1、Licensing vs. Innovation incentives under uncertaingovernment policiesTarun Kabiraja,*, Chun-Lei YangbaIndian Statistical Institute, Economic Research Unit, 203 B.T. Road, Calcutta, 700035, IndiabInstitute for Social Sciences and Philosophy, Academia Sinica, 123 Academia Road, Sector 2,Nankang, Taip
2、ei 115, TaiwanReceived 2 February 2000; accepted 27 March 2000AbstractWe discuss innovation incentives of a local firm when an advanced technology may be availablethrough a foreign firm. The domestic government policy, either protection or free trade, is uncertain. Weshow that while licensing with o
3、r without innovation occurs in equilibrium, the industry profits are notnecessarily maximized, and the license fee can be negative. Also, under the same parametric situation,an innovation decision can be optimal if a protective policy prevails with certainty, while licensingoccurs if free trade prev
4、ails for sure. The innovation incentives can, however, be lower if thegovernment cannot commit to its liberalization policy.D 2001 Elsevier Science Inc. All rights reserved.JEL classification: F13; O33Keywords: Protection; Liberalization; Licensing; Innovation; Imitation1. IntroductionLong-term econ
5、omic performance of a country depends, to a crucial extent, on theendogenous technological advances. Technological backwardness is identified as the singlemost important cause of economic backwardness and underdevelopment in developingnations.1Most of the less-developed countries (LDCs), however, ha
6、ve failed to motivate their* Corresponding author. Tel.: +91-33-577-1157; fax: +91-33-577-8893.E-mail address: (T. Kabiraj).1Stewart (1981) discusses why the developing countries should try to develop their own technologicalcapability. The importance of technological advances in growth and economic
7、 development is quite evident fromthe works of Solow (1957), Denison (1962) and Romer (1990), only to mention a few.International Review of Economics and Finance10 (2001) 2472611059-0560/00/$ see front matter D 2001 Elsevier Science Inc. All rights reserved.PII: S1059-0560(00)00067-8firms to invest
8、sufficiently in research and development (R thus, free trade implies a zero tariff situation.Naturally, there is uncertainty for the firms about the realization of a particular policy. Ifthe relevant policy is protection, then firm 1 operates in the home market realizing amonopoly profit with the av
9、ailable technology. If the policy of free trade or market prevails,we have a duopoly situation, with possibly asymmetric technologies. Let q2 0, 1 denote theprobability of protection. Then (1C0q) is the probability of free trade. We assume that q iscommon knowledge.It is a two-period model. At time
10、t=0 firms make their decisions about innovation,licensing, etc. Initially, there is a gap between firm 2s advanced technology, c1, and firm1s less advanced one, c0. We interpret these technologies as constant marginal costs ofproduction (so that 0c1c2. These states of technologies will be denoted by
11、 sC0 2, sC0 1and s0respectively, where the subindices reflect the technological gap between the two firms.Innovative research is not only risky but also costly. If the domestic firm decides toundertake its own RIz otherwise80 to be paid. Hence, under a licensing agreement we areleft with only two ac
12、tions for the domestic firm, LI and LqqXs2Spsapmis1 C0qXs2SpsapdisKia4where pimis the gross profit of firm i when the market structure is monopoly of the domesticfirm (because of protection), and it is pid(s) when duopoly of both firms, because of freetrade, prevails.Obviously, p2m(s)=0. Also p1d(sC
13、0 2)=0 is possible if the gap in production technologies instate sC0 2is too big.It should be noted that under a licensing agreement nidepends on z, but the industry profitn(a, q)=n1(a, q)+n2(a, q), a2A, is independent of z.LIILT. Kabiraj, C.-L. Yang / International Review of Economics and Finance 1
14、0 (2001) 247261252For a more precise notation, let us denote pq(s) as the q-weighted average of industryprofits under monopoly and duopoly market structures, given the state of technology s, i.e.,pqsqpm1s1 C0 qpd1spd2sC138:Hence, the industry profit has the form (Eq. (5)na;qXspsapqsk1ak2a: 5Similarl
15、y, we can rewrite the expression of ni(a, q) as Eq. (6)nia;qXs2Spsapqiskia6wherepqisqpmis1 C0 qpdis:3. AnalysisFrom the expression of ni(a, q) it can easily be observed that n1(LI, q) can be less than orgreater than n1(Lq n1LqnLnI;q nI;q8n1LnI;qnLq nI;q8pqsC01 pqsC02; A18In fact, if maxn(LI), n(Lc00
16、1=9A C0 c02A C0 c002 4c0C0 c002C1389if c0, c00be the marginal costs of two firms. From Eq. (9), it is straightforward to show thatEq. (A1) is valid for q=0 if2A 3c2 5c12A 8c2 5c0 c1: 10Assume arbitrarily A=20, c2=5. Then Eq. (A1) holds if c12(5, 11) and c02(c1,16C0c1); forinstance, if c1=7 and c0=8.
17、 This implies that Eq. (A1) is a reasonable assumption if thetechnological progress in an industry is moderate and smooth without big jumps. Because pqis a convex combination of pmand pd, Eq. (A1) holds for all q20, 1 in this case.Assumption 2,pqsC01C0pqsC02 K; A2states that adoption of c1technology
18、 by firm 1 is feasible from the viewpoint of the industry.Assumption 3,pq1s0C0pq1sC01 R K; A3states that licensing with innovation (Lq n1Lq() p0nI;q() p0nI;q()p0:14The following proposition is then straightforward.q, aq(q, bq)T. Kabiraj, C.-L. Yang / International Review of Economics and Finance 10
19、(2001) 2472612543.1. Proposition 1Assume Eqs. (A13. Let a1,a2be an arbitrary pair of the parameters sq, aqand bq. Then,for every parameter configuration (sq, aq, bq) we can find a1,a2such that LI is theequilibrium outcome for all p02(0, a1), while I is the outcome for all p02(a2, 1). Moreover,(i) if
20、 bqpq(s0)pq(sC0 1), similar results can be derivedanalogously. With this assumption we can immediately see that Lthere always exists some p*sqsuch thatnLnI nL0C0n1I;0 0 will certainly be imposed on foreign products if the local firm fails toinnovate successfully under a policy of free trade. With th
21、is the expected industry profit,12n(I, q; t), shrinks with increasing t, at least for small t.13Hence, there exist some tariffrates such thatnI;q;t 0 nI;q;t 0:3.4. Proposition 4Given q61, if the firms ex ante believe that the local government will intervene (i.e.,t0) if the local firm fails to innov
22、ate successfully under a policy of free trade, then theincentive to innovate can be lower compared with when the firms believe that there will beno government intervention.The result has the following implication. In our model, incentive to licensing is describedby the difference n(L, q)C0n(I, q). T
23、hus, a positive t increases incentives for licensing. It istherefore trivial to show that there are cases where n(I, q; t=0)n(L, q), while n(I, q;t0)n(L, q). Put differently, conditional government intervention can alter the outcomefrom innovation to licensing. Since the innovation/licensing decisio
24、n is taken ex ante, beforeany realization of the government policy in the future, policy makers face a seriouscommitment problem indeed when promising a free market.4. ConclusionWe provide a review of the licensing contracts vis-a-vis the innovation incentives of adomestic firm. In particular, we re
25、view some commonly held beliefs in the context of aninnovation and licensing game between a local firm and a foreign firm, and we provide somecontrary results. We have assumed that the local government can follow either a free trade ora protection policy, but there is uncertainty in the realization
26、of a particular policy. When alocal firm signs a licensing contract with a foreign firm, the local firm may continue itsinnovative research and can reach the foreign technology level with positive probability.Then, in equilibrium, we may have licensing with innovation, licensing without innovation,a
27、nd innovation without any licensing contract. Obviously, licensing with innovation cannotoccur unless the probability of success in innovation is large enough. There are situationswhere industry as a whole has larger incentives for licensing without innovation, but the13We tacitly assume that the go
28、vernment is not allowed to confiscate firm 2s profit and give it to the domesticfirm, in which case there would be no difference in industry profits.12nI;q;tq1C0p0pmc0p0pmc2C1381C0q1C0p0pdc0;c2tp0pdc2;c2C138 k1Ik2I:T. Kabiraj, C.-L. Yang / International Review of Economics and Finance 10 (2001) 2472
29、61 259perfect equilibrium can be licensing with innovation. Also, there are situations whenlicensing is feasible for the industry as a whole, but the firms cannot write a bindingcontract on licensing.The advocates of the trade liberalization policy generally press the LDCs to open up theireconomies
30、and to follow a free trade policy. They argue that, under the liberalizationenvironment, competitive forces will generate sufficient incentives for the LDC firms to doresearch and innovative activities. However, as we have shown, there are situations whereunder protectionism innovative incentives ar
31、e higher, while under free trade licensing ispreferred. We have also shown the possibility that in a licensing contract the net license feecan be negative. In fact, when a technology is transferred, the technology supplier has toincur a cost in the stage of adoption by the transferee,14and we found
32、that this cost may belarger than the direct money transfer from the technology buyer to the technology seller.Thus, charging a (net) negative license fee can be a strategy of the multinational firm to deterlocal R&D.In a democratic country where a government comes to power through an electionprocess
33、, there are various pressure groups that can influence the voters and public policies.Hence, there are uncertainties in government policies, but the decisions of licensing orinnovations are made ex ante much before the realization of a particular government policy.Given these uncertainties, decision
34、s regarding innovation and licensing depend on, amongother things, the present and future technology levels of both the domestic and foreignfirms, along with the success probabilities. Other types of uncertainties might arise due tothe failure of the government to credibly commit to its liberalizati
35、on policy.15In particular,the firms might perceive a positive chance that the government may fail to keep its presentcommitment in the future and intervene by, for instance, a tariff. These uncertaintiesinteract in a negative direction and reduce innovation incentives. Given this commitmentproblem,
36、innovation incentives are less under intervention compared with the unconstrainedfree trade situation. It is possible that while innovation occurs under free trade, licensingoccurs under intervention.AcknowledgmentsThe authors would like to thank Jonathon Eaton, Michael Riordan, Mihir K. Raskhit,Deb
37、raj Ray, and an anonymous referee of this journal for comments and observations,and the IED, Boston University for hospitality. The first and the second authorsacknowledge, respectively, the Ford Foundation and the Deutsche Forschungsgemeinschaftfor financial support.14See Teece (1977) for this type
38、 of costs involved in a technology transfer deal.15In fact, pressure groups activities are also ubiquitous, although in different forms, in authoritarian countries.Government commitments are crucial for the success of economic reforms as shown in the country studiescollected in Bates and Krueger (19
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