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We build a multi-sectoral North–South trade model to analyze international intellectual property rights (IPR) protection. By comparing the Nash equilibrium IPR protection standard of the South (the developing countries) with that of the North (the developed countries), we find that the former is naturally weaker than the latter. Moreover, we show that both regions can gain from an agreement that requires the South to harmonize its IPR standards with those of the North, and the North to liberalize its traditional goods market. This demonstrates the merits of multi-sectoral negotiations in the GATT/WTO.

One important breakthrough of the Uruguay Round of the General Agreement on Tariffs and Trade (GATT) is the signing of the Agreement on Trade-Related Aspects of Intellectual Property Rights (the TRIPS Agreement), which stipulates that all members adopt a set of universal minimum standards on intellectual property rights (IPR) protection.1 According to many observers (e.g., Reichman, 1995), most of the terms of the agreement are based on the prevailing standards in developed countries (the North) at the time of the negotiation. The major consequence is that developing countries (the South) have to strengthen substantially the legal protection of IPR. Based on this observation, it is often argued that the agreement ‘forces’ the South to harmonize its IPR standards with those of the North. The TRIPS Agreement has raised several questions. For example, has the South been doing too little to protect IPR (from the South’s and the global welfare points of view)? What are the welfare consequences, for the South, the North and the world, from strengthening IPR protection in the South? From the global welfare point of view, does the South protect too much if it adopts the North’s IPR standard? How can we make the TRIPS Agreement compatible with the South’s incentive? Answers to these questions would help us address other important issues as well. For example, if raising the South’s IPR standard improves the world’s welfare, then the TRIPS can potentially make all regions better off. This paper deals with the above questions and issues. We build a model with two regions in the world, the North and the South, which trade two types of goods, differentiated products and traditional products. Innovation and imitation are carried out in the differentiated-products sectors of both regions. We assume that the North and the South adopted their respective Nash equilibrium IPR standards before the TRIPS was put in place, and the TRIPS Agreement requires both regions to adopt the pre-TRIPS IPR standard of the North as a minimum standard. The cost–benefit analysis we adopt is not fundamentally different from Nordhaus’s (1969) classical work in which he calculates the optimal patent length. Like his analysis, our optimal IPR protection strikes an optimal balance between the gains from increased R&D efforts and the deadweight losses resulting from the prolonged monopoly power of the innovators. Based on our analysis, we find that the South’s equilibrium IPR standard is naturally not as strong as that of the North. Moreover, it is globally welfare-improving for the South to raise its IPR standard to harmonize with the North’s pre-TRIPS level. The major effects of the TRIPS are: the South’s consumers lose by paying higher prices, the North’s producers gain higher profits, but all consumers gain from a larger variety of goods. On balance, the South’s welfare decreases, the North’s increases, but the total welfare of the two regions rises, because of the existence of a positive inter-regional externality. The externality arises because an increase in a region’s IPR protection raises the profits of firms and enlarges the product variety in another region without raising the deadweight loss in the latter. However, an agreement that requires the South to raise its IPR standard without compensation benefits the North at the expense of the South, and would not be compatible with the South’s incentive. Therefore, we extend the above IPR model to incorporate multi-sectoral bargaining between the North and South to show that multi-sectoral negotiations (or multi-issue negotiations) in GATT/WTO can be mutually beneficial to both regions. For example, it would benefit both regions for the South to harmonize its IPR standard with the North’s, in exchange for the North lowering its import tariffs against South’s exports of traditional products. In this case, multi-issue negotiations can achieve incentive-compatible and mutually beneficial outcomes while single-issue negotiations cannot, since it is globally welfare-improving for each side to make concessions on a different issue. There have been many theoretical and empirical studies on the effects of IPR protection on innovation, trade, foreign direct investment and economic growth.2 As far as we are aware, however, the present paper is among the first to assume that both the North and the South have innovative capabilities and to consider optimal degrees of IPR protection for the North, the South and the world as a whole. It is also among the first to analyze the merits of raising the South’s IPR protection in the broader context of multi-sectoral (or multi-issue) negotiations, such as in the GATT or WTO. There are some other studies in the literature that are related to our study in one way or another. Both Chin and Grossman (1990) and Deardorff (1992) examine welfare effects of extending IPR protection from the North to the South. They find, as we do, that many results depend on the size of the South’s market.3 However, there are two notable differences between these papers and our study. First, they assume that the South does not have innovative capability. Second, they examine only the case in which the South has either full or no IPR protection. Diwan and Rodrik (1991) also consider various degrees of IPR protection in the North and the South. Interestingly, they find that to maximize the global welfare, which is the equally weighted sum of the North’s and the South’s welfare, the rates of patent protection in the two regions must be identical. They emphasize the taste difference between the two regions and assume no innovative capability in the South. Helpman (1993) uses a dynamic general equilibrium North–South model to study IPR protection, growth and welfare. He assumes that the North specializes in innovation and the South specializes in imitation. He finds that tightening IPR protection in the South hurts the South and may or may not benefit the North. We believe that this result needs to be modified if we take into account the South’s innovative capability. We examine this issue in our partial equilibrium model, which is able to include a more detailed microeconomic analysis of firm and government behaviors.4 Unlike our work, none of the above-mentioned papers deals with the incentive-compatibility issue of the South’s concessions in IPR. Our result that multi-issue negotiation makes both the South and North better off echoes the recent literature on linkage issue related to international trade negotiations (see Horsmann et al., 2001). More recently, McCalman (2001) makes estimates of the transfer of income from consumers to producers (mostly a transfer from South to North) resulting from the TRIPS. However, he does not estimate the welfare gains from larger product variety, which can be substantial. As we argue below, such a gain would actually outweigh the deadweight loss so that a rise in the South’s IPR protection is globally welfare-improving.5 The organization of the paper is as follows. Section 2 lays out the basic features of the model and derives the Nash equilibrium pre-TRIPS IPR standards in the two regions. Section 3 examines the effect of varying the South’s IPR protection standard on global welfare. Section 4 introduces a bargaining game between the two regions in a multi-sectoral negotiation. Section 5 summarizes the findings.

We find that it is globally welfare-improving for the South to increase its IPR protection above its (pre-TRIPS) Nash equilibrium level. Although this would hurt the South and benefit the North, the latter’s gains are larger than the former’s losses. Consequently, it can benefit both regions for the South to adopt the North’s pre-TRIPS IPR standard, in exchange for the North lowering its import tariffs. We conclude, therefore, that the inclusion of IPR negotiations in GATT/WTO agendas is constructive. We find that in the multi-sectoral negotiation it is globally optimal for the South to increase its IPR protection standard all the way to the North’s level. However, it is not necessarily optimal for the South to do so. It is optimal for the South only if its bargaining power in the negotiation is sufficiently large to elicit a large enough tariff reduction by the North. Otherwise, the extra surplus generated from strengthened IPR protection will mostly benefit the North. In that case, if the South has the choice, it would prefer an agreement that binds it to a higher standard than before, but below that of the North. In other words, giving the South an ‘all-or-nothing’ choice in either adopting the North’s IPR standard or maintaining the old standard might diminish the South’s gain from such a negotiation. It seems evident that the South was indeed presented with an ‘all-or-nothing’ choice regarding IPR protection in the Uruguay Round of the GATT negotiations. If this is the case, we can say that the TRIPS Agreement requires the South to give up too much. It is therefore no wonder that many developing countries are not enforcing as high an IPR standard as the developed countries want while the developed countries seem to be retracting from their market access commitments. In spite of these seeming retractions, however, our result has demonstrated that both regions would still gain as long as they can eventually willingly enforce some bilateral concessions in both sectors. This again demonstrates the merits of multi-sectoral negotiations. In future research, we hope to modify the existing model to a truly dynamic, and possibly general equilibrium one, and to consider interactions among trade policies, FDI policies and IPR policies in a unified model.