Despite results from both theoretical and empirical literature that show the benefits of increasing intellectual property rights (IPR) protection, some developing countries are still reluctant to adopt a strong IPR regime. This paper offers an alternative perspective capturing the above observation using a very simple signaling model.

Thitima Puttitanun

English

Research Papers in Economics

 
 
 
 
Intellectual Property Rights as a Signal 
 
 
Thitima Puttitanun
∗ 
 
Department of Economics, San Diego State University 
 
 
 
 
Abstract 
 
  Despite results from both theoretical and empirical literature that show the 
benefits of increasing intellectual property rights (IPR) protection, some developing 
countries are still reluctant to adopt a strong IPR regime. This paper offers an alternative 
perspective capturing the above observation using a very simple signaling model. 
 
 
 
JEL classification: O34, O40, F20 
Keywords: Intellectual property rights, Signal, Technology transfer. 
 
 
 
 
 
 
 
 
 
                                                 
∗ Contact: Thitima Puttitanun, Department of Economics, San Diego State University, 5500 Campanile 
Drive, San Diego, CA 92182, phone: (619)594-3556, fax: (619)594-5062, email: tputtita@mail.sdsu.edu 
 1.  Introduction 
 
An important issue in economic development is what can account for the 
differences in the levels of income and the economic growth rate between developed and 
developing countries. The typical explanation is that developing countries have less 
capital and human capital. Consequently, the cure for developing countries would be to 
increase the capital resources both through direct capital transfer and to encourage 
savings within these countries.  
Another cure for the economic growth gap between developed and developing 
countries, suggested by Stiglitz (1989), is to correct the market imperfection in 
developing countries. The most imperfect commodities are knowledge and information. 
In many respects, knowledge is like a public good. Firms may have difficult time 
absorbing their returns to knowledge, which results in an under-supply of knowledge and 
has impact on firms’ investment decisions and innovation of products within developing 
countries.  
As suggested by Fulton (1997), intellectual property rights (IPR) can create 
incentives for firms to invest in R&D through the creation of non-rival excludable goods. 
Langford (1997) also suggested that IPR can help increase allocative efficiency as 
resources are directed toward the creation and technology transfer of new high-value 
products. Langford (1997) concluded that countries that are the first to modernize their 
IPR regimes are likely to benefit more than laggard countries. Therefore, to correct the 
market imperfection, to create the incentives for domestic firms to invest more, and to 
attract foreign direct investment, developing countries can use intellectual property rights 
as a tool to do so. The literature in this area shows that by improving IPR protection, a country not 
only increases the innovation rate (Helpman (1993), Diwan and Rodrik (1991), Lai 
(1998), Yang and Maskus (2001) Deolalikar and Roller (1989), Lach (1995), Park and 
Ginarte (1997), Maskus and McDaniel (1999), Crosby (2000) among others) but also 
attract more foreign direct investment (Lee and Mansfield (1996), Smith (2001), Maskus 
et al (2005), Puttitanun (2006), Nicholson (2001)). Some of the existing studies even 
prove the link between IPR and economic growth (Gould and Gruben (1997), Thompson 
and Rushing (1996, 1999)). However, while the literature shows that IPR protection is 
beneficial to the growth of the country, many developing countries are still reluctant to 
adopt IPR. Based on the empirical results in Schneider (2005), this seems to be because 
the impact of IPR on innovation and growth can differ between developed and 
developing countries. This phenomenon is confirmed by Maskus (2000), Primo Braga et 
al (2000), and Chen and Puttitanun (2005). They find a U-shaped relationship between 
the adopted IPR level and development level of the country.  
This paper aims to offer an alternative perspective using a very simple signaling 
model to show why two groups of countries would choose different level of IPR. 
 
2.  Signaling Model 
 
In this section, I use a simple signaling model to capture the results of adopting an 
intellectual property rights.  
  The environment consists of two types of developing countries: strong institution 
country and weak institution country denoted by  s θ  and  w θ , respectively, where  s θ   >   w θ  
and let  () ( 1 , 0 ∈ = = s prob ) θ θ λ . A firm from a developed country decides where to invest, assuming that investment is in the amount of K. However, the firm does not know 
which country is of which type (strong or weak institution country). The firm’s main 
objective is to maximize its lifetime profit. 
max          where  πt  is a monopoly profit in period t  ∑
∞
=
−
0
1
t
t
t π θδ
δ  is a discount factor 
                                         θ   is the type of a country that this firm invests in 
Therefore, if there is no imitation, θ  is equal to 1. If there is imitation in country that the 
firm invests in, then 0 < θ  < 1. 
Comparing profit in a strong institution country with profit in a weak institution 
country, 
                                    ∑              >                 
∞
=
−
0
1
t
t
t
s π δ θ ∑
∞
=
−
0
1
t
t
t
w π δ θ
Thus, the firm will want to invest in a strong institution country rather than a weak 
institution country. 
To attract investment, a developing country will want to signal to the firm that it 
has a strong institution, assuming that the goal of a country is to increase investment level 
from abroad. The country can use IPR to do so; however, it does so at a cost. 
Intellectual Property Rights can be used as a tool to signal the imitation rate 
because once it is adopted, a country has a limited level of imitation. However, I have to 
assume that to impose IPR, it incurs some cost. Moreover, a strong institution country 
should have less cost in imposing IPR than a weak institution country.  
The cost of IPR could be in terms of the cost to reduce imitation rate. The cost of 
imposing IPR level i for a type θ  country is  ) , ( θ i c  with  0 ) , 0 ( = θ c , 0 ) , ( > θ i ci  (cost is an increasing function of level of IPR),  0 ) , ( > θ i cii , 0 ) , ( < θ θ i c  for  , and  0 > ∀i
0 ) , ( < θ θ i ci  (marginal cost of imposing IPR is also higher for a weak institution 
country). The benefit to the country choosing IPR level i is that it receives foreign 
investment of () θ | i K . We will assume that as a WTO membership, it is required that a 
country must impose a minimum level of IPR, i. 
The net benefit that each country will receive from imposing IPR level i is as 
follows: 
() , ( w i c i K ) θ −  if weak types choose  i i >  
() ) , ( w i c i K θ −  if weak types choose  i i =  
() ) , ( s i c i K θ −  if strong types choose  i i >  
() ) , ( s i c i K θ −  if strong types choose  i i =  
Two types of equilibrium exist here: 
2.1 Separating equilibrium: 
i 1.  A weak institution country chooses IPR level =  , and gets minimum 
investment () i K  from abroad. 
2.  A strong institution country chooses IPR level >i,  and gets more than a minimum 
investment. 
In order to get the results above, the condition below must be satisfied: 
  () ) , ( w i c i K θ −≤ ( ) ) , ( w i c i K θ −  and  ( ) ) , (i c i K s θ − ≥ ( ) ) , ( s i c i K θ −  or () () () ( s s w w i c i c i c i c ) θ θ θ θ , , , , − ≥ − . In other words, in order to have a separating 
equilibrium, the difference in the cost for a weak type must be larger than the difference 
in cost for a strong type in imposing the IPR at a level higher than WTO regulates. 
2.2 Pooling equilibrium: 
Both types of countries choose the same level of IPR (i ~ ), and then the 
investment received from abroad will be  ( ) i K ~  where  i i > ~  and  ( ) () i K > i K ~ . 
 To  support  i ~  as a pooling outcome,  ( ) ) , ~ ( ~
w i c i K θ −≥ ( ) ) , ( w i c i K θ −  must be 
satisfied since the weak type country is the most tempted to deviate from  i i > . In other 
words, the constraint is  ( ) ( ) i K i K − ~ ≥ ( ) ) , ( , ~
w w i c i c θ θ −  or the net benefit from imposing 
the i ~  level of IPR must be larger than the net costs of imposing it. 
 
3.  Conclusion 
 
While both theoretical and empirical literature show that IPR can be used to 
attract foreign direct investment, create incentives to innovation, and increase the growth 
for the country adopting it, countries still adopt different levels of IPR. Typically, 
developing countries adopt a lower level of IPR protection than developed countries. This 
paper uses a very simple signaling model to show that each country will set its own IPR 
level to maximize its welfare. Under a certain circumstance, both developed and 
developing countries will choose the same level of IPR protection. Otherwise, developing 
countries will choose a lower level of IPR protection than developed countries. 
 
 
 References: 
 
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Innovation in Developing Countries, Journal of Development Economics, Vol. 
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Crosby, Mark (2000), Patents, Innovation and Growth, Economic Record, Vol. 76, pp. 
255-262. 
 
Deolalikar, Anil B. and Lars-Hendrik Roller (1989), Patenting by Manufacturing Firms in 
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303-314. 
 
Diwan, Ishac and Dani Rodrik (1991), Patents, Appropriate Technology, and North-
South Trade, Journal of International Economics, Vol. 30, pp. 27-48. 
 
Fulton, Murray (1997), The Economics of Intellectual Property Rights: Discussion, 
Canadian Journal of Agricultural Economics, Vol. 45, pp. 361-363. 
 
Gould, David M. and William C. Gruben, (1997) “The Role of Intellectual Property 
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Intellectual Property Rights as a Signal

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Intellectual Property Rights as a Signal

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