Intellectual Property Rights,Innovation and Development: Is Asia Different?

I. Introduction

More than 20 years after the ratification of the Trade-Related Intellectual Property Rights (TRIPs) Agreement, many developing countries (and their intellectual advocates in the industrialized countries) still contend that the shift to stronger intellectual property rights (IPR) has worked against their interests. Stronger IPR can lead to higher prices for patent-protected goods, and that this can, in principle, generate short-run losses in consumer surplus, at least in a conventional and static sense (see Chaudhuri, Goldberg, & Jia, 2006; McCalman, 2001; Maskus, 2000 for early evidence on these points). On the other hand, the magnitude of these losses, at least in the critical domain of pharmaceuticals, has been brought into question by recent evidence (see Branstetter et al., 2016; Duggan et al., 2016 for more recent evidence). But this study will not focus on the relationship between patent strength and goods prices. Instead, it will focus on the relationship between patent strength and industrial development. This is because developing country opponents of TRIPs and TRIPs-Plus trade agreements also contend that stronger IPR may retard the process of industrial development. According to this view, weak IPR functions as a kind of infant industry policy––it allows indigenous firms to learn from, absorb and experiment with foreign technology at low cost. If one believes that local firms must build a capacity to imitate before they can innovate, then it is possible that premature imposition of a strong IPR regime could actually hold back economic development rather than promote it.

The premise that weak IPR can promote industrial development rests, in part, on a reading of the economic history of Asia that has been put forward by multiple generations of authors (see, among other writings, Ha-Joon Chang, 2003). In this view of industrial history, which often focuses on Japan, South Korea and Taiwan in the post-war era, Asian governments deliberately weakened or selectively enforced patent laws so that advanced Western multinationals were not able to enforce their IPR fully. This allowed local firms to imitate, experiment with and assimilate Western technology without fear of legal retribution (Lee, 2013). ¹ The freedom for local firms to experiment was also maximized by the regulations that limited the presence or operation of foreign firms in the local market and imposed limits on imports. Once a critical mass of local firms had acquired a high degree of facility with that technology, and were able to start innovating themselves, then and only then did the government strengthen IPR laws and get serious about their enforcement. Had South Korea or Japan heeded the demands of its trading partners and enacted and enforced strong IPR regimes, such as existed in Britain or the United States, the impressive industrial development of these countries would have been deeply undermined and at best severely retarded.

Sections 2 and 3 of this essay review recent theoretical work and empirical evidence, respectively, concerning the impact of IPR on growth and development. Section 3 argues that recent evidence suggests that stronger IPR has a positive impact on industrial development rather than a negative one. Sections 4 and 5 argue that the reading of Asian industrial history noted above omits some important facts. Section 4 notes the importance of human capital accumulation in enabling technological development, and Section 5 notes the amazing success of some Asian nations in accumulating advanced human capital. These sections suggest that the delayed introduction of stronger intellectual property rights was arguably less strategic than has suggested, that it played a less significant role in the industrial convergence of East Asia than other policies. Section 6 introduces the argument that the delayed introduction of stronger intellectual property rights in East Asia carried with it negative side effects whose costs have become more evident over time. Section 7 shifts the focus of the paper to the electronics/IT sector, and suggests that, in the IT industries, the shift to a greater reliance on patents and patent-protected product innovation, especially in the US, was, in part, a strategic reaction to the rise of low-cost Asian competition. Section 8 points to the growing struggles of the IT/electronics sectors in Japan, South Korea, and Taiwan, arguing that they exemplify some of the natural limits of a style of innovation that emerged in response to weak patents. Section 9 extends these arguments to India and China, and Section 10 concludes that a more comprehensive view of East Asian industrial history poses less of a challenge to the policy implications of recent empirical work on the impact of IPR on industrial development than it first appears.

II. IPR Reform, Industrial Development and Innovation in Theory

In theory, the relationships between stronger IPR in developing countries, inflows of foreign direct investment (FDI) into developing countries and their industrial development could be positive or negative. ² Even in the 1960s, international economists were aware of a ‘product cycle’, in which a manufactured good would be invented and initially manufactured in the most advanced industrial economies. Over the time, production would shift to less advanced economies as the technology embodied in the product became more standard and routine (Vernon, 1966 provided the first model of a product cycle). Theoretical work on the impact of IPR reform in developing countries put this notion of a product cycle at the centre of a stylized model of the global economy with an industrialized ‘North’ and a developing ‘South’. Important early research by Helpman (1993) developed several variants of a North–South general equilibrium product cycle model in which Northern innovation expands the range of differentiated goods produced in the world while Southern imitation leads to North–South production shifting. Helpman concluded that stronger IPR protection is never in the interests of the South. If stronger IPR in the South is treated as a reduction in the rate of Southern imitation and if Northern firms do not shift production to the South through FDI, then Southern IPR reform lowers the rate of Northern innovation and thereby limits the portfolio of products available globally. If North–South FDI is permitted, a reduction in Southern imitation leads to more FDI but hurts the South because Northern multinationals charge higher prices than Southern imitators.

It would be difficult to overestimate the impact of Helpman’s early work on the theoretical literature that followed. Helpman’s model provided elegant theoretical underpinnings for the concerns being raised by developing country representatives during the Uruguay Round trade negotiations that eventually produced the TRIPs Agreement. He was able to derive closed form results for welfare changes that subsequent researchers have struggled to match. Nevertheless, the stark results of Helpman’s model flow out of a particular set of assumptions. Helpman assumes that trade between North and South leads to an equalization of wages across regions. While this is a standard outcome in many trade models, North–South wage convergence has certainly not (yet) been achieved in the real world, and, in fact, low wages in the South are a key driver of FDI. Helpman also effectively assumes that Northern FDI does not respond to IPR changes in the South. Finally, Helpman assumes that there is no innovation whatsoever in the South. Changing these key assumptions can lead to quite different predictions.

Lai (1998) extended Helpman’s model to allow both the level of FDI and Northern innovation to respond endogenously to changes in the strength of Southern IPR protection. This model is further extended in work by Branstetter and Saggi (2011) to the case where innovation, FDI and imitation are all endogenously determined. In these extensions, in any equilibrium with a positive rate of imitation, North–South FDI does not lead to equal wages in the two regions. A lower wage in the South creates an incentive to move production of existing varieties there, but multinationals seeking to benefit from this incur a higher risk of imitation when they move production to the South. Imitation is a costly activity that requires deliberate investment on the part of Southern firms seeking to copy Northern products. Stronger IPR protection in the South increases these costs, reducing imitation and lowering the risks faced by multinationals. Multinationals that move to the South employ the labour resources freed up by the decline in imitative activity. Production shifting allows for a reallocation of Northern resources towards innovative activity. Under certain parameter assumptions, a strengthening of Southern IPR protection enhances Southern industrial development because the increase in North–South FDI more than offsets the decrease in Southern imitation. ³ In these theoretical extensions, it is possible that industrial expansion of the South could still be welfare reducing––if the prices charged by multinationals are sufficiently higher than prices charged by indigenous firms, the negative welfare effects engendered by those higher prices could outweigh the increase in Southern output, relative wages and terms of trade. Allowing for innovation, FDI and imitation to all respond endogenously to Southern IPR changes complicates welfare analysis, and no study yet circulated in the academic literature has provided a full-fledged mathematical analysis of welfare effects under these conditions. However, a necessary condition for welfare to rise with stronger IPR is that IPR reform accelerates industrial development, in part by inducing an increase in FDI.

III. Emerging Empirical Evidence on the Impact of IPR Reform on Innovation and Industrial Development

Recent evidence suggests that this effect is present in data taken from multiple countries. Branstetter, Fisman and Foley (2006) and Branstetter et al., (2011) identified 16 substantive IPR reforms and demonstrated that US multinationals increased their technology transfer to their affiliates in reforming countries after reform. Furthermore, the increase in the transfer was significantly higher for affiliates of technology-intensive parents, who could be expected ex ante to be more responsive to reform. A similar pattern was found in the R&D spending of US multinational affiliates. These rose in the wake of reform and more strongly among affiliates of technology-intensive parents. In most countries, affiliate R&D is a complement to technology imports from the parent––one designed to modify parent technology to suit local tastes or conditions (Kuemmerle, 1999). The similarities in the movement of R&D and technology transfer suggested that there was a real increase in the provision of technology to affiliates after reform. Of course, demonstrating a multinational response to IPR reform is not sufficient to prove that it fosters industrial development. Multinationals could increase the technological intensity of their operations without increasing its scale, and an expansion of multinational activity could come at the expense of a decline in indigenous activity, resulting in a net deceleration of industrial growth.

Recent research by Branstetter et al. (2011) addresses these broader issues. US multinationals expand their capital stock and compensation to local employees after IPR reform, and these effects are greater for the affiliates of technology-intensive parents. Additional regression analyses use industry-level data from the UN Industrial Development Organization to examine the impact of IPR reform on the level of industrial value-added. Controlling for country-specific time trends, the study demonstrates that industrial value-added expands rather than contracts, and these effects are especially large in technology-intensive industries. The study also attempts to get at a more direct measure of the speed with which countries are cycling into the production and export of new goods by counting, for their 16 reforming countries, the number of new 10-digit categories in which positive exports to the United States are recorded for the first time in their data. The study concludes that this count is systematically higher after reform, suggesting an acceleration in the operation of the international product cycle. Bilir (2014) takes a different, but complementary approach, examining all changes in IPR strength since the early 1980s, as measured by the Ginarte and Park index, and exploring how different industries respond to these shifts. Bilir also finds a large, relatively rapid, statistically significant impact of increases in IPR strength on US investment in IPR reforming countries, although this effect varies widely across industries.

Other authors have also found a positive relationship between FDI, technology transfer, industrial development and the strength of IPR, although most studies do not address all of these connections within the same study. Stronger patent rights in Eastern Europe and former Soviet Union states appear to have a positive effect on foreign FDI (from a range of host countries) in high-technology sectors (Javorcik, 2004). IPR reform appears to increase international technology transfer from Japanese multinational firms to their affiliates, a result that parallels the findings of Branstetter et al. (2006) (Ito & Wakasugi, 2009). Fewer authors have attempted to assess the impact of IPR on industrial development more broadly, but a recent study by Hu and Png (2013) is also consistent with the findings of Branstetter et al. (2011). Hu and Png find that patent-intensive industries in more advanced economies grow more quickly after IPR reform. They do not identify FDI as a causal mechanism nor do they directly measure FDI in their empirical work, but their finding that patent reform appears to have driven industry expansion through more rapid factor accumulation and increasing productivity is consistent with multinational enterprises (MNE) responding to IPR reform by increasing their capital stock and transferring technology to affiliates. The rise in developing country industrial activity could reflect far more than pure FDI effects. It is possible that some of the transferred technology could eventually diffuse to domestic firms, especially domestic suppliers in whose technical competence foreign firms have a vested interest. Evidence is also emerging that knowledge spillovers occur in developing countries through transfers of employees from MNEs to indigenous firms (Poole, 2013). Most theoretical North–South product cycle models of IPR reform also predict an acceleration in Northern innovation as production flows to the South. In the models, this stems not just from stronger protection but also from a general equilibrium resource reallocation in the North from production to R&D. Perhaps, not surprisingly, attempts to directly measure the impact of particular Southern IPR reforms on Northern innovation fail to find much discernible impact (Park, 2012). Most individual Southern countries are too small and the lags involved in such a resource reallocation are likely to be too long and variable for the data to identify much of an effect. It is nevertheless interesting to observe that the years following the ratification of the TRIPs Agreement have been ones in which innovative activity in the United States appears to have accelerated (Kortum & Lerner, 1999). In their book, From Silicon Valley to Singapore, McKendrick, Doner and Haggard (2000) argue with historical (but not econometric) evidence that the US-based hard disk industry followed exactly this path, using resources saved from the offshoring of manufacturing to invest in new product development. Moreover, according to the authors, this strategy was crucial in enabling US-based firms to respond to new (mostly Asian competition) and eventually retain industrial leadership.

While the empirical results reviewed in this section appear to hold, on average, for a wide range of countries that have reformed their patent laws in recent decades, the evidence is not nearly strong enough to lead one to the conclusion that an embrace of stronger IPR always promotes industrial development or that there are no circumstances under which weakening patents––or delaying a strengthening––could accelerate industrial development. It is reasonable to ask, is Asia different? Might Asian economies have developed under a particular set of circumstances that made IPR weakness preferable to IPR strength? And might there not be other countries that could find themselves in similar circumstances, even if the ‘average’ country has rarely found itself in such circumstances in the recent past? The rest of this study is devoted to that question.

IV. The Veil of Ignorance and the Rise of Industrial East Asia

The intellectual rationale for patents is this: Without them, innovators would be quickly imitated, they would fail to recoup the costs of innovation, and society would therefore not enjoy the social benefits of innovation. But in the early decades of industrialization, the profits of innovators were shielded by something far more than patents––ignorance. Only a few individuals in a handful of countries possessed the ability to create or to effectively imitate the early inventions of the industrial revolution. This is a difficult point for contemporary observers to see, because we live in a world in which the basic scientific and engineering principles embodied in even very recent industrial products are well understood and taught in universities around the world. However, the global organic chemical industry got its start in a nineteenth-century world in which the periodic table did not yet exist, the discipline of analytical chemistry had not been created, and there was almost no way for a would-be imitator of a new chemical substance to scientifically determine what this substance was or how it had been synthesized, unless he/she was somehow able to steal the full ‘recipes’ from the innovating firms. As the science of chemistry advanced, of course, new chemicals quickly evolved from more or less complete ‘black boxes’ to products that could be easily and quickly reverse-engineered. It is hardly surprising that, as these trends continued, the global chemical companies, some of which arose in countries with weak or non-existent patent protection, began to aggressively patent their products in countries where such protection was available and push those markets which did have product patents for chemicals to adopt them. Moser (2013) notes this––as the veil of ignorance retreated, firms had to protect themselves with patents.

The retreat of the veil of ignorance was a gradual and uneven process even in the industrial West. As developing nations emerged from colonial rule in the post-war era, many deliberately weakened their patent laws through new legislation or ‘selective’ enforcement. Despite this, the technological gap between developing and developed countries did not dramatically narrow, nor did most developing countries manage to substantively expand their share of world manufacturing output. The extent and expanse of the veil of ignorance is a key reason why deliberately weak IPR regimes failed to promote technological convergence with the West. Even as modern engineering colleges spread from the West to developing countries, and even as the number of adequately trained engineers outside the Western world expanded, these individuals and their skills were still a very scarce resource in most developing countries. The East Asian countries were unique in the speed and success with which their investments in education pulled back the veil of ignorance.

V. Human Capital and Industrial East Asia

Japan led the way after its Meiji Restoration, moving quickly and decisively to create a modern educational system at all levels and embed state-of-the-art Western expertise into its leading firms and government ministries. To their credit, the Meiji reformers established libraries full of translations of Western thought, science and engineering throughout the country, subsidized study abroad for thousands of Japanese students and imported enormous numbers of foreign instructors, consultants and experts. At least 3,000 foreigners of all types were in government service during the early Meiji period, and a total of 8,000 foreigners were in Japan in public and private positions. ⁴ In these early years, half of the Ministry of Education’s budget was spent on foreign experts, and a still higher fraction (two-thirds) of the national public works budget was spent on foreign experts. These foreign experts were expensive, often arrogantly dismissive of Japanese culture, and difficult to manage, and the Japanese institutions employing them had every incentive to replace them as quickly as possible with qualified Japanese citizens. Fortunately, Japan’s modernizing educational system was quickly able to prepare its citizens for rapid modernization. In 1891, 26 per cent of the labour force had a primary school education. By 1935, 98 per cent of the population had a primary education. Japan quickly transferred its educational system to its colonies, Taiwan and South Korea.

This early commitment to educational excellence strengthened in the post-war era in all three countries. Stanford’s eminent education expert Thomas Rohlen published his landmark study, Japan’s High Schools, in 1983 (Rohlen, 1983). In terms of the mastery of basic skills, Rohlen claimed that the typical Japanese high school graduate in the early 1980s was the equal of the average American college graduate. As early as the mid-1960s, Japanese students were dramatically outscoring Europeans and Americans on international standardized tests of mathematics and science. By the 1980s, Japan graduated more than twice as many engineers per capita as the United States, and its ordinary workers had dramatically higher levels of competence in science and math. Today, standardized tests of science and mathematics skills suggest that the average levels of skill mastery and the fraction of students scoring 1 standard deviation above the OECD average are extremely high in Japan, South Korea and Taiwan (Hanushek & Woessman, 2015). This excellence extends to the city states of Hong Kong and Singapore, who patterned their own educational systems after the ‘East Asian’ model. There can be little doubt that this effective investment in human capital is extremely important in explaining the technological convergence of these nations with the West. Economic research has shown as much. In his own highly cited paper in the American Economic Review, Romalis (2004) finds that once one accounts for the expansion observed in East Asia in human and physical capital, there is little left over in the variance of East Asian export flows for ‘industrial policy’ to explain. ⁵

VI. The Impact of Weak Patents on the Nature and Direction of East Asian Innovation

Whole volumes could be devoted to discussion of the post-war IPR systems in Japan, South Korea and Taiwan. ⁶ Given the space limitations of this article, I will necessarily be brief. First, there was no explicit doctrine of equivalents in Japanese patent law or jurisprudence during Japan’s rapid growth period. Such a doctrine was not explicitly confirmed by the Japanese Supreme Court until 1998. ⁷ As a consequence, it was difficult for truly innovative firms to successfully prosecute infringing products that were minor variants of existing products. Second, patent infringement fees tended to be low––low enough that large, well-capitalized firms were generally undeterred from making minor alterations to the patents of their rivals. Again, this changed in the 1990s, with the beginning of large patent infringement awards by Japanese courts. Third, prior to 1987, Japan’s patent system constrained inventors to describe their patents with a single claim. As Sakakibara and Branstetter (2001) have argued, this contributed to the difficulty Japanese firms faced in preventing rival firms from introducing closely related products into the market place. Finally, the Japanese patent office lay administratively within the Ministry of International Trade and Industry, was subject to political influence from that Ministry, and was limited in resources and prestige. ⁸ Reflecting the longstanding influence of colonial ties, Taiwanese and South Korean patent law and jurisprudence tended to follow these Japanese practices, with the additional constraint that Taiwan and South Korea had no product patents for pharmaceuticals or agro-chemicals until the mid-1980s.

At this point, I want to raise the possibility that the relative weakness of patents in the early post-war era has had significant and lasting consequences for Japan, South Korea and Taiwan, and for the development of their national innovation systems. In order to appropriate the returns from invention, firms had to rely principally on mechanisms other than patents. As the work of Cohen et al., (2002) has pointed out, even in the United States, industrial firms often rely on mechanisms other than patents, including being first to market, manufacturing skill and marketing acumen (i.e., the power of a brand). However, the relative breadth and strength of patent protection in the United States allowed individuals or firms with truly novel, broad, important inventions greater protection through patents alone. An inventor with a great idea but no manufacturing capability, for instance, could negotiate a licensing agreement with a larger enterprise without fear that the strong manufacturer would effectively appropriate the invention. Strong patents in the United States were thus a vital part of the institutional structure which allowed a diversified innovation ecosystem of established firms and innovative start-ups to develop. An industrial firm that came up with something brand new and needed to invest in manufacturing capabilities quite different from the ones it already possessed could do so, with some confidence that strong patents could hold potential imitators at bay while the internal capabilities were developed. So, strong patents also created an incentive for US industrial firms to fund research projects that were quite distant from the current portfolio of products. These features of the American innovation system were not simply a reflection of America’s IP system. They also reflected the presence in the United States of world class research universities that were sensitive to the needs and interests of industry, and they reflected a fluid and open labour market that allowed human talent to flow easily across firm boundaries. Nevertheless, I will assert that strong and broad IP was an important component.

In contrast, Japanese firms adopted a style of research that emphasized proximity to their existing portfolio of products; applied, rather than basic, research; and process, rather than product innovation. Table 1 summarizes this taxonomy, taken from a 1988 essay by Professor Henry Riggs of Stanford’s Department of Industrial Engineering.

Of course, this Japanese style of R&D reflected far more than just narrow patent protection. It also reflected a resource constrained university sector that did an excellent job of training competent engineers but had limited resources to support path-breaking research, and a ‘lifetime employment’ system that limited employee mobility across firm boundaries. Importantly, it also reflected the influence of relative wages that lagged Japanese productivity growth in the manufacturing sector and a favourable exchange rate, which enhanced the value of innovation that was closely linked to manufacturing. Japanese firms that were able to out-produce their rivals at home often found they were able to compete favourably against the leading firms in the West.

Japan’s rise as a competitor had a profound impact on the nature of competition among the existing incumbents in industries related to electronics and information technology. Accounts by industry insiders describe the nature of competition between IT firms that existed before Japanese firms arrived en masse as one in which patents were far less critical to competition than would be the case in the 1990s and 2000s. While US and European firms in information technology had always patented their most important technologies, the possibilities of ‘inventing around’ patented innovations meant that reliance on IP was limited. ⁹ Instead, the Western incumbents placed considerable importance on being the first to market with a new technology. The Western (mostly US) incumbents tended to have broadly similar costs of production, and if they offered up a close imitation of an existing product, they could only lure away customers from the innovator by offering a significant discount that depressed their profit margins. It was more profitable to offer a significant modification of their rivals’ technology, for which they could also charge a premium. This combination of evenly distributed costs and a premium on novelty fostered innovation without extensive reliance on patents.

The entry of a new set of Asian competitors with dramatically lower costs undermined this equilibrium. Japanese firms had costs low enough that they could sell products very close in the produce space to those of the incumbents, do so at a discount, and still earn a healthy profit. Western firms that sought to ‘innovate away’ from Japanese competitors found that their new rivals could quickly imitate their innovations––with high quality and low cost. ¹⁰ Existing narratives suggest that the election of Ronald Reagan and the establishment of the CAFC (Court of Appeals of the Federal Circuit) were the primary factors triggering a shift to greater reliance on patents in US high-tech industries, but these narratives omit the importance of the rise of Asian competition, starting with Japanese firms (see Gallini, 2002; Hall & Ziedonis, 2001 for useful descriptions of the evolution of US patent law and practice in the 1980s). The pro-patent shift in the United States was, in part, a response to the rise of Asian competition with low costs and advanced manufacturing skills. As patent law and practice shifted in favour of incumbent patent holders, US firms in IT increased their propensity to patent. The new strategy adopted by American IT firms sought to shift the location of products in the product space, through product innovation, and then prevent low-cost Asian competitors from following that movement by erecting a patent wall. It was still the case that a single patent could be invented around, but as IT firms aggressively carpeted the intellectual product space around their inventions with increasing numbers of patents, it became harder for any new entrant to build components, products and systems that were compatible with existing standards and interfaces without infringing on someone else’s patents. A number of significant patent law suits against Asian competitors revealed the potential power of this strategy, and Asian-based firms began increasing their patenting in the United States. Major producers with significant patent portfolios began to negotiate broad cross-licensing agreements with other firms. When two firms had broadly equivalent patent portfolios, the net licensing payments were often zero or near zero, but newcomer firms with small patent portfolios were charged heavy licensing fees to enter the market (see Grindley & Teece, 1997).

At the same time that leading American firms were accumulating large portfolios of product (and process) patents, they were also moving manufacturing to low-cost locations––especially in Asia. Long experience in electronics manufacturing had codified manufacturing processes and technologies, making this move easy. Asian nations beyond the Northeastern triumvirate of Japan, Taiwan and South Korea were investing in local human capital, making the shift less reliant on expensive expatriates. Host nations in Southeast Asia welcomed multinational investment with low taxes, complementary infrastructure investment and, increasingly, strong IP protection. Western incumbents that were increasingly relying on product innovation, protected by patents, were less wary of allowing some of their process technology to seep out to local firms, so long as the product innovations could be well protected. Some of this offshoring took the form of contract manufacturing agreements with South Korean and Taiwanese firms. As the yen appreciated in the 1980s, Taiwan and South Korea suddenly found themselves in a position to undercut Japanese firms on cost as Japanese firms had once been able to do to American firms, and Taiwanese firms, especially, began manufacturing electronics components and products under contract for American giants. As Taiwanese and South Korea costs rose, though, this offshoring shifted to lower-cost destinations in Southeast Asia and, increasingly, China. As it turned out, the modern manufacturing techniques mastered by Japanese, South Korean and Taiwanese firms were often not a lasting source of competitive advantage.

VIII. The Big Squeeze: East Asia’s IT Industry and Innovation in the Twenty-first Century

As a network of low-cost manufacturing sites in Southeast Asia and China emerged, smaller US firms increasingly specialized in product innovation were able to take advantage of it. New American business models, like the ‘fabless’ semiconductor design firm, were enabled by strong IP at home and the rise of contract manufacturing firms abroad that explicitly eschewed manufacturing under their own brand name, instead providing ‘manufacturing services’ to mostly foreign clients. Japanese firms that had specialized in a kind of R&D that was closely linked to manufacturing capability found themselves squeezed between Western competitors that were better at product innovation and Asian manufacturers with lower costs. The Japanese information technology sector saw its global market share shrink substantially over the course of the 1990s. The first half of the 2000s provided a bit of a respite with a short-lived boom in ‘digital appliances’ like digital cameras, but the introduction of the all-purpose digital appliance––Apple’s iPhone––ended this brief comeback, as some Japanese industry critics had predicted. ¹¹

Japan’s current situation hardly qualifies as an economic failure. It remains a wealthy economy, and the growth in output per person has only slightly lagged that of the United States over the last 20 years. (Japan’s much lower aggregate GDP growth rate stems in part from an accelerating shrinkage of its work force.) Its auto industry remains at the global forefront, and the total number of patents generated by Japanese inventors remains high. Nevertheless, I believe that Japan’s historically narrow patent system induced a style of research and a research focus that has not served Japan well in the longer run in the electronics industry that was once practically synonymous with Japanese success. The consequences of Japan’s early IPR policy choices may have been long lasting.

What about South Korea? There is no space here to discuss the drama that surrounded the punishing financial crisis of 1997–1998, or Korea’s heroic recovery from that bitter downturn. Since the ‘bounceback’ from that crisis, though, South Korean income growth, especially when measured in dollars, has slowed substantially from pre-crisis levels. South Korean GDP remains well below US levels, and while it is continuing to converge to the United States, it is doing so at a snail’s pace. ¹² There is widespread recognition within South Korea that the nation must become more innovative and entrepreneurial. Nevertheless, modern day Korea is, in the eyes of many, dangerously reliant on a single firm––Samsung. In recent years, Samsung, its subsidiaries and its related companies have accounted at times for nearly one-third of all US patents assigned to Korean inventors. Samsung, in turn, has been heavily reliant on two product lines––its commodity memory chip business and its smartphone business––for profit growth. The latter faces challenges as Samsung confronts an increasingly crowded field of Android smartphone manufacturers, including a number based in China (see Pesek, 2015, for a recent assessment of Samsung’s outsized role and its innovation challenges). The difficulties of Finland’s once-vaunted high-tech sector in the aftermath of Nokia’s decline illustrate what can happen when a national champion fails. Not only is Korean ‘strength’ dangerously concentrated in a small number of firms, but it also appears to be concentrated in domains that are close to manufacturing. With all due respect to Samsung’s celebrated team of product designers, the various iterations of the ‘Galaxy’ have closely followed (and generally not led) similar developments with Apple’s truly revolutionary iPhone. The key innovations that powered a meaningful alternative to the iPhone were not so much hardware innovations as software innovations. Without the Android operating system, it is likely that the iPhone would have had the smartphone market to itself for much longer. For Samsung, of course, the problem is that Android was not developed and is not owned by Samsung. Instead, it was developed and is owned by Google, a company which wishes to have as many rival Android-based smartphones in the market as possible. Samsung took a traditionally ‘Korean’ approach to competition in smartphones––be a close technological follower that competes on price. This strategy is increasingly untenable as a growing number of rivals with even lower costs (or costs that are at least as low) crowd into the marketplace with products similar to Samsung’s. In principle, Samsung could engage in fundamental innovations that would it to charge a premium price for truly innovative products or product features, as Apple continues to do. However, this would require a degree of innovation that was not supported by Korea’s early, limited IP system. South Korea’s significantly strengthened IP system of the late 1990s could support this more expansive approach to innovation, in theory, but the skills and capabilities built up over decades are difficult to change. There are a handful of Korean Internet companies that have built a niche for themselves in the local market, but none of them have expanded significantly beyond Korea.

What about Taiwan? Unlike South Korea, Taiwan’s innovative output is not dominated by a single firm, nor does a single firm count for such a disproportionately high fraction of US patent grants. However, like South Korea, the pace at which Taiwanese living standards have been converging to US levels slowed dramatically in the 2000s. ¹³ Real wage growth has been exceedingly slow in Taiwan over the past two decades, consumption growth has been limited, and there is a widespread sense that Taiwanese firms are also being squeezed between Western (especially American) firms that excel in product innovation and manufacturing centres in mainland China that beat Taiwanese firms on cost. Leading Taiwanese firms, such as TSMC and Hon Hai, have carved out a niche for themselves that is complementary to rather than a direct competitor to the titans of Silicon Valley, and a number of these firms have expanded the scale of their operations. However, the margins earned by contact manufacturers are limited, and a growing faction of the manufacturing is being done outside Taiwan. While its exact form differed from that in South Korea, Taiwan, too, was focussed on a kind of R&D that was closely linked to its manufacturing strength, and the value of that strength was diminished as the ‘veil of ignorance’ was peeled back in mainland China and in Southeast Asia. Like its Korean counterparts, Taiwanese firms have struggled to master the more challenging art of product innovation.

IX. China, India, Patents and Industrial Development

What about China? At the moment, China appears to be following in the footsteps of its East Asian predecessors, but with some uniquely Chinese twists. First, China has aggressively rebuilt and extended an educational system that all but ceased to function during Mao’s Cultural Revolution. China sends more science and engineering students to Western universities than any other single country, and it graduates more than four times as many bachelors-level engineers as the United States. China’s participation in international comparisons of student achievement suggests that China’s educational system meets reasonably high standards for a developing country at China’s income level (see Freeman & Huang, 2015, for an overview of China’s massive mobilization of science and engineering talent). Second, in a development model that is more closely adherent to the Southeast Asian growth model than the Northeast Asian model, China aggressively invited multinationals into its territory, lowered its barriers to imports of manufactured goods, and quickly became the most open large developing country in the world. ¹⁴ A number of multinationals now complain that China has become far less welcoming and that the regulatory playing field has tilted in favour of indigenous enterprises, but many of these enterprises have spent the past two decades investing aggressively in China, pointing to a Chinese policy environment that was clearly not an impediment to multinational expansion in the recent past.

On the other hand, China’s IPR system has been, at best, a work in progress. The incomplete enforcement of China’s IPR system, the narrow protection it seems to provide, and the degree to which it appears to be biased against Western multinational firms seems at least somewhat reminiscent of the Northeast Asian model. Has China been able to take this pathway to significant and successful innovation? At first glance, the answer might appear to be yes. China is generating enormous numbers of patents within its borders (see Branstetter, Li, &, Veloso, 2015; Hu & Jefferson, 2009). China has mastered modern manufacturing, and celebrated indigenous start-ups like the smartphone manufacturer Xiaomi, at least for a time, were able to take market share away from firms like Samsung in the Chinese market. Chinese indigenous enterprises, like Alibaba, Baidu and Tencent dominate the domestic Chinese market for digital services. This is, in part, because the Chinese government has taken effective steps to keep foreign digital service providers out of the Chinese market or in a weakened position. The success of China’s digital firms in internationally financed Initial Public Offering (IPOs) has generated a cadre of Chinese Internet millionaires who are, in many cases, bankrolling and providing executive leadership to a new wave of Chinese Internet start-ups. This entrepreneurial ferment has attracted international attention from leading venture capitalists and from American firms that want to ensure their hardware and software become important components of the Chinese internet services ‘ecosystem’.

However, China’s deviation from economic orthodoxy has had a limited payoff in terms of anything beyond incremental innovation. For decades, researchers have used the propensity of inventors to take out patents in multiple countries as a measure of patent quality. US firms tend to apply for foreign patents for about 50 per cent of their domestic inventions, and around one-third of US patents eventually obtain a patent grant in at least one other country (Branstetter et al., 2015). Impressive though China’s Great Wall of patents appears to be, the fraction of these inventions for which indigenous Chinese inventors seek foreign patent protection is quite small. For only about 5 per cent of domestic patent applications do Chinese inventors even go through the trouble of applying for patent protection abroad, and the fraction of Chinese patents for which foreign patent grants exist is tiny––on the order of 1 per cent of the total. In aggregate numbers, Chinese inventors appear to regards upwards of 95 per cent of their domestic inventions as being of such low quality, they are not even worth attempting to patent abroad (Branstetter et al., 2015).

What is true for patents in the aggregate also appears to be true for China’s most celebrated new companies. One of the handful of Chinese companies that actually are taking out significant numbers of patents abroad is Huawei, which has quickly emerged as one of the world’s major telecommunications equipment producers, due to its low costs and its relatively dominant position in the Chinese market, the world’s largest. However, industry observers would be hard-pressed to identify a new product category or even a major product innovation yet introduced by Huawei. China’s Internet start-ups generate international attention (and large valuations) because the internal market is large, Western firms operate at a government-engineered disadvantage, and Chinese firms can mine Chinese holidays, cultural traditions and preferences that differ substantially from those in the Western world. Nevertheless, with the possible exception of Alibaba, which is playing a role mediating China’s international trade with the rest of the world that was not anticipated by prior Internet firms in the West, none of the Chinese Internet giants have an appreciable market presence outside their home market, and the second generation of start-ups do not appear to have global ambitions (or novel technologies that could be applied outside China) either.

The comparison of China in the mid-2010s with Japan in the mid-1980s is a useful one. It is an unfair comparison, in that Japan had largely converged to US income and output levels by the mid-1980s, while China, despite decades of rapid growth, is still far below that level. Nevertheless, by the mid-1980s, Japanese firms had not only created a broad set of globally recognized brand names but also whole new product categories, introduced to the global market for the first time by Japanese firms. Japanese firms launched a consumer electronics revolution by introducing fax machines, CD players, personal portable stereos (i.e., the Walkman), home VCRs and video cameras and a completely new concept of the small car. Chinese firms have yet to advance to this point, and seem far from it at the time of this writing. At least so far, China does not, in my judgement, provide clear evidence that it has done any better than its predecessors. In fact, so far, it is not even doing as well.

Finally, we need to devote a bit of space to India’s pharmaceutical industry, which may offer the clearest example in all of Asia of a deliberate embrace of weak IPR as industrial policy. As is well known to industry observers, in the early 1970s, India effectively gutted the strong pharmaceutical product patent law it inherited from Britain at Independence (Arora, Branstetter, & Chatterjee, 2011). India made it impossible to patent pharmaceutical products, awarded only very narrow, short-lived pharmaceutical process patents, and effectively eliminated the intellectual property protection upon which the multinational branded pharmaceutical industry is uniquely dependent. The impact on the structure of the Indian pharmaceutical market was significant and fast––within a decade, that market shifted from one utterly dominated by high-cost multinational pharmaceutical firms to one utterly dominated by low-cost indigenous firms. These Indian firms were able to copy Western drugs almost as soon as they become available in Western markets, and would not only sell them in India but also export them to other markets around the world with weak patent rights.

The rise of large, internationally recognized generic drug companies in India was a rare success––a manufacturing industry with substantial net exports. The ratification of the TRIPs Agreement in 1995 appeared to pose an existential threat to this successful business model, but India’s drug companies thrived over the next decade, in part because India’s implementation of a TRIPs-consistent patent law was delayed as long as possible and watered down as much as India felt its trading partners would permit. India’s drug industry received an unexpected boost in the 1990s as currency and trade reforms allowed the rupee to fall to a level that made Indian firms attractively priced for America’s exploding generics drug market. By the mid-2000s, as India finally enacted what it claimed was a TRIPs-consistent patent law, and as global pharmaceutical companies were exploring R&D partnerships with Indian firms, it looked like a textbook case of industrial policy success. At the time, well-informed observers of the Indian economy thought it plausible that a real research-driven, drug-inventing Indian pharmaceutical industry could emerge as a high-tech success story to complement India’s software industry.

Ten years after that high point, things look less bright. India still has a large generics industry, but longstanding and expensive efforts to develop new drugs have borne little fruit. Exports of generic drugs to the United States have continued, but rapid entry into these markets has kept profits low, and a few cases of tainted drugs have marred the reputations of some of the larger producers. The multinationals have lowered their expectations for their joint drug development efforts and significantly dialled down their level of investment and engagement with Indian drug development partners, partly because of the lack of success and partly because of the limits of Indian patent law. Ranbaxy, one of the most celebrated Indian firms of the mid-2000s, was acquired by Japan’s Dai-Ichi Sankyo in a $4.2 billion deal that enriched the founding family. In the following years, Ranbaxy lost half its value, and Dai-Ichi ended up selling its holdings for significantly less than the purchase price to India’s Sun Pharmaceuticals. In India, too, a long-term view undermines the argument that embrace of IPR weakness yields successful industrial development. As in East Asia, it seems this policy only takes indigenous firms so far.

X. Conclusion

The policy debate over the shift to stronger IPR continues to rage, and developing countries (and their Western advocates) continue to advance the argument that premature imposition of strong IPR can retard industrial development in developing countries. Recent empirical evidence, reviewed in this study, suggests that stronger IPR can actually enhance industrial development, in part by attracting FDI. Countering this evidence, some scholars have pointed to Asia as an example of how delaying the embrace of strong IP had led to unusually dynamic growth and the emergence of innovative strength.

This study suggests that view is, at best, hazardously incomplete. Instead, it raises the possibility that efforts to weaken IPR can bring benefits in the short run but serious costs in the longer run. Exploiting the comparative advantage generated by low wages, weak currencies, and, especially, weak protection for foreign inventions, local firms in Asia became very adept at manufacturing products they did not invent, in industries whose technological trajectories they did not control. Outstanding human capital that could have been more evenly distributed between process and product innovation was, in this deliberately tilted playing field, induced to concentrate on process innovation. Weak patents made it that much harder for small firms specializing in product innovation to emerge and survive in an Asian context, and that tended to reinforce the concentration of engineering talent in either larger, established enterprises (as in Japan and Korea) or in enterprises of varying sizes that specialized in low-cost manufacturing of other firms’ products rather than innovative product development (as in Taiwan and India).

Ever since the seminar work of Klepper (1996) and Cohen and Klepper (1996), innovation scholars have understood the possibility of a trade-off between product and process innovation––strength in the latter undermines the incentive to conduct the former. In Asian national innovation systems, process innovation strength is overdeveloped and product innovation is underdeveloped. This carries two risks for incumbent firms––lower-cost countries could acquire advanced manufacturing skills, undermining the comparative advantage brought by superior process technology. Perhaps more significantly, radical product innovation eventually always comes, rendering at least some of the process innovation obsolete, because global markets no longer demand the older products or the processes optimized to manufacture them. As Southeast Asia and China have successfully lured foreign investment, and as a new wave of software-enabled, Internet-linked IT products and services have emerged from Silicon Valley, existing incumbent firms in Japan, South Korea and Taiwan have struggled to adapt. In the pharmaceutical space, India’s vaunted pharmaceutical industry seems unable to move past the role of low-cost generic manufacturer, even as US-based biotech start-ups receive generous funding from investors around the world.

Ironically, the steps taken by East Asian economies to undermine US technological leadership by weakening IPR within their borders may have had the effect of reinforcing some elements of that US technological leadership in the longer run. The presence of a low-cost production base in Asia in search of products (invented by others) that it could profitably manufacture was, in some ways, a perfect complement to the fabless chip design firms and biotech start-ups of the United States. The concentration of Asian engineering talent in manufacturing was complementary to the concentration of engineering talent in the United States in product development. The tyrannical logic of comparative advantage keeps both regions locked in this pattern of development––which may be efficient at the global level, but it not necessarily what Asia’s industrial planners set out to achieve. For those still advocating weak IPR as industrial policy, this view of history should give them pause.