The WTO and market-supportive regulation: a way forward on new competition, technological and labor issues, commentary

World Trade Organization

Vertical price control and parallel imports - theory and evidence

A policy of national exhaustion says that the rights to control distribution, end upon first sale only within a country, thereby permitting rights holders to exclude parallel imports. A policy of international exhaustion states that such rights end upon first sale anywhere, and therefore permits parallel imports. The European Union has a policy of regional exhaustion within its territory. Language in the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) suggests that this policy choice remains the prerogative of individual countries. The authors review the international policy debate about parallel imports, which are controversial because they erode the ability of intellectual property owners to segment markets. Against considerable opposition, for example, Australia recently deregulated its import controls in major copyrighted goods, because domestic prices were evidently sustained at high levels by those controls. Both the European Union, and the United States are considering permitting parallel imports of prescription pharmaceuticals from abroad. Developing countries must consider their exhaustion regimes in the context of competition policies, and intellectual property rights. Economic theory demonstrates that the welfare tradeoffs in regulating parallel imports, are complex and depend on circumstances. The authors advance a new model that analyzes parallel imports as a response to vertical pricing arrangements between a rights holder ("manufacturer") and a foreign distributor. In this model, if markets were segmented, the manufacturer would change a wholesale price to its foreign distributor to ensure an efficient (profit-maximizing) retail price. But if markets were integrated by parallel trade, the distributor could purchase the good at a wholesale price, and sell it back to the manufacturer's home market at the local retail price. If transport costs were low enough, this would be profitable, but would diminish the return to the manufacturer, and waste resources in costly trade. So there would be tradeoffs: Parallel imports would benefit consumers in the high-price country, but hurt consumers in the low-price country. Such trade forces the manufacturer to set an inefficientwholesale price to limit its extent; it also consumes resources. The welfare implications of allowing parallel imports are ambiguous. If the costs of engaging in such trade were low, there would be gains from permitting it; if the costs were high, it would be more sensible to ban it. Countries near each other, with low trade barriers, might prefer an open regime of parallel trade. The vertical pricing model provides an explanation of this pricing behavior that is consistent with manufacturer's preferences to deter parallel trade.Environmental Economics&Policies,Economic Theory&Research,Access to Markets,Markets and Market Access,Trade Policy

Intellectual Property Rights, Parallel Imports and Strategic Behavior

The existence of parallel imports (PI) raises a number of interesting policy and strategic questions, which are the subject of this survey article. For example, parallel trade is essentially arbitrage within policy-integrated markets of IPR-protected goods, which may have different prices across countries. Thus, we analyze fully two types of price differences that give rise to such arbitrage. First is simple retail-level trade in horizontal markets because consumer prices may differ. Second is the deeper, and more strategic, issue of vertical pricing within the common distribution organization of an original manufacturer selling its goods through wholesale distributors in different markets. This vertical price control problem presents the IPR-holding firm a menu of strategic choices regarding how to compete with PI. Another strategic question is how the existence of PI might affect incentives of IPR holders to invest in research and development (R&D). The global research-based pharmaceutical firms, for example, strongly oppose any relaxation of restrictions against PI of drugs into the United States, arguing that the potential reduction in profits would diminish their ability to innovate. There is a close linkage here with price controls for medicines, which are a key component of national health policies but can give rise to arbitrage through PI. We also discuss the complex economic relationships between PI and other forms of competition policy, or attempts to limit the abuse of market power offered by patents and copyrights. Finally, we review the emerging literature on how policies governing PI may affect international trade agreements.IPR; Parallel Imports; International Arbitrage; Research and Development

Development-Related Biases in Factor Productivities and the HOV Model of Trade

Past empirical failures of the basic Heckscher-Ohlin-Vanek (HOV) model related to the inability of data to meet its restrictive assumptions, particularly identical international technologies and factor price equalization. Trefler (1993) tried to resuscitate HOV by introducing a simple Hicks-neutral (HN) factor-productivity adjustment, an approach that was heavily criticized. In this paper, we re-examine the productivity question by estimating factor-specific productivities from the individual technology data of multiple countries. Using a dataset of 29 countries, both developed and developing, we find evidence of factor-augmenting technological differences. In particular, the factor-productivity adjustment works well for developed members of the OECD. Further, we find that the ratios of factor productivities are strongly correlated with corresponding factor endowments. This systematic bias implies that the ability of HOV to explain North-South factor trade depends both on relative factor abundance and factor-augmenting productivity gaps.Heckscher-Ohlin-Vanek, factor trade, productivity

Parallel Imports of Pharmaceutical Products in the European Union

We study the effects of parallel trade in the pharmaceutical industry. We develop a model in which an original manufacturer competes in its home market with parallel-importing firms. The theoretical analysis results in two key hypotheses. First, if the potential for parallel imports is unlimited, the manufacturer chooses deterrence and international prices converge. Second, with endogenously limited arbitrage the manufacturing firm accommodates and the price in the home market falls as the volume of parallel trade rises. Simple empirical tests favor the accommodation hypothesis with a time lag. Using data from Sweden we find that the prices of drugs subject to competition from parallel imports increased less than other drugs during the period 1995-1998. Approximately 3/4 of this effect on be attributed to lower prices of parallel imports and 1/4 to lower prices charged by the manufacturing firm. Econometric analysis find that rents to parallel importers (or resource costs in parallel trade) could be more than the gain to consumers from lower prices.  Parallel Imports; International Arbitrage; Drug Pricing

Wholesale Price Discrimination and Parallel Imports

We develop a model of vertical pricing in which an original manufacturer sets wholesale prices in two markets integrated at the distributor level by parallel imports (PI). In this context we show that if competition policy requires uniform wholesale prices across locations it would push retail prices toward convergence as transportation costs fall. However, these retail prices could be higher than those induced without restrictions on prices charged to distributors. Thus, the competition policy may not be optimal for consumer welfare.vertical restraints, parallel imports, market integration, price discrimination, competition policy

Intellectual property rights, licensing, and innovation

There is considerable debate in economics literature on whether a decision by developing countries to strengthen their protection of intellectual property rights (IPRs) will increase or reduce their access to modern technologies invented by industrial countries. This access can be achieved through technology transfer of various kinds, including foreign direct investment and licensing. Licensing is the focus of this paper.To the extent that inventing firms choose to act more monopolistically and offer fewer technologies on the market, stronger IPRs could reduce international technology flows. However, to the extent that IPRs raise the returns to innovation and licensing, these flows would expand. In theory, the outcome depends on how IPRs affect several variables-the costs of, and returns to, international licensing; the wage advantage of workers in poor countries; the innovation process in industrial countries; and the amount of labor available for innovation and production. The authors develop a theoretical model in which firms in the North (industrial countries) innovate products of higher quality levels and decide whether to produce in the North or transfer production rights to the South (developing countries) through licensing. Different quality levels of each product are sold in equilibrium because of differences in consumers'willingness-to-pay for quality improvements. Contracting problems exist because the inventors in the North must indicate to licensees in the South whether their product is of higher or lower quality and also prevent the licensees from copying the technology. So, constraints in the model ensure that the equilibrium flow of licensing higher-quality goods meets these objectives. When the South strengthens its patent rights, copying by licensees is made costlier but the returns to licensing are increased. This change affects the dynamic decisions regarding innovation and technology transfer, which could rise or fall depending on market parameters, including the labor available for research and production. Results from the model show that the net effects depend on the balance between profits made by the Northern licensor and lower labor costs in the South. If the size of the labor force used in Northern innovation compared with that used in producing goods in both the North and South is sufficiently small (a condition that accords with reality), stronger IPRs in the South would lead to more licensing and innovation. This change would also increase the Southern wage relative to the Northern wage. So, in this model a decision by developing countries to increase their patent rights would expand global innovation and increase technology transfer. This result is consistent with recent empirical evidence. It should be noted that while the results suggest that international agreements to strengthen IPRs should expand global innovation and technology transfer through licensing, the model cannot be used for welfare analysis. Thus, while the developing countries enjoy more inward licensing, the cost per license could be higher, and prices could also rise, with an unclear overall effect on economic well-being.Agricultural Research,Environmental Economics&Policies,Knowledge Economy,Labor Policies,Economic Theory&Research,Environmental Economics&Policies,Economic Theory&Research,Education for the Knowledge Economy,Knowledge Economy,Agricultural Research

Vertical Distribution, Parallel Trade, and Price Divergence in Integrated Markets

We develop a model of vertical pricing in which an original manufacturer sets wholesale prices in two markets that are integrated at the distributor level by parallel imports (PI). The manufacturing firm needs to set these two prices to balance three competing interests: restricting competition in the PI-recipient market, avoiding resource wastes due to actual trade, and reducing the double-markup problem in the PI-source nation. These trade-offs imply the counterintuitive result that both wholesale and retail prices could diverge as a result of declining trading costs, even as the volume of PI increases. Thus, in some circumstances it may be misleading to think of PI as an unambiguous force for price integration.Vertical Restraints; Parallel Imports; Market Integration