1. Aleksandar Stojkov, PhD Assistant Professor of Economics Iustinianus Primus Faculty of Law Economics of Intellectual Property An Introduction

2. Lecture outline Introduction The economics of intellectual property: theoretical considerations An economic perspective on the advantages of weak and strong protection of the intellectual property Proposals for reforming the system of IP protection Concluding remarks

3. “Like most academics, I have ambivalent feelings about intellectual property, illustrated by two personal stories. About twenty years ago I received a letter from a Chinese publisher asking me to write a preface to a pirated edition of one of my textbooks. As an academic, I was enthusiastic about the idea. The motivation of much academic writing is not to make money but to influence ideas and to shape the intellectual debate. China at the time was beginning the transition to a market economy: if my book helped shape that transition in a way that enhanced its likely success in raising the living standards of more than a billion people, it would have been a major accomplishment. Looking at it even in more narrow terms, if even 1 percent of China’s billion people read my book, it would be a larger readership than I would ever get in America. My publisher, of course, was not as thrilled as I was about the notion of my ideas reaching the Chinese audience through a pirated version of my textbook.” Introduction Source: Stiglitz, Joseph (2008), “Economic Foundations of Intellectual Property Rights“, Duke Law Journal, 57 (1): 1695- 1696.

4. “Later I was at a conference in Taiwan. At that time, I knew that intellectual property rights were not always strictly enforced there. During a break in the conference, I had a little time to go to a bookstore. As I went to the store, I had a debate in my mind about what I hoped to see when I arrived. On the one hand, there was the possibility that they had stolen my intellectual property, that they had pirated one or more of my books. As we all know, theft is a terrible thing, and stealing intellectual property is a form of theft, so that would have been terrible. The other possibility was that they had not pirated one of my books and stolen my intellectual property, that they had ignored me. As I walked to the bookstore, I came to the conclusion that being ignored is far worse than having one’s property stolen, and I resolved that I would actually be much happier if they had stolen my intellectual property than if they had ignored me. When I got to the bookstore, they had in fact stolen it, and I was relieved.“ Introduction Source: Stiglitz, Joseph (2008), “Economic Foundations of Intellectual Property Rights“, Duke Law Journal, 57 (1): 1695- 1696.

5. Economics of Intellectual Property: Theoretical Considerations The protection of the intellectual property is one of the areas in which the market cannot provide the most favourable outcome for the society. If there is no protection, there will be no innovations and technological progress, implying lower rates of economic growth and lower quality of life. The economic theory qualifies this as a domain of market failure and for these reasons, it justifies the state intervention and the protection of the intellectual property. More precisely, the economics of intellectual property relies upon the insights of the public good theory, by which it explains why the unregulated markets cannot sufficiently stimulate the creativity and production of original work. Economics of IP: Theory

6. Are the Intellectual Property Rights Public Goods? Public goods are neither excludable nor rival. That is, people cannot be prevented from using a public good, and one person’s enjoyment of a public good does not reduce another person’s enjoyment of it. The two main features of the public goods are: – Non-rivalry - the consumption of a good by one consumer does not prevent the others to enjoy it, and – Non-excludability – once it is produced, it is impossible to exclude somebody from their consumption. Economics of IP: Theory

7. Are the Intellectual Property Rights Public Goods? The knowledge is an example of a public good. The additional user of knowledge does not reduce the quantum of existing knowledge. In contrast, the private goods are characterized by rival consumption. If I eat this sandwich, the next consumer cannot eat it (the fast food restaurant must prepare a new one). The knowledge has a different character: if somebody shares his or her knowledge with us, that will not reduce his or her quantum of knowledge. For instance, Thomas Jefferson describes this much more poetically by using the candle as an example: “Knowledge is like a candle. Even as it lights a new candle, the strength of the original flame is not diminished.” Economics of IP: Theory

8. Are the Intellectual Property Rights Public Goods? Since the ideas and knowledge play a prominent role in promoting the economic growth, the society strives to stimulate the “production” of knowledge. On one hand, it would be much more efficient for the economy if there is a free access and distribution of knowledge. However, providing the public goods creates costs. As no one can be excluded from their use once public goods are provided, there is no incentive to pay for them. Put differently, the free access to knowledge does not provide sufficient incentives for production of innovations. Economics of IP: Theory

9. Are the Intellectual Property Rights Public Goods? One of the mechanisms to incentivize individuals and firms to engage more in creative work is of course to protect the intellectual property. This creates new problems: the intellectual property rights restrict the use of knowledge and lead to inefficiency. Even worse, they often create monopoly power and enable the creators to exclude many potential clients from the use of their knowledge. Since the intellectual property rights exclude those who have not paid for their use, they are considered as impure public goods. They are non-rivalrous, but excludable! Economics of IP: Theory

10. The intellectual property as an impure public good Four types of goods Are the goods rival? Yes?No? Are the goods excludable? Yes? Private Goods  Food  Clothing  Fuel Natural monopolies  Water supply system  Railway infrastructure  Fire protection No? Common Resources  Air  Fish in the ocean Public Goods  National defense  Knowledge Intellectual property rights Economics of IP: Theory

11. Static or dynamic efficiency? Due to this nature of the intellectual property, the society must make a choice (trade-off) between the static and dynamic efficiency. The static (or short-term) efficiency requires a wide access to new knowledge for the users at low costs. This suggests that it would be preferable to move straight from the invention phase to the public domain and bypass the protection phase (Lévêque and Ménière, 2004, p. 7). The dynamic efficiency requires incentives for investing in new knowledge and information (research and development). The incentive is the protection phase. Without the protection phase, the producer will not be able to recover his R&D expenses and therefore, the invention will not be produced. Economics of IP: Theory

12. From theory to practice Therefore, the countries that have a weak system of protection of the intellectual property favour the static efficiency, but they discourage the creative work of individuals and firms. The consequences are as follows: lower rates of economic growth, limited domestic cultural production and low quality products. The countries that have a strong system of protection of the intellectual property suffer from insufficient dissemination of the newly produced knowledge and tolerate the monopoly power of the holders of the intellectual property rights. However, they strongly support greater level of creativity. Economics of IP: Theory

13. The advantages of the weaker protection of the intellectual property 1. Lower market prices – If the country tolerates copyright infringement, for example, the consumers will enjoy lower market prices. Price Quantity Price Quantity МCМC d d 500 MKD 1000 CDs 100 MKD MC d=P=MR 5000 CDs Market for a pirated unit (perfect competition) Market for the legitimate copyright product (monopoly) Weak IP regime

14. 2. The level of protection of the intellectual property in the high-tech industry is irrelevant for the developing and transition countries – Even if there is a very strong protection of the patents, there are no close substitutes for the patent-protected products. – When providing the patent protection, the creator does not publish all important information. At least, this is relevant for many developing countries. Therefore, even highly specialized professionals could not replicate these innovations once the patent expires. The advantages of the weaker protection of the intellectual property Weak IP regime

15. 3. The patent protection restricts the access to important medicaments for a large portion of the world population – Several billions of people do not have an access (or have a very limited access) to medicaments of vital importance for them. – Stiglitz (2008) argues that the Trade-Related Aspects of Intellectual Property Rights agreement (TRIPS) is a triumph of the giant pharmaceutical corporations, because it restricts the access to life-saving medicines. The pharmaceutical industry does not like generic medicines, as they are sold at much lower prices. The advantages of the weaker protection of the intellectual property Weak IP regime

16. – An example: One-year anti-retroviral therapy for an AIDS infected person with branded (experimental) medicaments costs approximately 10,000 USD. Many patients, including those from Macedonia, cannot afford this. But, the patients could pay for the generic medicines that today cost approximately 200 USD. – According to Stiglitz (2008, p. 1701), “when the trade ministers signed the TRIPS agreement in Marrakesh in the spring of 1994, they were in effect signing the death warrants on thousands of people in sub- Saharan Africa and elsewhere in the developing countries.” The advantages of the weaker protection of the intellectual property Weak IP regime

17. Case study: The North-South tensions for the intellectual property rights The enforcement of the intellectual property rights is in favour of the developed economies (“the North”), because they create the largest portion of the newly created knowledge (World Bank, 2008). This restricts the access to new knowledge for millions of people, especially in the area of public health. A recent study by Mendis et al. (2007) examined the prices of 32 life-saving medicaments. The conclusion is that the patent-protected medicines, on average, were 34% more expensive than the cheapest generic medicines in Bangladesh, 40% more in Nepal, 90% more in Pakistan, 135% more in Brazil, 175% more in Sri Lanka and 257% more in Malawi. In the Republic of Macedonia, the price of patent-protected medicines is ten times higher than the generic ones (Source: Health Insurance Fund, 2011). MedicamentTherapy classLowest price for patent-protected medicine Price of generic medicine DIDANOSINEHIV-1 и HIV-2288 $132 $ NEVIRAPINEHIV-1219 $48 $ RITONAVIRHIV-1 и HIV-2190 $83 $ Source: Médecins Sans Frontières (2006).

18. 4. The protection of intellectual property stimulates the accumulation of “sleeping patents” – Sleeping patents are those that are intentionally not used by the patent holder in order to fulfill some strategic goals. In most cases, they remain in the shelves of the managers because of the fear that they have a potential value, that might be used by the competitors or firms from other industries. – It is estimated that IBM, Siemens and Philips use only 40% of their patent portfolio. Why do they sleep a lot? There are many examples when the companies have published their invention and this enabled a spectacular commercial success in other industries. The invention of glass-producing company Corning made it possible to invent high quality cables in the telecommunications sector. The Olestra molecule designed by Procter & Gamble, initially planned as a low fat product for the food industry facilitated huge profits for the companies that used it for the decontamination of the soil. The technological advancement by Boeing for the needs of the military industry ended as a profit for Touchbridge Systems, a company that offered integrated network system for the home. For these reasons, many patent applications or even patents do not have a commercial use and “sleep” in the company shelves. The advantages of the weaker protection of the intellectual property Weak IP regime

19. 5. Abuse of the dominant position or the monopoly power – Granting monopoly rights over certain patent- protected product creates an incentive to abuse the dominant position or the monopoly power. – Many companies are trying to prolong the patent life, by introducing small, incremental improvements of the product and then by requesting new patent protection. Bad news for NOVARTIS A victory for the “rights of patients over patents! In July 2007, the High Court in Madras refused the request by the Swiss giant „NOVARTIS“ to enable patent protection of slightly modified medicines. Novartis asked the High Court in Madras to clarify a key element of India’s 2005 patent legislation. The law denies patent protection to new versions of drugs invented before 1995. If the request was approved, the Indian companies would have been prevented from manufacturing generic versions of Gleevec, which they sell domestically and internationally for about a tenth of what Novartis charges. The Swiss company charges $2,600 for a month’s worth of the drug. See more: Amelia Gentleman, Setback for Novartis in India Over Drug Patent Protection, N.Y. TIMES, Aug. 7, 2007. The advantages of the weaker protection of the intellectual property Weak IP regime

20. 6. High costs related to the patent system – For the society, the protection of the intellectual property involves rather high costs. Duplication of the efforts to discover innovation first (patent race) High fees for registration and patent renewal High costs for translation to fulfill the requirements of the European Patent Office. – Still, for a small group in the society – the IP lawyers – this brings immense monetary benefits and reputation. The advantages of the weaker protection of the intellectual property Weak IP regime

21. Figure 1: When do patent costs kick in? Source: Van Pottelsberghe (2009). The advantages of the weaker protection of the intellectual property Weak IP regime Note: Author’s calculations, EPO fee structure as of May 2008 and renewal fees at national patent offices. Translation costs, which occur after the grant of the patent, are taken from van Pottelsberghe and Mejer (2008) and take into account the cost reduction brought about by the London Agreement. EPO6 stands for validation in 6 EPC countries, EPO13 stands for validation in 13 EPC countries. Costs in €1000.

22. 1. Sectors that rely on IPR protection are substantial contributors to the economy – In the G8 countries, copyright-based industries and interdependent sectors alone account for approximately 4- 11% of Gross Domestic Product (3.4% in Japan, 4.7% in Canada, 6.06% in the Russian federation, 6.9% in the European Union, and 11.09% in the United States). – Research in Germany has found, for example, that the branded goods sectors represent 22% of the domestic manufacturing industry, 20% of the country’s exports, and 7% of the overall economy. Arguments for a stronger protection of the intellectual property Strong IP regime

23. 1. Sectors that rely on IP protection are substantial contributors to the economy (cont.)  The World Bank studies devoted to the developing countries find that the industries that are protected from the infringement create between 2% and 6% of the gross domestic product and account for between 3 and 11% of the total employment. Arguments for a stronger protection of the intellectual property Strong IP regime Figure 2: Significance of IP-protected industries

24.  The empirical analysis by Arora et al. (2003) demonstrates that the patents have a positive influence on the investment in research and development (R&D).  Without the IP protection, these costs would be between 25% and 35% lower in the developed economies.  The patented inventions, on average, were sold at prices that were 180 and 240% higher than those for the same products not protected with patents. This is also known as a patent premium.  The patent premium is defined as the incremental profit due to patent protection as compared to the value of an innovation without patent protection. Arguments for a stronger protection of the intellectual property Strong IP regime

25. 2. Enhanced IP protection leads to larger FDI inflows and transfer of new knowledge – Many researchers underscore that there is a direct relationship between the enhanced protection of intellectual property and the foreign direct investment inflow. – After the reform of the patent and trademark laws in India at the beginning of the 1990s, the country experienced large FDI inflows. – The same phenomenon occurred in Brazil: after the adoption of the new Law on industrial property in 1996, there was a dramatic turnaround and unprecedented interest by the foreign investors. Arguments for a stronger protection of the intellectual property Strong IP regime

26. – The comprehensive study by Park and Lippoldt (2007), conducted with a sample of 120 countries during the period between 1990 and 2005, demonstrated that the protection of intellectual property stimulates the FDI inflows. – More than 25% of the U.S., Japanese, and German high-tech corporations do not want to invest in countries with weak protection of intellectual property. Arguments for a stronger protection of the intellectual property Strong IP regime

27. 3. The protection of intellectual property enhances the country’s competitiveness and increases the level of economic development According to the Global Competitiveness Report, published by the World Economic Forum, there is a strong and positive correlation between the competitiveness of an economy and the protection of the intellectual property rights. The correlation shows dependence between the two phenomena, but nothing about the causality. What is true? – One country strengthens the IP regime and then builds a competitive economy? – Or, the country manages to build a competitive economy and then strengthens the protection of IP rights? – Most probably, there is a bidirectional causality. Arguments for a stronger protection of the intellectual property Strong IP regime

28. Protection of the intellectual property rights Global competitiveness of the country Source: http://www3.weforum.org/ docs/WEF_GlobalCompetitivenessReport_2010-11.pdf. Figure 3: Correlation between the IP protection and country’s competitiveness Arguments for a stronger protection of the intellectual property Strong IP regime

29. The protection of the IPRs is also strongly and positively correlated with the level of economic development, most commonly measured by the country’s GDP per capita. The countries that have higher GDP per capita have also higher index of protection of the intellectual property rights (Source: World Economic Forum, 2012). According to the Global Competitiveness Report rankings, Macedonia stands on the 89 th position out of 142 countries. Finland has the best score in the world in terms of intellectual property protection, including anti-counterfeiting measures. Arguments for a stronger protection of the intellectual property Strong IP regime

30. Top tenCountryScore 1.Finland6.2 2.Singapore6.1 3.Switzerland6.1 4.Sweden6.0 5.Luxembourg5.9 6.Denmark5.9 7.France5.8 8.New Zealand5.8 9.Netherlands5.8 10.Ireland5.7 Strong IP regime Arguments for a stronger protection of the intellectual property RankCountryScore 41.Slovenia4.2 57.Montenegro3.7 69.Croatia3.5 89.Macedonia3.1 94.Albania3.0 98.Romania3.0 100.Bulgaria2.9 107.Serbia2.7 108.Turkey2.7 121.Bosnia&Her.2.6 Top 10 IP protectorsSouth Eastern Europe

31. Intellectual property protection GDP per capita (in U.S. dollars) Country’s GDP per capita and its protection of the intellectual property rights in 2010 Arguments for a stronger protection of the intellectual property Strong IP regime

32. 4. The protection of intellectual property is in favour of the small and medium enterprises (SMEs) -SMEs are important drivers of innovativeness and creativity. -In the past two decades, the investment in research and development by the SMEs have increased threefold. -SMEs have much higher share in the product innovations compared to the large companies (2.4 times more innovations than in the large companies). Arguments for a stronger protection of the intellectual property Strong IP regime

33. Proposals for reforming the system of protection of the intellectual property  Stiglitz (2008) argues that the intellectual property rights are important, but the importance of IPRs has been exaggerated, as they form only one part of the innovation system.  He underscores that there are other efficient mechanisms to motivate the firms and individuals to create and innovate, such as:  Government-funded research, and  Prize system;  The central idea he proposes is to drastically reduce the scope, duration and breadth of the IPRs. Reform proposals

34.  The government would announce a call for research proposals and than sponsor only some of them.  For instance, in the United States, the research in the defense and airspace industry are dominantly financed by the government agencies.  With a due respect to the Nobel prize winner in economics, Professor Joseph Stiglitz from the University of Columbia, most economists argue that the government-supported research has not been sufficiently effective in stimulating the diffusion of new knowledge. 1. Government subsidies and grants for the universities’ research laboratories Reform proposals

35.  One alternative to the patent system is called the prize system. This entails giving a prize to whoever comes up with an innovation, or at least those innovations that meet announced objectives.  The prize would be set in accordance with the estimated contribution for the society. The Royal Society of Arts and Technology in UK have been advocating and even using prizes to incentivize the development of needed technologies for some two centuries.  One of the widely discussed ideas for addressing this problem is a guaranteed purchase fund, where the World Bank or the Gates Foundation would guarantee one or two billion dollars to someone who discovers (and patents) a vaccine or a cure for AIDS or malaria or some other disease afflicting the developing world for the purchase of the drug Stiglitz, 2008). 2. Prize system Reform proposals

36. Source: Stiglitz (2008).

37. How we regulate and manage the production of knowledge and the right of access to knowledge is at the center of how well this new economy, the knowledge economy, works and of who benefits (Stiglitz, 2008). Economists have ambivalent feelings about the intellectual property. The fact that you have a property right does not mean you can abuse the monopoly power you were granted. Each country has a different commitment to the protection of the intellectual property, including anti-counterfeiting measures. Choosing the strength of the IP regime must rest on a sound analysis of the economic costs and benefits for the society. Concluding remarks Conclusions

38. The empirical research reveals a U-shaped relationship between the strength of a country’s IPR regime and the country’s per capita GDP using a cross-section sample of countries (Maskus (2000) and Chen and Puttitanun (2005)). As countries develop, their IPR regime will weaken before it is strengthened. Many economists believe that the developing countries must not have strong IP regime in the early stages of their development. In the more advanced stages of their development, the local innovators and foreign competitors will request strengthening of the IP regime. It is advisable that the national authorities fully support their calls. Concluding remarks Conclusions

39. Proponents of stronger IPR protection in developing countries often invoke, implicitly or explicitly, the dynamic efficiency hypothesis. It suggests that stronger IPR would lead to more resources committed to building up the indigenous R&D capability of the developing country firms, while inducing a higher rate of technology transfer from developed countries to developing countries (Hu, 2002). Stiglitz (2008) and other economists argue that this argument is in favour of the multinational corporations, which managed to impose this reasoning under the umbrella of the TRIPS agreement. Concluding remarks Conclusions

40. References Arora, Ashish; Marco Ceccagnoli, and Wesley M. Cohen (2003), “R&D and the patent premium”, NBER Working Paper No. 9431, National Bureau for Economic Research, Cambridge, Mass. Lévêque, François and Yann Ménière (2004), The Economics of Patents and Copyright, Paris: The Berkeley Electronic Press. Stiglitz, Joseph (2008), “Economic Foundations of Intellectual Property Rights“, Duke Law Journal, 57 (1): 1695-1696. Mendis, Shanti; Keiko Fukino; Alexandra Cameron; Richard Laing; Anthonio Filipe; Oussama Khatib; Jerzy Leowski, and Margaret Ewene (2007), “The availability and affordability of selected essential medicines for chronic diseases in six low- and middle-income countries”, Bulletin of the World Health Organization, 85 (4): 279-289. Van Pottelsberghe, Bruno (2009), Lost property: The European patent system and why it doesn’t work, Bruegel Blueprint No. 9, Brussels.