI and innovation both fall.FDI MattersComparing the case with FDI to that without, having FDI occur leads to a reversal of the effect of reducing the imitation intensity on innovation.Without FDI, less imitation leads to less innovation.With FDI (and no imitation prior to becoming a multinational), less imitation leads to more innovation.When FDI and imitation coexist as channels of international technology transfer, all depends on which channel is predominate.IPRs Encourage FDIThat stronger IPR protection in the South encourages FDI seems to make intuitive sense.Less imitation makes profit stream last longer (in expected value), which encourages innovation.Less obvious that there is an effect related to labor constraints.Without FDI, more demand for Northern labor due to longer monopolies pushes up the Northern wage and makes innovation more expensive.But with FDI, demand for labor rises in the South rather than the North, so this effect discouraging innovation is avoided.Modifications Needed to Add FDIHelpman’s base model was just Grossman and Helpman’s product cycle model but with exogenous imitation (no imitation valuation condition).Helpman’s model with FDI had already tackled how to put FDI into product cycle model.Lai’s model is a mixture of Helpman’s two models, which is Grossman and Helpman’s product cycle model plus FDI minus endogenous imitation.Lai’s ModelConsumer side is same as GH, as it is in most variety-based product cycle models.In terms of market structures, need to add one more: multinational production.Measures of products produced by Southern imitators, Northern firms producing in the North, and multinational firms producing in the South must sum to one.Profit Maximization by MNCsLai normalizes the unit labor requirement in production to one ax = 1.Multinationals, like Northern firms, price at a fixed markup over marginal cost.Multinationals enjoy lower costs producing in the South due to lower wage there, so they change lower prices than Northern firms. (pF is pm in article).NNSFpwwp Exogenous ImitationInnovation modeled the same as in GH but imitation is exogenous here.M (iδ in the article) is the exogenous hazard rate, the probability that a multinationalized product will be imitated in the next instant.There is no imitation targeting products produced in the North in the base model.Imitation is costless.Profit Maximization by Southern firmsOnce a product has been imitated, the Southern firm prices at marginal cost pS = wS . Bertrand competition against the multinational producing that variety. MNCs have same cost as Southern firms.Adding FDI gets rid of large gap versus small gap.Like always small gap as price at rival’s marginal cost.Here wage gap across countries irrelevant since rival producing in same country.IPRs and ImitationAs in Helpman, a strengthening of Southern IPR protection is captured as an exogenous reduction in the imitation hazard rate.Can be thought of as better enforcement of patent laws.If all imitation illegal (patent not expired), better enforcement means more copiers are caught so fewer successfully compete in the marketplace.MNCs More ProfitableThe pricing expressions for MNCs and Northern producers and the standard demand function lead to:Profits for MNC exceed those for Northern producer due to lower wage in the South.Wage is per efficiency unit of labor since unit labor requirement in production normalized to one.1NSNFwwProfit StreamsExpected present discounted value (PDV) of profits for a MNC (Πm in article):Expected PDV of profits for a Northern firm (ΠN in article):MrVFFrVNNValuation ConditionsValuation (free entry) condition for innovation: cost of innovation must equal reward.Valuation condition for multinationalization: Northern firms
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