Catalog

	Table of Contents
p. 74 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia III. Promoting competition for long-term development Introduction Benefits of competition Competition policy regimes Consistency with other development objectives Competition policy in the context of regional and global integration Issues for implementation Effects on government finances Toward a competitive future Summary and conclusions Endnotes and references Statistical appendix

Asian Development Outlook 2005 : III. Promoting competition for long-term development

---

Toward a competitive future

The discussions above have highlighted the importance of promoting competition. They have also indicated that many other issues are involved in consideration of competition.

The rich countries have … learned the hard way about monopolistic and oligopolistic behavior, predatory pricing, price fixing, insider trading, accounting conflicts of interest, perverse incentives from stock options, import tariffs, producer subsidies, government ownership of business, property rights, land use policies, and many other matters affecting the intensity and fairness of competition. These are the ways special interests gain favoritism. The so-called Washington Consensus about good economic policy in developing countries is hopelessly superficial about the importance and complexity of achieving intense and fair competition. To become rich, poor countries have to deal with these issues (Lewis 2004, p. 296).

To the extent that the enforcement of competition policy prevents or discourages incumbent firms from taking steps to foreclose entry by potential rivals, then such enforcement will strengthen the incentives of the potential rivals to invest in innovation. This is because these potential competitors will expect it to be easier to enter the market and so will have greater confidence that their investments in innovation will pay off.

Competition, innovation, and intellectual property

Innovation itself is a result of market interactions and the fact that even firms that are not currently competing with each other in existing product markets may be competitors in markets for future innovations. Competition in such markets (and hence the incentive for innovation) can be undermined by mergers or other (potentially) anticompetitive practices. Antitrust law promotes innovation and economic growth by combating restraints on competitive activity. Firms are more likely to innovate if they face strong competition. By deterring anticompetitive practices, antitrust law ensures that consumers have access to a wide variety of goods and services at competitive prices. More generally, preserving the ability of innovative firms to enter a market may well be contingent on the appropriate enforcement of various competition laws.

On the whole, innovation and productivity improvement are likely to be promoted rather than impeded by interfirm rivalry. Nonetheless, identifiable situations can arise in which--given the technologies available to firms in an industry--the maximization of the number of competitors in a market may lead to inefficient outcomes. According to the thinking of leading scholars in the field of industrial organization (see, e.g., Carlton and Perloff 2000), such situations by no means call for the wholesale rejection of competition policy as a tool of economic governance; rather, they call for appropriate tailoring of the application of such policy to take account of relevant technological and other considerations.

Competition policy promotes innovation and economic growth by limiting, if not removing, constraints on open markets and free competition. As noted earlier, firms are less likely to develop new and better products if other firms do not pose any threat of encroachment to their share of the market or if they are constrained from entering new markets. This means that the more stringent competition is among firms, the stronger the incentive to innovate. By preventing restrictive business practices, competition policy guarantees the availability of a large selection of goods, services, and processes at competitive prices.

Similarly, the protection of intellectual property is a spur to innovation in today's economy. Firms and individuals normally invest resources and effort to fashion a unique or better product, process, or service with the expectation of earning a reasonable return on their investment. If there is no possibility of this, then no profit-maximizing agent will make the investment. Intellectual property rights (IPRs) are vital for fostering innovation and growth in an economy. These rights provide the motivation for research and development leading to new products, services, and production processes.

Firms have an incentive to develop new and better products when the prospect of free riding by other firms is minimized. In general, the objective of IPRs is to compensate the innovator for his or her creative efforts, not to put the interests of the individual innovator over and above the interests of consumers. IPRs are usually granted to ensure that appropriate protection is provided to the innovator. Unlike physical property rights however, IPRs are often limited in scope and coverage. At the outset, consumers will be faced with higher prices as the initial innovator reaps the profits of the innovation. However, by justly rewarding the initial innovator, development of similar and related products will be encouraged, ultimately resulting in lower prices for consumers. This is the rationale for granting protection to intellectual property owners--so that the process of innovation becomes sustained over time. This helps drive the growth and development of an economy. By promoting innovation, IPRs also serve to benefit the public and increase consumer welfare.

Intellectual property law preserves the incentives for innovation. Firms are more likely to innovate if they are protected against free riding. Innovation benefits consumers through the development of new and improved goods and services, and spurs economic growth. The aim is not to promote the individual innovator's welfare, but to ensure a sufficient reward for the innovator to elicit his or her creative or inventive effort while not delaying follow-on innovation and not leading to unnecessarily long periods of high prices for consumers. In order to strike a balance between under- and overprotecting innovators' efforts, IPRs differ from, and are usually less absolute than, "normal" property rights.

Protection granted to intellectual property owners include patents, trademarks and service marks, and copyrights. A patent usually covers new inventions or improvements on an existing product. It is a form of recognition by the government that the inventor has the exclusive use and benefit of the invention. A patent may grant the inventor the right to exclude others from making, using, offering for sale, or selling the invention.

A trademark or service mark is a distinctive symbol, device, word, or name attached to a product to indicate that it is sourced from a particular firm or individual. It is a mark used to distinguish the product from the products of other firms or individuals. A trademark is an identifier for a good, while a service mark is for a service. Trademark and service mark rights are granted to prevent other firms or individuals from using substantially similar marks to take advantage of the reputation of the owner of the trademark or service mark and confuse consumers into buying similar products. They do not, however, preclude other firms and individuals from producing or selling similar goods or services provided that the trademark or service mark is different.

A copyright is a form of protection granted by governments to authors of original works, including literary, musical, dramatic or artistic works, films, sound recordings, broadcasts, and other matters, whether published or unpublished. It gives the copyright owner the exclusive right to prepare derivative works, to reproduce the copyrighted work or portions of it, to display or perform the copyrighted work in public, and to distribute copies or recordings of the copyrighted work. These rights may be sold or transferred to other parties. The copyright protects the work in the specific form it was created, but not the idea, subject matter, theme, or concept expressed in the work.

As discussed above, competition policy instruments include competition advocacy and all measures available to governments that affect competition in markets. In the application of intellectual property policy, competition policy may play a positive role. Among intellectual property instruments available to governments are patent scope, which establishes the extent to which an innovator has property rights over related innovations, and patent duration, which establishes the length of time the innovator has exclusive rights over his or her own innovation. Governments thus have the ability to ensure that competition concerns are incorporated into the implementation of intellectual property policy.

For example, in the PRC's 1993 Anti-Unfair Competition Law, Article 5 offers protection against trademark infringement. It prohibits not only the forgery of trademarks and certificates of quality and origin, but also the use of similar brand identification--brand names, packaging, or designs--that would be likely to confuse the consumer. A fine of 100-300% of the value of the illegal gains may be imposed for breaches of the law. Criminal sanctions may also be imposed. Article 10 protects trade secrets, which are defined as technical and operational information that is not known to the public; that is capable of bringing economic benefits to the owners of the rights; that has practical applicability; and that the owners of the rights have taken measures to keep secret. The law imposes a fine of CNY10,000-200,000 on those who obtain such secrets illegally, or who know or should know that a trade secret was obtained illegally but nevertheless agree to distribute such knowledge to a third party.

Intellectual property rights and competition policy

Intellectual property rights and competition policy are complementary since both seek to promote innovation and enhance consumer welfare. They are also complementary ways of attaining allocative efficiency in a market economy. Like IPRs, competition can inspire innovation. Competition drives firms to introduce new or improved products, services, or processes in order to survive in the marketplace, capture a larger share of the market, or simply increase profits.

The desire to gain control of a particular market segment can also encourage firms to develop new products to satisfy consumers' unmet needs. Thus, free enterprise and open markets serve to benefit the public and increase consumer welfare through innovation, as well as through keeping prices low.

Several intellectual property practices clearly have a competition dimension. Some of the more common ones are described below:²²

• Pooling and cross-licensing arrangements--owners of IPRs license their rights to one another and split royalty fees. This may result in cartel-like behavior on the part of the pool members.
• Exclusive territories--the licensor agrees not to license any other licensee in a particular area. This grants licensees monopolies to serve particular territories, but restricts them from expanding into other localities.
• Grantbacks--the licensee is required to license back to the licensor improvements made by the licensee on the licensor's intellectual property. To some extent, this is tantamount to exclusivity between the licensor and licensee, and excludes others from profiting from the intellectual property.
• Acquisitions of IPRs--outright purchases of IPRs or of firms owning IPRs. Similar to other asset acquisitions, this could allow a firm to have monopoly power over a market or to obtain a dominant market position.
• Exclusive dealing--an auxiliary agreement is attached to the granting of a license, which prohibits the licensee from selling, distributing, using, or licensing a competing technology. This denies rivals the opportunity to use the licensee as an outlet for their products or processes.
• Reach-through royalties--the licensor requires that royalties be based on the product's total sales, irrespective of whether the licensor's technology was used in each stage of the production process. This effectively presents an all-or-nothing choice to the licensee, and provides a disincentive to use other or similar technology in some stages of the production process.
• Tying arrangements--the licensed technology has a variable input related to usage that can only be sourced from the licensor. This allows the licensor to earn a profit both on the licensed technology and on the licensed complementary input. An illustration is home printers sold at low prices, but for which the consumable input, the toner, is sold at high prices.
• Compulsory licensing--legal intervention to restrict the monopoly rights of existing patent holders. This grants certain firms the license to use, sell, or distribute a patented technology to make it more available to a larger number of users. Compulsory licenses are often granted in cases of national emergency, such as during the anthrax attacks after the events of 11 September 2001 in the US, when many manufacturers were granted compulsory licenses in order to make the anthrax vaccine more readily available.
• Vertical price restrictions--the licensor determines the price at which the licensee must sell the licensed products. This effectively limits competition among licensees, as the licensor restricts the price at which the product can be sold.

From a short-run perspective, there appears to be some tension between the goals of IPRs and competition policy. The apparent conflict arises because intellectual property laws give the innovator the right to exclude others from exploiting the innovation. This may lead to market power, and even monopoly as defined under existing competition legislation. Thus, intellectual property law, in seeking to protect property rights, limits competition to a certain extent. Meanwhile, competition policy is generally driven by the assumption that the removal of barriers to free competition is the best way to maximize consumer welfare.

However, competition and IPRs are not essentially in conflict. IPRs, while providing some form of statutory monopoly, generally do not provide market power of such a significant degree as to cause concern to competition authorities. This is because the scope of a particular IPR is often smaller than the relevant market, so that the opportunity to create similar products to compete with the protected one still exists.

The apparent short-run tension between competition and IPRs also contrasts with a longer-term view. IPRs generally strengthen competition in the economy over the long run, by providing incentives for the development of new products and production processes. In recognizing that technological progress contributes to social welfare, the apparent conflict between IPRs and competition policy is resolved. Since the long-run goals of competition policy and IPRs are mutually reinforcing, governments are increasingly willing to restrict competition temporarily at present, so that competition in new products and processes can be attained in the future.

The above issues illustrate how competition policy can be associated with the implementation of IPRs. While there is some complementarity in the goals of intellectual property policy and competition policy, the interface between them may be difficult to manage. This is because IPRs can limit competition in the short run, resulting in a trade-off between the immediate benefits from increased competition and the future benefits from subsequent innovations. Therefore, governments need to balance policies on intellectual property and competition to ensure that consumer welfare is maximized and that policies support economic growth. Policy makers face the challenge of coordinating the instruments of intellectual property policy and competition policy to efficiently allocate resources toward the development of new and better goods, services, and processes.

Policy makers have striven to maintain the balance between intellectual property policy and competition policy by using various pre- and post-patent grant mechanisms. Pregrant measures typically include limiting the scope and duration of patents. This is because overly broad patent grants, interpretations, or applications of IPRs may unduly limit competition. Many agree that some form of protection for the innovator's investment is justified to encourage future innovation. Too much protection, however, may unintentionally result in just the opposite. This is because procedures that are too complicated or too stringent would actually serve to discourage prospective pioneers from innovating similar products and follow-on innovators from developing the next generation of products.

It is therefore imperative for governments to ensure that protection granted to intellectual property holders will still allow current and future innovators to build new and improved products or processes from the existing patented products or processes. By contrast, postgrant measures typically include allowing compulsory licenses and exemptions on specific uses of the patent, especially for patents related to health issues.

Apparent conflict arises because IPRs give an innovator the right to exclude others from exploiting the innovation, which may lead to market power and even monopoly as defined under competition law. Intellectual property law seeks to protect property rights, and in so doing, limits competition. Competition policy may therefore play a positive role in forming intellectual property law, especially through competition advocacy with the policy makers formulating the intellectual property law. Competition policy expertise should prove useful in helping to decide on issues like the correct scope and duration to be awarded under intellectual property law.

Competition law, meanwhile, has generally reflected the premise that consumer welfare is best served by removing impediments to competition. However, this short-run view of some competition authorities has been replaced by a longer-run view, which acknowledges that technological progress contributes at least as much to social welfare as does the elimination of allocative inefficiencies from noncompetitive prices. There is now growing willingness to restrict competition today in order to promote competition in new products and processes tomorrow.

Patent and competition policy are complementary instruments for rewarding the innovator most efficiently: patent scope by preventing imitation and antitrust by affecting price through constraints on contracts for transferring technology. Patent scope and competition policy are distinct instruments for affecting the incentives to research and to transfer technologies: one sets the "threat points" or the opportunity cost of entering into the licensing agreement (e.g., whether or not a rival can introduce an imitation) and the other establishes the feasible set of legal licensing contracts. Consequently, intellectual property law and antitrust law are complementary since both seek to promote innovation and enhance consumer welfare, and are complementary ways of achieving efficiency in a market economy.

Despite sharing important goals, IPR and competition policies are not purely complementary and managing the interface between them is difficult. A completely legitimate use of IPR can restrict competition, at least in the short run, thereby producing a trade-off between the benefits of increased competition and the gains from further innovation. A typical challenge facing policy makers is to coordinate patent instruments (patent scope and duration) and competition instruments (contractual restrictions) so as to achieve an efficient allocation of resources directed toward the development and use of new products and processes. Thus:

A country's optimal patent policy is found by equating the sum of the extra deadweight loss that results from strengthening the IPR protection granted to domestic firms and the extra consumer surplus loss that results from expanding the fraction of goods that are subject to monopoly pricing with the benefits that flow from providing greater incentives for innovation to firms worldwide. A country's optimal IPR protection depends on the policies set by its trading partner, because the strength of foreign patent rights affects the responsiveness of global innovation to a change in a country's own patent policies (Grossman and Lai 2004).

Back Effects on government finances	Next Summary and conclusions