The Economics of Intellectual Property Rights in China

Johannes Liegsalz The Economics of Intellectual Property Rights in China

GABLER RESEARCH

Johannes Liegsalz

The Economics of Intellectual Property Rights in China Patents, Trade, and Foreign Direct Investment With a foreword by Prof. Dietmar Harhoff, Ph. D.

RESEARCH

Bibliographic information published by the Deutsche Nationalbibliothek The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available in the Internet at http://dnb.d-nb.de.

Dissertation Ludwig-Maximilians-University Munich, 2010

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Foreword The importance of intellectual property rights in industrialized countries, as well as in emerging economies, has been increasing considerably over the past two decades. An important event in the course of this development was the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). Especially regarding the economic development of the People's Republic of China (PRC), intellectual property rights have attracted the attention of scientists and decision-makers in business and public policy. While China meets the basic legal requirements of a well-developed system for the application and examination of intellectual property rights, the enforcement of these rights still proves to be a major issue. Academic research regarding China's IPR system is still sparse. Moreover, there are considerable gaps in the literature. In previous academic studies, the examination process at the Chinese State Intellectual Property Office (SIPO) has not been researched thoroughly. Moreover, the fundamental relationship between international trade flows, foreign direct investment and the design of the patent system in the People's Republic is in need of more detailed analysis. In his dissertation, Johannes Liegsalz tackles three specific questions immediately related to this nexus. He applies multivariate econometric methods to different data sets which were assembled specifically for the purpose of this thesis. The first chapter of the thesis analyzes the duration of the examination process for patent applications at the SIPO. The second chapter provides new results which deepen the understanding on the relationship between patent rights and export flows to the PRC. In his third empirical study, Liegsalz analyzes the impact of patent rights and the value of patents on direct investments of foreign companies in China. This book is the product of more than three years of intensive research which earned the author a doctoral degree at the Ludwig-Maximilians-University of Munich. Johannes Liegsalz's studies of the economics of intellectual property rights in China are a valuable contribution to the field. The results deserve the attention of practitioners and researchers alike. Munich, April 2010 Prof. Dietmar Harhoff, Ph. D.

Acknowledgements In all beginnings dwells a magic force. For guarding us and helping us to live. So be it, heart: bid farewell without end. Hermann Hesse, The Glass Bead Game

The impulse to start this dissertation project was more driven by fortunate circumstances than by a clear picture of the years of work and the challenging process to finalize this thesis. An exceptional experience during my first visit to the Middle Kingdom in 2001, some occasional lectures emphasizing the growing importance of the Chinese economy and my practical experience in companies venturing into Asian markets were probably my main motives to conduct this research. Along this way, I had the chance to dive into a new scientific and cultural world allowing me to meet and work jointly with several interesting people. Many of them were an essential support and inspiration for my thesis and I would like to point out those how probably had the biggest influence on my doctoral studies. First and foremost, I wish to thank Dietmar Harhoff, my doctoral advisor, for his outstanding support and excellent guidance. His valuable advice and continuous encouragement during my time as a doctoral student were the basis on which this dissertation grew. In particular I wish to thank him for the opportunity to conduct this scientific research beside my regular job and for the resources provided by the Institute for Innovation Research, Technology Management and Entrepreneurship (INNO-tec) at the Ludwig-MaximiliansUniversity Munich. I am very much indebted to him. Moreover, I wish to thank Franz Waldenberger, my thesis referee and scientific advisor for his strong support and his advice. I am also grateful to Arnold Picot and Franz Ballwieser as advisors during my Master of Business Research program. Further on, I would like to thank my fellow researchers at the INNO-tec for their valuable advice and helpful support. In particular I am grateful to Karin Hoisl for her comments during seminars and on my project study as well as Philipp Sandner who supported me on various data topics. Special thanks go to Stefan Wagner for the countless discussions on my research projects. His encouragement and invaluable advice in case of scientific problems gave me the necessary motivation to go the extra mile.

VIII Further important milestones along the creation of this work were two academic visits abroad. For my short stay at the University of St. Gallen during the winter 2007/2008 I wish to thank Marcus Schögel and Nicolas Pernet. Also, I am grateful to Qinghai Li and Sizong Wu for the invitation to the School of Economics and Management at the Tongji University in Shanghai in 2009. By the same context I also would like to thank Thomas Zimmer for his help to prepare this visit and the Bavarian University Center for China for the financial support. I am also very grateful to Uli Lenz who encouraged me to start my professional and academic career in parallel. My initial discussions with Uli Lenz and Andreas Wolter are probably the nucleus of this work. In addition, I would like to thank Andreas Wolter for inviting me for an extended assignment to the BMW Group in China and Jennifer Qiu who provided me insights into the Chinese economy and society which otherwise would have been undisclosed to me. Finally, I would like to thank my parents for their love and support throughout my entire life. My interest in China is very much based on the cultural openness they have taught me. With deepest gratitude I would like to dedicate this book to my beloved mother – who left this place on earth too early, but who will never leave my heart.

Table of Contents Foreword Acknowledgements Table of Contents List of Figures List of Tables List of Abbreviations

V VII IX XI XIII XV

1. Introduction

1

2. Patent Examination at the State Intellectual Property Office in China

9

2.1 Introduction ................................................................................................................. 9 2.2 Institutional and Theoretical Background ................................................................. 10 2.2.1 Intellectual Property Rights in the Global Economy .................................... 10 2.2.2 Intellectual Property Rights and Patent Law in China .................................. 12 2.2.3 The Patent Application and Examination Process at the SIPO .................... 14 2.2.4 Previous Studies ............................................................................................ 18 2.2.5 Determinants of Patent Examination Duration at the SIPO ......................... 20 2.3 Research Design and Data Description ..................................................................... 22 2.3.1 Data Sources ................................................................................................. 22 2.3.2 Variables ....................................................................................................... 23 2.3.3 Descriptive Statistics..................................................................................... 26 2.4 Survival Analysis....................................................................................................... 35 2.4.1 Model Specification ...................................................................................... 35 2.4.2 Results ........................................................................................................... 39 2.5 Conclusion ................................................................................................................. 44

3. The Relationship between Trade and Intellectual Property Rights in China

45

3.1 Introduction ............................................................................................................... 45 3.2 Institutional and Theoretical Background ................................................................. 47 3.2.1 The TRIPS Agreement.................................................................................. 47 3.2.2 Effects of Intellectual Property Rights on International Trade ..................... 48 3.2.3 Existing Empirical Evidence ........................................................................ 51 3.3 International Trade and Intellectual Property Rights in the People’s Republic of China ...................................................................................................... 54 3.3.1 China’s International Trade Flows ............................................................... 54 3.3.2 Intellectual Property Rights in China............................................................ 57

X 3.3.3

3.4

3.5

3.6

3.7

Hypothesis on Intellectual Property Rights and International Trade in China ......................................................................................................... 59 Modeling International Trade .................................................................................... 62 3.4.1 Ricardian Trade Model ................................................................................. 62 3.4.2 Factor Proportion Model ............................................................................... 63 3.4.3 Gravity Model ............................................................................................... 64 Research Design and Data Description ..................................................................... 66 3.5.1 Data Sources ................................................................................................. 66 3.5.2 Variables ....................................................................................................... 67 3.5.3 Descriptive Statistics..................................................................................... 69 Analysis and Results.................................................................................................. 78 3.6.1 Model Specification ...................................................................................... 78 3.6.2 Results ........................................................................................................... 82 Conclusion ................................................................................................................. 87

4. The Relationship between Foreign Direct Investments and Intellectual Property Rights in China

89

4.1 Introduction ............................................................................................................... 89 4.2 Theoretical Background ............................................................................................ 92 4.2.1 Economics of Foreign Direct Investments.................................................... 92 4.2.2 Foreign Direct Investments and Intellectual Property Rights ....................... 95 4.2.3 Previous Empirical Studies on Intellectual Property Rights and Foreign Direct Investments ......................................................................... 100 4.3 Foreign Direct Investments and Intellectual Property Rights in China ................... 104 4.3.1 Institutional Framework for Foreign Direct Investments in China............. 104 4.3.2 Previous Studies on Foreign Direct Investments in China ......................... 108 4.3.3 The Cases of Volkswagen and Bayer in China........................................... 110 4.3.4 Determinants of Intellectual Property Rights and Foreign Direct Investments in China .................................................................................. 117 4.4 Empirical Analysis .................................................................................................. 121 4.4.1 Data on German Companies in China ........................................................ 121 4.4.2 Variables ..................................................................................................... 127 4.4.3 Descriptive Statistics................................................................................... 130 4.4.4 Model Specification .................................................................................... 133 4.4.5 Results ......................................................................................................... 134 4.5 Conclusion ............................................................................................................... 138

5. Conclusion

141

Bibliography

147

Appendix

161

List of Figures Figure 2.1: Patent examination process at the SIPO from 2001 onwards. ............................... 16 Figure 2.2: SIPO patent applications and grants (1990-2004) ................................................. 27 Figure 2.3: Grant ratios according to applicant’s origin (all SIPO applications) ..................... 27 Figure 2.4: Probability density function of SIPO patent grant lags ......................................... 29 Figure 2.5: Visualization of the proportional hazard assumption ............................................ 37

Figure 3.1: Chinese import and export flows ........................................................................... 55 Figure 3.2: Value of manufacturing exports from OECD countries to China ......................... 69 Figure 3.3: Division of manufacturing exports across industries............................................. 70 Figure 3.4: Development of the Ginarte-Park index for the PRC ............................................ 73 Figure 3.5: SIPO patent grants of exporting countries across application years...................... 74 Figure 3.6: SIPO patent grants of exporting countries across industries ................................. 75

Figure 4.1: Net inflow of foreign direct investments to China .............................................. 104 Figure 4.2: Patent applications by Volkswagen in Germany and China ................................ 112 Figure 4.3: Patent applications by Volkswagen in Germany across technology classes .................................................................................................................. 112 Figure 4.4: Patent applications by Volkswagen in China across technology classes ............ 113 Figure 4.5: Patent applications by Bayer in Germany and China .......................................... 116 Figure 4.6: SIPO polymer patent applications by Bayer, BASF and Dow Chemical ............ 117 Figure 4.7: Distribution of German companies across Chinese provinces ............................ 122 Figure 4.8: Distribution of German companies across investment types ............................... 122 Figure 4.9: Distribution of German companies across industry sectors ................................ 123 Figure 4.10: Evaluation of business challenges of German companies in China .................. 125 Figure 4.11: German patent applications and grants at the SIPO and DPMA ....................... 125 Figure 4.12: SIPO patent grants across technology areas of German and non-German applicants........................................................................................ 126 Figure 4.13: Distribution of German company sample across Chinese provinces ................ 132 Figure 4.14: Distribution of German company sample across industries .............................. 132

Figure A.1: Probability density function of SIPO patent grant lags with EP equivalents ............................................................................................. 161 Figure A.2: Probability density function of SIPO patent grant lags with US equivalents............................................................................................. 161

XII Figure A.3: Distribution of new FDI projects across Chinese provinces in 2006 ................. 166 Figure A.4: Distribution of new FDI volume across origin countries in 2006 ...................... 166 Figure A.5: Distribution of new FDI projects across industry sectors in 2006 ...................... 167 Figure A.6: Distribution of new FDI projects across investment forms in 2006 ................... 167

List of Tables Table 2.1: Grant ratios and lags across technological areas (all SIPO applications 1990-2002) ........................................................................ 30 Table 2.2: Yearly patent indicators of all SIPO patent applications (1990-2002). .................. 32 Table 2.3: Yearly patent indicators of SIPO patent applications with EP equivalents (1990-2002) .......................................................................... 33 Table 2.4: Yearly patent indicators of SIPO patent applications with US equivalents (1990-2002).......................................................................... 34 Table 2.5: Estimation results for the Cox proportional hazard model ..................................... 42 Table 2.6: Estimation results for the accelerated failure time model with log-logistic distribution and exponentiated coefficients ........................................................... 43

Table 3.1: Statistics for the gravity model baseline variables. ................................................. 72 Table 3.2: Correlations of the gravity model baseline variables. ............................................. 77 Table 3.3: OLS regression results ............................................................................................ 85 Table 3.4: Poisson PML regression results .............................................................................. 86

Table 4.1: Descriptive statistics for German company sample .............................................. 132 Table 4.2: Clustered and robust OLS regression results excluding export shares ................. 136 Table 4.3: Clustered and robust OLS regression results including export shares .................. 137

Table A.1: Grant ratios and lags across technological areas (SIPO applications with EP equivalents 1990-2002). ......................................... 162 Table A.2: Grant ratios and lags across technological areas (SIPO applications with US equivalents 1990-2002).......................................... 163 Table A.3: Country coverage of OECD Bilateral Trade Database. ....................................... 164 Table A.4: International Standard Industrial Classification. .................................................. 165

List of Abbreviations Art.

Article

Bn.

Billion/s

Co.

Company

Corp.

Corporation

DOCDB

Documentation Database

DPMA

Deutsches Patent- und Markenamt (German Patent and Trade Mark Office)

ECLA

European Classification

eds.

Editors

EP

Europe

EPO

European Patent Office

et al.

Et alii (and others)

etc.

Et cetera (and so on)

EU

European Union

EUCCC

European Union Chamber of Commerce in China

EUR

Euro

e.g.

Exempli gratia (for example)

FDI

Foreign Direct Investment

FI

File Index

GATS

General Agreement on Trade in Services

GATT

General Agreement on Tariffs and Trade

GDP

Gross Domestic Product

HO

Heckscher-Ohlin Model

IMF

International Monetary Fund

Inc.

Incorporated

incl.

Including

INPADOCDB

International Patent Documentation Database

IP

Intellectual Property

IPC

International Patent Classification

IPR

Intellectual Property Right

ISIC

International Standard Industrial Classification

ITCS

International Trade by Commodity Statistics

JPO

Japan Patent Office

km

Kilometer

Ltd.

Limited

Max.

Maximum

Min.

Minimum

XVI Mio.

Million/s

MNE

Multinational Enterprise

NAFTA

North American Free Trade Agreement

No.

Number

NSF

National Science Foundation

N.E.C.

Not Elsewhere Classified

OECD

Organization for Economic Co-operation and Development

OEM

Original Equipment Manufacturer

OLI

Ownership Location Internalization

OLS

Ordinary Least Square

PATSTAT

Worldwide Statistical Patent Database

PCT

Patent Cooperation Treaty

PML

Pseudo-Maximum-Likelihood

pp.

Pages

PRC

People’s Republic of China

RMB

Renminbi Yuan

RTA

Revealed Technological Advantage

R&D

Research and Development

SEZ

Special Economic Zone

SIPO

State Intellectual Property Office

Std. Dev.

Standard Deviation

Tho.

Thousand/s

TRIPS

Agreement on Trade-Related Aspects of Intellectual Property Rights

UK

United Kingdom

UN

United Nations

UNCTAD

United Nations Conference on Trade and Development

UPOV

Union for the Protection of New Varieties of Plants

US

United States

USD

US Dollar

USPOC

United States Patent Office Classification

USPTO

United States Patent and Trademark Office

USTR

United States Trade Representative

Vol.

Volume

vs.

Versus

WDI

World Development Indicators

WFOE

Wholly Foreign-Owned Enterprise

WIPO

World Intellectual Property Organization

WTO

World Trade Organization

1. Introduction About 2000 years have elapsed since paper was first invented in the country that bears the ancient name of the Middle Kingdom. Other groundbreaking inventions that can be attributed to this region include printing, gunpowder and the compass, all developed in medieval times. These are the four great inventions that are often cited when emphasizing China’s leading role in science and technology in ancient times (Needham, 1981). However, the turbulent periods after the imperial dynasties and during the Mao era have adversely affected the climate of innovation in the People’s Republic of China (PRC). During the course of the Cultural Revolution, the basis for creative work was considerably narrowed and the educational system and research at universities had to undergo radical changes. Not until the late 1970s, when Deng Xiaoping recognized the importance of advanced technology for the industrial development and economic welfare of his country, did China open its borders to economic exchange with foreign countries (Lardy, 1992). Today, China exhibits significant economic growth rates and ranks in the top three nations, below only the United States (US) and Japan, in terms of economic performance. Over the years, the PRC has established relations with all major economies and since its accession to the World Trade Organization (WTO) in 2001 it has taken a leading role in the global economy. However, in addition to its distinct cultural roots, decades of communist ideology have left gaps between the PRC and many Western countries in terms of its economic, legal and political development and orientation. Thus, the promotion of technological progress and the protection of intellectual property have emerged as controversial topics in contemporary China. While the PRC had to cope with multiple conflicting political and economic regimes during the last century, most industrial countries have enacted sophisticated innovation systems in which laws for the protection of intellectual property play a central role. The basic idea behind the assignment of an exclusive property right to the creator of an invention in a certain country is to stimulate innovative activities that lead to economic growth. However, in a globalizing world, the focus on national interests and borders has become less meaningful, especially for immaterial assets such as intellectual property rights (IPRs). In 2007, for instance, 158,400 international applications were filed at the World Intellectual Property Office (WIPO) for patents that may become effective in up to 141 contracting states (WIPO, 2008). Many industrialized countries have therefore put pressure on emerging countries, such

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2_1, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

2 as the PRC and India, to establish national IPR systems and to respect the intellectual property of multinational enterprises (MNEs) that operate worldwide. In recent years, the Chinese central government has become more aware of the IPR-related concerns of its economic partners and has made an effort to set up a national innovation system. In addition to establishing the State Intellectual Property Office (SIPO) in 1980, the PRC joined the Patent Cooperation Treaty (PCT) in 1993 and agreed to the Trade-Related Aspects of Intellectual Property Rights (TRIPS) in the course of its WTO accession. From a purely legislative perspective, China today has enacted laws for the protection of all types of IPRs (Yang, 2003). However, the growing importance of innovations in this communist country is not driven only by foreign forces. The PRC itself has more than tripled its nominal Research and Development (R&D) expenditure since the turn of the new millennium, and the proportion of R&D spending in the Gross Domestic Product (GDP) has increased steadily.1 Even though these facts and figures seem to indicate an innovation-friendly environment, the PRC has emerged as one of the major countries harboring counterfeiting and piracy due to lax IPR enforcement. In 2007, 57.9% of all goods intercepted at the borders of the European Union (EU) for IP-related reasons originated from China.2 Similar figures can be found for other countries and regions. The US, for example, has repeatedly put China on its IPR priority watch list Section 301 (an annual review of the global state of IPR protection and enforcement across countries) (Bender, 2006). Moreover, in 2007, the US initiated a WTO dispute over deficiencies in China’s protection and enforcement of IPRs, which was joined by eleven other countries and the European Union. In 2009, the dispute settlement panel of the WTO found that the PRC violated basic international rules on intellectual property and recommended that China alter its IPR laws in compliance with the TRIPS agreement.3 The protection and enforcement of IPRs in China has therefore attracted the attention of several scientists, but many economic and legal studies only address the ultimate problem of IPR infringement. Moreover, the dearth of reliable sources of data on economic and intellectual property statistics has limited empirical research. Previous studies in the area of

1

See http://www.stats.gov.cn/eNgliSH/statisticaldata/yearlydata, latest visit on June 9th, 2009.

2

See http://ec.europa.eu/taxation_customs/resources/documents/customs/customs_controls/ counterfeit_piracy/statistics2007.pdf, latest visit on June 9th, 2009.

3

See http://www.wto.org/english/tratop_e/dispu_e/362r_e.pdf, latest visit on June 9th, 2009.

3 IPR protection in China have therefore mainly focused on the generic development of the IPR regime in the PRC and the overall legal changes and issues based on theoretical considerations and case studies (see Yang, 2003; Fai, 2005; Wang, 2004). However, the different types of IPRs in China – patents, trademarks, designs, etc. – cover distinct economic areas, are based on different laws and have various economic implications. Little research has been conducted that examines the detailed mechanisms and processes associated with the Chinese IPR system. Nevertheless, the PRC is increasingly attracting foreign enterprises, and in light of rapid technological progress, economists are confronted with more detailed questions about the Chinese IPR system. Furthermore, the surge in IPR applications in the PRC in recent years challenges authorities dealing with IPRs, including the SIPO in particular. While the strong growth in IPR applications at the SIPO in the 1990s was driven mainly by utility models, patent inventions also started to rise considerably beginning with the second amendment to China’s patent law in 2000 (Hu and Jefferson, 2009). The growth in patent invention applications is of special interest because patent inventions confer broader protection for technical inventions compared to utility models. Although Chinese patent law has developed continually since the 1990s, and even though the legal framework for patent protection is similar to that of other countries, little is known about the efficiency of the patent examination process at the SIPO and patent filing strategies (see Yang, 2008). Many questions concerning the determinants of the patent examination process, examination outcomes and examination time have so far remained unanswered. In addition, the economic implications of IPRs in emerging countries like China are also often discussed. While patent rights promise protection for technical inventions in China as well, the reality in the PRC is that IPRs often do not prevent rival firms from infringing on rights related to protected products and technology. In certain cases, patents may even encourage and enable individuals and firms to copy an invention based on a detailed description in published patent documents. It is therefore unclear if IPRs in China have the positive economic effect on international trade flows and foreign direct investment that is assumed in the theory. A rise in international trade with China in knowledge-intensive products and the increasing investment activities of technology-oriented MNEs suggest that the improved Chinese IPR system might have contributed to this development; however, the relevant empirical evidence is nonexistent.

4 Thus, this dissertation seeks to contribute to a better understanding of the Chinese intellectual property system and the economics of IPRs in the PRC. The three subsequent chapters of this book will use unique datasets to shed additional light on the patent examination process at the SIPO and the effects of IPRs on international trade flows and foreign direct investments (FDIs) in China, using advanced methods of multivariate analysis. The findings of the three studies provide evidence of the economic relevance of IPRs in the PRC and highlight recent procedural achievements by the SIPO in a comprehensive context. Aside from the focus on China, I believe that the outcome of my dissertation allows general insights into the economics of IPRs in emerging markets and beyond. The first part of my thesis, Chapter 2, starts with the analysis of the patent examination process at the SIPO. While copyrights automatically come into force at the creation of a work, patent inventions, trademarks and unique designs are subject to different examination and registration processes. In addition to certain legal requirements that have to be fulfilled, the creators have to explicitly apply for these IPRs to be entitled to defend their rights. In particular, the patent application process is a costly and time-consuming procedure, and the examination outcome is of an uncertain nature. Compared to other patent offices, such as the European Patent Office (EPO) or the United States Patent and Trademark Office (USPTO), application fees and annuities for IPRs in China are reasonable. However, in most cases, several years elapse before the patent office comes to a final decision on the granting or rejection of a patent. This period, commonly termed the grant lag, leaves applicants uncertain about whether the invention can be exploited exclusively and presents a risk to firms’ ability to recoup their R&D investments. Notwithstanding such obstacles, since the establishment of the SIPO in 1980, the annual number of applications for patents, utility models and designs has increased tremendously, while the examination time has been shortened. In addition to the developing economic and legal environment in the PRC and revised IPR laws, new emerging technologies have continually affected the framework for patent examination. Against this background, my study analyzes the determinants of the patent examination process at the SIPO by observing a comprehensive dataset of more than 400,000 SIPO patents and sets of equivalent EPO and USPTO patents for the period between 1990 and 2002. Two statistical methods, a Cox proportional hazard model and an accelerated failure time model, are applied to reveal the effects of patent characteristics, applicant behavior and procedural features on patent grant lags in China. The assumptions are thereby derived from the characteristics of the Chinese patent system and from similar previous studies for other patent

5 offices, such as Harhoff and Wagner (2009) for the EPO and Johnson and Popp (2003) for the USPTO. The findings suggest that SIPO patent families with international PCT filings and patents from foreign applicants require a longer examination time. The statistics furthermore reveal that more valuable patents (measured as the number of citations a patent receives from other patents) and more complex patents (measured as the number of IPC classes of a patent) have longer grant lags. A shorter examination time is found for patents in areas of high technological relevance for the PRC (measured as the revealed technological advantage index based on SIPO patent grants), for patents applied for by more active patent applicants and those who convey a stronger focus on China in their patent filings. While the first analysis of my thesis mainly deals with the legal and procedural dimensions of the Chinese IPR system, Chapter 3 addresses the economic relevance of IPRs for the PRC and its trading partners. As mentioned before, Western governments often pressure emerging countries to strengthen their IPRs to protect the R&D investments of their MNEs. However, IPRs, as exclusive property rights, entail different economic impacts in developed and developing countries. On the one hand, firms that invest in R&D are able to expand their market and generate additional demand for an innovative product if the relevant technology can be protected by IPRs. On the other hand, IPRs may prevent competitors from applying the protected subject matter of an invention, which may lead to greater market power for technology-oriented MNEs. This latter point is one of many reasons why emerging markets are often skeptical about tighter IPRs. A major concern is that IPRs slow down the technological and economic development of these countries compared to the more advanced industrialized economies. The effect of these exclusive rights on international trade flows, a crucial parameter in a globalizing world, is therefore often a point of discussion. The TRIPS agreement, as an international framework for IPR protection, aims at facilitating global trade as more and more products that are exchanged between markets contain technological inventions, have unique designs or carry distinctive brand names. Several economists have theoretically modeled the effects of stronger IPRs on trade flows between developed and developing countries (see Chin and Grossman, 1991; Helpman, 1993), but only a few studies have addressed this topic empirically (see Maskus and Penubarti, 1995; Smith, 1999). By combining trade statistics of the Organization for Economic Co-operation and Development (OECD) and SIPO patent data, this empirical study blazes a new path for disclosing trade-supporting and inhibiting factors of IPRs. The rapidly changing Chinese economy in recent years, along with the stepwise development of the IPR system in the PRC,

6 provides an ideal basis for research. For the period between 1990 and 2002, exports from 30 OECD countries to China in 18 industry classes are analyzed in a gravity model. Moreover, solutions to common statistical pitfalls and shortcomings of gravity models that have often been neglected in previous research are captured. While most studies in this area have found evidence for either a trade-supporting or a trade-inhibiting effect of IPRs on trade, this study empirically separates these two countervailing effects for the first time. The results support the thus far assumed coexistence of market expansion and market power effects. Furthermore, the findings reveal that the continuous economic development and the strengthening of IPRs in the PRC have contributed to intensified trade of OECD countries with China. The outcome of this analysis suggests that the concerns of both developed and developing countries about tighter IPRs in emerging markets are justified and should be respected in the event of disputes. The last empirical section of this book, Chapter 4, addresses another economic implication of IPRs, namely the influence of IPRs on the attraction of FDIs. In recent years, the PRC has emerged as one of the major recipients of FDIs. Investments by MNEs are an important vehicle for China to gain access to technology, know-how and capital, and also to create jobs and to generate tax revenues. At the same time, the PRC, as an emerging economy, is often targeted by MNEs in labor-intensive industries due to its low prevailing wages and the sales opportunities in its massive market, comprising more than a billion potential consumers. Nevertheless, the PRC’s distinct economic and legal environment and unique cultural identity often cause problems for MNEs that attempt to enter and operate in its market. There is a vast body of literature addressing market entry strategies, analyzing success factors of foreign invested companies and observing the determinants of investment decisions (see Caves, 2007). The relevance of technological assets and IPRs for the competitiveness of MNEs has also been discussed extensively and observed empirically on a macroeconomic level (see Dunning, 1988). However, empirical research on the relationship between IPRs and FDIs at the firm level is almost nonexistent. In this context, China possesses some interesting characteristics that qualify its market for a detailed analysis. In addition to the high imitative abilities in China, cases have been reported in which the market access and the investment behavior of MNEs were negatively affected by the preregistration of IPRs by Chinese competitors. In contrast, other examples show that investment projects conducted by foreign companies in the PRC were facilitated through technology transfer and by protecting their technology through IPRs.

7 My empirical analysis in this chapter investigates the effect of SIPO patent grants of German parent companies on the investment volumes of their respective Chinese subsidiaries. A sample of 127 German parent companies and 155 corresponding Chinese entities is analyzed by matching SIPO patent data with company information provided by the German Chamber of Industry & Commerce in Shanghai. The results show that the SIPO patent grants of the parent companies have a significant positive effect on the investment volume of the Chinese subsidiaries. Moreover, it turns out that the value of technology that is transferred to China by a German parent company influences the investment volume of the Chinese entities. Altogether, the outcome of this study suggests that investment decisions of MNEs in China are affected by the protection of their technology and that firms will be reluctant to transfer valuable technology if they see a risk of uncontrolled technology outflow and imitation. Chapter 5 consolidates my work across the theoretical considerations and empirical findings detailed in the previous sections. Furthermore, the discussion is enriched by additional insights into other crucial IPR-related topics, such as IPR infringement and technology spillover that were not the main focus of the three empirical chapters. In addition to a retrospective on three decades of IPR laws and technological progress in China, concluding remarks are presented for the current state of intellectual property protection in the PRC, and a final outlook is provided on the future development of this controversial issue in the Middle Kingdom.

2. Patent Examination at the State Intellectual Property Office in China 2.1 Introduction Since the proclamation of the Open Door Policy in the late 1970s, the PRC has made a strong effort to promote innovation and establish an intellectual property system. Regarding the protection of intellectual property, the SIPO plays a central role in assigning property rights for patent inventions, utility models and design patents. Especially in recent years, there has been a tremendous surge in patent applications at the SIPO. For instance, while it took 15 years for the SIPO to receive its first million filings, it took only an additional year and a half to jump from three to four million fillings.4 At the same time, the SIPO has managed to shorten the examination time considerably. These contrary trends indicate the challenges and achievements faced by the Chinese patent office in trying to process more patent applications in a shorter period of time. Previous studies have already addressed patent examination procedures at major patent offices. An early study by Kotabe (1992) based on aggregated patent data analyzed patent grant lags at the Japan Patent Office (JPO), while Johnson and Popp (2003) observed the examination process of the USPTO. Moreover, a recent paper by Harhoff and Wagner (2009) sheds additional light on the determinants of the patent examination duration at the EPO. However, emerging economies and their patent offices have rarely been a topic of scientific research; Yang (2008) made the first attempt to examine grant lags at the SIPO. Nevertheless, studies with aggregated data like those of Kotabe (1992) and Yang (2008) lack important insights into the patent characteristics that may influence examination time. Hence, this study tackles the issue by using a unique dataset to analyze the patent examination process and its determinants at the SIPO. Certain patent characteristics that have not been analyzed in previous scientific research on SIPO, such as citation measures, are incorporated in this study.

4

See http://www.sipo.gov.cn/sipo_English/news/official/200904/t20090417_454008.html, latest visit on July 10th, 2009.

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2_2, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

10 The results suggest that the examination process follows a routine similar to those of other major patent offices, but does indicate some findings specific to the Chinese patent system. These differences can be found, for instance, for patents in areas of high technological relevance for the PRC. The remainder of this study begins with a theoretical and institutional background of the Chinese intellectual property system in Chapter 2.2. Here, assumptions are derived based on Chinese patent law, the stipulated patent examination process and previous studies in this area. The research design, model specification and corresponding descriptive statistics are discussed in Chapter 2.3. Chapter 2.4 presents the results of the multivariate analysis before the findings are summarized in Chapter 2.5.

2.2 Institutional and Theoretical Background 2.2.1 Intellectual Property Rights in the Global Economy Intellectual property rights are commonly seen as legal devices to promote innovative and creative work. Arrow (1962) demonstrated that there are different incentives for investing in R&D for a monopolist, a social planner and for companies in perfect competition if certain returns for R&D efforts can be anticipated. Based on this, different welfare implications can be derived. Depending on the inventive step of an innovation, the incentive for a monopolist to invest in R&D and to keep his exclusive position by IPRs might be higher or lower compared to a new firm entering the market. Also, patent race models show how market structure affects R&D spending and returns (see Loury, 1979; Lee and Wilde, 1980; Dasgupta and Stiglitz, 1980). The theory on patent races demonstrates that excessive and redundant R&D investments can be a result of firms competing for an innovation where only the winner of the race is awarded a patent. As politics intends to balance the welfare loss constituted by exclusive intellectual property rights with the benefits of technological progress, it is important to define an optimal length for the protection of IPRs. Within this context, Nordhaus (1969) modeled the optimal duration for patent rights. With an optimal patent life of 17 years, his results are close to the protection term of 20 years bestowed by most of the patent laws of modern economies. Beyond these studies about the benefit and design of IPRs, scientists like Machlup (1962) doubt the positive economic impact. In his analysis of the patent system, he challenged the theory that patents contribute to the dissemination of knowledge. He rather believes that inventions probably are patented only when the inventor

11 fears that competitors would independently come upon the same idea during the term of patent protection. Furthermore, Machlup questioned the positive impact of a patent system on the national income of a country. Even though patents provide incentives to invest in R&D, the majority of inventors are employed by big corporations. In addition to R&D investments, the earnings from patented products may therefore also be transferred to stock holders or lead to increasing wage levels of R&D personal without stimulating additional innovative activities. Based on this scientific foundation and economic experience, most countries have established national laws and joined international agreements for the protection of IPRs. For example, 189 nations are organized within the World Intellectual Property Organization, and 141 countries adhere to the Patent Cooperation Treaty (PCT). The prevalence of these memberships emphasizes the importance of IPRs in the global economy since most of the world belongs to the most important organization and/or subscribes to the most important treaty regarding IPRs. However, the differences between nations, economic systems and jurisdictions lead to complex problems – even for IPRs. As a result, organizations and agreements like WIPO and TRIPS appeared to coordinate the protection of IPRs on a global basis, which is of major importance for multinational enterprises. Against the background of a globalizing world, it is crucial for international firms to plan their business on a predictable basis. As countries such as China and India play an increasingly important role in the global economy, the need for IPRs to be harmonized rises. Maskus and Penubarti (1995) and Smith (1999) have shown that stronger IPRs have a positive impact on international trade. According to Saggi (2000) and Branstetter et al. (2007), foreign direct investments are affected by IPRs as well. As China advances to become one of the most important trade partners for all major economies and one of the largest receivers of FDIs in the world, the relationships between IPRs, trade and FDIs are of fundamental importance for the Chinese economy. From a Chinese perspective, IPRs will play a vital role when developing an innovation system as discussed by Maskus et al. (2005).

12

2.2.2 Intellectual Property Rights and Patent Law in China As outlined before, IPRs are an important legal part of all industrialized economies. China, as an emerging market, has established a comprehensive IPR system in recent years. In 1980, the PRC joined the WIPO and consequently paved the way for an IPR system in the post-Mao era. Since 1985, the PRC has been a part of the Paris Convention for the Protection of Industrial Property and they signed the Patent Cooperation Treaty in 1993. In joining the WTO, China reached another important milestone and must now adhere to the TRIPS agreement. Today, the PRC has implemented laws for all relevant IPRs (Yang and Clarke, 2005). However, many Western countries are still skeptical about IPRs in China, mostly as a result of concerns about enforcement rather than legality, but with regard to the legal framework, Chinese IPR laws are comparable to those of other industrialized countries (Bosworth and Yang, 2000). Different institutions within the PRC are responsible for dealing with IPRs and the corresponding laws. The National People’s Congress5 and its Standing Committee6 act as the legislative authorities, enacting all national laws. The State Intellectual Property Office,7 which is directly subordinate to the State Council, the Trademark Office under the State Administration for Industry and Commerce and the State Copyright Administration, takes on an executive role within the IPR system. All IPRs are filed at branches such as the Patent Office of the SIPO. These offices are responsible for the acceptance, examination and publication of all IPR related documents. Concerning IPR-related disputes, the PRC has established a system of people’s courts that enforce IPR laws. This tiered system is divided into the Supreme, Higher, Intermediate and Basic People’s Courts. At the Intermediate People’s Court level and above, there are specialized divisions for IPR disputes (Wang, 2004).

5

The National People’s Congress is the highest state body and main legislative house in the PRC. It consists of about 3,000 delegates and meets once a year for about two weeks.

6

Because the National Congress convenes only once a year, the Standing Committee takes the leading legislative role between the plenary sessions. It is provided with comprehensive power to enact and amend basic laws and to amend as well as supervise the enforcement of the constitution.

7

After strong recruitment efforts in recent years, the SIPO reached a size comparable to that of the EPO, with around 3,000 examiners. However, with almost 700,000 applications across three kinds of patents (including almost 250,000 patent inventions), the SIPO far exceeds the number of applications processed at the EPO.

13 Behind these institutions and authorities, the IPR laws build the legal backbone of the Chinese intellectual property system. Keeping the focus on patent inventions, a closer look will be taken at the Chinese patent law that was enacted by the Standing Committee of the sixth National Congress in 1984. This law went into force in 1985 and was amended twice, in 1992 and 2000. A third revision is currently in progress and will be completed in the near future. In Art. 2 of the Implementing Regulations of the Patent Law of the People’s Republic of China, an invention is defined as “any new technical solution relating to a product, a process, or improvement thereof.”8 According to the patent law, patents can be granted to inventions that fulfill the basic requirements of Art. 22: novelty, inventiveness and practical applicability. With the exception of some minor differences, these standards are comparable to the regulations of the USPTO and the EPO.9 For the SIPO, novelty means, that before the date of filing, no identical invention or utility model has been publicly disclosed in the PRC or in any other country.10 When examining the novelty of an application, examiners have to follow the principle of individual comparison. This means each document of prior reference is compared with the technical solution of the invention under review. Although the novelty standards are quite strict, Chinese patent law allows a grace period of six month for certain inventions. In the case of two or more applications on the same subject matter by different applicants, the patent should be granted to the first applicant; this is commonly known as the first-to-file principle. The requirement of inventiveness applies to an invention if it has prominent substantive features and represents a notable progress, compared with the technology existing before the date of filing. In order to prove this criterion, a mosaic of all relevant prior solutions is compared to the technical solution of the current application. The legal wording distinguishes patent inventions from utility models, which need only to show substantive features and to reveal progress. According to the jurisprudence of the Beijing Higher People’s Court, an invention is attributed prominent substantive features if it produces an essential technical breakthrough by leading to prominent and essential changes in the relevant field of

8

References to Chinese patent law were taken from the SIPO website; see http://www.sipo.gov.cn/sipo_English/laws/lawsregulations/200804/t20080416_380327.html, latest visit on September 5th, 2009.

9

The EPO grants patents to inventions provided that they are new, involve an inventive step and are susceptible to industrial application. The USPTO allows patent protection for inventions that are new and useful.

10

The standards of novelty are part of the current revision of the patent law.

14 technology. Notable progress is interpreted as either a great leap forward that overcomes shortcomings of the existing technology or a noticeable technical success (Ganea and Pattloch, 2005). The third condition – practical applicability – requires that inventions can be made or used and can produce effective results. “Made or used” refers to the commercial production or utilization of an invention. An invention is not seen as practically applicable if it is nonreproducible, if it violates the laws of nature or if unique natural conditions are necessary. The requirement of producing effective results aims to exclude inventions with no utility or with a utility that differs from society’s needs. As in other countries, Chinese patent law defines areas of non-patentable subject matters. Thus, patent rights shall not be granted to (1) scientific discoveries, (2) rules and methods for mental activities, (3) methods for the diagnosis or for the treatment of diseases, (4) animal and plant varieties, (5) substances obtained by means of nuclear transformation. In general, the law prohibits patents for inventions that are contrary to the laws of the state or social morality or that are detrimental to public interest. If an invention conforms to all of these requirements and exceptions, protection for the claimed subject matter can be granted for up to 20 years.11 The property right entitles the applicant to prevent other entities or individuals from exploiting the patented invention; that is, others are not permitted to make, use, offer to sell, sell or import the patented product, the patented process or a product directly obtained from the patented process. According to these legal provisions, Chinese patent law is strongly aligned with the regulations stated in the TRIPS agreement.12

2.2.3 The Patent Application and Examination Process at the SIPO Various regulations are relevant for the application and examination procedure at the SIPO. According to Art. 3 (National Treatment) and Art. 4 (Most-Favored-Nation Treatment) of TRIPS, as well as Art. 18 of the Chinese patent law, applications from foreign and domestic applicants should be treated equally. However, under current law, a differentiation is made

11

The term of protection was extended from 15 to 20 years by an amendment to the patent law in 1992.

12

When the Chinese IPR system was developed, the PRC adopted many areas of existing foreign IPR laws. The utility model law, for example, is based on the German law and parts of the guidelines for the examination of patents are very similar to the guidelines of the EPO (Ganea and Pattloch, 2005).

15 depending on the origin of the applicant. A foreign applicant without a residence or business office in China must appoint a patent agency designated by the patent administration department under the State Council to act as his or its agent. In contrast, a Chinese entity or individual can appoint any patent agency to act as its agent. However, Art. 20 limits the procedural rights of domestic applicants. If a Chinese entity or individual intends to file an application in a foreign country for a patent invention made in China, it must first file a domestic application for a patent at the SIPO and appoint a patent agency designated by the patent administration to act as its agent.13 In addition to these specific rules, there is only one institution that processes all of the patent applications in China. As determined in Art. 3 of the Chinese patent law, the patent administration department under the State Council is responsible for the patent work throughout the country. It receives and examines patent applications and grants patent rights for inventions in accordance with law. There are three major ways to file a patent at the SIPO. The most direct way is to file the patent as a Chinese priority. As stated before, a Chinese priority is mandatory for inventions made in the PRC by Chinese individuals and entities. Because China adheres to the Paris Convention for the Protection of Intellectual Property, a second filing option is to extend a foreign priority application with a subsequent SIPO application. There also exists a third option, based on the PCT treaty. An applicant may file an international PCT application at any of the defined receiving offices. This allows the applicant to delay the decision as to which jurisdiction he is seeking patent protection for up to 30 months. In 2006, 48,211 PCT applications entered the national phase at the SIPO. This accounts for 22.9% of the 210,490 patent inventions filed at the SIPO this year.14 After an application is lodged at the SIPO, the examination procedure runs as shown in Figure 2.1. The date when the Patent Administration Department under the Sate Council receives an application begins the twelve-month priority period. The application has to contain a request, a description, an abstract and the claims supplemented by potential drawings comparable to documents at other patent offices. Each application for a patent is limited to one invention. The basic application fee of Renminbi Yuan (RMB) 950 is

13

Art. 19 and Art. 20 of the Chinese patent law are part of the patent law revision started in 2006. The mentioned restrictions for foreign and domestic applicants will probably be abolished.

14

Some applicants combine the legal opportunities of the patent and utility model law by first applying for a utility model, then filing a patent application for the same invention at a later stage.

16 comparable to the online filing fee of EUR 100 at the EPO.15 The applicant may amend his application during the examination process as long as the amendments are within the scope of the initially submitted documents. As long as the patent has not been granted, the applicant may also withdraw the application. If the invention fulfills the basic formality requirements, it will be classified (the SIPO uses the internationally common International Patent Classification (IPC)). Eighteen months after the date the application was received, the invention will be published; however, the publication may take place earlier at the applicant’s request.

Application Formality Check Classification Laid-open Publication Request for Examination

No Request for Examination

Examination

Withdrawal of Application

Decision to Grant Patent

Notification of Pending Refusal

Publication of Granted Patent

Decision of Refusal

Invalidation Request

Appeal to Re-Examination Board

Invalidation Decision to Revoke

Decision to Maintain

Judicial Appeal

Judicial Appeal

Figure 2.1: Patent examination process at the SIPO from 2001 onwards.16

15

Along with the office fees, applicants also have to pay attorney fees; this must be kept in mind when considering the total cost benefit ratio.

16

According to Yasong and Connor (2008) and EPO: http://www.epo.org/patents/patent-information/eastasian/helpdesk/china/grant.html, latest visit on December 19th, 2008. In addition to the described examination path, applicants may withdraw their application any time before a patent is granted.

17 Within three years of the date of application, the applicant may request a substantive examination of the filed patent invention. If the applicant fails to do so, the application is deemed to have been withdrawn. At RMB 2,500, the fee for filing a substantive examination is cheaper than a comparable filing (EUR 1,405) at the EPO. The examination is carried out in compliance with the Guidelines of Examination of the SIPO, which are based on the Chinese patent law outlined previously. The guidelines are a comprehensive body of regulations comprising more than 600 pages. If the examination finds that the patent invention, as described in the application, is not in line with Chinese patent law, the SIPO has to notify the applicant. The applicant will then have the chance – within a certain time limit – to amend the application and correct the defects that led to the preliminary decision. If the examiners still judge the amended application to be not in conformity with the law, it will be rejected. In contrast, all applications that meet the legal requirements of patentability will be granted. For successful inventions, the SIPO issues the patent certificate and registers and publishes the granted patent. If the application is not rejected or invalidated, the patent right will be effective for up to 20 years as long as the applicant pays the annuities. These renewal fees increase over time, from RMB 900 in the first 3 years to RMB 8,000 during the 16th year.17 In the case of a refused application, the applicant may request a re-examination by the SIPO Patent ReExamination Board or directly file a judicial appeal within a certain time limit. Aside from challenging the rejected application, the applicant may also initiate an administrative reconsideration for details (e.g., the application date). Furthermore, the first administrative or judicial decision can be appealed again because the Chinese court system always permits at least two instances of appeal. Once a patent is granted, Chinese patent law allows any party to ask the SIPO Patent Re-Examination Board to invalidate the patent. The Re-Examination Board has the option to maintain the patent as granted, revoke the patent or maintain the patent in an amended form. If the person who requested the invalidation or the patent holder is not satisfied with the decision of the Re-Examination Board to maintain or invalidate the patent in dispute, another judicial proceeding can be initiated.18

17

The annuities at the SIPO are lower compared to the EPO. However, the SIPO fees are increasing more steeply up to the 16th year whereas at the EPO the fees only increase up to the 10th year.

18

Yasong and Connor (2008) provide a detailed analysis of the judicial protection of patents in China.

18

2.2.4 Previous Studies For an applicant seeking patent protection for a certain invention, there are some major economic parameters of interest. Aside from the time and costs associated with the examination process, whether or not the patent is granted within the intended scope is probably the most important factor. Many studies have addressed some of these points with regard to patent offices in the US, Europe and Japan. For example, Cornelli and Schankerman (1999) analyzed the patent lives and fees in France, Germany and the United Kingdom and derived welfare implications. While they do not state any concrete patent policy recommendations, they conclude that the patent length under certain conditions could even go beyond the maximum of 20 years and that renewal fees should increase more abruptly. Considering the applicant’s perspective, Harhoff and Reitzig (2001) pointed out different patent filing strategies. They demonstrated how applicants should anticipate the expected profits of a granted patent and the costs for obtaining and maintaining the rights to the patent. They describe how the application process can be accelerated, how to make use of PCT applications to extend the priority period, and when to file an EPO patent to leverage synergies and save application fees. Furthermore, their qualitative study examined the relationship between patent scope and the risk of receiving a rejection. With regard to patent examination duration, Popp et al. (2003) analyzed patent data from the USPTO between 1976 and 1996.19 Their findings showed major differences in examination time between technology areas. They found that applicant characteristics (e.g., whether the patent is filed by an independent inventor or a non-profit organization) and applicant origin were not major contributors to lags in patent approval. With regard to differences across application years, Popp et al. (2003) emphasized the impact of the availability of resources and examiners for the pendency times. Due to the highly skewed examination time within this data, more detailed results are provided by quantile regressions. According to these outcomes, government patents are generally processed faster, but the grant lags for 5% of government patents were much longer; Popp et al. (2003) assume this is a result of submarine patents that were kept secret due to national security interests. However,

19

Until March 29th 2000, the USPTO only published granted patents. Based on the American Inventors Protection Act of 1999, this rule was abolished, and pending applications were published after 18 months.

19 the study does have some limitation in that it considered only five very broad technology areas and the relationship between the importance of patents and the examination time was misinterpreted as discussed below. Using data on US patents for genetically modified crops from 1983 to 1999, Regibeau and Rockett (2003) conducted a similar study, observing the relationship between the importance of an invention and examination time. As a result, a basic model for the patent approval process was developed based on the assumption that patent offices were able to make more correct decisions on the patentability of inventions over a technology circle. Uncertainty about patentability falls over time while knowledge about technology within an industry rises. This means that – from an examiner’s perspective – as the scientific uncertainty about inventions in a technology area gradually decreases, the precision of the patent examiner’s decision increases. By controlling for the importance of different inventions, the empirical results show that, on the one hand, the length of the examination process decreases as the industry advances from the beginning of a new innovation cycle to a more mature phase. On the other hand, by controlling for the phase of an industry cycle and the corresponding scientific uncertainty, grant delays decrease when the importance of useful innovations increases. The duration of patent examination at the European Patent Office between 1982 and 1998 is observed by Harhoff and Wagner (2009). Compared to previous papers, this study covers more influential factors, such as examiner workload, and the results are presented across different examination outcomes. Due to continuously rising applications, increasing examiner workloads at the EPO in recent years have had a negative impact on grant lags. The complexity and value of patents are factors that further delay the examination decision. Features such as specific requests for accelerated research reveal no clear impact on the outcome of examinations by the EPO. Granted patents are examined faster by this request, while withdrawn and refused patents are not. An early study by Kotabe (1992) addressed two issues – grant lags and examination outcomes – by comparing the US and Japanese patent system. In comparing examination times, this study applied a lagged regression analysis. However, this statistical method is quite skewed as it computes data on an aggregated level by comparing the fit of models across different grant lags. During the period from 1963 to 1988, the Japan Patent Office had shorter pendency periods for applications of domestic applicants, whereas at the USPTO, domestic

20 applicants showed higher grant ratios. Kotabe (1992) interprets the differences in grant ratios and grant lags of domestic and foreign applicants as discrimination at the patent offices. Although the theoretic foundation for the discrimination hypotheses might have been given and is well described, the conclusions of this research are probably biased. There are multiple factors that might cause such variations in examination times and outcomes.20 Jensen et al. (2006) revived this discrimination argument by arguing that there is disharmony across patent offices. They compared examination outcomes between 1990 and 1995 for three major patent offices – the USPTO, the EPO and the JPO. The descriptive statistics showed that for patents within a patent family, decisions across the three patent offices can be quite distinct. For patents that were granted in the US, the EPO comes to an equal decision in 72.5% of the cases, whereas the JPO granted only 44.6% of the equivalent patents. Overall, only 37.7% of all granted US patents obtained the same status from both the EPO and the JPO. Even though Jensen et al.’s (2006) discrimination argument finds little support (see Katznelson, 2007), these results show how different the jurisprudence can be across patent offices.

2.2.5 Determinants of Patent Examination Duration at the SIPO Only a few empirical studies have researched intellectual property rights in China. One reason for this is the comparably young IPR system. In addition, dramatic changes in Chinese patent law quickly make findings outdated, and the availability and quality of useful data are an issue. With regard to examination outcomes, Bosworth and Yang (2000) provide some initial ideas and insights. Based on the fact that patent grants for foreign applicants exceed those of domestic applicants, the authors hypothesize that non-resident applications must be of higher quality. However, with aggregated data, such a conclusion is hard to prove. Since domestic applicants must file all of their priority applications in China and foreign applicants do not apply for all of their inventions in the PRC, two different groups of patents are compared. The empirical part of this study will address this issue. When controlling for different groups of applicants, it is assumed that in China, more valuable patents and more complex inventions have longer grant lags as shown by Harhoff and Wagner (2009).

20

A similar study for China was conducted by Yang (2008) using the same imperfect methodology.

21 Other applicant characteristics might impact examination time as well. For instance, Schneider (2007) considered the depreciated stock of applicant filings in his study, while Harhoff and Wagner (2009) incorporated the yearly number of patent applications per applicant as measures of patent activity and applicant size. In China, market entrants often lack market-specific knowledge, which is sometimes the reason for poor performance. Therefore, a new aspect will be tested in this study that measures the China focus of an applicant regarding patent applications. Applicants who seek patent protection in China for a higher share of their global patent portfolio are expected to have advantages in the examination process because of their knowledge about the patent examination procedure at the SIPO. Because negotiations between the patent office and the applicant also take place at the SIPO, these factors should shorten the examination time. Against the background of the described patent law, Fai (2005) pointed out that examination outcomes for some patents may have been incorrect from a legal standpoint in the early days of the Chinese IPR system. Examiners who lacked experience regarding patent search and examination requirements were considered the source of such errors. Consequently, patents were granted in the past that did not fulfill the requirements of novelty, inventiveness or practical applicability. According to the annual reports of the SIPO, the examination time for patents has decreased over the years as well. In 2003, the examination of a patent took an average of 30 months and was gradually shortened to 22 months in 2006. The following analysis will therefore include time dummies to account for these effects. Differences across technology areas are additional factors that can influence the examination process, as discussed by Regibeau and Rockett (2003). Based on the US data of Johnson and Popp (2003), medical care and biochemistry patents, for example, are processed much slower than patents within the area of engineering and physics. Industries in China are in different development stages and are more or less supported by a governmental plan. Hence, distinct grant ratios and examination times should also be observable at the SIPO. In addition to general industry characteristics, I assume that patents in technology areas that are of special interest to the Chinese economy will be processed more quickly.21

21

The Catalogue for the Guidance of Foreign Investment Industries is one example of the distinct treatment of industries in China. It classifies industries in three categories: encouraged, permitted, restricted and prohibited.

22

2.3 Research Design and Data Description 2.3.1 Data Sources There are only a few sources of reliable Chinese patent data. The Chinese Patent Abstract Database,22 the Experimental Platform of Patent Information Services,23 the Chinese Patent Search System24 and the SIPO Patent Search25 are probably the most important online search options. Bartkowski et al. (2008) highlighted that the number of Chinese patents and utility models and the available information within the databases are often not consistent. This empirical study is based on the International Patent Documentation Database INPADOCDB26 and the corresponding Documentation Database DOCDB, as it contains more Chinese patent documents than, for example, the Derwent World Patent Index. The EPO, as initiator and promoter of INPADOCDB, provides extensive patent information for patent examination as well as scientific purposes. On behalf of the OECD Taskforce for Patent Statistics, the EPO Worldwide Patent Statistical Database – often addressed by its abbreviation, PATSTAT – was developed to assist statistical research on patent information. The dataset used for this study contains information for patent families based on the April 2008 version of PATSTAT. Of the 705,092 patent applications at the SIPO between 1990 and 2004, three groups of patent families were extracted and analyzed. In addition to a reference group of 443,533 SIPO patents between 1990 and 2002, two further groups contain SIPO patent applications with equivalent patents at the USPTO and the EPO.27 The limitations of the two subgroups assure a minimum level of patentability to confront the claim of low quality in patents in China and provide additional patent characteristics like citation measures, which are not reported for SIPO patents within PATSTAT or other databases. The group of USPTO equivalents comprises 190,429 patent families, the EPO group comprises 188,388 observations.

22

See http://search.cnpat.com.cn/Search/EN/, latest visit on December 5th, 2008.

23

See http://pub.cnipr.com/enpubpisfts/common/page.do?method=cnSearch, latest visit on December 5th, 2008.

24

See http://ww2.pat-list.jp/CNEWEB/, latest visit on December 5th, 2008.

25

See http://ensearch.sipo.gov.cn/sipoensearch/search/tabSearch.do?method=init, latest visit on December 5th, 2008.

26

INPADOCDB is the latest database of EPO based on former versions of INPADOC databases and DOCDB.

27

The shortening of the observed period was necessary due to the right-hand truncation of patent grants in China (see Figure 2.2).

23

2.3.2 Variables In the following section, the variables used within the empirical analysis are briefly described. Grant lag. Only a few sources provide information on the legal status of SIPO patent applications. The Experimental Platform of Patent Information Services contains legal status information, but only for a test dataset. Therefore, the grant decision and date were derived from the kind code information within PATSTAT. Due to the simple system of document types at the SIPO,28 this approach allows us to compute the grant lags on a reliable basis.29 Thus, the duration between the application date and the publication date of a granted patent was taken as the examination time (GRANT_LAG). Family size. According to the Paris Convention for the Protection of Industrial Property, applicants can use their priority applications to file a patent for their inventions in other countries as well. This means an applicant may apply for a patent right in other contracting states and the invention will be treated as if it had been filed on the same day as the priority application. The family size (FAM_SIZE) of a patent represents the number of states in which an application for an invention was filed. For the two subgroups of SIPO patent applications with equivalents in the US or at the EPO, the minimum family size is greater than two. Harhoff et al. (2003) pointed out that family size is one indicator of the monetary value of patent rights. PCT application. The number of PCT filings (international patent applications at the WIPO) has increased steadily in recent years and a certain share of applicants chooses this procedural way to apply for a patent at the SIPO. Therefore, a dummy variable (PCT_APPL) is used to indicate whether the patent family contained an international patent application. The Harhoff and Wagner (2009) study disclosed that grant lags for patents with PCT applications are significantly longer than those for non-PCT applications. 28

The SIPO classifies patent documents as Unexamined Patent Publication (A – GǀngkƗi), Examined Patent Publication before 1993 (B – ShČndìng Gǀnggào) and Granted Patent Publication since 1993 (C – Shòuquán Gǀnggào).

29

Compared to other studies like Harhoff and Wagner (2009), this paper lacks advanced information on the legal status of Chinese patents. A differentiation between granted, withdrawn, rejected or pending applications cannot be covered. Due to the fact that the dataset was narrowed down to applications from 1990 to 2002 because of the truncation of granted patents after 2002, the share of pending patents should be negligible. Thus, the datasets should only contain applications that reached a final decision (granted vs. not granted).

24 Number of International Patent Classification (IPC) assignments. There are several classification systems that assign patents to different technological areas. The IPC classification is the most common internationally and is used by the SIPO as well.30 It is divided into eight sections and more than 70,000 subdivisions, which are specified by an alphanumeric 9-digit code in its eighth and most recent edition. Lerner (1994) applied the total number of IPC subclasses (the first 4 digits of the IPC classification, e.g., A21B Bakers’ ovens; Machines or equipment for baking) as a proxy for the breadth of patent protection. The study revealed that the patent scope is of higher value if a patent is classified by more IPC classes (IPC_TOT), as theoretically discussed by Klemperer (1990). This study will also use the 4-digit IPC subclasses as a measure of patent scope and complexity. Backward patent literature citations. When examining a patent application, the SIPO has to judge the inventiveness and novelty of an invention. Therefore, other patents and documents are researched to evaluate the state of the invention on the day of application. Such citations of other documents are listed in the patent application. According to Lanjouw and Schankerman (2001), a small number of backward citations may indicate that the invention is in a relatively new technology area. At the SIPO, applications with more backward patent literature citations (BWD_PL_CIT) should be easier to examine and consequently show shorter grant lags. In practice, however, a larger number of backward citations requires often more time for the examiners to read and review all the documents (Popp et al., 2003). Backward non-patent literature citations. Examiners may also refer to non-patent literature like scientific papers or publications to define the state of the art for an invention. Backward non-patent literature citations (BWD_NPL_CIT) are computed the same way as patent literature citations. Previous literature provides different explanations as to what non-patent literature citations imply regarding an invention. Besides the often-quoted link to basic scientific research, Schmoch (1993) listed further reasons why patents may refer to non-patent literature documents such as publications describing inventions that typically fall in the area of non-patentable subject matters.31 Moreover, Michel and Bettels (2001) emphasize that for

30

The USPTO, EPO and JPO also categorize patents by other classification systems. The USPOC (United States Patent Office Classification) is a system at the USPTO whereas the ECLA (European Classification) and FI (File Index) are adaptations of the IPC system used at the EPO and the JPO.

31

Schmoch (1993) brings forward the following reasons for non-patent literature citations: (1) the previous state of the art in science and technology is not yet documented in the format of patents, (2) the technology field develops so fast that only non-patent literature is available, (3) the cited document was published because it was not seen to be important enough for a patent application, (4) the cited invention is of a non-

25 one patent family, the amount of non-patent literature citations at the USPTO is, on average, considerably higher than at the EPO. Forward citations. Along with information on backward patent and non-patent literature citations, it is of interest how often a patent is cited by other patents. More frequently cited patents embody inventions of greater importance for the development of a technological area – similar to quotations across scientific publications. Trajtenberg (1990), for example, demonstrated the relation between forward citations and the value of an invention. Since early applications have the opportunity to be cited more often, the number of EPO and USPTO forward citations in this study (FWD_CIT) is limited to quotations made within five years of the application date.32 Global annual patent applications per applicant. Knowledge and economies of scale also apply to patent activities. Big companies may have more knowledge about patenting and may choose to employ special IP departments. On the other hand, small firms may consider a patent application more thoroughly. Similar to Harhoff and Wagner’s (2009) research, the number of global patent applications per applicant is computed on an annual basis. It can be assumed that the marginal learning effect of additional patent applications per year is a decreasing function. For instance, companies that already file many patents in a year may not gain additional knowledge regarding patent processes from a few more applications. Therefore, the number of global annual patent applications per applicant is taken in log form (PAT_YEAR_LN). Annual China focus per applicant. The technological China focus per applicant is the number of patent applications filed in a certain year in China as a share of all patent applications filed within the same year. The variable is computed by dividing the annual number of SIPO patent applications by the annual number of global patent applications by the same applicant. As most studies on grant lags concentrate on the major three patent offices, this variable is a new feature to measure the patenting focus of applicants regarding a not so prominent patent office like the SIPO. A higher technological China focus for an applicant should lead to a shorter grant lag. The ability to exchange documents with SIPO examiners in the Chinese language by a local IP department is one reason for this hypothesis.

patentable subject matter, (5) a citation is made to abstract services based on patents, and (6) a citation is made to very simple facts which are below the threshold of the required inventiveness. 32

All citation measures were separately computed and provided by Prof. Dietmar Harhoff, Ph.D.

26 Revealed technological advantage. Technological areas are of varying importance for the Chinese economy. Some technological areas in China are still in development, whereas other industries are already on a technological level comparable to other industrialized countries. As mentioned before, the Chinese government tries to push certain areas, while others are not within the scope of the government’s plan. It can be assumed that the promotion of technology via the Chinese patent office is also affected by this fact. To measure the importance and development stage of an industry in China, the revealed technological advantage (RTA_CN) index is computed according to Soete and Wyatt (1983):33

RTA _ CN it

PAT _ CN it ¦ PAT _ CN it i

PATit ¦ PATit

(1)

i

where RTA_ CNit represents the revealed technological advantage index of China in technology area i in year t based on SIPO patent grants. The number of SIPO patent grants is represented by PAT _ CN it for Chinese applicants in technology area i in year t and by PATit for all SIPO patent grants.

2.3.3 Descriptive Statistics Before providing results for the survival analysis of grant lags at the SIPO, the descriptive statistics will be presented. For brevity, the statistics will mainly refer to the reference dataset of all SIPO patents between 1990 and 2002. Nevertheless, differences in the USPTO and EPO subgroups will be highlighted and explained. As shown in Figure 2.2, the number of patent applications and grants increased steadily in recent years. The periods when the Chinese IPR system was amended and modified can be easily identified. Applications rose considerably after 1992 (when the patent law was amended the first time) and after 2001 (when China joined the WTO). More details on the ratios between applications and grants are displayed in Figure 2.3.

33

There are several comparable indexes that measure the strength of a country across industries or technological areas. The revealed comparative advantage index, for example, is calculated based on the volume of commodities or exports.

27 Patent Applications

Granted Patents

100,000

50,000

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Application Year

Figure 2.2: SIPO patent applications and grants (1990-2004).

US

DE

KR

JP

CN

100%

80%

Grant Ratio

No. of Patent Applications / Grants

150,000

60%

40%

20%

0% 1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Applica tion Year

Figure 2.3: Grant ratios according to applicant’s origin (all SIPO applications).

28 Between 1990 and 2002, the grant rate for all SIPO patent applications was 52.7%. While the grant ratio of all SIPO applications of non-residents varies between 50% and 80%, the rate for domestic applicants increased from around 20% in the early years up to 50%. A separate analysis for SIPO patents that were filed at the EPO or USPTO shows clearly higher grant ratios of between 60% and 90%, which supports the assumption of more patentable inventions being filtered in the two subgroups. Many past studies have relied on the SIPO patent statistics, distinguishing only between resident and non-resident applicants, (e.g., Bosworth and Yang (2000) or Fai (2005)). The comparison of the four foreign countries with the highest application figures brings further interesting facts to light. Japan and South Korea show considerably higher grant ratios within the observed period than the US, Germany or other non-Chinese countries.34 Thus, the importance of close economic relations between the neighboring Asian states like China, Japan and South Korea might also lead to a better understanding of patent applicants concerning the Chinese IPR system and allow predictions as to whether or not a patent application will be granted in China. Figure 2.4 highlights the probability density function of grant lags for all SIPO patents. There are only small differences in examination time compared to the subgroups.35 For example, while all SIPO patents have an average grant lag of 4.71 years, the US and EP subgroups show longer examination periods of 5.08 and 5.20 years, respectively. This can be explained by the lower share of domestic applications. Only a few foreign applicants file their priority applications in China, likely delaying the Chinese examination process (e.g., due to the need to translate documents, etc.). Moreover, the distributions of grant lags for all SIPO patents and subgroups are very similar. While some patents are granted in as little as 1.2 years, the grant lag of some patents filed in the early years surpasses 15 years.

34

More than 96.5% of the applications at the SIPO between 1990 and 2002 were filed by Chinese, Japanese, South Korean, US, German or other European applicants.

35

See Figure A.1 and Figure A.2 in the Appendix for the probability density function of grant lags for the two subgroups.

29 -1 S.D. Mean +1 S.D. 0.3

Density

0.2

0.1

0.0

0

5

10 Grant Lag in Years

15

20

Figure 2.4: Probability density function of SIPO patent grant lags.36

Differences across technological areas are listed in Table 2.1. The number of patent applications varies from around 1,000 applications or less in Nuclear Engineering or Space Technology and Weapons to more than 30,000 applications in areas like Electrical Machinery or Pharmaceuticals and Cosmetics. The grant ratios vary from 34.14% in Agriculture and Food Chemistry to 66.96% in Semiconductors. These figures also emphasize the major pillars of the Chinese economy and areas that are restricted due to governmental guidelines. This interpretation is supported by the Revealed Technological Advantage index. The areas of Agriculture and Food Chemistry, which China tries to protect for historical reasons, and Pharmaceuticals and Cosmetics, a promising technological area for the PRC, exhibit high RTA values. Patent applications within the area of Materials and Metallurgy show the shortest grant lags, with an average of 4.25 years, while filings within the area of Biotechnology are granted within 5.24 years.37 Since the technological level and progress in such industries are quite different, these differences could explain the variance of grant lags. More advanced inventions probably need more time for examination, especially if the examiners are not as skilled compared with the state of the art.38

36

Due to the right-censoring of SIPO patent grants within this dataset, patents with a longer examination time up to 10 years were typically filed in the early 1990s.

37

The difference in examination time varies even more when comparing grant lags across years. Long grant lags in young industries like Biotechnology are biased due to a general decrease of the examination time between 1990 and 2002.

38

See Tables A.1 and A.2 in the Appendix for the patent characteristics of the two subgroups.

No. of Patent Applications* 30,323 17,402 37,354 23,929 10,924 12,985 19,385 13,532 1,000 22,577 17,568 30,312 9,376 17,527 20,645 8,066 17,666 13,068 18,042 14,021 4,666 4,580 9,161 9,451 8,968 8,810 10,209 950 19,463 11,574 443,533 No. of Granted Patents* 18,612 10,942 21,368 12,383 7,315 7,885 10,297 5,993 617 12,439 10,365 14,721 3,584 5,984 9,989 4,741 10,196 8,261 9,991 8,978 2,044 2,284 5,497 5,177 4,656 5,163 5,118 416 8,999 5,359 239,373 Grant Ratio % 61.38 62.88 57.20 51.75 66.96 60.73 53.12 44.29 61.76 55.09 59.00 48.57 38.23 34.14 48.38 58.78 57.72 63.21 55.38 64.03 43.80 49.86 60.00 54.77 51.92 58.60 50.13 43.79 46.24 46.30 54.97 Min. Grant Lag in Years 1.14 1.21 1.09 1.09 1.34 1.43 1.05 1.33 1.66 1.21 1.11 1.21 1.21 1.22 1.16 1.19 1.05 1.17 1.05 1.05 1.41 1.22 1.20 1.16 1.22 1.18 1.03 1.57 1.20 1.07 1.03 Average Grant Lag in Years 4.75 5.03 4.93 4.95 4.70 4.78 4.83 5.22 4.91 4.98 4.82 4.86 5.24 4.30 4.75 4.78 4.25 4.63 4.73 4.63 4.49 4.52 4.53 4.64 4.87 4.53 4.60 4.65 4.83 4.58 4.71 Max. Grant Lag in Years 13.77 12.63 12.72 15.19 11.72 12.20 12.67 15.33 11.06 13.37 12.40 13.17 13.37 11.18 13.02 12.84 11.33 12.36 16.47 12.96 12.98 11.23 11.49 13.13 13.67 12.84 12.82 10.97 13.84 12.23 16.47

Table 2.1: Grant ratios and lags across technological areas (all SIPO applications 1990-2002).

* The number of patent applications and grants are weighted by the number of technology areas (one patent can fall into several technological areas).

Electr. Machinery, Electrical Energy Audiovisual Technology Telecommunications Information Technology Semiconductors Optics Analysis, Measurement, Control Tech. Medical Technology Nuclear Engineering Organic Fine Chemistry Macromolecular Chem., Polymers Pharmaceuticals, Cosmetics Biotechnology Agriculture, Food Chem. Chem. & Petrol Ind., Basic Mat. Chem. Surface Technology, Coating Materials, Metallurgy Chemical Engineering Mat. Proc., Textiles, Paper Handling, Printing Agricultural & Food Proc. Environmental Technology Machine Tools Engines, Pumps, Turbines Thermal Proc. & Apparatus Mechanical Elements Transport Space Technology, Weapons Consumer Goods & Equipment Civil Eng., Building, Mining All SIPO Patent Applications

Area Name 0.62 0.41 0.49 0.73 0.55 0.49 0.80 0.97 0.59 0.89 0.78 1.13 1.21 1.86 1.02 0.76 1.21 0.87 0.78 0.57 1.41 1.20 0.85 0.83 1.00 0.72 0.83 1.10 0.95 1.23 0.87

Chinese RTA Index

30

31 Table 2.2, Table 2.3 and Table 2.4 report the yearly patent indicators of the three patent groups. While the number of applications and grants within the observed period is growing for all three groups, the grant ratio exhibits the shape of an inverted U-curve. Starting in 1990, grant ratios increased up to the mid-1990s and decreased slightly afterwards. The examination times for the three groups show a similar development. Beginning with an average grant lag of 5 years, the examination time for granted patents extends to 6 years in the mid-1990s and decreases to about 4 years in 2002.39 The previously described patent characteristics reveal interesting patterns as well. While the patent family size for all SIPO patent applications is quite stable at roughly four applications in all jurisdictions, this number decreases for the subgroups, from about ten in 1990 to less than six equivalent patents in 2002. The decrease for the US and EP groups can be explained by the high share of foreign applicants within those groups and an increasing share of patents that are only filed in a few countries, including China – one of the important emerging markets. In addition to this trend, the share of PCT applications within the three groups rose continuously. The all SIPO applications group shows a clear increase after 1993 when China signed the PCT treaty. In 2002, more than 30% of all SIPO patents and more than 60% of patents within the US and EP groups had a PCT filing within their patent family. Less surprising results can be derived from the number of IPC assignments. All three groups show quite stable figures over time. However, patents of the EP and US groups were assigned to more IPC classes. The average yearly number of global patent applications by an applicant increased steadily after 1993 and exhibited a steeper increase after 2001, supporting the previously stated rising importance of the Chinese market. The citation measures are presented only for the EP and US groups, as references to other patents are hardly available for SIPO patents. While backward and forward citations do not vary much over time within the EP group, these measures increase up to the late 1990s and decrease afterwards for the US group. Generally, all citation measures are considerably higher within the US group than within the EP group, which harkens back to differences in creating patent references at the USPTO and EPO.

39

The decrease in grant lags for SIPO patents might also be caused by the censoring of data. A shortening of the observation period from 1990 to 2000, however, shows no considerable change in the findings in this study.

9,227 9,968 12,597 17,264 21,872 25,477 30,400 34,381 37,920 41,400 53,962 64,477 84,588 443,533

No. of Patent Applications 3,378 4,079 5,148 7,447 11,156 13,846 17,152 20,178 22,477 24,561 30,151 36,498 43,302 239,373

No. of Granted Patents 36.61 40.92 40.87 43.14 51.01 54.35 56.42 58.69 59.27 59.33 55.87 56.61 51.19 54.97

Grant Ratio % 4.77 4.64 4.89 5.47 5.93 6.05 5.85 5.47 5.16 4.76 4.32 4.00 3.62 4.71

Average Grant Lag in Years 4.39 3.99 3.49 3.78 4.56 4.74 4.64 4.68 4.74 4.75 4.21 3.86 3.21 4.14

Family Size

4.84 7.35 8.18 12.40 22.58 27.02 29.09 30.85 34.86 37.82 33.71 33.34 31.41 29.48

Share of PCT Applications %

Table 2.2: Yearly patent indicators of all SIPO patent applications (1990-2002).

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Total

Application Year

4.46 4.19 3.96 4.33 4.98 5.17 4.97 4.94 5.08 5.34 5.44 5.18 4.75 4.99

No. of IPC Classes

7.16 6.69 6.60 11.78 22.05 39.06 56.00 81.52 92.36 83.53 113.17 122.98 157.10 91.71

Average Global Patent Applications per Applicant

6.16 5.73 5.85 9.79 17.63 32.45 48.09 69.69 80.03 70.59 100.25 98.90 131.83 77.36

Average SIPO Patent Applications per Applicant

32

188,388

Total

117,702

1,681 1,732 1,884 3,305 6,039 7,894 9,612 11,132 12,277 13,572 15,527 16,959 16,088

No. of Granted Patents

62.48

54.92 62.30 64.17 65.01 65.47 66.50 69.29 69.40 65.05 64.68 64.71 61.57 50.08

Grant Ratio %

5.20

5.04 5.08 5.43 5.83 6.19 6.38 6.25 5.88 5.58 5.13 4.69 4.38 4.13

Average Grant Lag in Years

7.46

10.18 10.72 10.53 9.44 8.57 8.14 8.03 7.92 7.64 7.66 7.43 6.79 5.78

Family Size

65.44

14.37 25.94 33.45 39.87 51.21 55.78 61.06 63.05 67.22 71.63 71.89 72.57 75.43

Share of PCT Applications %

7.14

7.64 7.68 7.97 8.00 7.58 7.41 7.03 6.86 6.87 7.21 7.45 7.11 6.71

No. of IPC Classes

4.44

3.74 3.72 3.87 3.97 4.28 4.29 4.41 4.49 4.48 4.48 4.50 4.55 4.62

Backward Patent Literature

0.64

0.53 0.51 0.57 0.59 0.61 0.61 0.59 0.63 0.64 0.66 0.70 0.64 0.68

Backward Non-Patent Literature

Citations

Table 2.3: Yearly patent indicators of SIPO patent applications with EP equivalents (1990-2002).

3,061 2,780 2,936 5,084 9,224 11,870 13,873 16,040 18,874 20,982 23,995 27,546 32,123

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

No. of Application Patent Year Applications

1.52

1.21 1.18 1.28 1.39 1.54 1.65 1.74 1.81 1.73 1.64 1.49 1.39 1.25

Forward

126.08

14.18 14.22 14.25 25.13 33.43 50.22 64.48 89.68 97.68 107.31 131.62 178.24 252.10

99.80

11.75 11.62 11.90 19.90 25.33 40.25 52.97 73.24 79.72 86.99 108.60 130.43 200.70

Average Average Global SIPO Patent Patent Applications Applications per per Applicant Applicant

33

190,429

Total

128,920

1,548 1,639 1,806 3,219 6,073 8,249 10,424 12,350 13,666 14,032 15,968 19,622 20,324

No. of Granted Patents

67.70

59.20 68.69 71.21 71.53 71.95 72.32 75.24 75.67 72.40 72.18 72.69 65.04 53.59

Grant Ratio %

5.08

4.93 4.91 5.27 5.75 6.10 6.28 6.17 5.81 5.52 5.08 4.62 4.29 4.00

Average Grant Lag in Years

6.98

9.94 10.16 9.84 8.76 8.06 7.63 7.44 7.37 7.16 7.40 7.21 6.39 5.42

Family Size

54.67

13.05 21.33 26.74 31.61 41.41 44.95 48.78 50.84 53.98 60.84 61.28 61.29 61.99

Share of PCT Applications %

6.57

6.86 6.83 6.89 7.09 6.81 6.80 6.43 6.35 6.36 6.72 6.97 6.64 6.20

No. of IPC Classes

10.85

9.10 9.69 10.54 10.83 10.93 10.44 10.88 11.69 11.93 12.41 12.38 10.36 8.96

Backward Patent Literature

2.16

1.43 1.28 1.49 1.79 2.14 1.92 2.27 2.42 2.48 2.74 2.57 1.98 1.71

Backward Non-Patent Literature

Citations

Table 2.4: Yearly patent indicators of SIPO patent applications with US equivalents (1990-2002).

2,613 2,386 2,536 4,499 8,441 11,406 13,854 16,322 18,875 19,441 21,967 30,169 37,920

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

No. of Application Patent Year Applications

3.33

3.20 3.35 3.51 3.92 4.53 4.87 5.02 5.18 4.63 3.97 2.95 2.11 1.33

Forward

154.19

14.73 14.00 14.70 25.98 38.18 64.92 89.34 119.94 134.59 130.79 147.93 196.95 279.62

126.47

12.40 11.26 12.51 21.59 30.60 53.76 77.02 102.34 116.19 110.68 124.93 150.50 228.29

Average Average Global SIPO Patent Patent Applications Applications per per Applicant Applicant

34

35

2.4 Survival Analysis 2.4.1 Model Specification Survival analysis is a commonly used statistical method for modeling the time until a certain event occurs. The name “survival analysis” originates from observations of time to death or failure. A simple survival function can be written as: S t Pr(T t t )

(2)

where T denotes a non-negative random variable representing the time to failure. While the survival function describes how the risk for a certain event changes over time, the hazard function measures the instantaneous failure rate, also called the age-specific failure rate. This rate represents the probability of an event at time t conditional on “survival,” or no occurrence of an event up to that time:

O t lim

't o0

1 Pr t d T  t  't T t t 't

(3)

There are sometimes further variables available that might influence the survival time. Here, it is interesting not only to compute the survival function, but also to analyze the relation between the survival time and the so-called covariates.40 Such an extension can be written in a linear model where the log-hazard Oi t for observation i is:

Oi t exp ht  E1 zi1    E p zip

(4)

and the variables z1 ,, z p are the covariates. In this case, however, it would be necessary to specify a baseline hazard rate ht , as it is the point of reference if all covariates equal zero.

40

The Kaplan-Meier estimator – a non-parametric maximum likelihood estimator of the survival function – is a simple method for calculating the impact of one non-metric independent variable on survival time (e.g., to compare two different groups).

36 Nevertheless, for many phenomena, it is difficult or impossible to define a parametric function for the survival distribution.41 In this context, Cox (1972) introduced the proportional hazard model in which the hazard rate Oi t , z of observation i is:

Oi t , z O0 t exp E1 zi1    E p zip

(5)

where O0 t is an unknown function and the covariates z1 , , z p enter the form linearly. In cases where there is only one binary covariate vector z1 , the hazard rate is O0 t if z1 When z1

0.

1 the hazard rate equals:

O t , z1

O0 t expE1 O0 t

(6)

Dividing the hazard rate by O0 t results in the exponentiated coefficient E1 . Accordingly, the hazard rate arises from the comparison of observations with z1 with z1

1 to those

0 . With continuous covariates, the hazard rate represents the change in the age-

specific failure rate associated with a one-unit increase of this variable.42 When more than one covariate is incorporated into a model, the hazard rate E i measures the risk of failure across time for observations that differ on zi . Because O0 t can be determined by the data, the Cox regression is a semi-parametric model (Kalbfleisch and Prentice, 1980). Even though the baseline hazard is unspecified, estimates for the coefficients E i can be obtained using partial likelihood techniques. The Cox’s proportional hazard model will therefore also be applied in the multivariate analysis of SIPO patent grant lags in this study. One shortcoming of the Cox model is that it does not account for coefficients that change over time, but it is possible to define time-dependent covariates. With regard to patent data, this is of no major importance. Aside from the withdrawal of a pending patent application, there are no significant events after the filing of a patent that might occur without being related to the embodied invention at the day of application. While more important patents commonly receive more forward

41

There are several parametric models that are used in different scientific areas. The Gompertz and Weibull distributions are just two examples.

42

For continuous covariates, it is important to reconsider whether the assumption of linearity is fulfilled.

37 citations over the years, examiners at the patent office and the overall examination process will probably not be influenced by these. Furthermore, some patents are amended or changed after the date of application. Because this study also observes patents that have been filed in other jurisdictions, it can be assumed that the core of the invention is stable. Another important requirement of the Cox model is that the baseline hazard should be constant for all observations and across calendar time. This assumption should theoretically hold because the examination at the SIPO follows a standardized process. Additional analysis, however, showed that this assumption is violated for some variables in this study. The hazard curves for PCT and non-PCT applications, for example, are converging over the survival time, as illustrated in Figure 2.5.43

-ln[-ln(Survival Probability)]

15

10

5

0

-5 0

1

ln(Grant Lag) Non PCT

2

3 PCT

Figure 2.5: Visualization of the proportional hazard assumption.

43

This finding is not surprising given that PCT applications may enter the Chinese examination process at a later stage.

38 As a robustness test, the models are also estimated with a log-logistic distributed accelerated failure time model that does not rely on the proportional hazard assumption because there is a direct relation between the covariates and the failure time.44 The ln of the survival time T is determined as: ln T

E Z  GH

(7)

with covariate vector Z and the corresponding accelerating or decelerating vector of regression parameters E . The error variable H has a logistic distribution, and G is a scale parameter. The survivor function of the log-logistic distribution can be written as:

S t

1 1  (J t )D

(8)

where t represents the time to failure, J is a scale parameter and D is a shape parameter. The corresponding baseline hazard function has the following form:

O t

JD J t D 1 1  (J t )D

(9)

with a unimodal inverted U-shape for D ! 1 and a monotonically decreasing shape if D d 1 . Taking the outcomes of the Cox proportional hazard model and the accelerated failure time model into account, the results prove comparable and consistent for most covariates. This implies that the violation of the proportional hazard assumption, as illustrated above, is no major problem.

44

Kalbfleisch and Prentice (1980) provide a good overview of methods for failure time data analysis.

39

2.4.2 Results In the following section, the results for the Cox proportional hazard and accelerated failure time regressions are presented. For both estimation methods, the results were calculated for all SIPO patent applications and the two subgroups with USPTO and EPO equivalents for the period from 1990 to 2002. Furthermore, a basic model including standard patent indicators and an extended model with additional technology and applicant information were computed for each group of patents. The results for the Cox proportional hazard models are shown in Table 2.5; Table 2.6 depicts the results of the accelerated failure time models.45 The outcomes for the applicant origin and the corresponding dummy variables are consistent for both estimation techniques and across all groups. Compared to the reference group of Chinese patentees, the grant lags are significantly longer for applicants from Japan, South Korea, the US, Germany or any other foreign country. As discussed previously, most foreign patent applications in China are subsequent filings of non-Chinese priorities. This might be one reason for a longer examination period, as those patents enter the Chinese examination procedure in a different way. Furthermore, domestic applications may be processed faster because they are typically submitted in the Chinese language. For the patent references and citation measures, both tables present comparable and highly significant results. More patent literature, non-patent literature references and forward citations from other patents show a negative impact on the hazard of a patent being granted at a certain time. With regard to backward citations, the results indicate that examiners need more time if more documents are reviewed when judging novelty and inventiveness. Interestingly, granted patents with more forward citations seem to have a slower examination process. Here, the mentioned lack of experience and knowledge of examiners at the SIPO might be one reason for the disparity (Fai, 2005). Patents with more forward citations are often more valuable and potentially more cutting-edge or closer to the beginning of an innovation cycle, as discussed by Regibeau and Rockett (2003). It might be harder for examiners to evaluate the requirements of patentability for such inventions.

45

Additional information for the estimation results of the technological area and year dummies are available upon request.

40 Differences in the grant lags can also be found for PCT applications. As assumed, PCT applications are processed significantly slower than non-PCT filings. This special filing procedure allows applicants to delay their decision on subsequent patent filings. It seems obvious, that applicants of such patents may – in certain cases – also exploit the given legal framework of Chinese patent law and the Patent Cooperation Treaty to postpone the application and request for examination at the SIPO. Turning to the family size of patents, the findings are not consistent across the different models. This can generally be explained by the distinct character of the EP and US subgroups. Patent families in these two groups have a minimum family size of two applications, one at the SIPO and one at the EPO or the USPTO.46 Nevertheless, the results for all SIPO patents suggest that patents with a larger family size are processed faster. By interpreting family size as another indicator of patent value, these findings seem to be contradictory to the results for forward citations. However, the effect of family size is very small compared to the effect of the number of forward citations. With reference to the number of IPC classes that are assigned to a patent, the coefficients for all SIPO patents and the two subgroups are consistent for all models and estimation techniques. The patents that are attributed to more IPC classes show longer grant lags. These findings are in line with the previous expectation that more complex inventions would have a more intensive examination at patent offices. The technological importance of an invention for China was expressed in the extended models. Here, it can be seen that patents with a high RTA index within a technologically crucial area have shorter grant lags in almost all of the models (the only exception is the Cox model for SIPO patent grants with US equivalents). This outcome raises the question of whether the SIPO devotes more resources to the examination of patents in industries that are relevant to the Chinese economy or that are supported by the PRC government. Unfortunately, no numbers regarding examiners or capacity measures at the SIPO across different technology areas were available for this study to allow further insight into this point. With regard to the annual patent applications per applicant, the coefficients are in the expected direction. Applications from more patent-active companies are granted within a shorter period of time, supporting the assumption of potential learning and specialization effects. Compared to small- and medium-sized companies, large technology-oriented enterprises commonly have dedicated IP departments and cooperate with numerous patent

46

Filing patents at the EPO makes only sense if the patent is later designated to at least three states, which can be confirmed by the average family size of EP patents within the descriptive statistics in Chapter 2.3.

41 attorneys specialized in certain technology areas. Finally, patents from applicants who are more focused on China are processed faster; this finding is supported by most models. Knowledge and familiarity with the Chinese patent system seems to pay off. Some multinational enterprises like Siemens even have specialized IP departments in the PRC, which contributes to a better understanding of the Chinese IPR system and the drivers of the patent examination process at the SIPO.47

47

See http://w1.siemens.com/innovation/en/publikationen/publications_pof/pof_spring_2002/ patent_site.htm, latest visit on July 12th, 2009.

42

Grant Lag

SIPO Patent Grants (1)

(2)

SIPO Patent Grants (with US Equivalents) (1)

SIPO Patent Grants (with EP Equivalents)

(2)

(1)

(2)

FAM_SIZE

0.004*** (0.001)

0.003*** (0.001)

0.001 (0.001)

0.001 (0.001)

-0.003*** (0.001)

-0.003*** (0.001)

PCT_APPL

-0.253*** (0.005)

-0.250*** (0.005)

-0.312*** (0.007)

-0.307*** (0.007)

-0.255*** (0.008)

-0.252*** (0.008)

IPC_TOT

-0.007*** (0.000)

-0.007*** (0.000)

-0.006*** (0.001)

-0.007*** (0.001)

-0.006*** (0.001)

-0.006*** (0.001)

NON-CN_APPLICANT

-0.878*** (0.009)

-0.872*** (0.009)

-0.735*** (0.039)

-0.741*** (0.039)

-0.639*** (0.053)

-0.644*** (0.053)

JP_APPLICANT

-0.799*** (0.008)

-0.818*** (0.008)

-0.692*** (0.039)

-0.713*** (0.039)

-0.617*** (0.054)

-0.635*** (0.054)

KR_APPLICANT

-0.644*** (0.011)

-0.670*** (0.012)

-0.542*** (0.040)

-0.570*** (0.040)

-0.393*** (0.057)

-0.415*** (0.057)

US_APPLICANT

-0.977*** (0.009)

-0.978*** (0.009)

-0.796*** (0.039)

-0.806*** (0.039)

-0.777*** (0.053)

-0.786*** (0.053)

DE_APPLICANT

-0.821*** (0.011)

-0.831*** (0.011)

-0.709*** (0.039)

-0.725*** (0.040)

-0.620*** (0.054)

-0.634*** (0.054)

BWD_PL_CIT

-0.003*** (0.000)

-0.003*** (0.000)

-0.018*** (0.001)

-0.017*** (0.001)

BWD_NPL_CIT

-0.008*** (0.000)

-0.008*** (0.000)

-0.054*** (0.002)

-0.053*** (0.002)

FWD_CIT

-0.005*** (0.000)

-0.005*** (0.000)

-0.020*** (0.001)

-0.020*** (0.001)

RTA_CN

0.194*** (0.013)

-0.021 (0.020)

0.054*** (0.019)

PAT_YEAR_LN

0.020*** (0.001)

0.014*** (0.002)

0.012*** (0.002)

CN_FOCUS

0.061*** (0.012)

0.043*** (0.015)

0.029* (0.016)

SIPO Patent Grants

239,373

239,373

128,920

128,920

117,702

117,702

-2,657,978

-2,657,697

-1,356,103

-1,356,060

-1,228,636

-1,228,604

Wald Ȥ2

(49) 92,457.1

(52) 92,469.5

(52) 61,252.2

(55) 61,284.6

(52) 55,443.8

(55) 55,495.6

Prob. Ȥ2

0.000

0.000

0.000

0.000

0.000

0.000

Log Likelihood

The model contains dummy variables for 30 technology areas and year dummies (standard errors in parentheses). Significance levels: * 10% significant, ** 5% significant, *** 1% significant.

Table 2.5: Estimation results for the Cox proportional hazard model.

43

Grant Lag

SIPO Patent Grants

SIPO Patent Grants (with US Equivalents)

(1)

(2)

(1)

FAM_SIZE

0.999*** (0.000)

0.999*** (0.000)

1.000* (0.000)

PCT_APPL

1.077*** (0.001)

1.076*** (0.001)

IPC_TOT

1.002*** (0.000)

NON-CN_APPLICANT

SIPO Patent Grants (with EP Equivalents)

(2)

(1)

(2)

1.000 (0.000)

1.000*** (0.000)

1.001*** (0.000)

1.081*** (0.001)

1.081*** (0.001)

1.068*** (0.002)

1.068*** (0.002)

1.002*** (0.000)

1.001*** (0.000)

1.001*** (0.000)

1.001*** (0.000)

1.001*** (0.000)

1.280*** (0.003)

1.277*** (0.003)

1.217*** (0.008)

1.217*** (0.008)

1.198*** (0.012)

1.198*** (0.012)

JP_APPLICANT

1.250*** (0.002)

1.252*** (0.002)

1.199*** (0.008)

1.202*** (0.008)

1.184*** (0.012)

1.186*** (0.012)

KR_APPLICANT

1.206*** (0.003)

1.210*** (0.003)

1.160*** (0.008)

1.165*** (0.008)

1.127*** (0.012)

1.130*** (0.012)

US_APPLICANT

1.312*** (0.003)

1.310*** (0.003)

1.233*** (0.008)

1.234*** (0.008)

1.235*** (0.012)

1.235*** (0.012)

DE_APPLICANT

1.262*** (0.003)

1.262*** (0.003)

1.207*** (0.008)

1.210*** (0.008)

1.193*** (0.012)

1.194*** (0.012)

BWD_PL_CIT

1.001*** (0.000)

1.001*** (0.000)

1.003*** (0.000)

1.003*** (0.000)

BWD_NPL_CIT

1.002*** (0.000)

1.002*** (0.000)

1.011*** (0.001)

1.011*** (0.001)

FWD_CIT

1.001*** (0.000)

1.001*** (0.000)

1.004*** (0.000)

1.004*** (0.000)

RTA_CN

0.941*** (0.003)

0.972*** (0.004)

0.970*** (0.004)

PAT_YEAR_LN

0.996*** (0.000)

0.997*** (0.000)

0.998*** (0.000)

CN_FOCUS

0.991*** (0.003)

0.994** (0.003)

0.997*** (0.003)

SIPO Patent Grants

239,373

239,373

128,920

128,920

117,702

117,702

0.134

0.133

0.119

0.119

0.118

0.118

2,887.7

3,251.3

16,624.4

16,688.6

16,151.9

16,211.2

Wald Ȥ2

(49) 211,757.1

(52) 213,161.2

(52) 92,308.4

(55) 96,721.6

(52) 86,128.2

(55) 86,474.1

Prob. Ȥ2

0.000

0.000

0.000

0.000

0.000

0.000

Gamma Log Likelihood

The model contains dummy variables for 30 technology areas and year dummies (standard errors in parentheses). Significance levels: * 10% significant, ** 5% significant, *** 1% significant.

Table 2.6: Estimation results for the accelerated failure time model with log-logistic distribution and exponentiated coefficients.

44

2.5 Conclusion The People’s Republic of China experienced rapid development, from being a country without any intellectual property protection or reward for innovative and creative work to a state with a modern IPR system. Like the fast economic growth in China, patent applications at the State Intellectual Property Office in China have risen tremendously in recent years. In 2007, almost 250,000 intellectual property applications for patent inventions were filed at the SIPO. At the same time, the Chinese patent office was able to shorten the examination time considerably to an average of less than two years by 2006. This study discusses the examination procedure at the SIPO in depth and models the examination time of granted patents. By applying two estimation techniques – a Cox proportional hazard model and an accelerated failure time model – the findings suggest that the examination process and the grant lags are mostly driven by factors similar to other patent offices. Specifically, the citation measures indicate that broader and more valuable inventions require longer examination times for SIPO approval. This raises the question of whether China should devote more dedicated resources to the examination process through, for example, examiner training or access to broader databases for state of the art research to allow faster patent examinations. International patent applications that are filed in China and patents of foreign applicants undergo an extended examination procedure as well. However, these effects should be also present at other patent offices. On the other hand, more patent-active companies and applicants with a greater China focus have shorter grant lags due to learning and specialization effects. Moreover, a shorter examination time is also found for patents in areas of high technological relevance for the PRC. Compared to existing studies regarding the examination processes at other patent offices, this study has some setbacks due to lack of availability and quality of Chinese patent data. Additional patent characteristics from the SIPO such as number of claims, patent document language, procedural measures and capacity information would provide further valuable insights. However, China’s progress from an economic as well as scientific perspective gives hope that more detailed and comprehensive studies in this area will be feasible in the near future.

3. The Relationship between Trade and Intellectual Property Rights in China 3.1 Introduction Counterfeiting and piracy are contentious issues that frequently come up in the context of intellectual property protection in developing countries.48 In 2007, the Organization of Economic Co-operation and Development published a notable report indicating that the world market share of counterfeit goods, at two to four percent, was considerably lower than the five to seven percent figure that had been assumed up until that point (Dryden, 2007). This raises the question of whether the numerous scientific articles and media publications on the problem of intellectual property right infringement reflect reality. China49 is often accused by Western countries of violating foreign IPRs, such as patents and trademarks. According to these OECD figures, almost one third of all global counterfeit seizures and two thirds of all infringement imports in the United States originate from China (Bender, 2006). Industrialized states often refer to these figures and complain about welfare losses related to Chinese counterfeits that dampen the incentives of MNEs to invest in R&D. Over the last two decades, exports from OECD members to the billion plus Chinese market have increased more than twelvefold and emerged as an important economic pillar for most industrialized countries. Many attempts have been made to observe the relationship between IPRs and international trade flows, but little research exists regarding Chinese trade patterns. While several studies revealed a positive effect of stronger IPRs on trade, the overall picture is still ambiguous. Many important economic determinants affect this relationship, such as market characteristics and the abilities of different countries to mimic products. Moreover, countervailing forces of market expansion and market power do not result in a

48

According to the OECD, counterfeiting can be best described as the close imitation of products so as to mislead customers, whereas the term piracy represents the act of infringing on intellectual property rights. The two terms are commonly used synonymously.

49

China in the rest of this study refers to mainland China. There are also IPR disputes with Hong Kong and Macao, but this work focuses on mainland China to allow the analysis of a definable framework.

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2_3, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

46 clear effect of IPRs on trade. Hence, this study aims to attain a better understanding of this underlying problem by focusing on the People’s Republic of China. As a crucial trade partner for many foreign countries and given the ongoing IPR discussions, China is a logical choice for the focus of a detailed examination. The empirical analysis in this study deals with the relationship between exports from developed countries to China, patent activities in the PRC as related to these countries, and the reform of the Chinese IPR system. To observe the economic effects that are related to patent activities in the PRC, the study works from the key assumption that inventors and firms have to apply for IPRs in order to gain the ability to defend their rights. OECD export data and patent data from the Worldwide Statistical Patent Database (PATSTAT) of the European Patent Office were incorporated into an econometric gravity model in a new approach to the observation of the effects of IPRs on trade flows. Previous studies have primarily focused on analyzing the IPR strength, and therefore, only found evidence for either the market expansion effect or the reverse market power effect. However, the results of this study indicate the co-existence of the two features. To my knowledge, this is the first study that provides empirical results for both effects from a patenting perspective. The remainder of this study is divided into six sections. Chapter 3.2 deals with the institutional and theoretical background of the relationship between IPRs and trade in general. In addition to an outline of the Agreement on Trade-Related Aspects of Intellectual Property Rights, theoretical and empirical insights are provided. Chapter 3.3 narrows the focus to IPRs and trade in China. Based on the development of international Chinese trade flows and the establishment of an IPR system in the PRC over the last two decades, the assumptions for the multivariate analysis are derived. Bearing in mind the vast literature on international trade, Chapter 3.4 briefly highlights the most important trade theories. The empirical framework of this study is elaborated in Chapter 3.5, while Chapter 3.6 displays the regression results for the defined gravity models. Last but not least, the conclusion in Chapter 3.7 summarizes the findings and presents future work.

47

3.2 Institutional and Theoretical Background 3.2.1 The TRIPS Agreement Along with the umbrella agreement for the establishment of the World Trade Organization, another sustainable achievement of the 1994 Uruguay Round in the context of the General Agreement on Tariffs and Trade (GATT)50 negotiations was TRIPS.51 The main goal of this agreement is to establish the proper treatment of intellectual property rights on an international basis and delineate a minimum standard of IPR protection that WTO members have to fulfill (WTO, 2007). The basic idea behind a tightening of IPRs across the globe at that point of time was that providing protection to creative and innovative work leads to an increase in economic welfare. In the era before TRIPS, little scientific research had been conducted to analyze this underlying assumption. While Arrow (1962) was one of the first to show that there are different incentives for investing in R&D depending on the market structure of an economy, other scientists like Machlup (1962) doubted the economic benefits of patent protection. Consequently, many developing and emerging countries feared and still fear exploitation by innovative MNEs and protested against an international strengthening of IPRs. One main argument made by developing countries was that stronger IPRs would slow down the economic development of less developed countries because they allow exclusive property rights and protected technology of industrialized states (Lesser, 2001). Nevertheless, TRIPS became a binding agreement for all WTO members and countries aiming to join this organization. Thereby, the members made an agreement in five broad areas regarding international trade regulations: (1) the application of basic principles of trading systems and international intellectual property agreements, (2) the adequate protection of IPRs, (3) the proper enforcement of these rights at a territorial level, (4) the settlement of disputes between member states, and (5) the transitional arrangements when TRIPS is introduced. With regard to the scope of the treaty, TRIPS covers all important types of IPRs. Copyrights, trademarks, industrial designs, patents, and trade secrets as well as rights such as

50

After World War II, GATT was the first international institution facilitating trade between its contracting members. On January 1st, 1995, GATT was officially replaced by the WTO.

51

Besides GATT, there is also GATS (the General Agreement on Trade in Services), which was negotiated within the Uruguay Round and entered into force in January 1995.

48 geographical indications or layout-designs of integrated circuits are all covered by the agreement (WTO, 2007). For emerging and developing countries like China, such legal commitments are quite challenging and hard to fulfill in the short-run. In addition to deeply rooted cultural elements, such as the Confucian philosophy in China (Gregory, 2003), there are basic legal and procedural obstacles and protectionist policies in such developing countries that have to be overcome or adjusted to allow for the implementation of international IPR standards (Maskus et al., 2005).52 Thus, TRIPS allows a transitional period of five years during which developing countries can gradually begin to implement the rules, as well as an analogous period of up to eleven years for the least developed countries.

3.2.2 Effects of Intellectual Property Rights on International Trade The economic relations between industrialized and developing countries are often illustrated in so-called North-South trade models, in which the Northern region represents the developed economies and the Southern area consists of the developing markets. Country characteristics of the North and the South are incorporated into these models to explain economic relations between those regions.53 In addition to addressing common problems, such as unemployment and wage inequality (see Wood, 1995), these models are used to predict flows of FDI (see Branstetter et al., 2007), to explain differences in product quality (see Flam and Helpman, 1987), to disclose R&D spillovers (see Coe et al., 1997), and to address special issues such as environmental protection (see Chichilnisky, 1994). By applying this sort of North-South trade model, Chin and Grossman (1991) became some of the first to investigate the effects of IPRs on international trade. In a linear-quadratic Cournot duopoly model, they start from a two-country, two-firm, one-product situation. A basic assumption underlying their model is that only the Northern firm can conduct R&D to lower production costs for a defined good, and that the associated technology can be protected by IPRs. Different welfare implications on a national and global level can be derived depending on whether the Northern IPRs are respected by the Southern firm. Chin and Grossman show that in most cases, the interests of the North and South are contradictory. In

52

In some countries, like China, political reluctance is often a greater barrier to implementing stronger IPRs than the resources devoted to the IPR system and relevant IPR laws (Bender, 2006).

53

See Chui et al. (2002) for an overview of different North-South trade models.

49 the North, the protection of the R&D-based product is always favorable, whereas the South is better off in terms of economic welfare if it eschews the protection of foreign IPRs. Only if the Southern share of world consumption for the innovative product is very high (according to the results of Chin and Grossman: >88%), which only seems applicable for exceptional products and large markets like China, might the South also benefit from stronger intellectual property protection. All in all, these findings suggest that the protection of IPRs has a positive effect on global economic welfare in highly innovative industries, whereas the opposite is the case if innovations are likely to be small (Chin and Grossman, 1991). Diwan and Rodrik (1991) extended the model of North-South trade of Chin and Grossman (1991) by modifying the assumptions. It is important to consider, besides the integration of multiple technologies and differences in demands, the fact that their model is not limited to duopolistic competition. Their main outcome shows that an increase in IPR protection in any of the Northern or Southern regions will lead to an increase in innovative activities. Furthermore, the fit between technological needs and the invented technologies will be higher in countries with patent protection than in those without patent protection. Accordingly, to promote innovations that more closely follow the demand in developing countries, it makes sense to stimulate R&D activities in the South by ensuring a proper level of IPR protection in this region. Against the background of the GATT Uruguay Round, Deardorff (1992) argues that strengthening patent protection on a global basis may not be beneficial for all countries. Because a high share of R&D investment of MNEs is already recovered within the industrialized economies, the additional profits for the inventing firms in emerging and developing markets might not compensate for the losses in consumer surplus caused by extended patent protection. At some point, the losses incurred by extending monopoly pricing for existing innovations in Southern countries will even outweigh the incentives to invest in new inventions. However, in a globalizing world, it seems obvious that multinational companies will increasingly incorporate the growing profit potential in markets like China or India into their R&D activities and long-range planning. Helpman (1993) made further contributions to North-South economic relations. In line with Chin and Grossman (1991) and Deardorff (1992), Helpman (1993) fuels the theory that stronger IPRs in the South are not beneficial for emerging and developing countries. In contrast to the South, the North gains from stronger IPR protection in the South in most cases. Thereby, the welfare implications vary across different model assumptions, depending on the rate of imitation in the South and whether FDIs are a feasible option when a firm is serving a foreign market. When there are no

50 FDIs and there is a low rate of imitation in the South, both regions benefit from some relaxation of IPRs. Provided that IPRs are granted and properly enforced, such rights have various effects on trade patterns and on other channels serving foreign markets. In addition to direct arm’slength exports to foreign markets and indirect exports via affiliates (see Maskus, 1997), direct investment in foreign production facilities (see Branstetter et al., 2007) and licensing of technology (see Saggi, 1996) are additional opportunities for a company to appropriate returns from R&D activities outside the home market. A theoretical framework for the assessment of different modes of market entry is provided by the OLI (Ownership-LocationInternalization) paradigm of Dunning (1980). According to this theory, MNEs need a certain competitive advantage to compete in a foreign environment with local companies that are more familiar with their home market. This advantage may arise, for example, from exclusive access to resources, from skilled employees, or from protected technology. In this framework, IPRs are an important determinant of whether MNEs will decide to serve a country through exports or if there is another way they will operate in that market. The literature finds three main effects of IPRs on trade, which are best described by Maskus and Penubarti (1995). According to them, IPRs might expand a market for patentees, lead to market power because of exclusive property rights, and, under certain conditions, provide cost advantages in fighting piracy. However, the predominant market power and market expansion effects are indeterminate. On the one hand, if inventions are protected by IPRs, the market expansion effect may open up new market potential. The sales of an inventing firm will rise due to an increasing demand curve in the foreign market for an innovative product. Moreover, other companies can be prevented from imitating the innovation, which will leave a larger market share for the inventing firm. In the context of exports to a foreign market, the market expansion concept implies a positive effect on the export sales of inventing firms. On the other hand, the market power effect allows inventing firms to reduce scales and raise prices. As in a monopoly situation, local companies have to put more effort into inventing around the protected invention. Regarding trade flows to a foreign country, this would mean that the market power effect of stronger IPRs entails a negative impact on the total export volume to that country. The third effect of IPRs might appear in large economies. Accordingly, foreign firms would face lower expenditures directed towards fighting piracy and deterring local imitation, which would have a positive effect on exports because of lower overhead costs (Taylor, 1993; Maskus and Penubarti, 1995). In

51 addition to these three basic effects, there are definitely more factors that have to be considered regarding the interaction between international trade flows and IPRs. The following chapter will discuss the most important factors that have already been addressed by empirical research.

3.2.3 Existing Empirical Evidence The relationship between IPRs and trade has already attracted the attention of various economists.54 This chapter will highlight the most important empirical findings in general, especially those that are relevant for the following sections of this study. One of the first individuals to study the effects of IPRs on trade flows was Ferrantino (1993). In his study, he observed the impact of the adherence of US trade partners to the Paris and Berne Conventions, the total number of affiliations each country had cultivated with three IPR treaties (the Paris Convention, the Berne Convention, and the Union for the Protection of Varieties of Plants (UPOV)), and the term of patent protection. Upon applying the gravity model,55 Ferrantino found no relationship between involvement in IPR agreements and the arm’s-length exports and overseas affiliate sales of US firms. Nevertheless, this study showed that exports of US parent companies to their overseas affiliates are higher in countries that do not sign IRR agreements. According to Ferrantino, this indicates that firms investing in R&D prefer export over local production in countries where the IPR regime is weak, in order to avoid knowledge outflow and imitation (Ferrantino, 1993).56 Another study in this area was conducted by Maskus and Penubarti (1995).57 The authors use the Helpman-Krugman model of monopolistic competition with symmetric firms to analyze the exports of 22 OECD member states to 71 countries in 1984. As a measure of IPR strength, the Rapp and Rozek index was incorporated to reflect a country’s conformity to IPR regulations and enforcement compared to the minimum standards defined by the US Chamber of Commerce Intellectual Property Task Force in 1987. Maskus and Penubarti

54

See Falvey et al. (2006) for an overview of the most important studies in this area.

55

Based on the gravity model in physics, the gravity model of trade is meant to explain trade flows between “economic masses.” Chapter 3.4.3 provides a more detailed explanation.

56

In addition to considering trade flows, Ferrantino (1993) also investigated the location of FDI by US firms, as well as royalties and license fees received from economic partners.

57

A previous study by Maskus and Konan (1994) already revealed comparable results.

52 found a significant positive influence of stronger IPRs in a country on the corresponding exports of OECD members to that country. Controlling for market size, this effect is stronger in larger developing economies than in smaller ones. While this can be seen as evidence of the market expansion effect, the results are not significant for patent-sensitive industries (Maskus and Penubarti, 1995). Based on the work of Maskus and Penubarti (1995), Smith (1999) extended the concept by differentiating the countries according to their level of development and by incorporating their threat of imitation. Through the interaction of IPR strength with imitative ability, Smith predicted the threat of imitation within a country. Her results show that US exports react positively to stronger IPRs in countries where the threat of imitation is high. However, strengthening IPRs in countries with low imitative abilities leads the market power effect to dominate, resulting in lower trade flows. Unlike Maskus and Penubarti (1995), Smith found that exports in patent-sensitive industries are more positively affected by stronger IPRs than the aggregated exports across all industries (Smith, 1999).58 Rafiquzzaman (2002) applied a methodological approach similar to Smith’s, but used data on Canadian exports in 1990. The results for the gravity model across 10 Canadian provinces and 76 countries are comparable to those of the aforementioned papers. Across all sectors in the observed countries, the market expansion effect is predominant and contributes to an increase in Canadian exports. Unlike Smith (1999), in this study, the market expansion effect proves significant for all countries, independent of their stage of development. Nevertheless, high-income countries show a stronger effect than low-income countries. Furthermore, in an important note on countries with strong imitative abilities, weak patent rights are lowering Canadian exports, especially in patent-sensitive industries. Recently, Braga and Fink (2005) also carried out an analysis of the relationship of IPRs to trade. In their study, they used data related to trade relations between 88 countries that were separated according to the categories of non-fuel trade and high-technology trade. Another distinct feature of this analysis is that it accounts for zero trade flows between countries. Through the application of a bivariate probit regression model, evidence was found that IPR strength has a significant positive effect on non-fuel imports and exports and a significant negative impact on high-technology trade in terms of the probability that two countries would

58

In a later study, Smith (2001) considered not only exports, but also affiliate sales and license revenues. She revealed that stronger foreign patent rights favor affiliate sales and licenses over exports.

53 trade with each other. However, these unexpected results might have been skewed by different modes of market service (Braga and Fink, 2005).59 With 71 countries for the period between 1970 and 1992, Co (2004) used panel data to analyze the relationship between exports and IPRs and found that stronger protection of patent rights in a foreign country with an average level of imitative ability leads to an increase in R&D-intensive US exports, while US exports of non-R&D intensive goods are affected negatively. However, these results are not uniform across all countries and industries, as the impact of IPR strength on US exports in this study depends on the level of imitative ability in a foreign market. Only if the imitative ability exceeds a certain level are both R&D-intensive and non-R&D-intensive exports positively influenced by stronger IPRs, whereas below a critical value, the market power effect predominates (Co, 2004). One of the most recent studies on this topic was conducted by Falvey et al. (2006). Using a standard gravity model and OECD trade data, manufacturing exports of the five largest developed economies to 69 developed and developing countries were observed. The basic outcome was that imitative abilities matters more than market size in the relationship between IPRs and trade. Moreover, strong evidence emerged for the market expansion effect in larger economies with high imitative abilities. The application of threshold regressions makes ceiling effects apparent for different industries. Beyond these thresholds, a further strengthening of IPRs will not increase exports. Last but not least, this study revealed that the composition of exports is also affected by the level of IPR protection (Falvey et al., 2006). Overall, this brief overview of previous empirical studies shows that the strength of IPRs is indeed trade-related, and that it has a positive impact on exports in most of the listed studies. The imitative ability of a country, the size of a market, and the distinct characteristics of R&D-intensive and non-R&D-intensive products are additional features that should be kept in mind. Promoting IPRs only seems to make sense if the imitative ability in a country is high; otherwise, the market power effect will dominate trade patterns. Distinguishing between highand low-tech goods, there is no clear evidence that R&D-intensive goods are more affected by stronger IPRs.

59

The model has further limitations, such as the exclusion of tariff and non-tariff trade barriers.

54

3.3 International Trade and Intellectual Property Rights in the People’s Republic of China 3.3.1 China’s International Trade Flows Before turning to the empirical results of this study, it is appropriate to highlight some characteristics of China’s trade patterns. In the years immediately following the Communist victory after World War II and the proclamation of the People’s Republic of China in 1949, political and economic relations with other countries were limited largely to socialist states, and trade flows were heavily controlled by the government. The trading system was adapted from the Soviet Union’s and served the sole purpose of making China industrially independent. Because of governmental control and inefficiencies at the time, China incurred substantial losses within its trading system. Following the break with the Soviet Union in 1960, China had to intensify its efforts to keep the economy growing. A milestone in the economic development of the PRC was reached when Deng Xiaoping took over the leadership of the Communist Party in the late 1970s. In a reversal of the political orientation of Mao Zedong, Deng laid the foundation for the opening of the Chinese economy. In Deng’s eyes, it was vital to import advanced technologies from abroad to increase progress in industrial development. In addition to reforming the traditional trading system, special economic zones (SEZs) were established and the first joint venture law was introduced. Additionally, foreign trading authorities were decentralized, direct import subsidies were reduced and exchange rates were adjusted (Lardy, 1992). At the beginning, almost the entirety of Chinese trade was controlled by state-run trade corporations. After trade plans and import and export controls were lifted in the 1980s, China’s share of world trade surged and then continued to grow steadily.60 Furthermore, the availability of foreign exchange brought further relief for local governments and enterprises dealing with imports (Cerra and Dayal-Gulati, 1999).61 Last but not least, the sustainable trade

60

For example, in 1984 only 40% of Chinese exports fell outside mandatory trade plans or were assigned as value targets to the provinces (Cerra and Dayal-Gulati, 1999).

61

Previously, foreign exchange had been transferred to the central government and reallocated according to the central plan.

55 reforms and the lowering of tariffs laid a solid foundation for lasting trade development.62 Figure 3.1 displays the large increase in Chinese imports and exports, beginning in the early 1990s. However, the reforms have affected not only the total trade volume, but also the composition of imports and exports. The changes in China’s imports across industries show distinct characteristics. The share of processing imports increased from about 35% in the early 1990s to 50% in 1997. This trend can be seen as an indication of increased vertical specialization of production within the PRC (Rumbaugh and Blancher, 2004; Li, 2005).

Imports

Exports

100

Trade Flows (Bn. USD)

80

60

40

20

0 1992

1994

1996

1998

2000

2002

2004

2006

Reporting Year

Figure 3.1: Chinese import and export flows.63

62

Import tariffs of over 50% in the early 1980s were lowered to an average of 12% in 2002 (Rumbaugh and Blancher, 2004). Weiss (2005) reported comparable figures for import tariffs on manufactures, which fell from 47% in 1992 to 13% in 2001.

63

Source: OECD Main Economic Indicators 2007: http://stats.oecd.org/wbos/Default.aspx?usercontext=sourceoecd, latest visit on July 6th, 2008. These figures represent aggregated trade data and are not equivalent to the data used in the empirical chapter in this study.

56 Many of the economic reforms can be attributed to China’s WTO accession. The first negotiations regarding the WTO started when China expressed its wish to resume its status as a GATT contracting party in 1986.64 The obligations that came with China’s WTO accession, like those for any other country, are based on the WTO principles of trade. These five principles are: (1) non-discrimination of trading partners, (2) the lowering of trade barriers, (3) predictability through binding and transparency, (4) promotion of fair competition, and (5) encouragement of economic reforms in less developed countries. After almost 15 years of negotiations, a legal text of about 900 pages set out the terms of China’s WTO membership. In addition to very specific legal details, there are general obligations, the most important of which are listed here. Consistent with WTO principles, China committed itself to treating all foreign individuals and enterprises, independent of their investing or being registered in the PRC, like Chinese enterprises in terms of their right to trade. Additionally, China agreed to eliminate the dual pricing system for goods that are produced for sale in China versus those produced for export. Furthermore, China will not use price controls to protect the Chinese economy. Another obligation is that the Chinese government must align existing domestic law and enact new legislation to remain in compliance with WTO specifications. Moreover, the right to import and export all goods and trade them throughout the customs territory will be accorded to all companies three years after China’s accession to the WTO. Finally, the PRC committed to not maintain or introduce export subsidies on agricultural products. With regard to intellectual property, China agreed to implement TRIPS without restrictions, starting from the date of accession. In return, China was permitted to reserve certain rights, such as the state trading for specific products and commodities. To facilitate a smooth transition, a special transition safeguard mechanism is to be maintained for twelve years to avoid disruptions in certain industries of WTO members caused by imports from China. Concerning potential disputes, any restrictions against the PRC must be phased out or negotiated between China and the other members (WTO, 2001). Taking these extensive obligations into account, the PRC has already made substantial progress in implementing many of these requirements. The lowering of tariffs, the reduction of import licenses and the corresponding increase of import quotas can definitely be seen as successes that have contributed to the intensification of Chinese

64

China was one of the 23 original signatories of GATT in 1948 but after China’s revolution in 1949, Taiwan announced China’s GATT exit. The Chinese government in Beijing itself never recognized this withdrawal decision (WTO, 2001).

57 trade flows. Nonetheless, there remain areas that are still not in line with the WTO agreement or need further clarification.65 The positive effect of lowering tariffs was simultaneously offset by the introduction of subtle new barriers to imports.66 With regard to IPRs, a solid legal foundation was laid for the protection of intellectual property, but the enforcement of these rights remains in question (EUCCC, 2005).

3.3.2 Intellectual Property Rights in China In light of the WTO negotiations and since China’s accession in 2001, IPRs have emerged as a crucial issue in contemporary China. Large-scale counterfeiting, China’s distinct cultural roots and discussions on compliance with international standards highlight IPRs as an extraordinary topic in the PRC. There have been numerous attempts to explain the different views on IPRs of China and other industrialized countries. An oft-cited reason can be found in Chinese cultural roots of Confucianism. According to Confucius, copying the master faithfully is the highest form of flattery (Blass, 1992), and counterfeiting is therefore often played down. In addition to this philosophical perspective, the Communist Party has also had a significant influence on the development of the Chinese IPR system. After their victory in the Civil War, the Communists made a clean sweep and invalidated all previous laws, including the first Chinese copyright and patent law. Instead, a reward system for inventions was introduced, which was based on the socialist beliefs that property rights for any invention can only belong to society and not to an individual (Yang, 2003). The establishment of a systematic IPR system began with the Open Door Policy that was proclaimed in the late 1970s. After the first IPR discussions with the US in the context of the Sino-US Trade Agreement, China became a member of the WIPO in 1980. In the same year, the PRC established the Chinese Patent Office, which was renamed and incorporated into the SIPO in 1998. In the 1980s and 1990s, many important IPR agreements were signed by the Chinese government.67 During this period, various intellectual property and copyright

65

Since its WTO accession in 2001, the People’s Republic of China has been involved as the respondent in eight dispute cases of the WTO. One dispute dealt with measures affecting the protection and enforcement of intellectual property rights. Conversely, China has also made use of this right by filing two disputes against the US.

66

The prompt introduction of the automobile component import measures in 2005 is only one example.

67

The most noteworthy IPR agreements are: Paris Convention for the Protection of Industrial Property (1985), Treaty on Intellectual Property in Respect to Integrated Circuits (1989), Madrid Agreement Concerning the

58 laws were continually amended and revised (Yang, 2003). At present, the People’s Republic of China has implemented laws for the protection of all kinds of IPRs,68 and the Decision on Intellectual Property Protection was officially announced by the National People’s Congress in 1994. Much of the progress was made through confrontation by and pressure from foreign countries, especially the US.69 Until recently, China saw the protection of IPRs mainly in the light of encouraging FDI rather than promoting domestic R&D activities (Endeshaw, 1996; Wang, 2004). Some important characteristics of Chinese patent law will be described in more detail shortly, as patent inventions are the most important IPR type in this study. In general, China meets international standards with regard to patent protection in most legal dimensions. In the PRC, inventions are only patentable if they fulfill the criteria of novelty, utility and nonobviousness of an inventive step, identical to the requirements of the EPO. In contrast to the US and similar to European and Japanese IPR standards, China follows the principle of firstto-file instead of first-to-invent. In the case of two conflicting patent applications for the same invention, first-to-file grants a patent to the applicant who first filed the invention, whereas first-to-invent favors the person or firm that first made the invention. For the definition of patent scope, China applies a single-claim approach whereby one invention should correspond only with one claim. Once a patent application is filed at the SIPO, the corresponding invention will be published eighteen months after the filing date.70 The examination of a patent begins at the applicant’s request within three years of the application date. According to Chinese patent law, applications from foreign firms or individuals must be handled by Chinese patent attorneys. Last but not least, China provides patent protection for inventions up to the international common length of 20 years (Sun, 2003).

International Registration of Marks (1989), Berne Convention for the Protection of Literary and Artistic Works (1992), Geneva Convention for the Protection of Procedures of Phonograms against Unauthorized Duplication of their Phonograms (1992), Universal Copyright Convention (1992), Patent Cooperation Treaty (1993), Budapest Treaty on International Recognition of the Deposit of Microorganism for the Purpose of Patent Procedure (1993), TRIPS (2001); see Yang and Clarke (2005). 68

The first trademark law was published in 1982, the first patent law went into force in 1984 and the copyright law was promulgated in 1991 (Wang, 2004).

69

The Special 301 and Section 301 of the US Omnibus Trade and Competitiveness Act allow US individuals and enterprises to file complaints regarding trade and investment issues. Based on such complaints, a priority watch list is derived that includes IPR activities of other countries. According to this list, US customs are privileged with rights to detain imports of goods that are infringing intellectual property rights in the US. China has been on this list a couple of times.

70

For certain exceptions, multiple claims are allowed.

59 Even though intellectual property laws in general comply with international standards, most problems arise from the weak enforcement of these rights and laws. Almost all industries and countries that hold IPRs in the PRC are affected by Chinese counterfeiting and piracy. Two thirds of all IPR-infringing imports reaching the US border have their origins in China, mainly because of lax IPR enforcement in the PRC with regard to the standards defined in Art. 41 of TRIPS. There are various reasons why China still cannot meet its obligations in this regard. First, penalties for IPR infringement are insufficient, and border controls are not efficient enough to deter pirating activities. Second, the threshold for judging IPR infringement to be a criminal act is comparably high. Only when the quantity of infringing goods reaches a certain level can criminal enforcement be applied. Furthermore, counterfeits have to be identical to protected products to constitute a criminal act, and no penalties apply if infringing products are traded, transported, stored or distributed within the PRC. Third, civil enforcement is also quite weak. Lack of resources, inexperienced judges and inefficient procedures make civil enforcement very ineffective. Finally, only a small portion of all civil judgments are executed due to numerous legal exceptions (Bender, 2006). In addition to the legal controversy, governmental reluctance to fight IPR infringement is also a crucial point. While the central government appears to have succumbed to the international pressure to support the protection of IPRs, local protectionism regularly impedes proper IPR enforcement. Local officials often believe that counterfeiting is beneficial for their local economy because it provides employment to otherwise unemployed workers (Tao, 2007); therefore, local authorities do not take legal action against counterfeiters in many cases (Maskus et al., 2005).

3.3.3 Hypothesis on Intellectual Property Rights and International Trade in China As mentioned at the beginning, a few articles have already dealt with the relationship between IPRs and trade. Nevertheless, there are several reasons to extend the present knowledge in this area. For instance, many studies have used cross-country data for only a single year. However, research questions concerning longitudinal development cannot be observed with such a dataset (Smith, 2001). In addition, many economists have focused on developed countries due to data availability issues, but most conflicts regarding IPRs arise in the context of emerging and developing countries. Moreover, Braga and Fink (2005) recommend

60 analyzing structural changes in the relationship between IPRs and trade flows from the perspective of a country that has significantly changed its IPR system at a certain point in time. Accordingly, China is a perfect choice for addressing these considerations. The first hypothesis of this study is derived from the initial work of Maskus and Penubarti (1995). According to them, there is a positive relationship between the import volume and the patent strength of an importing country. Other studies have confirmed their empirical findings, and Chapter 3.2 shows that China has made substantial progress in many IPR dimensions. Even though there are still some controversial issues, especially in the area of IPR enforcement, it can be concluded that the overall development of IPR protection in China has progressed significantly toward international standards. Therefore, the following hypothesis is proposed:

H.1: Stronger intellectual property rights in China lead to increasing exports from OECD countries to the PRC.

In light of Braga and Fink’s (2005) recommendation to observe structural changes, there are two periods when China’s IPR system changed significantly. The first important step occurred in 1993, when China joined the PCT and other important IPR agreements. The second decisive year is 2001, when China entered the WTO and had to fulfill its TRIPS obligations. In this context, the following impact is assumed:

H.2: The changes in the Chinese IPR system in 1993 and 2001 had a positive impact on OECD exports to China.

With regard to the aforementioned necessity of applying for IPRs to be entitled to defend these rights, the third hypothesis will consider the relationship between foreign patent activities and export volumes. It is assumed that innovating companies first apply for an IPR and then, in a second step, start to export a corresponding product. As described by Smith (1999), IPRs expand the market for innovating firms by ensuring exclusive rights to the

61 technologies embodied in the exported products. According to this market expansion effect, more foreign patent grants should result in a higher volume of exports to China. In this case, the following hypothesis should hold:

H.3: An increase in SIPO patent grants fielded by OECD countries leads to increasing exports of these countries to the PRC.

Nevertheless, patents, as strong IPRs, may also lead to market power for patent holding companies. Because IPRs ensure an exclusive right to protected technology, IPR holders can exercise market power over competitors (Smith, 1999). Patent applicants may raise prices for products containing the protected technology and may deter competitors from exporting products with the same technology. By establishing such technological barriers, other firms have to make an additional effort to invent around the protected technology. However, from an industry perspective, if more firms hold patents, more competing technologies will be in the market and cross-licensing will be more likely to take place. The concentration of patent holders within an industry is used to disclose the tendency and ability of foreign companies to execute market power. The market power effect of patents is captured by the final hypothesis:

H.4: An increase in the concentration of patent holding firms within an industry in China leads to a decrease of OECD exports to the PRC.

62

3.4 Modeling International Trade 3.4.1 Ricardian Trade Model A trade model must be developed that is appropriate to test the above-described hypotheses. Various theories have emerged during recent decades to explain international trade flows. One of the most popular theories is the Ricardian trade model, also known as the theory of comparative advantage.71 Ricardo’s idea can be explained by a simple example of two countries and two products.72 The manufacturing of both products requires labor as the sole production factor, and the two countries are assumed to differ in their productivity levels in producing these two goods. If country A produces one unit of product A at lower cost than does country B, and if country B produces product B at lower cost than does country A, then the allocation of resources and the benefit of trade is quite obvious. However, the economic benefit of trade is not intuitive if we imagine that country A has a higher productivity in manufacturing both products. Ricardo theoretically demonstrated that trade is even beneficial if only one country displays a comparative advantage in the production of only one good. In this situation, country A should focus on the production of the good for which it has the highest productive advantage, and country B should focus on the production of the good for which it has the lowest productive disadvantage. Ricardo’s theory can be used to explain some important characteristics of international trade with China. As mentioned in the previous chapter, China experiences a high share of processing imports as a result of its low labor costs. Accordingly, the PRC has a comparative advantage in processing goods compared to most other countries. Chinese trade flows, exports as well as imports, are therefore higher in industries requiring processing of goods. Moreover, other exporting countries will focus their economies on different industries in which they have a competitive advantage over the PRC. Another example in the context of the Ricardian 71

The theory of comparative advantage was first described by Torrens (1815); Ricardo (1821) gave a more detailed explanation. This summary of trade theories here is derived from http://internationalecon.com.

72

There is a difference between the theory of comparative advantage and the theory of absolute advantage. The latter was developed by Adam Smith and demonstrates that a country has an absolute advantage if it enjoys higher productivity in producing one good than its trading partners. In such a case, it is beneficial for this country to focus on the production of the good for which it has the absolute advantage. The theory of comparative advantage goes one step further and also explains the benefit of trade if a country has no absolute advantage at all.

63 trade model is the Chinese textile industry. The strong position of China within this industry led to a shifting of focus and reallocation of resources in industrialized countries away from this sector. Although Ricardo’s theory is inappropriate for predicting volumes of trade flows, it gives fundamental explanations for Chinese trade patterns.

3.4.2 Factor Proportion Model The Ricardian trade model assumes that the production of goods is only based on the labor factor. In contrast, the Factor Proportion Model, also named the Heckscher-Ohlin (HO) model, extends this theory by incorporating capital endowments.73 Another important feature of this theory is the variability of production technologies. Unlike Ricardo, Heckscher and Ohlin assumed that production technologies are the same for all countries. Furthermore, each industry within a country is characterized by a specific capital-labor ratio, the so-called factor proportion, and industries can therefore be described according to their labor and capital intensities. Regarding differences across countries, the capital and labor resources within an economy allow for categorization according to the differentiation between labor and capital abundant markets. Several implications can be derived from the Heckscher-Ohlin model. The most important one, the Heckscher-Ohlin theorem, claims that a capital-abundant country will export capital-intensive goods and that a labor-abundant country will export labor-intensive goods. Against the Chinese background, the Heckscher-Ohlin theorem explains why laborintensive production has steadily increased since the introduction of the Open Door Policy. A high labor supply in China and a low exploitation of this resource in the early years have led to low labor costs and low production costs for labor-intensive goods.74 Furthermore, the model shows why, in comparison to China, industrialized countries with strong capital endowments are more dominant in capital-intensive industries.

73

The Heckscher-Ohlin model is based on a publication of Eli J. Heckscher and the dissertation thesis of Bertil Ohlin.

74

Further important implications of the Heckscher-Ohlin model are the Stolper-Samuelson theorem, which explains the relationship between changes in output prices and factor price variations, the Factor-Price Equalization theorem, which describes the convergence of factor prices in free trade constellations, and the Rybzynski theorem, which addresses changes in production due to variable volume and availability of input factors.

64

3.4.3 Gravity Model In recent years, the so-called gravity model has been frequently used to estimate international trade flows. Inspired by Newton’s law, the gravity model of trade considers the gravitational pull between economic masses. The economic concept emerged in the 1960s and 1970s, foremost in the work of Tinbergen (1962) and Anderson (1979), and was elaborated by economists like Bergstrand (1985) who provided further theoretical explanations.75 According to Bergstrand (1989), the general gravity equation can be expressed in the following way:

PXij E 0 (Yi ) E1 (Yj ) E2 (Dij ) E3 (Aij ) E4 H ij

(1)

where PXij is the value of trade flow from country i to country j. Following the law of physical gravitation, Yi and Yj represent the economic masses of countries i and j, and the distance between the economic centers of the countries i and j is represented by Dij. The remaining independent variable Aij accounts for all factors that encourage or inhibit trade, and

H ij completes the model as a log-normally distributed error term. The multiplicative form of the gravity model allows for transformation of the equation by logs to produce a linear function:

ln PX ij

E 0  E1 ln(Yi )  E 2 ln(Yj )  E 3 ln(D ij )  E 4 ln(A ij )  ln H ij

(2)

The economic masses are typically measured as the gross domestic products (GDPs) of countries i and j. However, problems arise when one simply uses total GDP data. One issue is that imports and exports are already included in the GDP of a country. Some economists have tried to solve this problem by using instrumental variables, such as GDP per capita, or by incorporating the population size into the gravity model. Regarding the spatial proximity of 75

See Head (2003) for a basic introduction to the gravity model.

65 markets, the distance between countries is commonly measured by the greater circle distance between the economic centers (this can be the capital city or the geographic center of a country), but the explanatory power of this variable is limited. The greater circle distance measures the shortest distance on the globe, which seems accurate for the transportation of goods by air. However, the largest share of world trade falls into the category of seaborne trade because of comparably lower transportation costs, making this measure an inaccurate representation of trade distance.76 Indeed, there are additional aspects that affect bilateral trade. The remoteness of markets, as well as common languages and common borders between trading partners, have emerged as additional relevant factors for bilateral trade flows. While taxes on imports or non-tariff barriers impede the frictionless exchange of goods, belonging to free trade agreements commonly facilitates trade among the member countries. There are different ways to incorporate such parameters into econometric models. Earnings from taxes for dutiable imports or the black market exchange premia are only two factors that cover trade distortions caused by economic policies. In addition to using the standard gravity model, some economists also apply the Helpman-Krugman model, a comparable trade model that allows the estimation of trade volumes and composition. Helpman and Krugman (1985) take the fundamentals of the Heckscher-Ohlin model and expand the theory using features such as scale effects, variable returns, and country size. Based on this brief introduction to the gravity model, adaptations are made in the next chapters for the specific analysis of trade flows to China.

76

The common sea route from Iceland to China, for example, is about 40% longer than the greater circle distance.

66

3.5 Research Design and Data Description 3.5.1 Data Sources The data for this study were taken from various sources. There are several international institutions such as the International Monetary Fund (IMF), the OECD, the United Nations (UN), and the World Bank that provide macroeconomic data for different countries and periods. However, identical variables from different sources are not always consistent because they use different data inquiry and calculation methods. It is therefore important to use the sources of data that are most suitable for a given study. With regard to international trade data, there are two major data providers. The OECD and the IMF report trade data for a broad set of countries and industries. Due to their country coverage, the concordance opportunities between the International Patent Classification (IPC) and the International Standard Industrial Classification (ISIC), the available time period and the industry classification, the Bilateral Trade Database (part of the OECD International Trade by Commodity Statistics (ITCS) database) was chosen for the following analysis.77 Data for the determination of economic mass were taken from the World Economic Outlook Database of the IMF. The IMF offers data on GDP, GDP per capita, and population size, which represent baseline variables for the gravity model. Distances between capital cities were obtained from Kristian Skrede Gleditsch of the Department of Government at the University of Essex.78 The Ginarte-Park index was applied to measure the strength of IPRs in China. The respective data and information for this index were provided on a five-yearly basis by Walter Park. However, for this study, the index was separately recalculated on a yearly basis in order to derive more accurate data over the observed period of time. All patent data, such as SIPO patent grants and the concentration of patent applicants within an industry, were extracted from the Worldwide Patent Statistical Database (PATSTAT) of the European Patent

77

The IMF datasets cover more countries over a longer period of time, but the 30 OECD countries in this study are responsible for most IPR activities in the world.

78

See http://privatewww.essex.ac.uk/~ksg/data-5.html, latest visit on May 22nd, 2009.

67 Office. By combining all data sources, it was possible to construct a dataset with 30 exporting countries for the period from 1990 to 2002 across 18 industries.79

3.5.2 Variables For the analysis of the different effects of IPRs on exports to China, the following variables were incorporated in the later-described gravity models: Export value. Within the OECD, the 30 declaring countries report data on the monetary

value of imports and exports. For each declaring country, the trade flows are recorded for 61 partner countries and for geographic regions and institutional groups. In addition, the data are split by industry according to the ISIC classification. The value of trade is presented in thousands of US dollars at current prices. Gross domestic product per capita (GDP). The economic sizes of the exporting countries

and China are defined by the GDP and GDP per capita. The GDP represents the sum of total consumption, gross investments, and government spending, as well as the balance of trade of a country, over one year. The values provided by the IMF are measured in thousands of US dollars at current prices. The GDP per capita is calculated as the GDP of a country divided by population size. Population. Another parameter for the economic mass of exporting countries and the PRC is

population size. This is measured in thousands of people on a yearly basis. Distance. The distance between two countries is calculated using the greater circle distance

formula and is reported in kilometers. The end points of the greater circle distance are the latitude and longitude of the capital cities of each country. IPR strength. The strength of IPRs in China is measured using the Ginarte-Park index; a

numeric value is assigned on a five-score scale, with five representing perfect protection for patents and zero representing the weakest possible IPR regime. The IPR strength index covers five categories of Chinese patent law: (1) the coverage of patent law, (2) the duration of patent protection, (3) the enforcement mechanism, (4) affiliation with international treaties, and (5)

79

The Appendix provides detailed information on the coverage of countries and industries associated with this study (Table A.3 and Table A.4).

68 restrictions of patent rights. The Ginarte-Park index is only available on a five-yearly basis from 1960 to 2005, and was therefore recalculated on a yearly basis for the period between 1990 and 2002 (Ginarte and Park, 1997). Time dummies for 1993/2001. The years 1993 and 2001 represent the dates when Chinese

patent law underwent significant changes. Two binary variables were introduced indicating whether an observation belongs to the period before or after these two years to address the stepwise development of the Chinese IPR system. SIPO patent grants. All SIPO patent grants were extracted from the PATSTAT database,

which includes foreign and domestic applications. Each patent contains information on the applicant and the applicant’s country of residence. In addition, each patent is classified using the IPC classification as belonging to a different technological area. Using the applicant’s country code, the application date, the publication kind code and an industry concordance table for concordance between the IPC and ISIC classifications,80 the annual number of SIPO patent grants for each exporting country and industry was computed. Concentration of patent applicants. The concentration of patent applicants within an

industry was derived from the previously described SIPO patent grants and the corresponding patent applicant information. The Herfindahl-Hirschman index was used to measure the concentration of patent applicants based on the number of SIPO patent grants of each applicant and the total number of applicants in an industry and year. If a patent was assigned to more than one IPC and ISIC class, or if a patent belonged to more than one applicant, fractional counts were used to avoid double counts (e.g., a patent belonging to two ISIC classes was counted as a half-patent in each industry). The concentration of patent applicants was computed using the following equation (3):

PACait

80

§ PAait · ¨¨ ¸¸ ¦ a 1 © PSit ¹ n

2

(3)

The École Polytechnique Fédérale de Lausanne provides special concordance tables between IPC classes and standard industry classifications for the PATSTAT dataset. See http://wiki.epfl.ch/patstat/sector, latest visit on March 9th, 2008.

69 where PACait is the concentration of patent applicants in industry i in year t. PAait represents the sum of all patent grants that applicant a holds in industry i in year t, and PSit is the total number of patent grants in industry i in year t.

3.5.3 Descriptive Statistics In the following, descriptive statistics will provide valuable insights into the international trade flows and patenting activities of foreign applicants in the PRC. Figure 3.2 displays the development of manufacturing exports among the major OECD declaring countries to China from 1990 to 2002.81 USA

Japan

Korea

Germany

Others

40

Export Value in Bn. US D

35 30 25 20 15 10 5 0 1990

1992

1994

1996

1998

2000

2002

Reporting Year

Figure 3.2: Value of manufacturing exports from OECD countries to China.

Overall, Japan, South Korea, Germany and the US account for more than three quarters of all OECD manufacturing exports to China within the observed period. In the early 1990s, these countries had export values at a comparable level, whereas in the late 1990s, and the new millennium, the neighboring markets of Japan and South Korea became the most

81

Data were not available for all years for the declaring OECD countries within the given period. The Appendix provides details on data availability for the different countries and years (Tables A.3 and A.4).

70 important trade partners for the PRC. The overall export value of all OECD countries to China increased almost sevenfold during these years. The manufacturing exports of OECD countries to China account, on average, for almost 90% of all OECD exports to China (exports in the areas of agriculture, mining, etc. are not counted as manufacturing exports). Figure 3.3 illustrates the share of OECD exports across the main ISIC industry classes. The largest sector is the area of Machinery and Equipment, accounting for more than one fifth of all goods exported to the PRC between 1990 and 2002. Moreover, notable changes can be discovered over time. While the share of exports in the area of Basic Metals decreased, Radio, Television and Communication Equipment continuously increased in importance. This trend reflects the industrialization and transformation of the Chinese economy and the associated decline of exports to China in the primary industry sector.

1988

2002

30.0%

20.0%

10.0%

Figure 3.3: Division of manufacturing exports across industries.

Manufacturing N.E.C., Recycling

Other Transport Equipment

Machinery and Equipment, N.E.C.

Office, Accounting and Computing Machinery Electrical Machinery and Apparatus, N.E.C. Radio, Television and Communication Equipment Medical, Precision and Optical Instruments Motor Vehicles, Trailers and SemiTrailers

Basic Metals

Fabricated Metal Products (Except Machinery and Equipment)

Other Non-Metallic Mineral Products

Rubber and Plastics Products

Chemicals and Chemical Products

Wood and Products of Wood and Cork

Pulp, Paper, Paper Products, Printing and Publishing Coke, Refined Petroleum Products and Nuclear Fuel

Textiles, Textile Products, Leather and Footwear

Food Products, Beverages and Tobacco

0.0%

71 Table 3.1 lists the baseline gravity variables of GDP per capita, population size, and greater circle distance. In terms of the average GDP per capita for the exporting countries, Luxembourg, Switzerland, and Norway emerge as the wealthiest countries, whereas Turkey and Poland belong to the least prosperous markets. In contrast, smaller states such as Ireland and the Czech Republic have the strongest growth in GDP per capita, while mature economies such as Canada, France, and Italy only grew modestly between 1990 and 2002. Also, the population size of all OECD countries rose in this period. Statistical outliers in terms of this variable are the city-state Luxembourg and the island Iceland, as both countries have less than one million citizens. All other markets can be categorized as follows: there are 9 countries with a maximum population below 10 million people, 16 countries with a population of 10 to 100 million people, and 4 countries with more than 100 million citizens. The four largest countries (measured in terms of maximum population size) are Mexico with 101 million citizens, Japan with 127 million people, the US with 288 million citizens, and China with almost 1.3 billion people. The East European countries Czech Republic, Poland, and Italy are the slowest-growing states, while Mexico turned out to be the fastest growing population. The last column in Table 3.1 contains information about the distance from these OECD countries to China. Of the 30 countries, 24 capital cities have a greater circle distance to Beijing between 6,000 to 10,000 kilometers. This stems from the fact that 22 of the 30 OECD exporting countries are located within Europe. The nearest economies to the PRC are South Korea, with a distance of 959 km, and Japan, with 2,125 km. The most remote markets from the Chinese perspective are Mexico, with a distance of 12,518 km; the US, with 11,236 km; and New Zealand, with 10,691 km. The average distance between Beijing and OECD capital cities is 7,637 km.

19,907 25,557 23,502 21,301 5,100 30,754 23,965 24,048 25,327 21,397 13,129 4,354 27,376 20,568 20,446 33,350 44,087 4,567 24,110 14,306 33,555 3,554 10,640 3,676 9,489 14,747 27,681 37,751 2,745 29,435 688

Average GDP per Capita in Tho. USD 17,222 21,542 19,824 19,497 2,636 26,519 17,255 21,923 19,593 16,799 10,421 3,186 23,177 13,632 17,998 24,560 33,268 3,140 19,761 11,368 27,404 1,625 7,691 1,935 6,154 13,111 22,926 34,802 2,126 23,208 339

Minimum GDP per Capita in Tho. USD 22,761 30,170 27,314 23,659 7,401 35,132 28,042 27,179 30,861 26,719 15,486 6,548 31,261 31,394 22,403 42,076 50,970 6,434 27,207 17,929 42,526 5,185 12,349 4,544 12,258 16,693 30,850 44,804 3,175 36,311 1,132

Maximum GDP per Capita in Tho. USD

Table 3.1: Statistics for the gravity model baseline variables.

Australia Austria Belgium Canada Czech Republic Denmark Finland France Germany Great Britain Greece Hungary Iceland Ireland Italy Japan Luxembourg Mexico Netherlands New Zealand Norway Poland Portugal Slovak Republic South Korea Spain Sweden Switzerland Turkey United States China

Country 18,345 7,931 10,166 29,515 10,276 5,248 5,112 58,120 81,548 58,217 10,677 10,302 272 3,664 56,913 125,621 415 92,271 15,519 3,705 4,391 38,472 10,045 5,366 45,401 39,703 8,805 7,050 61,458 269,523 1,220,154

Average Population Size in Tho. People 17,090 7,678 9,977 27,639 10,171 5,135 4,986 56,709 78,959 57,237 10,160 10,175 256 3,506 56,694 123,438 382 83,226 14,952 3,411 4,245 38,200 9,835 5,308 42,869 38,890 8,591 6,751 55,294 250,047 1,143,330

Minimum Population Size in Tho. People 19,672 8,084 10,355 31,323 10,331 5,368 5,201 59,863 82,537 59,322 11,038 10,375 288 3,917 57,382 127,400 446 100,819 16,149 3,942 4,543 38,664 10,357 5,397 47,622 41,255 8,941 7,230 68,390 288,331 1,284,530

Maximum Population Size in Tho. People

Capital City Distance to Beijing in km 8,901 7,529 8,080 10,544 7,513 7,306 6,399 8,337 7,927 8,225 7,658 7,411 7,966 8,379 8,219 2,125 8,005 12,518 7,912 10,691 7,146 6,999 9,784 7,771 959 9,307 6,792 8,199 6,915 11,236 0

72

73 Turning to the IPR variables, the Ginarte-Park index measures the strength of Chinese patent law. As depicted in Figure 3.4, the index has a value of 1.89 in 1990 and a maximum value of 4.38 in 2002. The value of this index was constant over the periods between 1990 and 1991, between 1993 and 1998, and from 2001 onward. A major increase in the index occurred from 1991 to 1993, when China made substantial changes to its IPR system and acceded to some fundamental international IPR agreements. A minor step was made upon WTO accession in 2001, which required adherence to TRIPS.82

Ginarte-Park Index

5 4 3 2 1 0 1990

1992

1994

1996

1998

2000

2002

Year

Figure 3.4: Development of the Ginarte-Park index for the PRC.

In line with the rise in trade volumes, the number of SIPO patent grants in the exporting countries increased steadily. Figure 3.5 displays this development for the OECD countries over the mentioned period. Again, the four countries Japan, the US, Germany and South Korea account for a large share (77%) of all foreign patent grants in the corresponding manufacturing industries between 1990 and 2002. However, unlike in the export figures, some smaller countries such as the Netherlands, Switzerland, and the Scandinavian states rank significantly higher. In comparison to the export figures, the overall number of patent grants rose more steeply and increased almost tenfold.

82

Very underdeveloped countries from an IPR perspective, such as Burma or Angola do not exceed a level of 1.00. On the other hand, the US reached a ceiling score of 4.88 several years ago.

74 USA

Japan

Korea

Germany

Others

No. of Granted Patents at SIPO

16,000

12,000

8,000

4,000

0 1990

1992

1994

1996

1998

2000

2002

Patent Application Year

Figure 3.5: SIPO patent grants of exporting countries across application years.

Figure 3.6 provides insights into foreign patenting activities across industrial sectors by classifying the SIPO patent grants of the OECD countries into industries via a concordance table between IPC and ISIC data. This figure reveals a strong increase in SIPO patent grants within the area of Radio, Television and Communication Equipment and the area of Office, Accounting and Computing Machinery, each accounting for almost 20% and 15%, respectively, of all SIPO patent grants in 2002. In contrast, Chemicals and Chemical Products fell sharply from around 30% in 1990 to less than 20% in 2002. While certain levels of trade flows can be found in almost all industry sectors, as illustrated in Figure 3.3, there are some ISIC classes, such as Wood and Products of Wood and Cork or Pulp, Paper, Paper Products, Printing and Publishing, that are associated with negligible levels of patent activities by foreign applicants. This can mainly be attributed to the difference in relevance of patents according to industrial sector. There are some industries, such as Chemicals and Chemical Products that rely heavily on the protection of IPRs, whereas other sectors like those mentioned above are less driven by innovation and technological progress.

75 1990

2002

30.0%

20.0%

10.0%

Manufacturing N.E.C., Recycling

Other Transport Equipment

Machinery and Equipment, N.E.C.

Office, Accounting and Computing Machinery Electrical Machinery and Apparatus, N.E.C. Radio, Television and Communication Equipment Medical, Precision and Optical Instruments Motor Vehicles, Trailers and SemiTrailers

Basic Metals

Fabricated Metal Products (Except Machinery and Equipment)

Other Non-Metallic Mineral Products

Rubber and Plastics Products

Chemicals and Chemical Products

Wood and Products of Wood and Cork

Pulp, Paper, Paper Products, Printing and Publishing Coke, Refined Petroleum Products and Nuclear Fuel

Textiles, Textile Products, Leather and Footwear

Food Products, Beverages and Tobacco

0.0%

Figure 3.6: SIPO patent grants of exporting countries across industries.

This presentation of the descriptive statistics closes with the findings on the concentration measure of patent applicants. The Herfindahl-Hirschman index has a mean of 32.6, with a minimum of 0.5 and a maximum of 519, across all industries and years. More than 50 percent of the observations have an index lower than 11. Comparing these scores to other industry concentrations (e.g., based on market shares), these figures are seen to be quite low. Industries are commonly seen as moderately concentrated within a range from 1,000 to 1,800 and concentrated above 1,800. This distinct outcome for the concentration of patent applicants might result from the assignment of patents to multiple IPC classes and applicants. This argument will be illustrated using two simple examples. For instance, a few major car manufacturers may hold a dominant market share in the automotive industry, but there may also be numerous other automotive suppliers and companies in related industries that develop technological solutions and apply for patents in the automotive industry. Another argument could be that products are often based on more than one patented invention, and therefore that

76 an exported product can be related to several patents. Across all industries, an intensification of the concentration of patent applicants can be observed over the years. Furthermore, areas such as Chemicals and Chemical Products; Machinery and Equipment; Radio, Television and Communication Equipment belong to those industries with the lowest average concentration. In contrast, Wood and Products of Wood and Cork; Pulp, Paper, Paper Products, Printing and Publishing; Coke, Refined Petroleum Products and Nuclear Fuel represent the classes with the highest average concentrations of patent applicants. Before turning to the multivariate analysis, Table 3.2 provides information on the correlations between the gravity baseline variables. All correlation measures between export volume and the other variables are weak or modest, ranging from -0.3 to 0.4 (except for the high correlation of 0.7 for SIPO patent grants). With regard to the exporting countries, there are comparably low correlations for the GDP per capita and the other explanatory variables. The population sizes of the OECD countries have a low correlation with the greater circle distance of the capital cities and the SIPO patent grants. The Chinese GDP per capita and the population size show significant correlations with all variables (except for the population size of the OECD countries). In particular, there are strong correlations between Chinese GDP per capita, Chinese population size, and Chinese IPR strength. The remaining correlations – between the greater circle distance, the IPR index, the SIPO patent grants and the concentration of patent applicants – are in most cases significant but low.

0.160* 0.100* 0.370* 0.099* -0.308* 0.088* 0.705* -0.092*

GDP per Capita OECD

GDP per Capita China

Population OECD

Population China

Distance

IPR Strength

SIPO Patent Grants

Patent Applicants Concentration

-0.046*

0.180*

0.097*

-0.075*

0.115*

0.060*

0.111*

-*

GDP

-0.344*

0.123*

0.814*

0.000*

0.982*

0.014

-*

GDP CN

Table 3.2: Correlations of the gravity model baseline variables.

* Significance level: 5 percent.

-*

Export Value

EXP

-0.004

0.377*

0.010

0.118*

0.013

-

POP

-0.373*

0.125*

0.866*

-0.000

-

POP CN

-0.000

-0.186*

-0.000

-

DIST

-0.379*

0.103*

-

IPR

-0.096*

-

PG

-

PAC

77

78

3.6 Analysis and Results 3.6.1 Model Specification Following the previously introduced gravity model from Chapter 3.4, a similar approach was chosen for the multivariate analysis. Like in other studies, a baseline gravity model is elaborated upon and extended by those variables that are of particular interest. The baseline equation (4) contains the GDP per capita and population size of the exporting countries and China for the observed period of time and the distances between the OECD countries and the PRC as follows:83

ln EXPijt

lnE ijt  lnE jt (GDPjt )  ln E jt (POPjt )  lnE t (GDP_CN t )  ln E t (POP_CN t )  ln E j (D j )  ln H ijt

(4)

where EXPijt represents the export value to China of country j in industry sector i in year t. GDPjt is the gross domestic product per capita of country j in year t, and GDP_CNt is the gross domestic product per capita of the PRC in year t. POPjt and POP_CNt are the population sizes of the OECD countries and China, and Di is the greater circle distance between the capital city of country j and Beijing. The log-normally distributed error term is represented by Hijt. To analyze hypothesis H.1 on the effect of patent strength on exports to China, the Ginarte-Park index IPRt is added to the described model.84 For hypothesis H.2, the model is extended by two dummy variables, D1993t and D2001t, to observe the changes made to the Chinese IPR system. The amendments of Chinese patent law after 1993 and 2001 should show an increase in exports to China from OECD countries. So far, these models cover the Chinese framework for IPR protection.

83

It would have been a theoretical advantage to integrate tariff and non-tariff barriers. However, the countervailing effects of reducing tariff barriers, such as import taxes, and increasing non-tariff barriers make it difficult to incorporate such parameters into Chinese trade models.

84

As in the work by Maskus and Penubarti (1995) and Smith (1999), this index is not converted to log form.

79 For the analysis of market expansion and market power effects, the baseline equation (4) is extended by the number of SIPO patent grants PGijt and the concentration of patent applicants PACit.85 Following theory, the coefficient for the SIPO patent grants in equation (5) should be positive, whereas the concentrations of patent applicants should be negative. In contrast to the previous models, equation (5) represents the OECD perspective on exports to the Chinese market:

ln EXPijt

lnE ijt  lnE jt (GDPjt )  ln E jt (POPjt )  lnE t (GDP_CN t )  ln E t (POP_CN t )  ln E j (D j )

(5)

 ln E ijt (PG ijt )  ln E it (PAC it )  ln H ijt

Finally, equations (4) and (5) are merged to afford an overall view of the development of the Chinese IPR system and the influence of foreign patent rights on OECD export flows. With regard to gravity models, Baldwin and Taglioni (2006) pointed out some common but severe issues. The main problems described are the incorrect estimation and deflation of trade data and the ignorance of a variable gravitational term. In the case of bidirectional trade data, many studies take the log of the sum of trade flows between two countries. However, the correct method would be to average the logarithms of the two export flows between trading partners. This bias is eliminated in this study because only unidirectional trade data are analyzed. Furthermore, trade and GDP data are based on current prices in current USD, so deflation of these data is no longer necessary. Regarding the variable gravitational term, Baldwin and Taglioni suggest integrating time-varying nation dummies and time-constant country pair dummies to remove the cross-section and time-series biases. Because this study analyzes unidirectional trade flows to China, the proposal for country pair dummies could be covered by simple country dummies. Regarding time-varying nation dummies, this would mean including t u j variables, which would yield 390 dummy variables for the underlying data structure. However, the dataset at hand only contains 6,444 observations. The 390 dummy variables would consequently reduce the degrees of freedom

85

To tackle the problem of zero SIPO patent grants, the number of patent grants is augmented by one.

80 and make it difficult to interpret the results. As the data structure of this study is not comparable to the one described in Baldwin and Taglioni (2006), a smaller set of dummy variables is constructed to address the mentioned statistical concerns, and also to cover some theoretical considerations. The problem of the variable gravitational term arises because the often-assumed constant impact on trade of the baseline gravity variables such as distance or economic mass might change over time and across countries. Nevertheless, for several years and across comparable countries, the assumption that the observed variables will have a constant impact on exports should hold. Countries such as the Scandinavian states might have the same country-specific gravitational constant as these economies that show similar industry characteristics and are economically interrelated. The trade relationships of these countries to China should therefore develop in a more or less similar way. This assumption can be illustrated by an exemplary but important aspect of economic relations between OECD countries and the PRC. Double taxation treaties are fundamental agreements between countries that strengthen economic relations and facilitate trade and foreign direct investment. Taking a closer look at the double taxation treaties in China makes it apparent that many of the OECD countries signed such contracts within the limited period of four years between 1984 and 1987.86 Coming back to the countries Finland, Norway, and Sweden, we find that all three Scandinavian states signed a double taxation agreement with the PRC in 1986. Furthermore, with regard to the cross-section bias, economic agreements with China are often negotiated by groups of countries or institutions rather than individual states. The EU-China textile agreement and the opening of the Chinese NAFTA (North American Free Trade Agreement) ports in Mexico are only two examples where negotiations took place and agreements were signed on a multinational level. As this study only focuses on China, it can be assumed that many other trade-supporting or inhibiting changes between China and groups of OECD countries might have happened within defined periods of time, and that they mainly depend on the development stages of the PRC. The challenge for this study, therefore, is to find a tradeoff between controlling for the variable gravitational term for homogenous country groups and time periods and having a dataset with a reasonable number of dummy variables. As indicated above, free trade

86

A large set of double taxation agreements can be accessed via the United States Treaty Collection platform: http://untreaty.un.org, latest visit on June 9th, 2008.

81 agreements to a certain degree describe homogeneous groups of economies, and the previously mentioned years 1993 and 2001 allow for the construction of a clear set of timevarying country group dummies. In addition to the progress in the Chinese IPR system, the PRC certainly made other economic advances during these periods. For the multivariate analysis, the countries are grouped as follows: Japan & South Korea – Australia & New Zealand – North American Free Trade Agreement (NAFTA) – European Union 15 (EU15) – Other European countries. Based on the three development stages (1990-2002, 1993-2002, and 2001-2002) and the five country groups, the model will finally contain two time-period dummies (the period 1990-2002 is the reference period) and twelve time-varying country group dummies (the group of other European countries is the reference group for each development stage). This approach is not fully in line with Baldwin and Taglioni (2006) because of the stepwise character of the time dummies and the time-varying country group dummies. However, an advantage of this organization is that the main effects associated with the time dimension (the two time dummies) and the country groups (the time-varying country group dummies for the period of 1990-2002) can be observed.87 Finally, the remarks of Baldwin and Taglioni (2006) are not the only statistical weaknesses of the gravity model. In most studies, the log linear equation of the gravity model is estimated using an Ordinary Least Square (OLS) regression. However, Silva and Tenreyro (2006) emphasize that the OLS regression is a biased estimation method for constantelasticity models in general and for the gravity model in particular. The problem arises from Jensens’s inequality in the presence of heteroskedasticity.88 By applying a Monte Carlo simulation, Silva and Tenreyro compared the performance of different estimation methods and proposed the use of a Poisson Pseudo-Maximum-Likelihood (PML) estimator because it exhibits the lowest bias. To make the results of this study comparable to those of previous publications in this area, the results of the above-described models are estimated with both OLS and a Poisson PML regression.

87

The idea of incorporating country-group dummies and trade agreements into trade models can also be found in previous studies in this area. For example, Maskus and Penubarti (1995) integrated country-group dummies into their model, measuring whether developing countries are small or large markets, whereas Ferrantino (1993) clustered countries according to their international economic policies. Moreover, a detailed analysis of the effect of free-trade agreements (e.g., NAFTA, EU) on trade flows between countries was conducted by Ekholm et al. (2007).

88

Jensen’s inequality implies that Ef  X d f EX if f is a concave function and X is a random variable. The inequality also applies to logarithmic functions such as those in the gravity model.

82

3.6.2 Results Tables 3.3 and 3.4 present the results of the gravity model regressions. Both tables display the basic findings for the gravity baseline equation and the model extensions. For both estimation methods, the baseline gravity models show significant coefficients and the expected signs for GDP per capita as well as the population sizes of the OECD countries and the greater circle distance. However, the population size and GDP per capita of China are insignificant in most of the models. Including the time-varying country group dummies results in little change in the OLS and Poisson results in terms of the coefficient signs and levels of significance. Comparing the Poisson results of Models (1) and (2) with those of Silva and Tenreyro (2006) shows that the effect sizes in this study are much larger. Silva and Tenreyro (2006) point out that GDP variables commonly have coefficients near unity for OLS regressions and around 0.7 for Poisson regressions. This divergence can probably be explained by the focus on unidirectional data and the growing importance of China in the global economy during recent decades. Models (3) and (4) address the IPR changes in China. Tables 3.3 and Table 3.4 show a positive and significant impact for the years after Chinese WTO accession but varying results for the period after 1993 across all models and estimation methods. Hypothesis H.2, the relationship between changes in the Chinese IPR system and exports to China, can therefore only be supported for the economic advances after WTO accession. One reason for this outcome could be that the amendments of Chinese IPR law did not impact economic relations with other countries as strongly as expected. Nevertheless, some time-varying country group dummies have a significant influence, but in most cases, the coefficients carry negative signs. Turning to IPR strength, the OLS and Poisson results disclose a positive relationship between the Ginarte-Park index and the OECD trade flows. However, the coefficients are only significant in Model (6) of Table 3.3, and are insignificant in all other models. Therefore, hypothesis H.1 regarding the relationship between IPR strength and the OECD exports to China cannot be supported. One explanation for this unexpected finding could be the strong increase of the index in the years between 1991 and 1993, whereas the index is constant or only varies slightly during the other years. The components and weights of the Ginarte-Park index, which focuses mainly on written law and less on the enforcement of IPRs, might not be

83 that relevant for trade relations between the PRC and other economies. Another reason for this outcome could be the high correlation among the Ginarte-Park index, the Chinese GDP per capita and the Chinese population size, which causes problems in determining and separating the statistical effects of these variables in the regressions. Models (5) and (6) in Tables 3.3 and 3.4 provide information on the relationship between the OECD exports to China, the foreign SIPO patent grants, and the concentration of patent applicants. The SIPO patent grants of the OECD countries have a highly significant and positive impact in both models and for both estimation methods. Hypothesis H.3 regarding the relationship between foreign SIPO patent grants and exports to China can be supported. According to Table 3.3 and the log-log specification of the OLS models, a 1.0 percent increase in patent applications leads to a 0.3 to 0.4 percent increase in OECD exports to China. These results are in line with the interpretation of Sun (2003) that foreign patenting activities in the PRC are driven by the Chinese demand for foreign goods and the corresponding Chinese imports. With regard to the concentration of patent applicants, the coefficients carry the expected negative signs and the results are significant for the OLS and Poisson regressions. Industries with a higher concentration of patent applicants exhibit lower trade flows to China. Hypothesis H.4 regarding the relationship between the concentration of patent applicants and OECD exports can therefore be supported. These results confirm the argument of Liu et al. (2006) that foreign firms in the PRC tend to use the exclusive rights associated with patents and inhibit technological competition.89 Comparing market expansion and market power effects shows that the number of SIPO patent grants has a smaller magnitude than the countervailing and negative effect of the concentration of patent applicants. However, the two measures cannot be compared that easily. The effect of the number of SIPO patent grants is a one-unit increase in patent grants, whereas the concentration of patent applicants reflects an increasing concentration of patent holding firms and individuals based on the Herfindahl-Hirschman index. Even though both measures would properly represent the effects discussed here, it would be necessary to determine whether an additional SIPO patent grant belongs to a firm that already holds patents in a concentrated industry, or if a new market entrant, from a trade perspective, files the first patent in an undeveloped Chinese industry sector and consequently opens up the Chinese market.

89

The study by Liu et al. (2006) analyzes the patent applications of 500 foreign companies invested in China.

84 The results of the SIPO patent grants in terms of the concentration of patent applicants and the development of the Chinese IPR system lead to the conclusion that IPRs of foreign companies in China, such as patents, do expand markets while contributing to lower trade flows if the industry becomes concentrated in terms of patent applicants. Although the strength of IPR protection (measured as the Ginarte-Park index) in the PRC shows no clear impact on exports to China in this study, the positive development of the Chinese economy and the IPR regime during the observed period contributed to increasing OECD trade flows to the PRC. With regard to policy implications, it should be beneficial for China to continue promoting the protection of IPRs in the future. Even though there is evidence of a market power effect, this should not be seen as an argument against IPR protection. For the PRC, this result could even represent a chance to turn this feature into a national economic advantage if it promotes innovative and creative work by domestic companies in industries with a high concentration of foreign IPR-holding firms. In addition to tapping into industries with growth potential for Chinese firms, this could also reduce the negative market power effect caused by technologically dominant foreign MNEs.

85

ln GDP per Capita OECD ln GDP per Capita China ln Population OECD ln Population China ln Distance

Model 1 ln Export 2.621*** (0.162) -0.200 (0.337) 1.495*** (0.059) 22.626*** (3.901) -1.462*** (0.121)

Period (1993-2002) Period (2001-2002) IPR Strength

Model 2 ln Export 2.624*** (0.162) -0.459 (0.341) 1.495*** (0.059) 22.038*** (4.056) -1.461*** (0.121) 0.225 (0.145) 0.243*** (0.083)

Model 3 ln Export 2.650*** (0.180) -0.411 (0.337) 1.625*** (0.075) 21.647*** (3.994) -4.554*** (0.335) 0.405** (0.192) 0.983*** (0.134)

Model 4 ln Export 2.651*** (0.181) -0.403 (0.332) 1.625*** (0.075) 21.379*** (4.818) -4.555*** (0.336) 0.393** (0.175) 0.981*** (0.127) 0.017 (0.094)

ln Patent Grants ln Patent Applicants Conc. NAFTA (1990-2002) EU15 (1990-2002) JPN & KOR (1990-2002) AUS & NZL (1990-2002) NAFTA (1993-2002) EU15 (1993-2002) JPN & KOR (1993-2002) AUS & NZL (1993-2002) NAFTA (2001-2002) EU15 (2001-2002) JPN & KOR (2001-2002) AUS & NZL (2001-2002) Constant Observations R2 Clustered by Industries

0.580 0.583 (0.382) (0.382) 0.892*** 0.894*** (0.210) (0.205) -4.397*** -4.396*** (0.690) (0.685) 2.829*** 2.831*** (0.529) (0.525) 0.534* 0.531* (0.258) (0.259) -0.352** -0.355** (0.157) (0.155) -0.946*** -0.948*** (0.220) (0.223) -0.343 -0.346 (0.286) (0.281) -1.363*** -1.363*** (0.231) (0.231) -0.917*** -0.917*** (0.117) (0.117) -1.095*** -1.095*** (0.129) (0.129) -1.058*** -1.057*** (0.185) (0.185) -334.888*** -325.215*** -294.415*** -290.769*** (53.073) (55.576) (54.076) (65.877) 6,444 6,444 6,444 6,444 0.567 0.568 0.594 0.594 Yes Yes Yes Yes

Model 5 ln Export 2.121*** (0.186) -0.024 (0.380) 1.376*** (0.092) 5.691 (6.776) -4.259*** (0.326) 0.168 (0.185) 1.139*** (0.128) 0.376*** (0.068) -0.501** (0.188) 0.685* (0.381) 1.185*** (0.228) -3.894*** (0.679) 2.882*** (0.543) 0.546** (0.258) -0.457** (0.174) -1.295*** (0.257) -0.317 (0.288) -1.313*** (0.237) -0.998*** (0.111) -1.403*** (0.101) -1.140*** (0.187) -72.328 (92.403) 6,444 0.651 Yes

Robust standard errors in brackets. Significance levels: * 10 percent, ** 5 percent, *** 1 percent.

Table 3.3: OLS regression results.

Model 6 ln Export 2.123*** (0.188) 0.004 (0.375) 1.376*** (0.092) 4.766 (7.612) -4.260*** (0.327) 0.127 (0.178) 1.133*** (0.119) 0.059 (0.104) 0.376*** (0.068) -0.502** (0.188) 0.692* (0.380) 1.192*** (0.223) -3.889*** (0.674) 2.890*** (0.537) 0.538* (0.260) -0.465** (0.171) -1.301*** (0.259) -0.325 (0.282) -1.313*** (0.237) -0.998*** (0.111) -1.403*** (0.101) -1.139*** (0.187) -59.725 (104.095) 6,444 0.651 Yes

86

ln GDP per Capita OECD ln GDP per Capita China ln Population OECD ln Population China ln Distance

Model 1 Export 0.812*** (0.135) 0.499* (0.287) 0.894*** (0.069) 5.258 (4.293) -0.992*** (0.127)

Period (1993-2002) Period (2001-2002)

Model 2 Export 0.811*** (0.134) 0.206 (0.216) 0.894*** (0.069) 5.008 (4.437) -0.991*** (0.128) 0.268* (0.138) 0.202*** (0.067)

IPR Strength ln Patent Grants ln Patent Applicants Conc. NAFTA (1990-2002) EU15 (1990-2002) JPN & KOR (1990-2002) AUS & NZL (1990-2002) NAFTA (1993-2002) EU15 (1993-2002) JPN & KOR (1993-2002) AUS & NZL (1993-2002) NAFTA (2001-2002) EU15 (2001-2002) JPN & KOR (2001-2002) AUS & NZL (2001-2002) Constant Observations Clustered by Industries

-74.231 (57.876) 6,444 Yes

-69.070 (60.344) 6,444 Yes

Model 3 Export 1.459*** (0.201) 0.215 (0.222) 0.992*** (0.117) 3.997 (4.443) -2.737*** (0.246) 0.039 (0.137) 0.253*** (0.073)

Model 4 Export 1.453*** (0.200) 0.293 (0.233) 0.991*** (0.117) 2.117 (5.000) -2.731*** (0.246) -0.036 (0.108) 0.239*** (0.072) 0.102 (0.070)

Model 5 Model 6 Export Export 1.012*** 0.987*** (0.170) (0.174) 0.295 0.479* (0.255) (0.270) 0.776*** 0.769*** (0.142) (0.142) -6.832 -10.956 (6.071) (6.869) -2.305*** -2.279*** (0.328) (0.335) -0.067 -0.211 (0.172) (0.134) 0.422*** 0.399*** (0.118) (0.111) 0.210** (0.096) 0.217* 0.223** (0.111) (0.113) -0.340** -0.335** (0.133) (0.133) 0.940 0.943 0.951 0.963 (0.694) (0.693) (0.685) (0.679) 0.151 0.152 0.336 0.353 (0.282) (0.282) (0.263) (0.262) -2.608*** -2.597*** -1.901** -1.851** (0.886) (0.886) (0.813) (0.817) 0.672 0.677 0.702 0.716 (0.671) (0.670) (0.673) (0.673) -0.097 -0.098 -0.094 -0.101 (0.107) (0.107) (0.105) (0.105) 0.307** 0.308** 0.208 0.199 (0.130) (0.131) (0.151) (0.155) 0.091 0.091 -0.068 -0.076 (0.112) (0.112) (0.160) (0.164) 0.290 0.285 0.300 0.286 (0.226) (0.227) (0.226) (0.227) -0.265*** -0.264*** -0.250** -0.248** (0.101) (0.101) (0.104) (0.105) -0.041 -0.042 -0.123 -0.127 (0.094) (0.094) (0.099) (0.099) 0.066 0.066 -0.151 -0.159 (0.133) (0.133) (0.116) (0.116) -0.031 -0.032 -0.110 -0.112 (0.207) (0.207) (0.199) (0.199) -46.969 -21.426 104.066 160.138* (60.421) (67.831) (82.935) (93.785) 6,444 6,444 6,444 6,444 Yes Yes Yes Yes

Robust standard errors in brackets. Significance levels: * 10 percent, ** 5 percent, *** 1 percent.

Table 3.4: Poisson PML regression results.

87

3.7 Conclusion In recent years, many economists have reviewed the ambiguous impact of intellectual property rights on international trade flows. However, the countervailing theoretical effects of market expansion and the market power of IPRs on trade have often led to varying empirical findings. Moreover, emerging markets such as China and India are becoming increasingly important trade partners for most major economies and have often been neglected in previous research. At the same time, these countries are often accused of violating the IPRs of foreign MNEs. This work contributes to new empirical evidence of the relation between IPRs in China and export flows of OECD countries to the PRC. In addition to changes made to the Chinese IPR system and the strength of IPRs in China, SIPO patent grants of OECD countries and the concentration of patent applicants across different industries are examined. The empirical part of this study is based on an adapted gravity model of trade and different estimation methods to avoid common errors found in many previous studies. The results show a positive impact of SIPO patent grants to foreign applicants on the export volume of those countries to China. However, the empirical results also reveal a negative relationship between the concentration of patent holders within an industry and the export flows of the OECD countries to the PRC. Both results clearly confirm the theoretical assumption of a trade-inhibiting market power effect and the opposing trade-supporting market expansion effect. With regard to the strength of IPRs in China, measured according to the Ginarte-Park index, no significant results were found that might result from the model specification or the limited applicability of this index for the PRC. Nevertheless, the continuous economic development and the enhancement of the Chinese IPR system have contributed to a trade-supporting climate in China. In particular, the progress made in the context of China’s WTO accession and the adherence to the TRIPS agreement had a positive impact on OECD exports. All in all, these findings suggest that IPRs are indeed trade-related in China and that the protection of IPRs such as patents influences trade flows to the PRC. Nevertheless, this study also revealed that patents can lead to market power. The concern among developing countries that strong IPRs slow down their economic and technological progress should therefore be taken seriously. The results of this study, however, do not come without caveats. As this study only focuses on the People’s Republic of China, based on the distinctive development of this

88 country in recent years, it would be interesting to see if these findings hold true for other developing and emerging countries. Furthermore, the integration of other intellectual property rights such as trademarks or utility models could enrich the discussion of trade and IPRs. Last but not least, it should be kept in mind that exports are only one way for MNEs to serve foreign markets. Extending the discussion of trade flows and IPRs to other modes of operation in a foreign market such as FDI and technology licensing could reveal further interesting insights into the economics of IPRs in the global economy.

4. The Relationship between Foreign Direct Investments and Intellectual Property Rights in China 4.1 Introduction In recent years, China has emerged as a major recipient of foreign direct investments. Many international companies have decided to establish wholly foreign-owned enterprises or joint ventures in the People’s Republic of China, either to serve the Chinese market with their products and services or to produce goods on-site for export to third countries. The past, however, has proven that entering the Chinese market is often a challenging venture due to economic, legal and cultural differences. Multinational enterprises therefore must possess certain capabilities or assets to be able to compete with domestic firms that are more familiar with their home market and with other foreign competitors that have entered the market earlier and gained more experience (Dunning, 1980). The relation between FDIs and other economic parameters such as taxes, wage levels or different provinces in China has already been observed by various economists (see Tung and Cho, 2000; Zhao, 2001; Cheng and Kwan, 2000). Another decisive factor that is often discussed in the context of FDIs, especially in developing and emerging markets, is the protection of intellectual property rights. Patents, for example, are property rights and technological assets that allow companies to prevent competitors from applying the protected invention. This gives patent-holders a technological advantage and compensates for other drawbacks that emerge upon their entering a foreign market. Most studies in this field of research address the relation between IPRs and FDIs through theoretical models (see Grossman and Helpman, 1991; Helpman, 1993; Lai, 1998; Markusen, 2001; Glass and Saggi, 2002) on a macroeconomic level (see Ferrantino, 1993; Braga and Fink, 1998; Smarzynska Javorcik, 2004); only a few studies such as Lee and Mansfield (1996) rely on company-level data. Furthermore, most studies analyze the relation between the strength of IPRs and FDI flows. However, some companies do not hold any IPRs

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2_4, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

90 at all or rely on only one kind of IPR, such as patents or trademarks. In these cases, investment decisions and foreign subsidiaries of such firms might not be affected by tighter IPRs. In addition, other companies may develop a superior technology or build strong brands but not apply for IPRs for secrecy reasons or due to other economic considerations. However, a timely application of these rights is necessary if a firm is to be entitled to block other companies from using the protected subject matter. Especially in markets with high imitative abilities, such as the PRC, the protection of IPRs is often a crucial success factor for MNEs. For instance, companies that do not protect their trademarks in China run the risk of seeing their brands registered by another company. It can take several years to cancel a preregistered trademark and to proceed against an opponent.90 If there is a negative court ruling, market access for a foreign company’s brand might be even completely blocked. Similar problems can occur with technological inventions. Because utility models are not subject to substantive examination in China (as in other countries), someone else might apply for these rights even if an identical or similar invention is already protected by a patent or utility model in another country.91 MNEs therefore keep a close watch on the development of IPR protection and on jurisdiction over IPR infringements. The case of the Viagra patent by Pfizer Inc. is just one example that emphasizes the relevance of IPRs to the investment decisions of MNEs in the PRC. Three years after the patent for the main Viagra ingredient Sildenafil Citrate was granted, the Re-Examination Board of the State Intellectual Property Office revoked its decision in 2004 and caused a great stir in the pharmaceutical industry. Based on this case, Glaxo Smith Klein PLC has withdrawn a pending patent application for its diabetes drug Avandia that was challenged by three Chinese drug makers, and Pfizer Inc. announced that it might cut future investments in the PRC (Andrews, 2006).

90

See, for example, the case of Starbucks Coffee Co. Ltd. vs. Shanghai Xingbake Coffee Shop Co. Ltd. The translation of the name Xingbake is very close to the English brand name Starbucks (“xing” means “star” and “ba ke” is phonetically similar to “bucks”). When the US coffee retailer entered the PRC, it discovered that the trademark had already been preregistered in 1998 by the Chinese company, which was also using a similar logo. After several legal proceedings, Xingbake was finally ordered to stop using the trademark and logo and to pay damages of 500,000 RMB (Carnabuci and Oh, 2007).

91

See, for example, the case of Chint Group Corp. vs. Schneider Electric Low-Voltage (Tianjin) Co. Ltd. The Chinese electronic firm Chint sued the French competitor for infringing on its utility model, whereas Schneider referred to an earlier implementation of a patent. In 2009, the case finally resulted in a victory for Chint and an unprecedented 23 Mio. USD settlement, the largest amount ever awarded in the PRC for patent rights infringement at that time (Foley, 2009).

91 This study is one of the first to describe the necessity of applying for IPRs in China, analyzing the relation between foreign IPRs and FDI flows on a firm level. In particular, it examines the influence of SIPO patent grants and the value of technology that MNEs transfer to China on the investment behavior of the respective companies in the PRC. The empirical analysis is based on 127 German parent companies and their 155 Chinese subsidiaries (wholly foreign-owned enterprises and joint ventures) that were founded between 1990 and 2003. This unique dataset was constructed using matching company information from the German Delegation of Industry & Commerce in Shanghai with the Worldwide Statistical Patent Database (PATSTAT) of the European Patent Office. The results reveal that the number of SIPO patent grants of a German parent company has a significant positive impact on the investment volume of a Chinese subsidiary. Moreover, it turns out that the value of technology transferred by a German MNE to China has a significant negative effect on the investment volume of the Chinese subsidiary. These findings are in line with the results of a survey conducted by Mansfield (1994). Accordingly, companies are often reluctant to invest in joint ventures in a country with weak intellectual property protection. Instead, firms that possess a valuable technology seek other opportunities to serve a foreign market – exports, for example. The remainder of this study is organized as follows. Chapter 4.2 contains the theoretical background for FDIs and IPRs in general. In addition to the economics of FDIs and the influence of IPRs on FDIs, an overview of previous studies in this area is provided. Chapter 4.3 establishes the institutional background of investments in the PRC and presents previous empirical findings, especially against the Chinese background. The discussion is enriched by insights into the investment and patenting behavior within the PRC of Volkswagen and Bayer, two major German MNEs that operate in distinct industries. Based on the theoretical and institutional framework, determinants for multivariate analysis are derived. In Chapter 4.4, the findings of the empirical analysis are described. The investment and patent activities of German companies in China are presented, and a simple OLS model is developed before the findings of the multivariate analysis are discussed. A summary of the results and concluding remarks follow in Chapter 4.5.

92

4.2 Theoretical Background 4.2.1 Economics of Foreign Direct Investments Economists have long investigated cross-border movements of commodities and production factors. Most economic trade theories, however, assume perfect mobility of commodities and immobile production factors. Nonetheless, the first implications regarding companies’ decisions to become multinational originate from basic trade theories such as the HeckscherOhlin (HO) model (Mundell, 1957). In contrast to the Ricardian trade theory, the HO model considers two production factors – labor and capital – and assumes differences in labor productivity across countries. Since some countries have abundant capital and others abundant labor, the location where labor- and capital-intensive goods are produced will depend on the factor endowments of the economies. Changing factor prices and varying wage levels across markets will consequently result in shifts of production of labor- and capitalintensive goods between countries. According to the HO model, a company’s decision on where to establish production facilities depends on the production factors of the specific good to be produced and the availability of these factors in different markets. Vernon (1966) incorporates the distinction between labor- and capital-intensive goods into his product cycle model. Accordingly, capital-intensive new products are developed and first produced in advanced countries. When the product becomes more mature and standardized, its production will gradually move to less-developed countries with lower wages. Many North-South trade models pick up this differentiation between a capital- and knowledge-endowed North and a labor-abundant South.92 Caves (1971) derives further implications from the HO model by considering fully mobile factors that are industryspecific. In his model, the dependency between factors and labor causes factor price equalization, movements of industry-specific factors across countries and changes in wage levels. Product differentiation and distinct demands across countries are other aspects that are brought forward by Caves as drivers of FDIs and international trade flows. Differences in demand and, for this purpose, market-specific products leave firms with a home market advantage compared to potential foreign market entrants. FDIs, under these circumstances,

92

See, for example, Chin and Grossman (1991).

93 occur along with the development of a company. A company’s good must first reach a certain sales volume and economy of scale in the home market before it will be exported to or produced in a foreign market. A comprehensive theoretical model of the economics of FDIs is provided by Dunning’s (1980) Ownership-Location-Internalization (OLI) framework.93 The OLI theory is based on the assumption that foreign companies face some initial disadvantages compared to local companies when entering a market. Such drawbacks and additional costs may arise from, for instance, higher transportation costs when serving a country through exports, cultural gaps when negotiating with local partners or a missing business network within a foreign market. To be able to compete with local companies, foreign firms have to overcome such shortcomings with certain ownership advantages. These ownership advantages can be both tangible and intangible assets. Natural resources, skilled employees, organizational or marketing skills and know-how are just a few examples and can be supplemented by superior technology and intellectual property rights such as patents, trademarks and protected designs. Assets that are considered ownership advantages can confer a certain market power and cost advantage on MNEs and their foreign subsidiaries but do not explain why a company should prefer foreign production over serving a market by exports. In addition to ownership advantages, foreign production confers location advantages, including access to customers, lower transportation costs, tariffs and economic policies, procurement advantages and distribution networks. Only if location advantages make local production more profitable than other market entry modes will investments theoretically take place. However, in addition to the home market of a company and its most important sales markets, additional countries must also be considered as potential locations for production and global exports. When ownership and location advantages make production in a foreign market favorable, a company must decide, in the last step of the OLI framework, whether the production should be run by its own subsidiary or by a local partner. While license agreements or sales of technology and know-how to another company are easy ways to access and develop a foreign market, some companies are better off safeguarding their technological position, product quality and reputation by establishing joint ventures and wholly foreignowned enterprises.

93

For further details on the OLI framework, please refer to Dunning (1988).

94 By taking a closer look at the nature and composition of FDIs, a further differentiation can be made. The literature and theory for FDIs deal mainly with two-country models and simple production of goods, rather than other corporate activities such as R&D, sales or distribution. While some investments are only made to produce and sell final goods in a foreign country, others involve a more fragmented production process. Some companies only relocate a portion of their production processes and export intermediate goods back to their home market for final assembly of the product. These two different forms of investments are commonly called horizontal investments when the same lines of products are produced abroad as in the home market and vertical investments if input factors are produced abroad for a production process in another market.94 By expanding the theory of two-country models, more complex investment constellations emerge. Ekholm et al. (2007), for example, categorize investments into third-country export-platform FDIs, global export-platform FDIs and home-country export-platform FDIs. The third-country export-platform category represents production for exports to third countries, while the global export-platform also comprises exports back to the home market. The home-country export-platform typically refers to vertical investments, as described above. These differentiations are important for answering the frequently asked question of whether FDIs and trade are complements or substitutes. On the one hand, FDIs can be seen as substitutes for exports to a foreign country in the case of horizontal investments. On the other hand, the production of intermediate products and the export of these goods may complement trade if investments are of a vertical nature. In addition to these basic distinctions, further economic parameters complicate the relationship between trade and FDIs. Tariff barriers, for instance, hamper exports to foreign countries and therefore make FDIs more favorable because locally-produced goods are not affected by these restrictions (Mundell, 1957). In a broader context, FDIs may also demonstrate agglomeration effects. If two companies are both serving a foreign market by exports and one company switches to a local production mode due to cost advantages, the other firm might be forced to react in the same way to stay competitive (Saggi, 2000).

94

According to Markusen (1995) and Brainard (1993), most foreign production investments are horizontal and serve the purpose of selling products in a foreign market.

95 Besides the determinants that facilitate FDIs, some studies have observed the economic development of capital-lending and capital-borrowing countries. In particular, developing countries are often skeptical of providing market access to foreign companies. A common concern of these countries is the domination of their markets and comparably underdeveloped companies by technologically superior MNEs and their IPRs. However, the past decades have shown that emerging and developing markets’ access to foreign capital and technology depends to a large degree on their integration into the global economy and their openness to foreign firms. Borensztein et al. (1998) verify empirically the positive impact of FDIs on economic growth in developing countries. One major outcome of the study is that the effect of FDIs on economic growth depends on the absorptive capacity of human capital within a developing country. Furthermore, their findings reveal that FDIs are a better stimulus for economic development than local investments, but in general, only scant evidence exists regarding the complementary effects of FDIs and local investments. While most studies find comparable results regarding the positive impact of FDIs on economic growth,95 some observers doubt the veracity of this relationship. Rodriguez and Rodrik (2000), for example, argue that MNEs do not stimulate economic growth in a foreign country. They instead believe that MNEs invest in regions with fast economic growth, arguing for a reversed direction of causality from the assumption made in studies such as Borensztein et al. (1998).

4.2.2 Foreign Direct Investments and Intellectual Property Rights The relationship between IPRs and FDIs has already been briefly touched upon in the context of the OLI framework. As described, MNEs must possess ownership advantages to compete with local companies in a foreign market. Dunning (1988) distinguishes between two types of ownership advantages: asset and transaction advantages. While the first category applies if firms hold proprietary assets, transaction advantages represent the ability of enterprises to leverage transactional benefits and to lower transaction costs due to their organizational structure and operations within their company network (e.g., by shifting assets between company entities).

95

See, for example, Dees (1998) for a comparable study regarding China.

96 IPRs, such as patents, utility models, trademarks and registered designs, obviously fall into the first category of asset advantages. However, maintaining a competitive advantage based on a superior technology, a strong brand or a unique design cannot be taken for granted. According to Braga and Fink (1998), in the absence of IPRs, knowledge would be available free of charge to all companies within an industry due to its nature as a quasi-public good. Based on this assumption, there would be no incentive for companies to invest in R&D as they would not be able to recoup their expenditures if competitors could simply copy a new technology. IPRs therefore allow companies to exercise exclusive property rights within selected markets. According to Dunning (1988), such rights entail structural market distortions because competitors can be prevented from producing products with the protected technology, trademark or design. Against the background of the OLI framework, IPRs confer ownership advantages upon the holder of such rights that enable it to compete with local firms in markets where these rights are effective. The international success of many companies does not, however, rely only on one of the two types of ownership advantages. Asset and transactional advantages are often interrelated, which also applies for technology and know-how. In many theoretical models, knowledge is ascribed the character of a non-rival good. Products or services that contain a certain technology can be manufactured simultaneously at different locations and by different agents (Romer, 1990). Accordingly, MNEs can leverage economies of scope through multi-plant production and can spread their R&D investments across several production facilities (Markusen, 1984). Apart from this theoretical consideration, the transfer of knowledge can also be costly. Following Teece (1977), technology transfer not only comprises physical items, but also requires information that is necessary to handle a technology properly.96 This specific knowledge of how to apply a certain technology within a company instead belongs to the category of transactional advantages. Both the non-rival character of knowledge and the costs of transferring technology are important parameters that firms have to consider when planning production in different locations. When deciding how to serve a foreign market, companies must assess whether to export goods, invest in a local plant or license their technology to a third party. In this regard, protected technology shows some advantages over unprotected technology. Technology that 96

Teece (1977) highlights that technology transfer to government enterprises in centrally-planned economies involves substantial extra costs, which is of particular relevance for communist countries like China.

97 is protected under IPR laws may already have been published, for example, when patent documents are opened to public access. Hence, it is easier for companies to negotiate with potential licensees about a documented invention because an infringement of the respective IPRs can legally be prevented. Regarding trade secrets, MNEs face a higher risk because they have to disclose sensitive information that is not protected under IPR laws to a third party.97 Furthermore, an innovating firm and a potential licensee each possess different information about the undisclosed technology of a trade secret, its applicability in products and the respective market demands in different countries. This asymmetry of information causes problems when negotiating about a protected technology and more so in the case of unprotected technology. Moreover, if a company arrives at a decision to license a technology to another firm, agreements have to be signed and enforced, and the problem of incomplete contracts arises, especially for complex technologies that are linked to tacit knowledge. Therefore, FDIs are theoretically more likely than license agreements in industries with complex technologies, in sectors with differentiated products and when costs for technology transfer are high (Maskus, 1997). However, a problem of IPRs is that they do not necessarily result in a uniform right across all designated states in which protection is sought. The decision of a patent office in one country to grant a patent for a certain invention does not guarantee a similar examination outcome in other countries.98 Moreover, even if patents are granted in more than one country, they need not have the same technological scope. In theory, the freedom that developing countries enjoy when designing their local IPR systems allows them to set the strength and scope of intellectual property protection to a level that leads to an economic welfare optimum by balancing the supposed benefits of local imitation and the potential losses by technologically dominant MNEs (Markusen, 2001). However, in a globalizing world, the strength of IPRs in one country also affects other economies. While industrialized countries are pushing for tighter IPR laws to protect the R&D investments of their MNEs, developing countries are often lax in enforcing these rights. Developing countries, therefore, have to trade off the positive effect of FDIs as an important channel of obtaining new technologies with the negative effect of stronger IPRs, which might produce market power for foreign MNEs.

97

To lower the risk of knowledge outflow, a common procedure is to require non-disclosure agreements.

98

The biotechnology and software industries are two examples of technological areas that are treated heterogeneously at different patent offices due to distinct local patent laws.

98 The level of IPR strength and its welfare implications are theoretically analyzed by Helpman (1993) in a North-South trade model with and without FDIs. Helpman supposes that the strength of IPRs in the South is directly related to the number of products that are imitated there. According to Helpman’s assumptions,99 the South is always facing economic welfare losses from tighter IPRs in the presence of FDIs. This effect results from the monopoly power of Northern companies that consequently are able to price their goods higher. In contrast, the welfare implications for the North are a bit more complex. In the presence of FDIs, the North may gain or lose economic welfare depending on the strength of IPRs and the rate of imitation in the South. The North-South relationship is also addressed by Glass and Saggi (2002). Their analysis develops a theoretical model to observe the effects of tighter IPRs in the South on imitation, technology transfer and FDIs. Based on the assumption of two channels of technology transfer – imitation and FDIs – they conclude that a strengthening of IPRs in the South makes MNEs more secure from imitation but decreases the rate of innovation and the level of FDIs in the South. Imitation becomes more costly in the South, leading to a wasting of resources on this activity. A higher demand on labor for imitation crowds out FDIs and reduces innovative activities. Markusen (2001) develops a product cycle model for two periods with export and subsidiary modes for serving a foreign market. In the case of creating a subsidiary, a local agent is involved in the production process who can learn the technology of the MNE in the first period. In the second period, the local agent may start a rival firm based on the acquired knowledge and the MNE may cooperate with a new local agent. A strengthening of contract enforcement and IPRs in this model induces MNEs to shift from an exporting to a local production mode. This yields a welfare gain for the MNE and the foreign country. However, when a MNE already produces a good in the foreign market, tighter contract enforcement and IPRs will result in a welfare loss in the host country due to a shift of rents from the local agent to the MNE. Some economists note that the relationship between IPRs and FDIs has to be seen in a broader context. The strength and enforcement of IPRs interact with other economic parameters that affect FDIs (Braga and Fink, 1998). Preferential tax regimes and investment 99

The general transferability of Helpman’s findings is limited due to the constraints of his model, such as the assumption of an exogenous rate of new products in the North.

99 incentives are as important as determinants for FDIs as is the enforcement of IPRs. Furthermore, adjustments of only some economic factors in a developing country might not be sufficient to facilitate FDI flows. The strengthening of IPRs in transitional economies instead comes with overall economic development and policy changes. Beyond the direct economic effects, as outlined in the previous paragraphs, the protection of IPRs signals the willingness of a government to respect the rights of foreign investors and to create a stable economic framework for MNEs. Nevertheless, social and cultural aspects also matter in this context. Even if a government introduces a proper IPR system and laws, some MNEs can be deterred by the common attitudes toward intellectual property within a country (Lee and Mansfield, 1996). While laws for IPRs, in most cases, can be promulgated or amended easily and within a short period of time, it is quite hard to change the mindset of a whole nation within a few months. This is especially an issue for rapidly developing countries like China. The relevance of and relationship between IPRs and FDIs also vary across industries. While some sectors rely heavily on the legal protection of their R&D investments, other branches do not depend on IPRs at all. Trademarks, for example, are of major importance for FDIs in service industries. For services that cannot be exported or that are less suitable for licensing, FDIs are often the only way to operate in a foreign market. In this case, companies will pay more attention to the protection of their brands and to potential infringements to safeguard their competitive advantage. Turning to industries with sequential product innovation, some companies are reluctant to bring their latest technology to markets with high imitative abilities and weak IPR laws (Mansfield, 1994).100 This stems from the fact that the transfer of outdated technology generates fewer incentives for potential imitators to infringe the respective IPRs.101

100

In this context, it can also be argued that countries with a high threat of imitation commonly share a poor level of economic development. Selling goods with outdated technology in these markets might also take place given local consumers’ lower purchasing power and the resulting lower demand for higher-priced and more innovative products.

101

This is of special importance for joint ventures, when the outflow of knowledge is hard to control.

100

4.2.3 Previous Empirical Studies on Intellectual Property Rights and Foreign Direct Investments One of the first researchers to study the influence of IPRs on trade and foreign-invested enterprises empirically was Ferrantino (1993) for the United States and its numerous trading partners. Although this analysis did not address companies’ general decision to invest abroad, the impact of a foreign country’s adherence to selected IPR agreements on US arm’s-length exports, US revenues through royalty and license fees, sales of US overseas affiliates and US exports to overseas affiliates were observed.102 Against the background of FDIs, the last two dimensions are the most relevant ones, but the results do not disclose any significant effects concerning a country’s adherence to IPR agreements. The only valid outcome with regard to FDIs and foreign subsidiaries can be found for transfer exports. US firms export more to their affiliates in countries that do not belong to IPR agreements. Ferrantino (1993) sees the reason for this in the desire of US firms to conceal the production process for the exported goods within their home market borders. On the other hand, this would mean that MNEs prefer foreign production facilities in countries that adhere to IPR agreements and respect foreign IPRs. The impact of IPR protection on US arm’s-length exports and overseas sales by US affiliates is also observed by Braga and Fink (1998). The effects of stronger IPRs are analyzed by applying a gravity model for pooled data in three manufacturing industries (chemicals and allied products, non-electrical machinery, and electrical and electronic equipment). Braga and Fink incorporate the average tariff rates in each of these industries, the language similarity between countries, a dummy variable for the countries bordering the US (Mexico and Canada), and the baseline gravity model variables of GDP, GDP per capita and geographic distance. As a measure of a country’s IPR strength, the Ginarte-Park index is integrated.103 The results for arm’s-length exports and sales by US overseas affiliates do not show a significant impact from tighter IPRs. Braga and Fink therefore extend the study to German exports and FDIs in 25 countries and four manufacturing industries (chemicals, non-electrical

102

In particular, Ferrantino (1993) observes a country’s adherence to the Paris Convention for the Protection of Industrial Property, its adherence to the Berne Convention for the Protection of Literary and Artistic Works, the overall number of memberships in three IPR agreements and the duration of patent protection.

103

The Ginarte-Park index measures a country’s conformity with international IPR standards (Ginarte and Park, 1997).

101 machinery, electrical engineering, transportation equipment). In contrast to the findings based on the US data, German exports are affected by the IPR strength in a foreign country, but no significant results are found for the German FDIs. In 1991, Mansfield (1994) conducted a survey based on a random sample of 100 major US companies in different industries. The main contribution of this study lies in its provision of the companies’ perspective because many empirical papers in this field of research rely only on macroeconomic data.104 The firms were asked whether they would make different types of foreign investments depending on their evaluation of IPR protection in sixteen developed and emerging countries. According to the respondents, there is quite a big difference in IPR protection in the countries covered by this study. On average, only two percent of the companies reported that IPR protection is too weak in Spain for them to invest, compared to 44 percent for India.105 The results vary even more at the industry level. The IPR protection in India was evaluated to be so weak that only 20 percent of the surveyed chemical companies said they would invest in Indian joint ventures with local partners. In contrast, all of the same chemical companies had essentially no IPR-related concerns for investing in Spanish joint ventures. Across all countries and for almost all investment types, the chemical industry ranked the importance of IPRs for foreign investment decisions highest, while the machinery sector exhibited the lowest scores. The investment decisions were furthermore broken down by different types of business activities (e.g., sales and distribution, R&D, etc.). Regarding the investment types, only about one out of five companies reported that IPR protection is important for investments in sales and distribution activities via affiliates in a foreign country, whereas about four out of five companies declared that IPR protection is important for foreign R&D activities. With regard to different ways of serving a foreign market, the firms were asked to evaluate whether the level of IPR protection in a country was too low to invest in joint ventures with local partners, to transfer their newest or most effective technology to a wholly owned subsidiary, and to license their newest or most effective technology to unrelated firms in a certain foreign country. The results for all three measures are highly correlated with each other. In contrast, the correlation between one

104

Mansfield (1995) extended this study to Japanese and German firms. The results are very similar to the findings outlined here.

105

This study did not explicitly cover China, but Hong Kong and Taiwan were two of the sixteen countries about which respondents were asked. Transferring the results for these two countries to the Chinese context of this study, the issue of IPR protection in Greater China in the beginning of the 1990s, when the Mansfield survey was conducted, was apparently not as problematic as it is today.

102 industry’s evaluation of the IPR strength in a particular country and another industry’s evaluation of the IPR strength within the same country is quite low. While the macroeconomic studies of Ferrantino (1993) and Braga and Fink (1998) do not reveal any significant effect of IPR strength on FDIs, Lee and Mansfield (1996) draw a different conclusion. Their dataset originated from the US Department of Commerce and covered the years between 1990 and 1992. The US FDI volume was estimated in a model containing the market size of a foreign country, one country dummy for the neighboring market of Mexico, the level of FDI stock in the previous year, the degree of industrialization in the foreign country and the market openness of a foreign country. As a measure of IPR weakness, in contrast to IPR strength in other studies, Lee and Mansfield (1996) adopt the scores of Mansfield’s survey (1994), in which companies were asked to judge the level of IPR strength in selected markets. According to the significant findings in all of their regression models, the volume of US FDIs tends to be inversely related to the weakness of IPR protection in a foreign country.106 Lee and Mansfield (1996) and Smarzynska Javorcik (2004) do not observe the effect of IPR strength only on levels of FDI flows, but also on the composition of the investments. Lee and Mansfield analyze the share of FDIs that is devoted to sales and distribution outlets, rudimentary production facilities and assembly facilities, in contrast to facilities to manufacture intermediate or final goods and R&D facilities. Their results indicate that there is a direct relationship between the share of FDIs in the first group of business activities (sales and distribution, rudimentary production facilities and assembly facilities) and the weakness of a country’s IPR system. These findings support the theoretical assumption that firms are hesitant to invest abroad and to transfer IPRs in sensitive areas of their business (facilities to manufacture intermediate or final goods and R&D facilities) to countries with low IPR standards and high imitative abilities. Regarding the composition of FDIs, Smarzynska Javorcik (2004) differentiates between IPR-sensitive and IPR-insensitive industries. Her results, however, vary depending on the measure of IPR strength used. The regression results for models with the Ginarte-Park index show a positive effect of stronger IPRs on FDIs in IPR-sensitive industries, while other

106

Lee and Mansfield (1996) report that a 10-point decrease on their 100-point scale (measuring the weakness of IPR protection in a country) for a given country results in an increase of US FDIs in this country of about 140 Mio. USD for the observed period.

103 industries are not affected by changes in the IPR strength. By applying another IPR index that also covers the IPR enforcement dimension, all industries are positively influenced by tighter IPRs.107 The study also addresses the effect of IPRs on FDIs at the project level by distinguishing between production facilities and distribution networks. Smarzynska Javorcik’s findings support her assumption that firms are more likely to invest in local production facilities than in distribution networks in countries with stronger IPRs. The results are consistent for both IPR index measures and for IPR-sensitive as well as IPR-insensitive industries. Only a few economists have explicitly discussed the relationship between IPRs and FDIs in China. Nevertheless, some papers touch on the topic in a broader Chinese context, together with other economic parameters. Wu (2000), for example, investigates the effect of IPRs and FDIs on technological development and wage levels in China. She finds that stronger IPRs expose Chinese firms to more competition from MNEs and hamper technology spillover. However, she also concludes that the technology transfer of MNEs may also encourage domestic firms to develop products with higher quality. Altogether, Wu (2000) supports the strengthening of IPRs in the PRC and considers it to be an integral part of China’s FDI policy. Another study by Maskus et al. (2005) highlights the importance of FDIs alongside domestic R&D activities for the productivity of the Chinese economy. The paper suggests a dual strategy for countries such as China to acquire new technologies from foreign firms and to enhance productivity. In addition to FDIs, technology transfer through licensing is also seen as an option for facilitating technology transfer. However, MNEs might be reluctant to license their best technologies in countries with a weak IPR regime due to a higher degree of technology disclosure to foreign firms and a higher threat of being imitated. Nonetheless, Maskus et al. (2005) believe that stronger IPRs in the PRC should support technology transfer through both channels, licensing and FDIs. Aside from such studies, the effects of IPRs on Chinese inward FDIs have so far rarely been investigated empirically in economic research, which supports the relevance of the following analysis.

107

This three-point scale index captures legislative and enforcement aspects of IPR protection and is based on the US Special 301 Watch List, which is defined by the International Intellectual Property Alliance.

104

4.3 Foreign Direct Investments and Intellectual Property Rights in China 4.3.1 Institutional Framework for Foreign Direct Investments in China Since the opening of the Chinese economy in the late 1970s, the PRC has emerged as one of the largest recipients of FDIs in the world. As illustrated in Figure 4.1, the flow of FDIs to China has increased considerably since the early 1990s. In recent years, China has emerged as one of the top three destinations for foreign-invested enterprises, alongside the US and UK. Compared to other economic indicators in China, such as GDP figures or trade volumes, the amount of FDIs grew less steadily, which may indicate the economically more complex nature of foreign investment activities.

Foreign Direct Investments (Net Inflow in Bn. USD)

100 80 60 40 20 0 1980

1985

1990

1995

2000

Year

Figure 4.1: Net inflow of foreign direct investments to China.108

108

Source: World Development Indicators (WDI) dataset of the World Bank, www.worldbank.org/data/wdi2005/index.html, latest visit on August 31st, 2009.

2005

105 With an annual inflow of more than 60 Bn. USD in recent years, FDIs play a crucial role in the Chinese economy. Although the number of employees at foreign affiliates makes up only three percent of the total employment in the PRC, the total FDI-induced workforce amounted to remarkable 24 million people in 2006 (UNCTAD, 2007). Furthermore, these jobs in developing countries are often associated with higher wage levels. Aside from providing employment to Chinese people, FDIs in China are also an important source of foreign capital for the local economy. In times of capital scarcity, MNEs may provide financial credibility to a Chinese business partner that is trying to fund certain business activities or to raise capital in the international financial markets. The tax revenues of local and central government paid by foreign MNEs are another advantage in economic welfare, as these payments account for about 10 percent of all tax revenues in China. Last but not least, FDIs serve as a vehicle to promote technological progress in the PRC (Henley et al., 1999), as already outlined in the previous chapter. Starting as a socialist and communist regime in the late 1970s, the PRC had to undergo massive economic and legal transformations and turbulences to facilitate FDI inflow in the capacity described above. A major step toward a more FDI-friendly environment was taken through the promulgation of the Law of the People’s Republic of China on Joint Ventures Using Chinese and Foreign Investment in 1979. The Chinese joint venture law marks the first legal foundation that allowed foreign companies to operate jointly with Chinese organizations in the PRC. Moreover, four special economic zones were established in 1980 along the Chinese southeast coastline in Shantou, Shenzhen, Xiamen and Zhuhai. These locations provide preferential treatment to foreign-invested enterprises, such as tax incentives that are not in effect for the rest of the PRC or for local firms. In the following years, the Chinese government gradually opened more cities and regions to foreign investors,109 and as of 1986, foreign companies were also allowed to establish wholly foreign-owned enterprises.110 At the same time, import and exchange rate restrictions on joint ventures were eased. In 1995, further regulations for foreign investments went into effect, and a regularly updated catalogue

109

In 1984, fourteen additional open coastal cities and the island of Hainan were accessible to MNEs. One year later, the economic development of the inland provinces and cities along the Yangzi-River began, and in 1990, the Pudong New Area in Shanghai was established.

110

By allowing MNEs to found wholly foreign-owned enterprises according to Art. 1 of the Provision of the State Council of the People’s Republic of China for the Encouragement of Foreign Investments, the Chinese government especially aimed to improve the investment environment and introduce advanced technology. In addition, the PRC expected an upgrade in product quality and an expansion of Chinese exports to generate foreign exchange.

106 was created that classifies industries as belonging to encouraged, permitted, restricted and prohibited areas for foreign investors (Nicolas, 2008). Currently, there are a few different types of entry modes that are feasible and relevant for foreign investors. Against the background of the following empirical analysis, the most important ones will be highlighted here. A common way for foreign enterprises to start a business in China (apart from exports) without taking the full risk of establishing a wholly foreign-owned enterprise is the joint venture. For restricted industries, joint ventures are often the only method by which MNEs can access the PRC. However, one limitation of joint ventures is that some decisions require the agreement of all partners, who do not necessarily pursue the same strategic goals.111 From a legal perspective, there are two different forms of joint ventures in China: the equity joint venture and the contractual joint venture. The equity joint venture is a company with limited liability and the status of a legal person, typically founded for long-term projects between 30 and 50 years. Profits and losses of the venture are shared in proportion to investments by the local and foreign partner, in accordance with the principles of equality and mutual benefits. Besides cash, the partners may also contribute machinery, technology or land to the investment. To enjoy economic benefits such as tax exemptions, the non-Chinese partner must hold a share of at least 25% of the registered capital. In 2006, the National Bureau of Statistics reported that almost 25% of all FDI projects were founded as equity joint ventures. Measured by the contracted value of the investment projects, equity joint ventures were responsible for 17% of the total new FDI volume in the PRC. In contrast to equity joint ventures, cooperative or contractual joint ventures are mainly founded for short-term projects. The profit, loss and risk-sharing of the partners do not have to represent the respective capital contributions. All special rights and obligations of the partners are stipulated in the joint venture contract. While foreign companies typically provide capital, technology and product and process know-how, the Chinese partners often contribute land, facilities and knowledge about the Chinese market. Furthermore, foreign companies may also hold capital shares of less than 25%. This makes the contractual joint

111

Amendments to the article on association, capital increases, capital reductions, mergers and liquidations are especially affected by this restriction. In the past, such decisions often caused trouble within Sino-foreign joint ventures, which made foreign investors more cautious about joint ventures in China (Beiten and Burkhardt, 2005).

107 venture a very flexible market entry option but at the same time complicates negotiations with potential Chinese joint venture partners. This is only one reason why the number of equity joint ventures in China is significantly higher than the number of contractual joint ventures. In 2006, contractual joint ventures only accounted for 2.5% of all FDI projects but accounted for more than 4% of newly contracted value.112 Because of foreign companies’ negative experience with joint ventures and in light of a less regulated investment regime that can be attributed to the WTO accession of the PRC, the wholly foreign-owned enterprise (WFOE) has become the dominant market entry mode in most industries in recent years. Unlike joint ventures, the WFOE does not necessarily depend on local partners, and the investment is fully provided by a foreign enterprise. The significant advantage over joint ventures is the complete management control over the company and all associated business activities. All profits but also all risks and losses, consequently belong to the foreign company. Hence, this investment type appears frequently in industries that are encouraged or that do not require a local partner. The WFOE represents a legal person and is founded as a limited liability company, as with equity joint ventures. Also, the application and legal registration procedure of a WFOE is usually faster and easier than for joint ventures. In 2006, WFOEs made up almost 73% of all new FDI projects and more than 78% of the contracted value in China. A fourth (and most inexpensive) option for a company that wishes to enter the PRC is the representative office. The representative office, however, is not a legal entity – in contrast to joint ventures and wholly foreign-owned enterprises – and no capital has to be transferred from the parent company to China. For this reason, the Chinese government only allows certain business activities for this entity type, such as market research and promotion of products and services, but prohibits the signing of contracts, billing and any investment activities. The application process is very easy because no central government approval is required. For many foreign companies, a representative office is often the first step towards a greater investment at a later stage.113

112

The higher investment volume of contractual joint ventures is largely driven by capital-intensive projects in industries like mining, public transportation and energy production.

113

There are further market entry options for foreign companies that are not described here for the sake of brevity. Other forms of market entry are especially relevant for certain industries such as the financial services business or, in the case of build-operation-transfer projects, in the energy production sector. For companies operating with multiple entities in the PRC, it is also feasible to set up a holding company as a

108

4.3.2 Previous Studies on Foreign Direct Investments in China Even though only three decades have elapsed since the opening of the PRC and the first foreign investments, a few economists have already investigated the characteristics and economic determinants of FDIs in China. The regional distribution of FDIs in China received attention in several studies. Wei et al. (1999) came to the conclusion that FDIs across the different Chinese provinces are mainly driven by international trade flows, a sufficient R&D capacity, low wage levels and high GDP growth rates. Other determinants are a preferential investment policy, an improving infrastructure and agglomeration effects. Such results help to explain why foreign FDI projects are founded in emerging coastal provinces rather than in the comparatively underdeveloped inner provinces. Other factors that are often discussed are the wage level and labor cost development in China and their relevance for FDI inflows and economic development. According to Fung et

al. (2003), a survey of the Japanese Ministry of Economy, Trade and Industry revealed that more than 40% of Japanese companies invest in China for cost reasons, whereas about 20% of the surveyed firms invest to expand their market share in the PRC. Regarding labor costs, Cheng and Kwan (2000) analyzed the relationship from a provincial perspective and disclosed that the regional wage level in China has a negative impact on FDIs. Based on micro data from an urban household survey in 1996, Zhao (2001) compared wage levels in state-owned enterprises and foreign-invested enterprises. Controlling for the educational level and work experience of Chinese workers, she found higher wage levels for skilled jobs in foreigninvested enterprises than in state-owned enterprises, while less skilled workers earned less in state-owned enterprises than in foreign companies. Cost advantages for foreign companies, however, might arise not only from low labor costs but also from tax incentives. Foreign-invested enterprises enjoy tax benefits, especially in special economic zones and open coastal cities. The corporate tax rate of about 15% in the SEZs is considerably lower than the rate that Chinese companies pay elsewhere in the PRC. Tung and Cho (2000) examined the impact of tax incentives on the inflow of FDIs in special economic zones, and evidence was found that tax incentives have contributed to attracting

joint venture or wholly foreign-owned enterprise. Furthermore, the Chinese government established a legal framework that allows mergers and acquisitions and the founding of companies limited by shares. In this context, I would like to refer to a general legal introduction to the investment options of foreign companies in China by Beiten and Burkhardt (2005).

109 FDIs because they ensure a higher after-tax return on investment. Because of the rapid development of the Chinese economy in recent decades, it is inappropriate to assume that the determinants of FDIs and other economic parameters are stable over time. Sun et al. (2002) therefore split their analysis into two periods and came to varying results. Labor costs, for example, had a positive effect on FDIs in the period between 1986 and 1991, whereas higher wages from 1992 to 1998 did not promote FDI flows. From a Chinese perspective, FDIs also affect the performance of domestic firms. Zhou

et al. (2002) revealed a positive influence of FDI flows to a certain region in the PRC on the productivity of local firms. This outcome seems to support the existence of positive externalities related to foreign-invested enterprises. For certain industries, however, the effect goes in the opposite direction, so that some local companies might even go bankrupt due to the intensified competition. To expand on the concept of this crowding-out effect, a shift of skilled personal from local firms to better-paid jobs at foreign-invested enterprises is brought forward as an argument. Another important economic aspect of FDIs in China is the acquisition of knowledge and technology. Learning effects may occur via different channels, and reverse engineering, labor turnovers and demonstration effects are common ways in which Chinese firms may directly or indirectly gain knowledge from foreign-invested companies. In this context, Cheung and Lin (2004) analyzed technology spillover from FDIs to local companies and their impact on domestic IPR applications in the PRC. Their results suggest a positive effect on protected external designs, but their findings are not significant for patent inventions and utility models.114

114

The results also reveal that the effect of local R&D personnel and investments on patent applications is generally larger than that of FDIs.

110

4.3.3 The Cases of Volkswagen and Bayer in China The cases of Volkswagen and Bayer will illustrate the specifics of FDIs and the relation between IPRs and FDIs in China on a more detailed company level. Both firms are German MNEs with strong positions in the automotive industry and the chemical and pharmaceutical industry, respectively. The companies were chosen due to their distinct industries and the differences in their operations and patenting behavior.115 Volkswagen was one of the first foreign car manufacturers that ventured into the PRC. In 1984, an initial joint venture agreement was signed for Shanghai Volkswagen Automotive, and one year later, operations first began. A second joint venture with First Automobile Works was founded in 1990. In the 1990s, the Volkswagen Santana excelled as the most-sold car in China, and Volkswagen was able to gain a remarkable market share of over 50%. One reason a car manufacturer such as Volkswagen, which typically operates in markets with fierce competition, was able to gain such a high market share was the underdeveloped state of the local Chinese automobile market, in addition to import restrictions and strong regulations necessary for foreign Original Equipment Manufacturers (OEMs) to respect to get market access. As described by Mundell (1957), FDIs and exports are substitutes under such circumstances. Foreign car manufacturers were forced to cooperate with local partners in joint ventures to be allowed to sell cars in China. Even though many restrictions on foreigninvested companies were eased after WTO accession in 2001, some barriers still exist in certain industries. In the automotive sector, for instance, lower import tariffs were replaced by non-tariff barriers. A higher tax rate is added to cars that are sold in China but are not assembled with a certain share of local components.116 Global car manufacturers, however, operate in international production networks, which allow them to react to such varying market conditions by shifting production among plants. Volkswagen, for example, also exports vehicles from Volkswagen Brazil to the PRC. This strategy is similar to the thirdcountry export-platform of Ekholm et al. (2007), as described earlier.

115

Corporate information in this chapter was obtained from different sources (annual reports, websites and discussions with industry experts).

116

See Lee et al. (1996) for more details on the local content rate.

111 Another strategic change on the part of Volkswagen occurred when the OEM began to establish local production facilities for components. Joint ventures were founded to manufacture gearboxes and transmissions, investments that fall into the category of vertical FDIs. Even though the total investment volume of Volkswagen China between 1984 and 2005 amounted to more than 6 Bn. EUR, this fact did not prevent a sharp decline in the market share, to less than 20% in recent years. There are several reasons why Volkswagen China failed to remain successful. Indeed, due to the entry of several new competitors after WTO accession by the PRC, it was unavoidable to lose market share. Nevertheless, the offered model range of Volkswagen probably also did not fit market need any longer. While models that are based on outdated technology and design, such as the Volkswagen Santana, might have been a good entry choice in the 1980s, customers’ purchasing power and level of demand have advanced. Thus, Volkswagen had to catch up and introduced several new models after competitors started to upgrade their product portfolios. The different technology levels of Volkswagen and other OEMs are reflected in their Chinese patent portfolios. Before 1997, when Volkswagen started to promote its innovations in China, the company had only applied for 14 patent applications with the SIPO. At the same time, General Motors, as a comparable competitor, had already filed twice as many patents, and Toyota had applied for 212 patents. In contrast, between 1997 and 2002, Volkswagen filed 198 patents, General Motors 10 patents and Toyota more than 600 patents with the SIPO. According to these figures, it seems obvious that Volkswagen revised its strategy so as to focus on transferring more technology to China and protecting it. However, the change was not that drastic. Figure 4.2 illustrates the development of patent applications by Volkswagen to the DPMA (German Patent and Trade Mark Office) and SIPO. Besides noting a strong increase in SIPO applications, we can also see that Volkswagen also applied for considerably more patents in Germany. The ratio of DPMA applications to SIPO applications changed from 200:1 to 25:1. Regarding the technology areas of the DPMA and SIPO applications, as depicted in Figure 4.3 and Figure 4.4, no major differences can be discovered. This indicates that Volkswagen transfers certain key inventions in each technology area to China rather than emphasizing certain technology areas. This approach seems logical given the high degree of technological complexity of cars (the technologies that are relevant for a car cannot be protected by a few patents) and because many Volkswagen China plants fall into the category of horizontal investment projects that cover the complete production process and all relevant technological components.

112

No. of Patent Applications

DPMA

SIPO

1,500

50

1,200

40

900

30

600

20

300

10

0

0 1985

1987

1989

1991

1993

1995

1997

1999

2001

Application Year

Figure 4.2: Patent applications by Volkswagen in Germany and China.

Transportation

14.5%

43.8%

3.6%

Motors MechElements

3.8%

Analysis/Measurement/ControlTechn

4.5%

Electr/Energy

7.0%

Environment MachineTools

10.6% 12.3%

Others

Figure 4.3: Patent applications by Volkswagen in Germany across technology classes.

113 25.1%

15.9%

Transportation Motors

4.8%

MechElements Environment

6.6%

SurfaceTechn MachineTools

7.9%

ChemEngineering

8.4%

21.1% 10.1%

Others

Figure 4.4: Patent applications by Volkswagen in China across technology classes.

The SIPO applications filed between 1998 and 2002 include some low-technology and market-specific inventions. For instance, Volkswagen filed a patent for a theft-proof fence that can be attached to a driver seat, which typically can be found in taxis in China but are not widespread in Europe or the US.117 Other SIPO applications refer to high-technology inventions that are filed in several countries (including PCT applications), and that receive citations from subsequent patent filings, characteristics that indicate the high value of an invention.118 A third group of patents represents inventions that are relevant for several markets. Volume car manufacturers such as Volkswagen apply a platform strategy to leverage economies of scale and scope across vehicle models and production plants. Basic components of a car, such as power trains and chassis, are often part of several models within the product range of an OEM and are produced in multiple markets.119 The protection of such inventions at the SIPO can be seen as an important technological asset of Volkswagen as it seeks to compete with other car manufacturers on a global basis and allow profitable production in China as well.

117

See SIPO Publication No. 0215102. This patent is an interesting example because the taxi fleets in cities such as Shanghai are an important sales channel for Volkswagen in China. Another characteristic of this patent is that the invention was developed by Volkswagen jointly with the joint venture partner SAIC.

118

See, for example, SIPO Publication No. 1287505 and SIPO Publication No. 1296452.

119

See, for example, SIPO Publication No. 1298356.

114 All in all, Volkswagen in China is an example of a company and of an industry that only slightly relies on the protection of technology in terms of patents. This is in line with the findings of Mansfield (1994). Compared to other sectors, the protection of technology in industries such as transportation equipment is less important. Competitors often have to invest in expensive complementary goods to make use of another company’s technology. The relation between patent protection and FDIs therefore seems to be weak, if it exists at all. Nevertheless, there is evidence that the automotive industry has more and more often promoted innovations in the PRC in recent years. The Volkswagen Lavida, for example, is a new model that has been introduced especially for the Chinese market. Moreover, between 2001 and 2005, Volkswagen planned to invest more than 1.5 Bn. EUR in the development of new vehicles for the Chinese market. It also seems that competitors such as General Motors, Ford and Toyota have become aware of the importance of transferring technology to the PRC. Toyota, for example, has applied for 26 SIPO patents since 1998 to protect its market-leading technology for electric hybrid cars; it finally established a local production facility for the hybrid vehicle Toyota Prius in cooperation with FAW in 2005.120 The protection of this technology is of special importance for Toyota in the PRC because the Chinese company BYD, one of the world’s leading manufacturers of batteries, has also entered the Chinese automotive market. Another example is Ford. In recent years, the OEM has filed several SIPO patents for hydrogen car technology, a technology that is still far from market readiness.121 Nonetheless, this could be a first step toward a promising new technology and might result in Ford’s having a Chinese production facility for hydrogen cars in the future. Unlike those in the automotive and transportation equipment industry, companies in the chemical sector rank the importance of IPR protection significantly higher, according to the survey results of Mansfield (1994). The German company Bayer is therefore another distinct case that illustrates the relation between IPRs and FDIs in the PRC. Bayer reports that its first business links to China emerged in 1882, when the company started to sell textile dyes. In the beginning of the 20th century, the chemical and pharmaceutical enterprise established its first independent companies in Shanghai, such as the Firma Friedrich Bayer & Co in 1913. After World War II, Bayer founded a trading entity in Hong Kong in 1958 to organize its Chinese business during the Mao era and opened representative offices in Beijing and Shanghai in

120

See, for example, SIPO Publication No. 1222461, SIPO Publication No. 1235106 or SIPO Publication No. 1280536.

121

See SIPO Publication No. 1488848, SIPO Publication No. 1523217 and SIPO Publication No. 1833764.

115 1986. The year 1993 marks a major milestone for Bayer, when a broad cooperation agreement with the Chinese Ministry for Chemical Industry was signed. One year later, Bayer (China) Ltd. was founded as a holding company to coordinate technology transfer and market development and to support the preparation and implementation of joint venture projects. After two more years, entities such as Bayer Health Care and Bayer Material Science were set up, and several companies in other business areas were established in the following years.122 The mentioned cooperation agreement and the foundation of the holding company particularly highlight the importance of Bayer’s technology transfer to China for subsequent investment projects. Along with the company statements by Bayer, Figure 4.5 supports this view by illustrating annual DPMA and SIPO patent applications. Until 1992, the company only filed 24 or fewer patent applications per year with the SIPO, while at the same time, the number of DPMA filings ranged between 590 and 734 annual applications. However, between 1993 and 1996, the number of SIPO applications increased sharply. Since 1997, Bayer has filed more than 182 patents in China per year, with a maximum of 280 applications in 2002. In this period, the ratio of DPMA applications to SIPO applications was three to one, which is considerably higher than in the previous example of Volkswagen in the automotive industry. Another noteworthy characteristic of these figures is the early rise of SIPO applications in 1993 compared to the later foundation dates of the first joint ventures in 1996. This supports the idea that the protection of Bayer’s technological assets in China facilitated subsequent investment projects. Moving from the company level to the product level, Figure 4.6 allows a closer look at polymer patent applications by Bayer, BASF and Dow Chemical, companies that are main competitors in this technological area. This technological field is chosen for a more detailed analysis because polymers are among the most important chemical products produced and sold in the PRC.123 The illustration reveals the strong technological position that Bayer has gained in this area. In recent years, polymer patent applications accounted for almost half of all SIPO applications of the German enterprise. Over the course of an intensified process of technology transfer, the company has established several subsidiaries related to this

122

See http://www.bayerchina.com.cn/scripts/pages/en/about_bayer/bayer_china/history/index.php, latest visit on August 26th, 2009.

123

Polymers are macromolecules that can be found in a variety of convenience products and across industries such as electronics, construction and automotives. Typical polymer derivatives are Polyethylene, Polyvinyl Chloride or Polystyrene. Similar chemical products that are manufactured by several firms often bear common brand names, like Kevlar, Styropor or Teflon.

116 technological area. In 1996, Bayer Material Science founded the Bayer Guangyi Panel Co. Ltd., producing polycarbonate panel systems, and three years later Bayer Jinling Polyurethane Co. Ltd. was introduced. In 2001, Bayer Polymers (Shanghai) Co. Ltd. was launched, and Bayer (Shanghai) Polyurethanes Co. Ltd. started business in 2003. Besides the expansion of operations in China, Bayer also emphasized the importance of IPRs by setting up the Bayer Chair for Intellectual Property Rights at Tongji University. With regard to Bayer’s competitors, we can note that Dow Chemical was filing almost the same number of SIPO patents in the area of polymers until 1998. However, between 1999 and 2002, the number of applications declined. A similar picture can be drawn for Dow’s investment behavior in China in this period. Between 1994 and 2002, the US firm only founded one entity in the PRC, the Polyurethane System House in Guangzhou in 1998. Instead, Dow obtained two plants in China through its acquisition of Union Carbide, another competitor in this technological area. Given the intensified competition in the late 1990s between Bayer, BASF and Dow Chemical, the strategies of these MNEs in China seem to support the underlying assumption of this study that investments in the PRC are driven by IPRs and technology transfer, while another way to gain market access and to increase market shares is to acquire one’s competitors.

No. of Patent Applications

DPMA

SIPO

900

300

600

200

300

100

0

0 1985

1987

1989

1991

1993

1995

1997

1999

2001

Application Year

Figure 4.5: Patent applications by Bayer in Germany and China.

117

Bayer

Dow Chemical

BASF

No. of Patent Applications

150

100

50

0 1990

1992

1994

1996

1998

2000

2002

Application Year

Figure 4.6: SIPO polymer patent applications by Bayer, BASF and Dow Chemical.

4.3.4 Determinants of Intellectual Property Rights and Foreign Direct Investments in China This chapter discusses the economic determinants of FDI flows to China, and two IPR-related hypotheses are formulated for the empirical analysis that follows. The decision of firms to invest in foreign markets is often triggered by location advantages, such as tax incentives offered by the host country. The study by Tung and Cho (2000) emphasizes the importance of lower tax rates in SEZs in attracting foreign capital. Because detailed information on tax rates for foreign companies in the PRC is often not available for economic research, the SEZs can be used as a proxy to cover this factor. The location of a foreign company in a SEZ, however, also captures other FDI-supporting aspects such as the supply of skilled labor, the availability of input factors and a preferential infrastructure. Therefore, it is assumed that SEZs are beneficial for foreign companies in general and have a positive influence on the investment volume of foreign firms in China.

118 Productivity, wage levels and labor supply are further reasons why foreign companies invest in a certain country. In the light of global competition, China is often chosen as a manufacturing site due to its low wage levels and an ample supply of labor. Such economic conditions allow MNEs to profit from cost advantages that are not available when they pursue production and operations in their home market or third countries. However, a low wage level per se does not guarantee high productivity. MNEs have to consider the varying skill level of their foreign workforce, which can, on average, be higher but may also be lower than that in their home market, especially in low-wage destinations. The output level of the workforce is therefore another dimension that affects the volume of FDIs, and MNEs will be more likely to invest in subsidiaries with a high level of productivity. Both parameters, the productivity and the size of the workforce, are considered to have a positive impact on the investment volume of foreign companies in the PRC. As outlined before, there is a variety of laws and regulations for FDIs in China. Depending on the activities planned by a foreign company in the PRC, the decision regarding how to enter the market and how to run a business is often limited. While in recent years some industries have become completely open to foreign investors, others still remain under strong governmental control and can only be accessed through cooperation with local joint venture partners. The type of legal entity and the foreign stake are two important governance dimensions for MNEs to steer a foreign subsidiary. A logical assumption would be that MNEs enterprises invest more in wholly foreign-owned enterprises and in joint ventures where they hold majority stakes because that way, they can implement decisions without involving other partners. However, large-scale investments often fall into the category of restricted investments, which complicates the prediction of a clear effect of different legal entity types and ownership structures on investment volumes. Besides the regulatory dimension, the industry in which an MNE is active in China is another decisive factor in terms of investment decisions and volume. Some investments by MNEs only serve to found sales subsidiaries, while companies in other sectors establish comprehensive production networks or even relocate R&D activities to China. It seems obvious that the establishment of production plants requires much more capital than the foundation of a lean sales subsidiary. Furthermore, investments in branches such as the financial services industry involve more equity and registered capital than is true in other service industries. In addition, some MNEs may establish multiple local entities that are vertically integrated while other foreign companies operate with multiple subsidiaries that are

119 geographically distributed to cover the Chinese market in different provinces. All in all, it is hard to anticipate how companies in a certain industry will invest more or less in one or multiple entities in the PRC. Nevertheless, supposing that MNEs in an industry make similar investment decisions, it can be assumed that belonging to a certain industry is related to the investment behavior of MNEs. Keeping in mind the rapid economic development in China, the founding date of a subsidiary in the PRC is another important feature. Firms that entered the Chinese market at an early stage faced a much higher degree of uncertainty and market risk than did those who followed, and they may consequently have been reluctant to invest extensively. The legal environment and changes over time for FDIs and IPRs are additional factors that have to be considered. The legal and regulatory framework for FDIs has developed quite uniformly during the years since the promulgation of the first joint venture law in 1979. In contrast, Chinese IPR law has advanced stepwise over the last few decades and can be classified according to three development stages: the early phase before the signing of the Patent Cooperation Treaty and other important IPR agreements in 1992 and 1993, the second phase between the early 1990s and China’s WTO accession in 2001, and the third phase after WTO accession and the adherence to TRIPS. The development of the Chinese IPR system through these stages should show a positive impact on the investment behavior of MNEs. The most important determinants of FDIs in this study are IPRs and, in particular, patent inventions. As outlined in the previous chapters, IPRs interact with FDIs in various ways, and most empirical findings suggest that stronger IPRs promote FDIs. However, from a company perspective, tighter IPR protection alone will not result in investment activities, especially if companies do not hold any IPRs. According to Dunning (1980), firms have to possess ownership advantages such as patents or trademarks, and these rights have to be granted and enforced. It is therefore assumed that MNEs that hold more SIPO patent grants will exhibit higher investment volumes in their Chinese subsidiaries. Accordingly, the following hypothesis is proposed as follows:

H.1: The more SIPO patent grants a foreign company holds in China, the higher the investment volume in the respective foreign entities.

120 The number of SIPO patent grants per se does not fully reflect the degree and composition of technology that a company brings to China. While some MNEs transfer their latest and most valuable technology to the PRC to compete with domestic and foreign companies, other firms avoid operating with their best technologies in a market with high imitative abilities and low purchasing power. According to Mansfield’s survey (1994), MNEs are often reluctant to transfer their most effective technology to foreign countries, especially to emerging markets such as India and China. It is therefore assumed that companies that transfer more valuable technologies to China will be more likely to invest in projects with a low risk of technology outflow. Such companies will prefer investments in lean sales subsidiaries rather than in large production facilities and joint ventures with Chinese cooperation partners.124 Thus, the following hypothesis regarding the value of transferred technology is proposed as follows:

H.2: The higher the value of the technology transferred to the PRC by a foreign company, the lower the investment volume for the respective foreign entities.

124

Another perspective could be that the transfer of more valuable technology is related to higher investment volumes because of the more valuable complementary assets that are required to produce the respective products abroad. The discussion in the previous chapters and the case of Volkswagen and the Chinese automotive industry, however, supports the derivation of the hypothesis as described above.

121

4.4 Empirical Analysis 4.4.1 Data on German Companies in China In the following, the relation between FDIs and IPRs will be analyzed in detail for German companies in China. The analysis is based on the German Company Directory of the Delegation of German Industry & Commerce in Shanghai, a regularly updated online database.125 In the latest version, the dataset contained 3,445 German entities in the PRC. However, the fill level of information varies across the different firm characteristics and companies. Basic information such as that regarding company names and firm locations is available for more than 99% of all entries, and the industry classification is specified for 95% of the observations. Additional firm characteristics such as the total investment volume, the annual turnover, the date of establishment, the total labor force, the export share and the German-owned share in a foreign entity have a lower filling degree, between 15% to 40%. According to Figure 4.7, the distribution of German companies across Chinese provinces looks quite similar to that indicated in the findings of previous studies and other Chinese FDI statistics.126 Investment projects can mainly be found along the coastline, and the provinces Shanghai, Beijing, Jiangsu, Guangdong and Zhejiang account for almost 80% of all entities. With 34.9%, more than every third German entity is located in Shanghai. The distribution of German FDI projects across investment types in Figure 4.8 shows a large share of wholly foreign-owned enterprises: 37.3%. In addition to information on the three main FDI types that were described before, this dataset also contains entries for representative offices and branch companies that are often omitted in other FDI statistics for the PRC. Regarding joint ventures, the equity joint venture is, for German companies, the preferred way to cooperate with local Chinese partners.

125

For the multivariate analysis, two versions of this dataset, from the years 2005 and 2009 were used to cover the largest possible number of German companies in China and additional firm characteristics.

126

Please refer to the Appendix to allow a comparison to the overall distribution of FDI projects and volumes in the PRC in 2006 across different industries, investment types, origin countries and provinces (Figures A.3-A.6).

122

<1 % 1-2 % 2-5 % 5-10 % >10 %

Figure 4.7: Distribution of German companies across Chinese provinces.

10.7%

1.0%

1.1%

Wholly Foreign-Owned Enterprise 37.3%

16.1%

Representative Office Equity Joint Venture Branch Company Contractual Joint Venture

33.8%

Others

Figure 4.8: Distribution of German companies across investment types.

123 Figure 4.9 displays a high-level industry classification for the German companies in China.127 Firms in the area of Engineering and Metal Products, a strong industrial sector in the German economy, represent the largest share of all entities. Nevertheless, the industries of Electronics, Precision Mechanics, Optics and Laboratory Technique as well as the sector Chemical Products and Health, each account for more than 10.0% of German FDI activities. With regard to the foundation date, 11.1% of the companies were established before 1993, 70.2% were established between 1993 and 2000, and 18.7% were established after China’s WTO accession.

3.9%

30.7%

29.4%

Raw Materials, Food Products and Environmental Protection Engineering and Metal Products Motor Vehicles, Rail Vehicles, Aircrafts, Ships etc. Electronics, Precision Mechanics, Optics and Laboratory Technique Construction, Energy, Water, Heating, Building Materials etc.

10.0%

Chemical Products and Health 6.2%

6.7% 13.0%

Services and Others

Figure 4.9: Distribution of German companies across industry sectors.

Turning to IPRs, Figure 4.10 illustrates the evaluation of current business challenges by German companies in China, derived from a survey of the German Chamber of Industry & Commerce in 2007. According to these results, the protection of IPRs ranks as one of the top challenges. Almost three out of four surveyed companies said that IPR protection is a problem or a major problem in China. In addition, more than half of German operations declared that they have experienced violations of their IPRs. Again, this confirms the importance of IPRs for MNEs in the PRC.

127

The industry classification within the dataset was available at a more detailed level. Against the background of the following multivariate analysis, the industries were aggregated on a higher level to allow good coverage across more and less patent-sensitive industries.

124 Figure 4.11 illustrates the number of patent applications and the number of granted German applications with the DPMA and SIPO. While German inventors and companies already filed more than 25,000 patents per year at the DPMA in the beginning of the 1990s, the numbers at the SIPO did not exceed 1,000 applications until 1993. The SIPO applications of German applicants started to increase after 1993, when China signed some major international IPR agreements and adjusted the IPR system; at the same time, the number of SIPO patent grants started to rise. The grant ratio of German patents filed at the SIPO was below 50% in 1990 and reached a level of 67% in 2000.128 Figure 4.12 provides insights into the distribution of German and non-German SIPO patent grants across technology areas. There are areas such as Organic Fine Chemistry and Engines, Pumps and Turbines, of which German companies enjoy a comparably high share, whereas in areas such as Agriculture and Food Chemistry and Audiovisual Technology, other foreign firms and Chinese firms are dominant. Again, this pattern reflects the major industrial pillars of the German economy. For instance, MNEs such as Bayer, BASF and Hoechst contribute considerably to the number of patent applications in the chemical sector. However, the inventions of the numerous medium-sized German enterprises in the area of mechanical engineering have certainly also led to a high share of patents in the industries of Engines, Pumps, Turbines; Mechanical Elements and Machine Tools.

128

Note that these figures do not equal the patent applications and grants of German companies with operations in China. However, the findings of Figure 4.11 and Figure 4.12 allow some general insights into the technologies of German companies that have relevance for the PRC.

125 Don't Know

No Problem

Problem

Major Problem

100% 29%

27%

23%

21%

20%

14%

80%

5%

4%

34%

37%

43%

60% 45%

47%

56%

53%

46%

40% 58%

5%

1%

3%

10% Non-tariff Trade Barriers

Legal Security & Compliance with Business Terms

2%

Infrastructure and Logistics

1%

Availability of Market Data

1%

42%

24%

Corruption

4%

20%

Bureaucracy & Authorities

25%

Protection of Intellectual Property Rights

0%

29%

22%

Availability of Qualified Human Resources

20%

49%

Figure 4.10: Evaluation of business challenges of German companies in China.

Patent Applications / Grants

SIPO Applications

SIPO Grants

DPMA Applications

5,000

50,000

4,000

40,000

3,000

30,000

2,000

20,000

1,000

10,000

0

0 1990

1992

1994

1996

1998

2000

2002

Application Year

Figure 4.11: German patent applications and grants at the SIPO and DPMA.

126 12.0%

8.0%

4.0%

0.0% Electr. Machinery, Electrical Energy

Telecommunica tions Information Technology Semiconductors Optics Analysis, Measurement, Control Tech. Medical Technology Nuclear Engineering

Macromolecular Chem., Polymers

German

Organic Fine Chemistry

Pharmaceuticals, Cosmetics Biotechnology Agriculture, Food Chem. Chem. & Petrol Ind., Basic Mat. Chem. Surface Technology, Coating Materials, Metallurgy Chemical Engineering Mat. Proc., Textiles, Paper Handling, Printing

Environmental Technology Machine Tools Engines, Pumps, Turbines Thermal Proc. & Appa ratus Mechanical Elements Transport Space Technology, Wea pons Consumer Goods & Equipment Civil Eng., Building, Mining

Others

Agricultural & Food Proc.

Figure 4.12: SIPO patent grants across technology areas of German and non-German applicants.

Audiovisual Technology

127

4.4.2 Variables From the described dataset, it was possible to extract 155 German joint ventures and wholly foreign-owned enterprises in China for which comprehensive firm characteristics and information were available. Other investment types, such as representative or branch offices, were excluded because those investments only allow for a very limited scope of business activities in the PRC. Based on these 155 Chinese entities, the patent activities of the 127 corresponding German parent companies in China were identified by matching the data of the German Delegation of Industry & Commerce in Shanghai with the Worldwide Statistical Patent Database (PATSTAT) by the European Patent Office.129 By combining company information with SIPO patent data, the following variables were computed:130 Total investment volume. The total investment volume (INV) of the German entities in the

PRC was provided by the German Chamber of Industry & Commerce in Shanghai in thousands of USD. In the case of observations in other currencies, the data were converted to this format using daily exchange rates from the US Federal Reserve System based on the date of foundation of an entity.131 To balance the inflation effect and to allow for a comparison of firms founded in different years, the investment volumes were deflated by the Chinese GDP deflator, which was taken from the World Economic Outlook Database of the International Monetary Fund.132

129

Note that one German parent company may invest in multiple Chinese entities. Because not all Chinese entities of each German parent company are covered within this dataset, the following analysis estimates the investment volume for each Chinese entity separately.

130

It is obvious that this sample is biased due to the limited availability of data for many observations. Nevertheless, there are some decisive reasons why these data and this approach were chosen. An alternative would have been to use data from the Deutsche Bundesbank, which provides a wide range of information on German companies in China. However, these data only have to be reported for nonresident companies if their assets exceed 3 Mio. EUR, whereas, many German subsidiaries in China do not have such a high investment volume. The dataset of the German Chamber of Industry & Commerce in Shanghai reveals that about half of the German companies in the PRC have a total investment volume of less than 3 Mio. EUR. Another argument for the approach used in this study can be found in the information within the dataset. The dataset from the German Chamber of Industry & Commerce in Shanghai also contains information on the export share of the German companies in China, information that is an important factor in the context of FDIs but that is not covered by the dataset provided by the Deutsche Bundesbank.

131

See http://www.federalreserve.gov/releases/H10, latest visit on May 26th, 2009. When exchange rates were not available because the foundation date fell during a weekend, the last available entry was chosen.

132

See http://www.imf.org/external/ns/cs.aspx?id=28, latest visit on May 26th, 2009.

128 Total labor force. As outlined before, the labor supply of the PRC is an important

determinant of many companies’ decisions to undertake business ventures in China. When deciding to invest abroad, firms already have an idea of which business activities and parts of their value chain they will transfer and how many employees they will need for their operations. The total labor force (LAB) variable is measured as the number of employees of a German entity in China. Productivity. Depending on the skill level of employees in the PRC, German subsidiaries

may exhibit a different level of productivity from their Chinese competitors, but also with regard to other foreign entities of a parent company. Thus, the annual turnover in thousands of USD divided by the number of employees is computed as a measure of productivity (PRD). To account for inflation, which also affects the annual turnover in different years, the value is deflated by the Chinese GDP deflator. Computation on an employee level avoids the incorporation of both the annual turnover and the total labor force into one model, as both measures are highly correlated. German majority stake. To address management control over foreign entities by their

German parent companies, a dummy variable was created. The dummy takes a value of one if the German parent company holds a majority stake (MAJ) in the Chinese subsidiary and zero if the German-owned share is 50 percent or below. Entity type. As different business activities of foreign companies in China are under various

types of regulation, it is necessary to control for different types of legal entities. Because contractual joint ventures are very rare, only one dummy variable was created, distinguishing between joint ventures and wholly foreign-owned enterprises. The variable has a value of one if the foreign entity was founded as a joint venture (JOV) and zero otherwise. Province. To cover the effects of different economic environments across provinces and

special economic zones, four dummy variables were introduced for the most important regions. Guangdong and Jiangsu are the provinces that mainly attract manufacturing activities, whereas investments in the cities of Beijing and Shanghai are driven by the availability of skilled labor, a developed infrastructure and the proximity to public and governmental authorities. Foundation period. Based on the foundation dates of the German-owned companies in the

PRC, the entities were divided into three groups. As discussed earlier, the development of the

129 Chinese economy in terms of IPRs and FDIs can be classified into three stages: the period before 1993, that between 1993 and 2000 and that from 2001 onward. To permit comparison to the reference period before 1993, two dummy variables were computed indicating whether the observation belongs to one of the last two mentioned periods. Industry. The German Delegation of Industry & Commerce in Shanghai uses an industry

classification that was formerly developed by the German Chamber Network to group foreign subsidiaries of German companies into different branches. However, this alphanumeric classification categorizes firms on a very detailed level into more than 100 industries. To avoid there being too many industry dummy variables in the later-described model for the small sample of German companies, the classes were aggregated on a higher level. Seven broad industries were defined representing the following areas: Raw Materials, Food Products and Environmental Protection; Engineering and Metal Products; Motor Vehicles, Parts, Accessories, Rail Vehicles, Aircrafts and Ships; Electronics, Precision Mechanics, Optics and Laboratory Technique; Construction, Energy, Water, Heating, Building Materials, etc.; Chemical Products and Health; and Other Industries and Services. Hence, six dummy variables were created, with a value of one if a subsidiary belonged to a certain industry and zero otherwise. The class of Other Industries and Services was taken as a reference industry. Wage level. Another crucial factor for FDIs in China is labor costs, which vary across

provinces and years. The National Bureau of Statistics in China provides information on the average wages in RMB on a national level before 1995 and on a provincial level afterwards. In addition to the data that were already available on a provincial level, the wage level (WAG) within the provinces before 1995 was computed by extrapolating the provincial values from 1995 down to the national level in 1990. As for the total investment volume and the productivity variable, the values were deflated by the Chinese GDP deflator. Export share. Out of these 155 firms, 94 companies also reported the export share (EXP) of

their entities in the PRC; these data were used to extend the basic regression models. The export share of a foreign entity indicates whether the engagement in a foreign country is meant to serve the local market, or if goods are produced for export to third countries. While sales subsidiaries in the Chinese market are predominantly established to expand the market share of MNEs, production for third-country exports is often a matter of production and labor costs. The variable export share is available on a percentage level with values between 0% and 100%.

130 Stock of SIPO patent grants. For the German parent companies, the number of patent grants

at the SIPO was extracted from the PATSTAT dataset. The names of the parent companies were matched manually with more than 9,000 German patent applicants in China. Because there is a time gap between the application date and the final grant date (on average 5 years), only SIPO patent grants (PAT) up to the year 2002 were included. Based on the foundation date of a Chinese subsidiary, the stock of SIPO patent grants was computed for the German parent company and the year in question. Average family size. There are different ways to measure the value of an invention and of the

related patent. A widely used indicator is the number of forward citations a patent receives from other subsequent patent filings (Trajtenberg, 1990). Unfortunately, citation measures are hard to obtain for SIPO patents and are also not included in the PATSTAT dataset. Another indicator of the value of an invention is the family size of a patent. The family size represents the number of states in which an applicant filed a patent. If patent protection for an invention is sought in more countries, previous studies have found, the associated technology is of a higher value (Harhoff et al., 2003). To estimate the value of a patent portfolio that a German company holds in China, the average family size (FAM) of a firm’s SIPO patent grant stock was computed. To determine the overall value of the Chinese patent portfolio in a German company, an interaction term was created by multiplying the average family size by the stock of SIPO patent grants, as described below in the model specification for the multivariate analysis.

4.4.3 Descriptive Statistics Table 4.1 provides an overview of the descriptive statistics for the 155 German companies in the PRC. The investment volume shows an average of 14.6 Mio. EUR within a range from 29,000 EUR to 778 Mio. EUR. While smaller investments can be attributed to medium-sized enterprises, larger projects with extensive production facilities belong to companies such as Volkswagen, Siemens, Robert Bosch and BASF. A similar picture can be drawn for the total labor force. The mean workforce of the entities amounts to 210 employees, with a maximum of 2,600 and a minimum of 2 employees. The strong variation implies that a certain number of the companies are invested in labor-intensive manufacturing activities, whereas other firms have lean subsidiaries with a different business focus. Companies in the service sector, such as Allianz, are also within the top group, employing 1,200 people. A high degree of variance

131 can also be discovered for the productivity variable. On average, each employee of the observed companies realized an annual sales volume of 2.5 Mio. EUR. However, there is a significant gap between the highest and lowest value, which might be true for different reasons. On the one hand, companies that are producing intermediate goods in the PRC might report sales volumes calculated with internal prices due to tax advantages (transfer pricing). On the other hand, lean sales subsidiaries with few employees might generate high sales volumes for imported final goods. Regarding labor costs, the wage level variable has an average of 4,640 RMB. The lowest score, 2,140 RMB, represents the PRC average in 1990, whereas the maximum, 13,153 RMB, can be discovered in Shanghai in 2003.133 With regard to IPRs, all German companies hold on average 7.0 granted SIPO patents. However, out of the 155 entities, 109 firms belong to a German parent company that did not file any patents in China. If one excludes those firms, the average stock increases to 23.6 SIPO patent grants.134 The parent company with the largest stock of SIPO patent grants before the foundation of a subsidiary was Bayer in 2000, with 309 patents. The average family size for the SIPO patent grants across all companies amounts to 2.5 countries in which protection for the respective inventions was sought, and it rises to 8.3 for those firms that hold patents in the PRC. The high average family size for the patent-holding firms suggests that the technology of many German companies is relevant not only for their home markets and the PRC but also for other foreign markets. German parent companies with high average family size can be found especially in the sector of Chemical Products and Health (e.g., Bayer, Henkel, Böhringer Ingelheim and Hoechst). On average, the companies within the sample export about one third of their goods; 61.3% of the entities are founded as joint ventures; and in 80% of cases, the German parent companies hold a majority stake in the subsidiary. According to Figure 4.13, more than 40% of the companies are located in the metropolitan centers of Beijing or Shanghai, and almost 20% are located in the province of Jiangsu. More than 80% of the companies were founded in the period between 1993 and 2000, when market entry was eased by the Chinese government. The distribution of the companies across industries in Figure 4.14 reveals a high share of subsidiaries in the sector of Engineering and Metal Products, as well as in the industry of Electronics, Precision Mechanics, Optics and Laboratory Technique.

133

Note that monetary figures are deflated.

134

The SIPO patent grants were only counted up to two years before the foundation date of a Chinese entity to avoid endogeneity, as explained in 4.4.4.

132

Variable

Mean

INV (in Tho. EUR)

Min.

Max.

Std. Dev.

14,557.38

29.27

778,195.40

65,134.24

210.32

2.00

2,600.00

347.86

PRD (in Tho. EUR)

2,504.05

0.09

24,838.26

30,2077.10

WAG (in RMB)

4,640.28

2,140.08

13,152.67

2,044.84

PAT

7.00

0.00

309.00

30.32

FAM

2.45

0.00

20.00

4.18

34.15

0.00

100.00

27.94

LAB

EXP* (in %)

* Only available for 94 companies.

Table 4.1: Descriptive statistics for German company sample. 4.5%

36.8%

Guangdong

29.0%

Shanghai Beijing Jiangsu

12.3% 17.4%

Other Provinces

Figure 4.13: Distribution of German company sample across Chinese provinces. 9.0%

3.9% 30.3%

Raw Materials, Food Products and Environmental Protection Engineering and Metal Products

16.1%

Motor Vehicles, Rail Vehicles, Aircrafts, Ships etc. Electronics, Precision Mechanics, Optics and Laboratory Technique 5.2%

Construction, Energy, Water, Heating, Building Materials etc. Chemical Products and Health

23.9%

11.6%

Services and Others

Figure 4.14: Distribution of German company sample across industries.

133

4.4.4 Model Specification To estimate investment volume among German companies in China, a basic OLS regression is applied. The model is specified as follows:

ln INVt

E 0  E1 ln LAB  E 2 ln PRD  E 3 EXP  E 4 MAJ  E 5 JOV  E 6 ln WAG  E 7 ln PATt 2  E 8 ln FAM t 2  E 9 ln PATt 2 u ln FAM t 2  ln H t

(1)

where the dependent variable INVt represents the total investment volume of a German entity founded in China in year t. LAB is the total labor force, PRD is the productivity on an employee level, and the export share of a subsidiary is denoted by EXP . Whether the German parent company holds a majority stake in an entity is expressed by MAJ . The dummy variable JOV indicates whether the company was founded as a joint venture, and WAG is the average

wage level in the province of the subsidiary in the foundation year. Finally, PATt 2 measures the stock of SIPO patent grants, and FAM t 2 is the average family size of the SIPO patent grant stock of the German parent company. Both measures are lagged by two years to avoid endogeneity and to inhibit a reverse impact of investment activities on patenting behavior.135 The interaction term between the SIPO patent grant stock and the average family size is represented by ln PATt  2 u ln FAM t  2 . As described before, all monetary variables, the total labor force, the number of SIPO patent grants and the average family size are specified as logs to normalize these positively skewed variables.136 Moreover, dummy variables are included for the two described time periods, the six industries and the four Chinese provinces.

135

The minimum time gap between the application date of the last patent grant and the foundation date of the entity is consequently greater than one year.

136

Since the logarithm of zero is not defined, the following variables are augmented by one: total investment volume, total labor force, productivity, average wage level, SIPO patent grants, and average family size.

134

4.4.5 Results Table 4.2 and Table 4.3 present the findings of the OLS regressions. Table 4.2 depicts the outcomes excluding the export shares of the German subsidiaries in China, whereas Table 4.3 covers the results including the EXP variable. All models show highly significant and positive coefficients for the total labor force and productivity, as expected. Also, the establishment of joint ventures tends to have a positive effect on investment volume. This supports the assumption that many large-scale investments in China are regulated and have to be founded in cooperation with local Chinese partners. The variables for the majority stake and the wage level in the province in the foundation year, however, are insignificant and reveal no clear effect. The integration of the export share has no major impact on the coefficients and the level of significance of the other explanatory variables. The coefficient of the export share variable itself has a small negative but insignificant effect. Regarding geographic differences, the province dummies show positive signs for the non-manufacturing-intensive locations Shanghai and Beijing and the manufacturing-intensive sites Guangdong and Jiangsu. The results for the province of Jiangsu are especially significant in all models. The coefficients for the foundation period dummies are negative but insignificant in all models. Turning to the IPR-relevant outcome, both tables confirm that the lagged number of SIPO patent grants contributes positively to the investment volume of German companies in China. The coefficients are highly significant in almost all models. The elasticity in Model (II) in Table 4.2 shows that a one percent increase in SIPO patent grants for a German parent company leads to a 0.3 percent increase in the total investment volume for a subsidiary in China. The magnitude is smaller in Model (IV), when the average family size variable and the interaction term are included. The results support hypothesis H.1 and are in line with the OLI framework developed by Dunning (1980). Granted patents, representing technological assets, indicate ownership advantages enjoyed by the IPR holder in a foreign market and allow a firm to compete with other foreign companies. The protected technology compensates for other drawbacks that a firm may face in a foreign business environment. The coefficients for the value of transferred technology to the PRC, measured by the interaction term between the average family size and the stock of SIPO patent grants, carry the expected negative signs and are significant at a five percent level in Table 4.2. The main effect of the average family size is negative but not significant. Even though the findings for

135 the interaction term in the extended model in Table 4.3 are not significant, what can probably be attributed to the smaller sample size, Hypothesis H.2 can be supported, meaning that the investment volume of a German subsidiary in China is negatively affected by the value of technology that is transferred by a German parent company to the PRC. This outcome is in line with the findings associated with Mansfield’s survey (1994). MNEs are often reluctant to transfer their latest and most effective technologies to developing countries, and they often avoid investing in joint ventures or large manufacturing facilities if there is a risk of uncontrolled technology outflow and imitation. The combined findings for the stock of SIPO patent grants and the value of technology transferred to the PRC suggest that FDIs in China are sensitive to IPRs of foreign MNEs. Model (IV) in Table 4.2 reveals that the magnitude of the effect on the stock of SIPO patent grants is higher than the estimated effect of the interaction term between the average family size and the stock of SIPO patent grants. This implies that more SIPO patent grants lead in general to higher investment volumes, independent of the technological value of the inventions in question. Nevertheless, a large patent stock alone does not warrant large-scale investment. As the results show, the value of technology that a company transfers to the PRC seems to affect the decision of MNEs regarding how to operate in a foreign market. Accordingly, one would expect that companies with more valuable technologies seek to establish wholly foreign-owned enterprises instead of joint ventures with Chinese partners. However, when one takes a closer look at the Chinese entity types of German parent companies with high average family size in terms of their SIPO patent portfolio, it emerges that the share of joint ventures is not lower than for the other German firms that are invested in the PRC. While 69.2% of all German patent holding firms in China in this dataset are partnering with Chinese enterprises, 72.7% of the top quartile of these German companies (regarding the value of technology transferred to China) were established as joint ventures as well. One reason for this unexpected result can definitely be found in the regulation of certain industries in the PRC. The Chinese government tries to promote technological progress through spillovers from technology-oriented MNEs by forcing them to cooperate in Sinoforeign joint ventures. For instance, the regulations for Sino-foreign automotive joint ventures oblige the partners involved to set up joint research centers.

136 ln INV ln LAB ln PRD JOV MAJ ln WAG

I 0.844*** (0.115) 0.506*** (0.134) 0.395 (0.292) 0.328 (0.337) -0.607 (0.741)

II 0.751*** (0.116) 0.456*** (0.127) 0.309 (0.280) 0.242 (0.327) -0.947 (0.708)

III 0.799*** (0.121) 0.475*** (0.135) 0.372 (0.296) 0.312 (0.335) -0.668 (0.727)

IV 0.785*** (0.114) 0.471*** (0.116) 0.294 (0.262) 0.144 (0.318) -1.165 (0.710)

0.740 (0.657) 0.271 (0.585) 0.441 (0.623) 0.812** (0.325) -0.247 (0.564) -0.452 (0.896) 0.265 (0.816) 0.794 (0.509) 1.093* (0.615) 0.300 (0.533) 0.411 (0.776) 0.890 (0.570)

0.836 (0.578) 0.497 (0.558) 0.603 (0.604) 0.808** (0.309) -0.328 (0.563) -0.304 (0.859) 0.280 (0.804) 0.671 (0.499) 0.762 (0.585) 0.096 (0.507) 0.351 (0.750) 0.542 (0.540) 0.311*** (0.081)

0.761 (0.630) 0.286 (0.579) 0.427 (0.620) 0.839** (0.322) -0.283 (0.558) -0.471 (0.892) 0.252 (0.818) 0.725 (0.499) 0.971 (0.599) 0.192 (0.511) 0.280 (0.790) 0.762 (0.541)

0.896 (0.604) 0.642 (0.552) 0.768 (0.606) 0.627** (0.310) -0.230 (0.567) -0.118 (0.860) 0.257 (0.802) 0.660 (0.521) 0.501 (0.590) 0.080 (0.524) 0.573 (0.705) 0.732 (0.549) 1.907*** (0.645) -0.283 (0.199) -0.638** (0.309) 11.006* (5.838) 155 0.558 (20, 127) 15.27 0.000

EXP Guangdong Shanghai Beijing Jiangsu Foundation Period (1993-2000) Foundation Period (2001-2003) Raw Materials, Food Products and Environ. Prot. Engineering and Metal Products Motor Vehicles, Rail Vehicles, Aircrafts, Ships etc. Electronics, Precision Mech., Optics and Lab. Tech. Const., Energy, Water, Heating, Building Mat. etc. Chemical Products and Health ln PAT ln FAM

0.155 (0.135)

ln PAT x ln FAM Constant Observations R2 F-Test (df) Prob. > F

5.866 (6.150) 155 0.506 (17, 127) 11.93 0.000

9.391 (5.889) 155 0.534 (18, 127) 17.11 0.000

6.728 (6.006) 155 0.511 (18, 127) 11.83 0.000

Robust standard errors in brackets. Significance levels: * 10 percent, ** 5 percent, *** 1 percent.

Table 4.2: Clustered and robust OLS regression results excluding export shares.

137 ln INV ln LAB ln PRD JOV MAJ ln WAG EXP Guangdong Shanghai Beijing Jiangsu Foundation Period (1993-2000) Foundation Period (2001-2003) Raw Materials, Food Products and Environ. Prot. Engineering and Metal Products Motor Vehicles, Rail Vehicles, Aircrafts, Ships etc. Electronics, Precision Mech., Optics and Lab. Tech. Const., Energy, Water, Heating, Building Mat. etc. Chemical Products and Health

I 1.027*** (0.129) 0.655*** (0.155) 0.650** (0.295) -0.069 (0.326) -0.496 (0.920) -0.002 (0.008) 0.031 (0.868) 0.065 (0.743) 0.225 (0.732) 0.743** (0.334) -0.029 (0.480) -0.167 (0.854) -1.483** (0.586) 0.375 (0.635) 0.350 (0.774) -0.193 (0.613) 1.420* (0.746) 0.461 (0.685)

ln PAT

II 0.935*** (0.119) 0.620*** (0.150) 0.530* (0.314) -0.255 (0.348) -0.735 (0.793) -0.002 (0.007) 0.085 (0.707) 0.245 (0.672) 0.373 (0.676) 0.750** (0.298) -0.246 (0.503) -0.177 (0.809) -1.314** (0.657) 0.262 (0.621) 0.201 (0.791) -0.358 (0.645) 1.381* (0.745) 0.226 (0.651) 0.262** (0.100)

ln FAM

III 0.958*** (0.127) 0.620*** (0.145) 0.587* (0.323) -0.208 (0.346) -0.437 (0.873) -0.003 (0.008) 0.037 (0.804) -0.006 (0.720) 0.183 (0.703) 0.764** (0.321) -0.206 (0.492) -0.373 (0.859) -1.430** (0.668) 0.282 (0.632) 0.205 (0.784) -0.343 (0.643) 1.422* (0.734) 0.306 (0.666)

0.233 (0.169)

ln PAT x ln FAM Constant Observations R2 F-Test (df) Prob. > F

4.129 (7.945) 94 0.677 (18, 79) 21.25 0.000

7.010 (6.785) 94 0.697 (19, 79) 20.18 0.000

4.416 (7.447) 94 0.687 (19, 79) 19.55 0.000

Robust standard errors in brackets. Significance levels: * 10 percent, ** 5 percent, *** 1 percent.

Table 4.3: Clustered and robust OLS regression results including export shares.

IV 0.942*** (0.123) 0.615*** (0.144) 0.521* (0.305) -0.259 (0.363) -0.806 (0.828) -0.002 (0.007) 0.057 (0.716) 0.324 (0.666) 0.423 (0.643) 0.697** (0.306) -0.240 (0.503) -0.132 (0.865) -1.275** (0.625) 0.279 (0.630) 0.186 (0.806) -0.376 (0.655) 1.388* (0.776) 0.309 (0.639) 0.938 (0.889) -0.083 (0.261) -0.275 (0.417) 7.542 (7.042) 94 0.700 (21, 75) 17.23 0.000

138

4.5 Conclusion In a globalizing world, intangible assets such as capital and know-how become more and more mobile across borders. The relevance of IPRs for the decision-making of MNEs regarding investment in a foreign country has therefore attracted the interest of many economists in recent years. While numerous theoretical studies have been conducted, empirical evidence in this area of research is rare, especially on a company level. In particular, the availability of reliable data on foreign investment and IPR activities of MNEs is limited in this field of study and has drawn attention mainly on the macroeconomic level. However, the questions surrounding the economics of FDIs are not only a matter of political policies designed to stimulate economic growth and to facilitate technology transfer. Venturing into foreign markets such as China or India has become a crucial topic for many MNEs and often sets the course for the future success or failure of a company. As has been pointed out by Dunning (1980), MNEs have to possess certain capabilities or assets to be competitive in a foreign business environment. Patents and trademarks are only two examples of such assets, which enable companies to execute ownership advantages in foreign countries. Fast-growing emerging markets with high levels of imitative abilities, such as China, therefore play a crucial role when companies transfer technology and invest abroad. This study examined the relation between the patenting behavior and investment behavior of German companies in the PRC. A unique dataset including information on 155 German firms in China was constructed by merging firm data from the German Delegation of Industry & Commerce in Shanghai with information from the PATSTAT Database of the European Patent Office. The estimates show that the patent activities of German parent companies in the PRC have a significant positive effect on the investment volume of their Chinese subsidiaries. Furthermore, it emerged that the value of the technology transferred to China also affects the investment volume of the German subsidiaries in the PRC. German parent companies that hold a more valuable patent stock in China tend to invest less in their Chinese subsidiaries. This outcome is in line with that of a survey conducted by Mansfield (1994) that revealed that MNEs are often hesitant to transfer their latest technology to a foreign market and that they avoid investing in joint ventures and extended manufacturing facilities if there is a risk of technology outflow and imitation.

139 Finally, this study is only a first attempt to measure the importance of IPRs for FDIs on a firm level and should be viewed with appropriate caution. Future research is needed to extend the Sino-German focus of this study to other developing and emerging countries. Observing larger samples and considering additional patent characteristics (such as the complexity of technology deployed by MNEs to their affiliates) could yield more comprehensive insights into the complex topic of FDIs. Moreover, the incorporation of other IPR types, such as trademarks and utility models, could enrich the present knowledge available on the relation between IPRs and FDIs.

5. Conclusion In the aftermath of World War II, the Mao regime and the state-planned system had run the Chinese economy completely into the ground. The country experienced an unprecedented humanitarian disaster after agricultural production was heavily restricted in favor of allegedly promising sectors such as the steel-producing industry. When one considers contemporary China in contrast with this historical background, it seems quite impressive how the communist country managed to rise to such a high level of economic power. A turning point in this development was the proclamation of the Open Door Policy by Deng Xiaoping in the late 1970s, when the People’s Republic recognized the importance of introducing advanced technologies in order to modernize its ailing industries. While the previous chapters of my dissertation often focused on the economic partners of the PRC, I would like to begin my closing remarks by sharing some thoughts on innovations and the role of technology in China. Based on five-year plans, the Communist Party sets the course for the country’s political, social and economic development. The national science-, research- and technologyrelated targets are also part of this recurring planning procedure. For the period between 2006 and 2011, the Chinese government has stipulated detailed high-tech projects: for instance, in the area of advanced computing, biomedicine, and satellite application.137 Because of this ambitious and goal-oriented approach, China has been able to successfully execute technology related lighthouse projects such as its recent space missions. With this accomplishment, China became the third nation capable of sending men into space. Other activities in this context include the reform of the Chinese higher education system. Projects “211” and “985”, for example, aim to provide substantial financial support to selected universities so that they may become world-class institutions for science and research (Wu, 2007). Moreover, in the wake of globalization on the part of other nations and using existing global technologies, the PRC has been able to quickly narrow the technological gap between itself and other industrialized states. In addition to their own efforts in the area of science and research, there are various other channels for promoting technological progress. On a governmental level, cooperation with other countries is often a fertile resource for emerging

137

See http://english.gov.cn/2006-03/06/content_219817.htm, latest visit on September 3rd, 2009.

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2_5, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

142 countries looking to progress through joint research projects and academic exchange programs. Germany and China, for example, celebrated their 30th anniversary of an intergovernmental agreement on scientific and technological cooperation in April 2008.138 Trade relations between economic partners are often another important way to gain insight into the technological expertise of another country. Innovative products that are imported may reveal information about embodied technology and the production process (Coe and Helpman, 1995). The demonstration effect of such products may promote the technological skills required to manufacture and to conduct research related to the development of similar goods. Nevertheless, exports are considered to contribute to the technological progress of a country as well. Domestic companies are urged to improve the quality of their products and production processes by investing in R&D and competing with foreign firms (Branstetter, 2006). At the firm level, the transfer of technology across countries may also take place in the form of license agreements. For many MNEs, founding a subsidiary in China is not the best strategy for entering the market. In certain industries, the licensing of technology to an unaffiliated firm is the preferred method of tapping into potential growth in foreign markets. On the other hand, for licensees in developing countries, such agreements provide access to advanced technologies under a defined legal framework accompanied by potential learning effects and stimuli for R&D activities. In 2005, US manufacturing know-how sold to the PRC amounted to 198 Mio. USD. While this seemingly small amount only accounted for three percent of the total receipt of royalties and license fees reported in the US, this share almost doubled within ten years (NSF, 2008). Allowing MNEs to establish subsidiaries in China, such as wholly foreign-owned companies and joint ventures, also supports technology transfer. Since 1979, foreign companies have invested in more than 600,000 Chinese projects that fall under the category of FDI.139 Even though a large share of FDI projects are associated with rudimentary sales activities, other foreign-owned entities are related to large production facilities for innovative products or dedicated R&D centers. By restricting certain industries and urging foreign investors to engage in Sino-foreign joint ventures, the Chinese government aims to facilitate

138

See http://www.auswaertiges-amt.de/diplo/en/Laenderinformationen/01-Laender/China.html#t6, latest visit on September 4th, 2009.

139

See http://www.stats.gov.cn/tjsj/ndsj/2008/indexeh.htm, latest visit on September 5th, 2009.

143 technology spillovers between non-Chinese and Chinese partners. However, previous research on this phenomenon evidenced that cooperation between innovative MNEs and Chinese firms does not necessarily guarantee a flow of technology. Liu and Buck (2007), for example, emphasized the importance of the absorptive capacity of domestic firms in exploiting the externalities of a foreign partner. While emerging countries such as China are eager to absorb foreign technologies to the largest possible extent, industrialized nations and foreign MNEs are often worried about the uncontrolled outflow of knowledge in which they have made substantial R&D investments. The immaterial character of knowledge, however, complicates the attempt to control the application of technologies by different agents. Intellectual property rights thereby play a key role in the assignment of exclusive rights to inventions and provide incentives to invest in innovative activities. In this context, there are various international agreements for the regulation of IPRs worldwide. Aside from the Patent Cooperation Treaty, the Agreement on Trade-Related Aspects of Intellectual Property Rights is probably the most important attempt to introduce international rules for the protection of IPRs. China has been obliged to adhere to the regulations of TRIPS since its accession to the WTO in 2001. According to Art. 7, the basic objectives of this agreement are to contribute to the promotion of technological innovation and to the transfer and dissemination of technology.140 Since the opening of China’s economy, the PRC has introduced various laws for the protection of the intellectual property of domestic and foreign inventors and to comply with the obligations of TRIPS. However, a solid legal foundation is only one part of the complex puzzle of IPR protection. The enforcement of these regulations often turns out to be a major problem in developing and emerging markets. In 2008, for instance, the Chinese IP administration had to handle 1,092 patent disputes and 56,634 cases of trademark violations.141 The United States also closely monitors the protection of the IPRs of its MNEs in foreign countries and has established an annual review mechanism, named Special 301 (based on the Omnibus Trade and Competitiveness Act in 1988) for examining the effectiveness of IPRs around the world. An outcome of this yearly review is a watch list containing those countries that are considered to exhibit IPR-related deficiencies. China has

140

See http://www.wto.org/english/docs_e/legal_e/27-trips_03_e.htm, latest visit on September 5th, 2009.

141

See http://www.sipo.gov.cn/sipo_English/laws/whitepapers/200904/t20090427_457167.html, latest visit on September 5th, 2009.

144 been on this list a few times. The 2009 report states that the Chinese government continues to provide increased attention to its IPR environment. However, the document objects that the goal of significantly reducing IPR infringement has not been achieved thus far due mainly to the ineffective and non-deterrent IPR enforcement mechanism (USTR, 2009). In 2007, the US launched formal proceedings against the PRC at the WTO and requested consultation with China concerning measures affecting the protection and enforcement of IPRs.142 With regard to trade quarrels – including such IPR related issues – the WTO has set up a procedure for resolving disputes. Concerning the complaint of the US, it can be noted that the WTO panel of the dispute settlement body found that there were inconsistencies in Chinese IPR laws incompatible with WTO obligations. In light of such disputes, different perspectives emerge on the economic effects of IPRs and the optimal design of IPR systems. On the one hand, developing countries are often concerned about tighter IPR laws and the potential domination of their industries by technology-oriented MNEs. On the other hand, industrialized states try to strengthen IPRs globally to protect the R&D investments of their domestic enterprises. The previous chapters of my dissertation therefore aimed to shed light on the economics of IPRs in China. Chapter 2 focused on the patent examination process at the State Intellectual Property Office. The examination of patents, trademarks and designs is a crucial process for domestic and foreign applicants who are seeking protection for their innovative and creative work. In addition to the outcome of the examination process (whether an IPR application is granted or rejected) a decisive factor is the amount of time that elapses as examiners come to a final decision. Against the backdrop of Chinese IPR laws, the determinants of the examination time for patent inventions were observed in this empirical study. Based on a dataset of almost 250,000 SIPO patents granted in the period between 1990 and 2002, the examination time was modeled by applying advanced statistical concepts, a Cox proportional hazard model and an accelerated failure time model. The results suggest that the grant lags at the SIPO are longer for filings from foreign applicants, for international patent applications, and for more complex or valuable inventions. In contrast, inventions in technological areas of relevance for the PRC, applications from more patent-active companies and inventions from applicants with a more intense focus on China (in terms of their patent applications) show shorter grant lags. Compared to similar studies that have been conducted on the European Patent Office (Harhoff

142

See http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds362_e.htm, latest visit on September 5th, 2009.

145 and Wagner, 2009) and the United States Patent and Trademark Office (Johnson and Popp, 2003), the findings of Chapter 2 allow the conclusion that the patent examination at the SIPO, with the exception of some specific features, follows a routine similar to those of other major patent offices. The relationship between trade flows and IPRs in China was discussed in Chapter 3. Due to the incentives of IPRs to invest in R&D and the exclusive character of these rights, the theory basically assumes two contradicting effects. While the market expansion effect supposes that IPRs contribute to increasing trade flows, the market power effect implies lower trade flows because competitors can be prevented from applying protected technologies (Maskus and Penubarti, 1995). In the Chinese context, this part of my dissertation observed the impact of the Chinese IPR system and the influence of the patent activities of foreign countries in China on export flows to the PRC. Based on SIPO patent data, a first attempt was made to empirically separate the above-mentioned effects. The outcome indicates the existence of both features; patents of foreign applicants in China are opening the market for new innovative products and lead to increasing exports. However, the concentration of patent applicants in an industry shows a negative impact on trade flows to the PRC. Moreover, the results also reveal the positive influence that China’s emerging IPR system had on OECD exports, especially in the context of China’s WTO accession and the TRIPS obligations. The last empirical study in this book, Chapter 4, addressed the relationship between IPRs and FDIs. As mentioned before, FDIs are an important channel for emerging countries to use to gain insights into the advanced technologies of foreign countries. However, MNEs typically consider investments in emerging markets only if they find a stable economic and political environment and if the rights of foreign investors are respected, including IPRs. Rights such as patents and trademarks are important assets for MNEs in a foreign market if they hope to successfully compete with local firms that are more experienced and embedded in their home market (Dunning, 1980). One of the major technology-oriented countries investing in the PRC is Germany. Based on a sample of 127 German parent companies and their 155 Chinese subsidiaries, the impact of IPRs on FDIs is observed. In particular, the number of SIPO patent grants and the value of technology transferred to China by German parent companies are analyzed. The results suggest that the stock of SIPO patent grants that the German parent company holds in China has a positive effect on the investment volume of the Chinese subsidiaries. However, the findings also reveal that the value of technology transferred to the PRC affects investment volume negatively. This outcome is in line with the

146 results of a survey conducted by Mansfield (1994), who asked US companies about their willingness to invest in different foreign locations. Accordingly, MNEs are often reluctant to transfer their most effective and valuable technology to foreign markets if they see a risk of uncontrolled knowledge outflow and imitation. Finally, because the empirical element of my dissertation mainly focused on patents of industrialized states in the PRC, I would like to point out the relevance of IPRs for Chinese companies. The Shenzhen-based provider for telecommunications solutions named Huawei, for instance, applied for more than 5,000 patents at the SIPO in 2006. Other Chinese companies and research institutes, such as the Zhejiang University, also contributed to the surge in domestic patent applications.143 In 2008, Huawei also topped the list of PCT applicants by filing 1,729 international patents at the WIPO, more than any other company in the world that year.144 The rising number of patent applications at the SIPO and WIPO by Chinese applicants provide hope for the future treatment of IPRs in the PRC. As detailed in the previous chapters, tighter IPRs often accompany the overall economic development in a country. In light of China’s strong economic and technological progress in recent years, I believe it is only a matter of time before the PRC will require stronger intellectual property rights across the globe.

143

See http://www.sipo.gov.cn/sipo_English/laws/annualreports/ndbg2006/200804/t20080416_380208.html, latest visit on September 5th, 2009.

144

See http://www.wipo.int/pct/en/newslett/2009/02/article_0001.html, latest visit on September 5th, 2009.

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Appendix -1 S.D. Mean +1 S.D. 0.3

Density

0.2

0.1

0.0 0

5

10 Grant Lag in Years

15

20

Figure A.1: Probability density function of SIPO patent grant lags with EP equivalents. -1 S.D. Mean +1 S.D. 0.3

Density

0.2

0.1

0.0 0

5

10 Grant Lag in Years

15

20

Figure A.2: Probability density function of SIPO patent grant lags with US equivalents.

J. Liegsalz, The Economics of Intellectual Property Rights in China, DOI 10.1007/978-3-8349-8865-2, © Gabler Verlag | Springer Fachmedien Wiesbaden GmbH 2010

No. of Patent Applications* 14,204 8,734 21,216 9,774 4,619 6,354 8,222 5,840 506 13,334 9,337 12,280 3,663 2,058 7,376 3,697 4,996 6,169 8,487 7,703 893 1,107 3,727 3,700 2,486 3,992 4,064 304 6,613 2,929 188,388 No. of Granted Patents* 9,535 5,939 12,462 5,693 2,996 3,949 4,890 3,294 315 7,934 6,072 5,904 1,711 1,141 4,319 2,417 3,537 4,123 5,592 5,692 538 722 2,599 2,605 1,687 2,791 2,786 177 4,351 1,929 117,702 Grant Ratio % 67.13 68.00 58.74 58.24 64.85 62.16 59.48 56.40 62.29 59.50 65.03 48.08 46.71 55.44 58.56 65.38 70.80 66.83 65.88 73.90 60.33 65.18 69.75 70.41 67.87 69.90 68.55 58.41 65.80 65.86 62.48 Min. Grant Lag in Years 1.53 1.72 1.42 1.45 1.59 1.75 1.59 1.65 1.74 1.21 1.75 1.21 1.21 2.03 1.82 1.53 1.53 1.53 1.61 1.52 2.03 1.75 1.56 1.59 1.76 1.61 1.48 2.35 1.32 1.48 1.21 Average Grant Lag in Years 5.07 5.23 5.24 5.31 5.10 5.18 5.36 5.70 5.23 5.40 5.29 5.74 6.28 5.43 5.38 5.22 4.97 5.12 5.11 4.80 5.24 5.31 4.94 4.86 5.26 4.77 4.77 5.06 5.11 5.10 5.20 Max. Grant Lag in Years 12.90 12.63 12.72 15.19 11.68 12.20 12.67 15.33 11.06 13.25 12.40 13.17 13.30 11.18 12.36 12.59 11.33 12.36 16.47 10.95 12.98 11.23 10.70 13.13 10.64 11.39 10.65 10.97 13.84 11.41 16.47

Table A.1: Grant ratios and lags across technological areas (SIPO applications with EP equivalents 1990-2002).

* The number of patent applications and grants are weighted by the number of technology areas (one patent can fall into several technological areas).

Electr. Machinery, Electrical Energy Audiovisual Technology Telecommunications Information Technology Semiconductors Optics Analysis, Measurement, Control Tech. Medical Technology Nuclear Engineering Organic Fine Chemistry Macromolecular Chem., Polymers Pharmaceuticals, Cosmetics Biotechnology Agriculture, Food Chem. Chem. & Petrol Ind., Basic Mat. Chem. Surface Technology, Coating Materials, Metallurgy Chemical Engineering Mat. Proc., Textiles, Paper Handling, Printing Agricultural & Food Proc. Environmental Technology Machine Tools Engines, Pumps, Turbines Thermal Proc. & Apparatus Mechanical Elements Transport Space Technology, Weapons Consumer Goods & Equipment Civil Eng., Building, Mining All SIPO Patent Applications

Area Name 0.62 0.41 0.49 0.73 0.55 0.49 0.80 0.97 0.59 0.89 0.78 1.13 1.21 1.86 1.02 0.76 1.21 0.87 0.78 0.57 1.41 1.20 0.85 0.83 1.00 0.72 0.83 1.10 0.95 1.23 0.87

Chinese RTA Index

162

No. of Patent Applications* 16,663 11,481 22,388 11,076 7,036 8,177 8,425 5,032 552 11,060 8,062 9,438 2,852 1,699 6,135 3,563 4,792 5,736 7,671 7,634 875 1,068 3,875 4,017 2,746 4,241 3,953 292 6,904 2,985 190,429 No. of Granted Patents* 11,924 8,412 14,513 7,161 5,067 5,635 5,450 2,962 371 7,070 5,645 4,897 1,439 1,028 3,899 2,465 3,591 4,015 5,370 5,944 553 725 2,856 2,968 1,972 3,107 2,815 186 4,821 2,060 128,920 Grant Ratio % 71.56 73.26 64.82 64.66 72.00 68.91 64.69 58.87 67.15 63.93 70.02 51.89 50.46 60.48 63.55 69.19 74.94 70.00 70.01 77.85 63.18 67.90 73.72 73.87 71.80 73.25 71.21 63.87 69.83 69.01 67.70 Min. Grant Lag in Years 1.49 1.32 1.42 1.45 1.59 1.69 1.59 1.65 1.74 1.21 1.67 1.21 1.21 1.70 1.84 1.72 1.56 1.64 1.64 1.35 1.70 1.75 1.56 1.51 1.76 1.61 1.48 2.35 1.32 1.48 1.21 Average Grant Lag in Years 4.90 5.10 5.15 5.19 4.88 4.96 5.22 5.53 5.19 5.29 5.18 5.62 6.10 5.35 5.28 5.11 4.87 5.03 5.00 4.73 5.17 5.24 4.86 4.78 5.29 4.72 4.68 5.07 5.05 5.04 5.08 Max. Grant Lag in Years 12.90 12.63 12.72 11.51 11.72 12.20 11.39 15.33 11.06 12.98 12.40 13.17 13.30 11.18 12.36 12.59 11.33 12.36 11.87 10.95 12.98 11.23 10.70 10.70 10.64 10.70 10.14 10.97 13.84 11.41 15.33

Table A.2: Grant ratios and lags across technological areas (SIPO applications with US equivalents 1990-2002).

* The number of patent applications and grants are weighted by the number of technology areas (one patent can fall into several technological areas).

Electr. Machinery, Electrical Energy Audiovisual Technology Telecommunications Information Technology Semiconductors Optics Analysis, Measurement, Control Tech. Medical Technology Nuclear Engineering Organic Fine Chemistry Macromolecular Chem., Polymers Pharmaceuticals, Cosmetics Biotechnology Agriculture, Food Chem. Chem. & Petrol Ind., Basic Mat. Chem. Surface Technology, Coating Materials, Metallurgy Chemical Engineering Mat. Proc., Textiles, Paper Handling, Printing Agricultural & Food Proc. Environmental Technology Machine Tools Engines, Pumps, Turbines Thermal Proc. & Apparatus Mechanical Elements Transport Space Technology, Weapons Consumer Goods & Equipment Civil Eng., Building, Mining All SIPO Patent Applications

Area Name 0.62 0.41 0.49 0.73 0.55 0.49 0.80 0.97 0.59 0.89 0.78 1.13 1.21 1.86 1.02 0.76 1.21 0.87 0.78 0.57 1.41 1.20 0.85 0.83 1.00 0.72 0.83 1.10 0.95 1.23 0.87

Chinese RTA Index

163

164 AUS AUT

Australia Austria

1 2

KOR

Korea1

LUX

Luxembourg1

MEX

Mexico1

NLD

Netherlands

BLX

Belgium/Luxembourg

CAN

Canada

CZE

Czech Republic1

NZL

New Zealand

DNK

Denmark

NOR

Norway

FIN

Finland

POL

Poland1

FRA

France

PRT

Portugal

DEU

Germany3

SVK

Slovak Republic1

GRC

Greece

ESP

Spain

HUN

Hungary1

SWE

Sweden

ISL

Iceland

CHE

Switzerland

IRL

Ireland

TUR

Turkey1

ITA

Italy

GBR

United Kingdom

JPN

Japan

USA

United States1

Table A.3: Country coverage of OECD Bilateral Trade Database. 1

For the following declaring countries data start later than 1988: Austria (1995), Czech Republic (1993), Hungary (1992), Korea (1994), Luxembourg (1999) Mexico (1990), New Zealand (1989), Poland (1992), Slovak Republic (1997), Turkey (1989), USA (imports: 1990; exports: 1989).

2

BLX as a declaring country: data refer to Belgium/Luxembourg up to and incl. 1992, data refer to Belgium as from 1993.

3

DEU as a declaring country: data refer to Western Germany up to and incl. 1990 and to total Germany thereafter.

165 15-16 17-19 20 21-22 23 24 25 26 27 28 29 30 31 32 33 34 35 36-37

Food Products, Beverages and Tobacco Textiles, Textile Products, Leather and Footwear Wood, and Products of Wood and Cork Pulp, Paper Products, Printing and Publishing Coke, Refined Petroleum Products and Nuclear Fuel Chemicals and Chemical Products Rubber and Plastics Products Other Non-Metallic Mineral Products Basic Metals Fabricated Metal Products (except machinery and equipment) Machinery and Equipment , N.E.C. Office, Accounting and Computing Machinery Electrical Machinery and Apparatus, N.E.C. Radio, Television and Communication Equipment Medical, Precision and Optical Instruments Motor Vehicles, Trailer and Semi-Trailers Other Transport Equipment Manufacturing N.E.C.; Recycling

Table A.4: International Standard Industrial Classification.

166

<1 % 1-2 % 2-5 % 5-10 % >10 %

Figure A.3: Distribution of new FDI projects across Chinese provinces in 2006.

16.1%

32.1%

2.4% 3.1% 3.3% 3.4% 3.6% 4.5% 6.2% 7.3%

17.8%

Hong Kong, China Virgin Islands Japan Republic of Korea United States Singapore Taiwan, China Cayman Islands Germany Samoan Islands Others

Figure A.4: Distribution of new FDI volume across origin countries in 2006.

167

Manufacturing

12.5% 61.4%

2.7% 3.4%

Real Estate Leasing and Business Services

4.8%

Wholesale and Retail Trades

15.2% Transport, Storage and Post Others

Figure A.5: Distribution of new FDI projects across industry sectors in 2006.

2.5% 24.6%

0.1% 72.7% Wholly Foreign-Owned Enterprise Equity Joint Venture Contractual Joint Venture Others

Figure A.6: Distribution of new FDI projects across investment forms in 2006.