Drivers of Innovation in Europe: The Importance of Intellectual Property Rights

(1)

Drivers of Innovation in Europe:

The Importance of Intellectual Property Rights

Master Thesis Holmer Jan Kok Student number: 1771663 Hamburgerstraat 74, 9714 JG, Groningen tel.: +31 (0)6 81542496 e-mail: h.j.kok@student.rug.nl Supervisor Dr. A.Visscher (ad.visscher@rug.nl) Co-supervisor

Dr. K. van Veen (k.van.veen@rug.nl)

(2)

[ 1 ]

Abstract

In the past few decades, the number of patent applications has increased exponentially. At the same time, intellectual property rights have been given a central role in determining innovation rates. Yet, much is still unknown and ambiguous about the antecedents of innovation, especially in specific contexts such as the EU-27 countries. This study aims to investigate the role of intellectual property rights in advancing innovative activities. In addition, considerable attention is paid to other factors believed to influence innovation rates. Our results indicate that, between 2001 and 2011, high tech imports were the single most important drivers of innovation output in the EU-27 countries. In contrast, evidence of the importance of intellectual property rights in enabling and stimulating innovation was only found in relatively less developed EU-27 countries. The same holds for R&D expenditures and human capital. Hence, we suggest a strong disconnection between factors driving innovation and patent applications in the relatively more developed EU-27 countries.

(3)

[ 2 ]

List of abbreviations

AC Absorptive Capacity

FDI Foreign Direct Investments

GDP Gross Domestic Product

HC Human Capital

IPR Intellectual Property Rights

MNE Multinational Enterprise

OECD Organization for Economic Co-operation and Development

R&D Research and Development

TFP Total Factor Productivity

TRIPS Trade Related Intellectual Property Rights

WDI World Development Indicators

WIPO World Intellectual Property Organization

(5)

[ 4 ]

List of tables

Table 1 Positive and negative impacts of stronger IPR protection in developing and developed countries 19 Table 2 Overview of two groups according to division by initial GDP per capita in the year 2000 51

Table A1 List of Countries 84

Table A2 Comparison of average EFW index, R&D expenditures, FDI inflows and GDP per capita 84

Table A3 Data overview 85

Table A4 Comparison of high tech imports from global technological leaders and the rest of the world 85

Table A5 Summary of variable initial GDP per capita 86

Table A6 Summary of data 89

Table A7 Skewness and kurtosis test 89

Table A8 VIF analysis prior to removal of market size control variable 92 Table A9 VIF analysis after removal of market size control variable 92 Table A10 Pair-wise correlations of variables (values exceeding threshold of 0.80 are bolded) 93 Table A11 Breusch-Pagan / Cook-Weisberg test for heteroskedasticity 94

Table A12 Wooldridge test for autocorrelation in panel data 94

Table A13 Breusch and Pagan Lagrangian multiplier test for random effects 94 Table A14 Hausman test for fixed and random effects full sample 95 Table A15 Hausman test for fixed and random effects high-capita sample 95 Table A16 Hausman test for fixed and random effects low-capita sample 96

Table A17 Regressions for full sample 97

Table A18 Regressions for low-capita sample 98

Table A19 Regressions for high-capita sample 99

Table A20 Regressions for robustness analysis full sample 100

Table A21 Regressions for robustness analysis low-capita sample 101 Table A22 Regressions for robustness analysis high-capita sample 102

List of figures

Figure 1 OLI framework and its relation to IPRs 31

Figure A1 GDP per capita between 2000 and 2010 (The World Bank) 86 Figure A2 High-tech exports as a percentage of manufacture exports in 2000 and 2010 (The World Bank) 87 Figure A3 Distribution of USPTO patent applications in our sample 87 Figure A4 Scatterplot between USPTO patent applications and the strength of IPR 88

Figure A5 P-P plot of residuals 90

Figure A6 Q-Q plot of residuals 90

Figure A7 Distribution of residuals 91

(6)

[ 5 ]

Acknowledgements

Prior to commencing my Master’s in International Business and Management, my knowledge of intellectual property was limited, to say the least. That is why I would like to express my gratitude to Dr. DongBack Seo for teaching the excellent course Strategy Management and Technology at the University of Groningen.

During the course of my thesis, I have received unconditional support from my family and friends. I would particularly like to thank my parents Menno Kok and Nanny Kok-Sol and Sister Suzanne Kok for giving me much intellectual and common advice, and support during the past few months. I would also like to thank my friends Bram van Boxtel, Wessel Schot, Pieter Bot, Adinda Baltes and Ning Yang.

A special word of gratitude also goes out to my thesis supervisor Dr. Ad Visscher for his much appreciated advice and feedback on my theses drafts.

This thesis has given me the opportunity to conduct research on a topic which I am very much interested in. In the future, I hope to be offered the opportunity to expand my knowledge on the subject even further.

I sincerely hope you enjoy reading my thesis as much as I have enjoyed writing it.

(7)

[ 6 ]

1 Introduction

In the past 30 years, the global number of patents, utility models, trademarks, and copyrights applications has grown tremendously (OECD, 2008; WIPO, 2013). While this growth in Intellectual Property (IP) applications has mostly been taking place in developed countries before the turn of the millennium, this trend seems to have shifted to developing countries in recent years (OECD, 2008). Naturally, this increase in IP applications seems to imply that the world has witnessed unparalleled rates of innovation in the past three decades. At the same time, much scepticism has been raised about the true benefits of Intellectual Property Rights (IPR and IPRs will be used interchangeably hereafter) in playing a role as a major driver of innovation and growth. Much prior research has explored the antecedents of innovation and growth, and yet no unanimous conclusion has been reached with regards to the benefits and costs of strong IPR systems.

(8)

[ 7 ]

market power to patent holders have arisen. These increases in market power could potentially reduce competition, raise prices, and lower welfare in the countries in which the firms are active, as should be familiar from basic economics.

On the other side of the spectrum, proponents of strong IPRs base much of their arguments on the necessity of IPRs in the process of innovation. In short, it is stated that in order to provide actors in a market with the incentive to create and invent new products, process, and services, IPRs are required. For example, if a firm invests substantial amounts of capital in R&D with the aim to create a new product, it will need the guarantee that it will at least be able to recoup its investment through the rents made on that product. Therefore, in order to provide firms with these incentives, the government guarantees them a monopoly on the sale of their product for a certain period of time (generally 20 years, depending on the country). However, this guarantee is only provided on the condition that the firms disclose all relevant information with respect to the product, process or service they are applying a patent for. Accordingly, in countries with weak IPR, we would expect innovation rates to be lower due to a lack of incentive for actors in the market to create and invent new things. In addition to this, the information disclosed in patents can be used by other firms to develop new things themselves. This is well summarized and put into historical perspective by Granstrand (2003, p. 54): “Certainly a strong motive historically for handing out patent-like privileges was to disclose and diffuse secrets, e.g. held by skilled artisans and guilds. The disclosure would thereby stimulate and coordinate the R&D of others, speed up differentiation and cumulation of results, speed up exploration of new, promising areas, help to avoid duplication, and provide for more efficient technology markets.”

The impact of stronger IPRs on these inflows may be limited to the industries in which the costs associated with imitation are high. These industries are characterized by high R&D spending and high ease of imitation of products (World Bank, 1998).

In terms of foreign technology transfers, empirical studies have indicated that FDI, exports and license agreements react quite strongly to weak IPRs. In short, strong IPRs increase a market’s attractiveness, while weak IPRs diminish it.

(9)

[ 8 ]

contributes to the ever-expanding literature regarding innovation. As foreign technology transfers have gained in importance in the past few decades due to the waves of globalization and integration the world has faced, their role in driving innovation will receive particular attention in this thesis. In this regard, the distinction between FDI, high tech imports and license agreements will be made.

Besides this, countries are expected to benefit more from incoming foreign technology on the condition that their absorptive capacity (AC hereafter) is of an adequate level. Much research has revolved around the idea that developing countries are catching up to developed countries thanks to their absorption of foreign technology. However, empirical evidence suggests that this process is complex and strongly influenced by a country’s AC. For this reason, it is expected that a country’s AC acts as an additional channel that influences innovation rates. In sum, much ambiguity still exists about the true benefits and hazards which strong IPRs bring to a country. Furthermore, the role of other drivers of innovation in this study’s particular context is also underinvestigated. To my knowledge, much research about these subjects is still lacking in the context of Europe (more specifically, the EU-271). Most prior research has been conducted on a very general level; that is, by grouping developed or developing countries together thereby disregarding any true sense of a context. While this may hold useful results on a holistic level, the intricate elements which countries are composed of go missing in these types of research. On the European level, this could prove especially inaccurate due to the varying types of policies, industries, and economic systems which reside in each country. On the one hand, we have the developed countries in Northern, Western and Southern Europe which have displayed varying degrees of innovation and growth in the past few decades. On the other hand, we have the Central Eastern European countries, representing the developing countries in this study2. These countries have demonstrated their innovative capabilities in recent years and have been shown to exhibit strong rates of growth (as illustrated in figures A1 and A2 in appendix 1). Additionally, data about European countries is rich in detail and quantity. This data has gained in completeness in the past couple of years. Data related to CEE countries from before 2000 was largely incomplete. Unfortunately, much of the relevant IPR literature is based upon this older data;

(10)

[ 9 ]

that is, data from before 2000. This is another contribution of the current study: It employs recent data by analysing innovation output between 2001 and 2011. What is more, the majority of studies that investigate the role of foreign technology transfers usually focus on one type of channel. Instead of limiting our scope of research, the current study looks at each important channel through which technology may be transferred. Lastly, additional factors which are believed to influence domestic innovation rates are incorporated into the analysis. As a final note in this introduction, it is worth reminding that these study’s results should not be taken too literally. As Adams (2010) mentions, much of the empirical research on IPRs and FDI is influenced by data heterogeneity, country-specific effects, and TRIPS. The current study aims to take these issues into account by incorporating country-specific effects into the analysis. In addition, as this is a post-TRIPS study, issues regarding pre- and post-TRIPS differences are non-existent. Yet, it must be noted that data heterogeneity is most definitely present.

The research questions which this study will attempt to answer are:

What are the drivers of innovation in the EU-27 countries?

What is the role of IPR protection in stimulating innovation rates? Is the relationship between IPR protection and innovation rates non-linear?

(11)

[ 10 ]

2 Literature Review

The literature review will start off with an extensive description of IPRs. As will be explained, much ambiguity persists regarding the benefits and costs of IPRs under different circumstances. As this study’s primary focus lies on the role of IPRs in stimulating innovation, much attention will be directed towards this subject. Nevertheless, this study’s other contributions, namely, the role of foreign technology in stimulating innovative activities and a country’s AC, will not be overlooked.

2.1 Intellectual Property Rights

For starters, it is evident that intellectual property must be given a formal definition in order to enhance the credibility and comprehension of the current study. To this end, the World Intellectual Property Organization Handbook (WIPO) provides the following definition: “Intellectual property, very broadly, means the legal rights which result from intellectual activity in the industrial, scientific, literary and artistic field (WIPO, 2008)”. These rights typically grant the holder of the intellectual property the right to use his creation for a pre-determined period of time (WTO, 2012). Without delving into too much detail, these creations are sub-divided into two categories: industrial property and copyright (WIPO, 2008). Industrial property is concerned with inventions and industrial design. Inventions are

new solutions to technical problems, while industrial designs determine the aesthetic

appearance of a product. In addition to this, industrial property may also refer to signs that communicate information to consumers (i.e. trademarks, service marks, etc.). Copyrights, on the other hand, govern the creations of intellectual creators such as books, poems, music, paintings, etc. The current study will place its focus on industrial property, more specifically, on patents. Patents are widely regarded as the best indicator of innovation output. Therefore, they will play a central role in this study.

(12)

[ 11 ]

growth. Additionally, they state that ideas have to be discovered before they can create any economic value. The discovery of ideas is often done through substantial investments in R&D. In order to create incentives for these investments to take place, a mechanism for appropriation of rents is required. This is generally where IPRs come in. As knowledge is a non-rival and non-excludable good, there needs to be a mechanism in place to appropriate returns from one’s own creation of new knowledge. With patents, the government and the inventor engage in a long-term pact in which the inventor discloses all relevant information regarding the invention, and where the government “guarantees that it will provide legal protection to give exclusive rights on the economic returns of the invention (Archibugi and Filippetti, 2010, p. 138).” Thus, in order to secure creators’ investments and make sure that benefits can be reaped from their inventions, patents are granted to these creators. Once a patent has been granted, the holder has the sole right to exercise a monopoly over a certain product or service. This right is guaranteed by the government, and it generally lasts for a period of 20 years3. In addition, through the information provided in the patent, other actors in the market are given the opportunity to create new products or services themselves or make modifications to already existing products. It should be noted that patents are generally filed separately for each country. Eaton & Kortum (1996) state that patents can be expensive due to obligated information diffusion and certain fees that have to be paid (i.e. filing, agents and translation fees). Therefore, only technologies that are worthwhile will be filed a patent for abroad. They argue that for this reason, most patents are only protected in few countries. Hence, following their logic, foreign patents will only be applied for in countries which are “worth” it. As follows, U.S patent applications are often used as indicators of innovation output, as they will be in the current study. Lastly, it is necessary to observe that patent applications are unevenly distributed among countries. The most developed countries in our sample (i.e. Germany, the United-Kingdom, The Netherlands, etc.) literally file a thousand times more patents a year than some of the less developed countries in our sample (i.e. Latvia, Lithuania, Estonia, etc.). This is illustrated in figure A3 in appendix 1.

With regards to the use of patents, we observe that the impact of stronger IPRs on innovation may be limited to certain industries. Generally speaking, industries that rely heavily on R&D expenditures, and industries which produce products which are easily imitated tend to be more sensitive to strong IPRs. In his influential study, Mansfield (1986) finds that

3_{“The effective duration of patent protection is the length of protection granted from the time of the grant date. In countries}

(13)

[ 12 ]

pharmaceutical and chemical inventions are heavily sensitive to patents. In fact, 65% of pharmaceutical inventions and 30 % of chemical inventions would not have taken place if there were no patent protections, according to him. Furthermore, Hu & Png (2009) argue that changes in patent strength may have different impacts depending on the type of industry under investigation. For one, they state that it is expected that the pharmaceutical industry, which relies strongly on patents to obtain returns from innovation, should experience a relatively stronger impulse from stronger patent protection. In their empirical analysis, they find that strong patent rights indeed affect technical progress. What is more, this impact is found to be stronger in the 1990s than in the 1980s.

Now that the fundamentals regarding IPRs and patents have been laid out and explained, we can go deeper into their actual purpose and consequences. The following quote is quite illustrative for the next sections:

“If we did not have a patent system, it would be irresponsible, on the basis of our present knowledge of its economic consequences, to recommend instituting one. But since we have had a patent system for a long time, it would be irresponsible, on the basis of our present knowledge, to recommend abolishing it. This last statement refers to a country such as the United States of America—not to a small country and not a predominantly nonindustrial country, where a different weight of argument might well suggest another conclusion. (Machlup, 1958, p. 80)”

Based upon this idea, the arguments for and against stronger IPR protection will be explained in the following section. These should provide a strong basis for the overall understanding of this thesis

2.1.1 The Pros and Cons of IPR Protection

(14)

[ 13 ]

creating new inventions, or improving on existing products or services. In contrast, if IPRs protection is perceived as weak in a country, creators may have less incentive to invest into the creation of inventions. This is because, in contexts with a weak rule of law or the absence of proper laws, the rights of citizen may not be properly enforced or be given representation of. Consequently, we would expect the rates of innovation to be depressed.

Early work by economists in the fields of IPR and innovation still remains relevant to this day. For instance, in his canonical work, Arrow (1962) describes how firms underinvest in R&D when the risk of being unable to appropriate returns from inventions and creations is high. He states that, under patent laws with limited scopes of appropriation, incentives to invest in R&D are low. In other words, due to the interconnectedness of inventions, patents can never fully cover all the extents to which information should be appropriable to the inventor or creator.

Davis (2004) proposes four recent trends that have taken place in the past few years which have been strongly related to the growing importance of IPRs in global economics and business. According to him, these trends have set the stage for a more prominent role of knowledge assets and IPRs in our society. First of all, he mentions that intangible assets are becoming increasingly more important as a form of competitive advantage for firms4. Secondly, globalization has enabled firms to expand their operations across borders. Thirdly, it has become easier to replicate and transfer information and digital products due to advances in digital technology. Lastly, as emphasized in the current study, recent years have seen major changes in the strength and scope of IPRs following reforms in legal frameworks. However, strong IPRs seemed to have had an adverse effect on R&D. In other words, instead of increasing incentives to innovate, thereby pushing up R&D expenditures, recent changes in the field of IPRs have had a neutral or even negative impact on them. This is best explained starting from the firm-level and gradually moving up to the country-level.

On the firm level, IPRs are increasingly being perceived as useful competitive tools. Support for this notion is provided by Rivette & Kline (2000) who explain how firms can use IPs in order to secure market share, improve financial performance, enhance competitiveness, and even lock competitors out of a certain market. These acts of hampering and/or locking competitors out of a market are referred to by them as clustering or bracketing. Clustering entails that a firm builds a so-called patent wall around a particular product or service, thereby

(15)

[ 14 ]

effectively obtaining a monopoly on producing that particular product or service. Much related to this is the concept of bracketing. This tactic involves patenting certain key elements of your rivals’ products in order to block them in their attempts to bring new products to the market. Following these basic ideas, the idea of granting a monopoly to patent-holders may seem counterproductive.

Additional evidence against the benefits of patents and patent protection are explained and found by Cohen, Nelson, & Walsh (2000). Drawing back upon results from studies such as the one by Mansfield (1986), they argue that patents only seem to be important in certain industries. On top of this, firms often list other factors to be more important than patents for appropriating returns from innovation. According to Cohen et al. (2000), these are: secrecy, lead time, and complementary capabilities. Moreover, the authors’ surveys indicate that a large share of patent applications is not explained by patent effectiveness. Instead, firms in particular industries use patents to block competition, as means for increasing their bargaining position in negotiations, or to maintain their position as major competitors in a market. As a result, patent suits are becoming increasingly more common in some industries. Thus, it is insinuated that stronger patent protection, and a high growth in patent applications, may have an adverse or neutral effect on innovation rates (i.e. R&D incentives), and/or lead to wasteful spending of capital. This phenomenon is expected to be more prevalent in developed countries where IPR systems are stronger and where patent-sensitive industries are relatively more frequently present.

(16)

[ 15 ]

competitive tool for firms. Increasing the length of patents should confer longer benefits to the holders of patents, and potentially higher costs for society. The same is expected to hold for the scope of patents. If patents can be used to cover a larger number of products and processes, cumulative and regular innovations in general may become harder to materialize. The increasing number of patents being issued makes it difficult to apply for a new patent without the risk of infringing on many other patents. This also makes it difficult to invent around the increasing number of patents in existence. These problems of multiple patents, holdups, and overlapping patents (Shapiro, 2001) likely raise the transaction costs for firms attempting to bring innovative technologies to the market. However, Shapiro (2001) also elaborates on potential solutions to these problems; namely, cross licensing, package licensing, and forming patent pools. In short, cross licensing entails that two firms license their vast patent portfolio to each other, package licensing (and the much related patent pools) entails that a single entity licenses a “package” of patents of multiple to a third party licensee. Lastly, Primo Braga & Fink (1998) suggest that on a higher level, stronger IPR protection may in fact hurt welfare in certain types of countries. These countries generally possess strong imitative capabilities, but limited innovative capabilities. According to Primo Braga & Fink (1998, p. 167), in these countries, stronger IPR protection is likely to “displace local producers, raise prices, and transfer rent from local consumers and producers to foreign title-holders, resulting in a negative welfare impact”. This is something which will play a central role in this thesis.

The next sub-section will propose additional arguments in the debate about IPRs at the country-level. A concise summary will follow.

2.1.2 The Trade Related Aspects of Intellectual Property Rights Agreement

The aim of this sub-section is to provide further explanation on the TRIPS Agreement and its impact on IPR protection in developed and developing countries. On top of this, this section provides a useful complement to the debate about the benefits and costs of stronger IPRs in countries with different levels of economic development and innovative capacities.

(17)

[ 16 ]

Intellectual Property Rights (TRIPS) Agreement. This agreement, which was signed in 1994 and came into effect on January the first in 1996, basically entailed that all participating economies should improve their enforcement of IPRs5. Vishwasrao (1994) states that Northern governments have long demanded stronger IPRs in Southern countries because these would, in theory, be welfare-enhancing. That is, stronger IPRs should increase R&D spending and transfers of technology between developed and developing countries.

In recent years, the World Trade Organization (WTO) has made IPRs one of its principal businesses (Archibugi & Filippetti, 2010). One of the WTO’s founding elements is the TRIPS Agreement. This agreement has the primary aim to create international standards of IP protection and enforcement. Unlike other WTO-related activities, the TRIPS Agreement does not directly affect bilateral trade flows. Instead, it establishes standard minimum requirements of IPR enforcement and protection for each member, regardless of their country characteristics. In their article, Archibugi & Filippetti (2010) discuss the consequences of this agreement for developed and developing countries. Besides this, they also argue that the importance of IPRs has been overestimated in terms of their role in generating and diffusing knowledge and innovation. One of the primary arguments which they mention against stronger IPRs in developing countries is the fact that “Without imitating it is impossible to learn and innovate (Archibugi & Filippetti, 2010, p. 139).” According to them, most large economies have benefited from imitating the current leading global players. For instance, the Asian tigers (Japan, South Korea, Singapore and Taiwan) relied much on the imitation of technologies that were developed abroad. Furthermore, they mention four channels which are used to transfer technology between countries, three of which are used in the current study (FDI, imports and licensing). Through their analysis of the TRIPS Agreement, they derive four major theses. The first one holds that Western countries have tried to impose rules upon developing countries based upon their own Western logic. However, these rules may have an adverse effect as the usefulness of IPRs largely depends on the context of the country in which they are enforced. That is, developing countries benefit more from imitation and their adaptive abilities. Secondly, the authors argue that TRIPS is particularly an outcome of U.S corporations lobbying their government to force developing countries to improve their IPRs. As mentioned earlier, patent holders are expected to benefit largely from stronger global IPRs. Thirdly, TRIPS does not seem to have much improved the situation of citizens in Western countries. While the large emerging economies have continued to increase their worldwide

(18)

[ 17 ]

shares in high tech exports, the large western economies have only managed to maintain their dominance in the pharmaceutical industries. Lastly, it is argued that too much emphasis has been placed on the importance of the legal conditions within a country. Instead of focusing on the enforcement and instatement of IPR laws, western countries should help emerging economies to develop sustainable economic systems of their own.

In a similar vein, Cardwell & Ghazalian (2012) discuss the consequences of TRIPS on a global level. First of all, they find empirical evidence that TRIPS has indeed increased the domestic protection of IPRs in countries which are a member of the WTO. In support of this finding, they find evidence that “income, education, governance, and domestic R&D activity generate stronger IPR protection (Cardwell & Ghazalian, 2012, p. 35).” Unsurprisingly, they also find that the TRIPS agreement has had a relatively larger impact on the level of IPR protection in developing countries than in developed countries. This is due to the fact that most developed countries already conformed closely to the standards set by TRIPS in 1996. For developed countries, the benefits of IPR reforms in developing countries are abundant. Qiu & Yu (2010) find that TRIPS has had a significant and positive impact on innovation rates in the U.S. Stronger IPR protection in foreign markets allows U.S. firms to expand their operations, thereby increasing their profits. In addition to this finding, they find that higher expenditures on education have raised the number of patent applications in the U.S. For their measure of patent protection changes, they use patent reforms which have changed the Ginarte & Park (1997) index for no less than 0.5 points in two subsequent 5-year intervals6. In the end, the authors find that no single patent reform significantly changed innovation rates in the U.S. They suggest that their finding regarding TRIPS may have originated from the fact that it represented a simultaneous global change in IPR protection. Furthermore, they suggest that the U.S. market by itself may generate enough incentives for firms to innovate, and that increasing IPR protection abroad may simply increase the rents associated with patents that these firms hold.

Coming back to developing countries, Kumar (2003) projects potential and actual costs and dangers related to the implementation of the TRIPS Agreement and stronger IPP (Intellectual Property Protection) in general. First, he presents several facts regarding global innovative activities. For instance, he states that a very high share of the world’s patent applications and

6

(19)

[ 18 ]

technology transfers can be found in 10 developed countries. Furthermore, he summarizes previous findings regarding the role of IPRs in development, innovation, and technology transfers. These are also documented in the current study; therefore they shall not be included in this section. Despite this, his specific analysis of IPRs, innovation, and development in East-Asian countries deserves some attention. In brief, he finds that weak IPR protection actually benefited some of those countries. Insofar as a country possesses adequate imitative abilities, it may strongly benefit from obtaining foreign technology through, for instance, imports. As a country grows along this path of imitation, the need for strong IPRs increases as the country’s innovative abilities begin to dominate over its imitative abilities. However, in this instance, one must be aware of the middle-income trap (Wu, 2010) that could possibly arise, as will be explained later on. In today’s global economy, developing countries continuously face pressure by developed economies to improve their IPRs systems. Therefore, instead of being able to benefit largely from an imitation and adoption development path, they may instead be forced to implement IPRs systems which actually limit imitative, adoptive, and incremental innovative developments. Kumar (2003) expands on this analysis by explaining some of the consequences that the TRIPS Agreement had or may have had on developing countries. To avoid repetition, only the most unique and important ones will be explained here. For one, developing countries may become more dependent on developed economies due to the technology that is incorporated in imports, FDI, and licenses. Secondly, due to the market power effect, prices of products may increase and welfare losses may ensue. This is particularly important in the case of prices of medicines. Thirdly, TRIPS may simply serve as a mechanism for patent holders in developed countries to increase the rents they obtain from their patents, thereby leading to developing countries suffering net losses. Lastly, stronger IPRs may not provide enough incentives for large Western firms to develop specific medicines and products for the least-developed and developing countries. The second and last points are worth emphasizing as they illustrate the far-reaching consequences of inadequately strong IPRs.

(20)

[ 19 ]

Positive Impacts Neutral or Negative Impacts Developing Countries  Increased foreign technology

transfers

 Increased domestic incentives for innovative activities

 Information diffusion through information disclosure

 More attractive location for MNE’s to locate in

 Increase in innovative activities may be limited due to poor infrastructure, legal framework, research base

 Market power effect from domestic and foreign firms

 Increased prices of some products

 Increased dependence on developed countries

 Large net transfers to developed countries

Developed Countries  Increased domestic incentives for innovative activities

 Information diffusion through information disclosure

 Offers opportunities for small firms to access large markets

 Large net transfers from reforming developing countries

 Overinvestment in R&D

 Excessive use of patent system to block competition

 Market power effect which leads to higher prices and welfare losses

Table 1 Positive and negative impacts of stronger IPR protection in developing and developed countries

(21)

[ 20 ]

2.2 Intellectual Property Rights, Innovation and Growth

This section of the report will focus on one of the antecedents of economic growth; namely, innovation. Innovation is something which economists see as crucial in modern economies. Therefore it is of essence that its roots must be uncovered. More specifically, in the following section, the role of IPRs in stimulating innovation and growth will be explored. Although the latter is not directly implemented in this study’s empirical analysis, the impact of innovation on growth is worth paying attention to, especially in light of recent debates on the benefits and costs of IPR protection. What is more, innovation is often included in studies regarding IPRs and economic growth. This is because the channel through which IPRs affect economic growth goes through innovation. No direct effects of IPRs on economic growth should therefore be expected.

Reasons for economic development differences between countries are plentiful. Generally speaking, these are summarized in two categories: object gaps and idea gaps (Romer, 1993). The former involves the idea that some countries lack certain resources, thereby hampering their chances at achieving substantial economic growth. The second concept states that poor countries do not have proper access to ideas generated in industrialized countries. Romer (1993, p. 544) also states that “According to either view, a functioning legal system, stable monetary policy, and effective support for education will all be desirable policy goals because they can help reduce both gaps.”

(22)

[ 21 ]

other firms. Using patent citations data, they find that spillovers are mostly geographically bounded.

Ahlstrom (2010) mentions that, not only do firms provide profits to their owners, they also provide innovative products which have the added benefit of contributing to economic growth and employment. Furthermore, he goes on to discuss how much of the increase in living standards can be traced back to innovation.

Building upon endogenous growth models, a large number of empirical studies have been carried out to test the importance of innovation in driving economic growth. It is said that technology has been the single most important factor in driving economic growth in the past few decades (Mitchell, 1999). By definition, technology involves creating new solutions to problems. Generally speaking, business processes are made more efficient through technology. That is, the input-to-output ratios of production are decreased through technology. In other words, innovation is about “inventing new “recipes” that generate more economic value per unit of raw resource (Dosi, Marengo, & Pasquali, 2007, p. 471).” Thus, one would expect advances in technology to enhance economic productivity.

In their article, Eaton & Kortum (1997) contribute to the literature on innovation and growth by stating that technologically backwards country can converge to the standards of more advanced economies. According to the authors, this is done through the absorption of advanced technologies that are easy to adopt. They reinforce this statement by mentioning how most of today’s large economies’ growth was significantly affected by technology found outside national borders. This is in strong support of Kumar’s (2003) discussion about East-Asian countries, which was previously mentioned in this study.

In his study, Jones (1995) questions the scale effects of prior R&D-based models. Based upon empirical evidence, he explains how dramatic increases in the number of researchers have not been conducive to relatively paralleled increases in economic growth. Thus, this offers some support for the idea that there is more to economic growth and innovative activity than just increasing the number of researchers or expenditures in R&D.

(23)

[ 22 ]

per- capita income can be traced back to technical progress. According to them, productivity performance within firms is determined by accumulation of physical capital, human capital, and the rates of innovation change. However, if people were to merely focus on these three factors, only a small portion of the drivers of innovation would be illustrated. The business environment must also be conducive to innovative activities in order for firms and countries to achieve growth in productivity. For example, countries must be open to trade, competitive, have sound financial systems, and possess decent systems of intellectual property protection. In sum, Rao et al. (2001) consider five primary factors to influence the creation of fundamental innovation. These are R&D, human capital, knowledge infrastructure, market framework policies, and the business environment.

According to Lall (1992), national technological capabilities (NTC) are the result and combination of capabilities and incentives. In short, capabilities are the factors which make technological advances possible. These are composed of, but not limited to, human capital, physical capital and technological effort. For these capabilities to be utilized, proper incentives for investment and production are required. An environment conducive to innovation is economically stable (i.e. stable growth rates, low inflation rates, stable exchange rates, little political disturbance, etc.), provides incentives for competition, and has a solid set of institutions in place. Strong IPR protection is considered as an essential institution in this matter.

(24)

[ 23 ]

expected to be related to higher rates of innovation. This effectively provides the first two hypotheses:

Hypothesis 1: A country’s R&D expenditures are expected to have a positive impact on innovation output.

Hypothesis 2: A country’s stock of human capital is expected to have a positive impact on innovation output.

It is important to emphasize that hypotheses 1 and 2 will be significantly reinforced through additional explanations provided in section 2.4, in which a country’s AC is related to innovative activities.

(25)

[ 24 ]

subsequently use this index to find out which factors drive the level of patent protection in a country. This index will be explained in the data section of this study. Ginarte & Park (1997) find that market freedom determines the level of patent protection in a country to a large extent. In addition, they find that lagged R&D investment rates are strong determinants of patent protection in developed countries, and lagged openness for developing countries. Lastly they suggest that a certain threshold for the innovating sector may exist before a country decides to improve its patent protection. This is in agreement with Kumar (2003) and Wu (2010). Thompson & Rushing (1999) take a similar approach and find results that are quite similar. In doing so, they find that the greater the openness to trade of a country, the higher the observed level of patent protection. Also, countries which have not yet built a strong R&D infrastructure do not show signs of a strong emphasis on adequate patent protection. Thirdly, the likelihood of finding high patent protection in countries with low education attainment levels (generally low-income countries) is quite low. Lastly, political instability does not seem to be significantly related to the level of patent protection in a country. These results collectively suggest that IPRs are an essential part of regional innovation systems.

Lerner (2002) states that most of the current empirical research about relationships between IPRs and economic growth suffers from the fact that they examine these relationships over a very short period of time, or even at a single point in time. Consequently, he says, these studies find it hard to determine which direction the causal relationship goes into. For instance, does stronger IPR protection lead to more trade, or does more trade lead to stronger IPR protection? His research aims to partially solve this problem by extending the research period to 150 years, and applying the analysis to 60 different countries. In order to control for domestic policy changes, he only focuses on patent filings made by residents of the nation that is undertaking the policy change into a country with a somewhat stable and constant history of policy changes, in this case, Great-Britain. He finds that patent policy shifts in fact have a negative impact on domestic and foreign patent filings (in Great-Britain).

(26)

[ 25 ]

This begs the question: What roles have IPRs and innovation played in this process?

Falvey et al. (2006) conduct research about the relationship between IPRs protection and growth. In their study, they find that the relationship between IPRs protection and growth is non-linear. According to them, this is a somewhat unsurprising result. They find that countries with a high per capita income are more likely to experience higher growth when IPRs protection becomes stronger. This is due to the fact that most of the world’s R&D is conducted in these countries, thus most of the innovation which is protected by IPR is also generated there. One other noticeable finding is that, for middle-income countries, no significant relationship was found between stronger IPRs and growth. This could be due to the fact that these countries generally rely more on imitation and on their adaptive capabilities. Thus, if IPRs become stronger, it becomes more difficult to imitate patented products, thereby rendering the relationship between IPRs and growth insignificant. Thompson & Rushing (1996) further contribute to this notion. They use data covering 112 countries over the period from 1970 until 1985. They find that the so-called turning point for the IPR-growth link is around $3,400 GDP per capita in 1980 dollars. That is, once a country’s GDP per capita is greater than or equal to $3,400, patent protection becomes significantly positively related to economic growth.

Chen & Puttitanun (2005) use a sample of 64 developing countries in order to explore the relationship between IPRs and GDP per capita. They find a non-monotonic U-shaped relationship between the two. That is, starting from a low level of economic development, a country benefits more from lowering its IPR protection because of the fact that its imitation abilities are superior to its innovative abilities. However, once a country passes a certain threshold, the innovative abilities tend to dominate thereby making stronger IPRs more beneficial. Lastly, they state that the best way for the North (i.e. developed economies) to promote IPRs in the South (i.e. developing countries) would be to help them increase their domestic innovative activities.

(27)

[ 26 ]

impact on innovation and growth in developing countries, but not in developed countries. In order to make sense of these results, a short explanation of utility models is due. Utility models are generally granted for minor inventions, they have a shorter duration of protection (6-10 years as opposed to 20 for patents), they are less expensive to apply for, and most importantly, they require a small inventive step. Thus, for firms and countries that are less technologically advanced and rely more on their adaptive abilities, utility models are more useful than patents. One downside is that utility model patents are not used in most developed and even developing countries. Also, utility model patent laws tend to differ greatly between countries. Therefore, due to these complexities, including them in the current study was not possible.

Furukawa (2007) has a different take on the relationship between IPR and innovation. According to this author, the relationship follows an inverted U-shape form. Strong IPRs increase the fraction of monopolized sectors. In these sectors, monopoly prices are higher and the scales of production are lower. Therefore, experience accumulation declines, and thus demand for intermediate goods decreases thereby negatively affecting incentives to innovate. Furthermore, Gangopadhyay & Mondal (2012) propose a different but still very similar theoretical point of view regarding the IPR-innovation relationship. Similarly to Furukawa (2007), according to them, this relationship follows an inverted U-shape form. This is because strong IPR protection may hinder the free flow of scientific knowledge. That is, strong IPR protection might make it more difficult to accumulate knowledge. In this instance, prior innovative acts are a proxy for knowledge. Thus, once IPR protection becomes stronger, innovators might find it difficult to continue the sequential process of innovation. Ergo, we would expect to find a non-linear relationship between IPR protection and innovation.

(28)

[ 27 ]

of the previously mentioned empirical findings regarding the IPR-growth link in developing countries.

Finally, Branstetter (2004) summarizes prior empirical evidence on the relationship between IPRs, innovation, and economic growth. In the end, regarding developing countries, he concludes that positive effects should not be expected in the short to medium term. Instead, developing countries may only start benefiting from strong IPR protection once their research base reaches a certain level, or once they simply reach a particular level of economic development. Since it has been approximately 17 years since TRIPS came into effect, we would expect relatively less developed countries (i.e. the SE and CEE countries in our sample) to have enjoyed at least some benefits from increased IPR protection.

Ideally, an IPR system should be suited to the specific country itself. It should be welfare-enhancing, innovation-encouraging, and above all, it should be a fair system. History has shown that this utopian view of IPRs is unrealistic in practice. Agreements such as TRIPS have basically forced developing countries to adopt a certain IPR standard, as criticized by Archibugi and Filippetti (2010). Therefore, it is of critical interest for economists and policy makers to comprehend the intricacies of IPR systems. One cannot just expect a country to grow based solely on the assumption that whatever works in one country will work just as well in the other. Djankov, Glaser, La Porta, Lopez-de-Silanes, & Shleifer (2003) articulate this concern particularly well. According to them, several underlying factors such as available resources, institutions and culture in general differ to a great extent between countries. Therefore, “copy-pasting” a set of developed economies institutional frameworks onto a developing country is not sound policy-making. As should be clear by now from the literature review, developing countries have different needs when it comes to legal institutions. That is not to say that developed countries are expected to benefit fully from strong IPR systems. As shown in section 2.1.1, issues of over-patenting and using patents as competitive tools could be detrimental to innovation rates in developed countries. Taken together, these studies suggest an ambiguous relationship between IPRs, innovation and growth. In developing countries, strong IPRs should be conducive to more innovation and growth only once solid innovative abilities are in place. Furthermore, in developed countries the effects are also ambiguous. Based upon the previous section, we express the following hypothesis:

(29)

[ 28 ]

In order to test the non-linearity between IPRs and innovation, a squared term of IPR protection will be used in the regression analysis. We expect the squared variable to be positive, while the regular variable should be negative7.

7

(a) PAT = β1IPR + β2IPR2

Differentiating equation (a) yields: (b) (dPAT/dIPR) = β1+2 β2IPR (c) β1<0; β2>0

(d) β1>0; β2<0

(30)

[ 29 ]

2.3 Foreign Technology Transfers and Innovation

This section is divided up in two parts. The first part discusses the OLI framework and its relation to MNE entry mode choice (Dunning 1980). While the impact of IPRs on entry mode choice will not be empirically tested, explaining the relationship between the two is valuable in the context of this study. The second part discusses the importance of foreign technology transfers in stimulating domestic innovation. In contrast to the first part, testable hypotheses will be included in the second part.

2.3.1 IPRs and the OLI framework

Investors are looking for institutional environments which facilitate the development of their global firm-specific advantages (Bevan, Estrin, & Meyer, 2004). Of particular relevancy for the current study is the idea that a proper legal institutional framework is required in order to enhance the attractiveness of a country for foreign multinational firms. These legal institutions reduce uncertainty and transaction costs. Bevan et al. (2004) examine the impact of the institutional frameworks in East European transition economies on FDI. They mention how the transition from a socialist planning to a market economy has been quite cumbersome for most economies. In fact, a large number of institutions had to be started from scratch; one of these being a sound system of private property. Furthermore, these authors mention how institutions are increasingly being perceived as a locational advantage. Additional evidence for this is provided by An, Maskus, & Puttitanun (2008).

(31)

[ 30 ]

market opportunities (Luo, 2001). Thirdly, when the context and situation favour high integration of transactions within the firm, high control entry modes are preferred. With regards to IPRs, weak IPR protection should, in theory, favour high-control modes such as wholly-owned subsidiaries. According to Luo (2001), this is due to the fact that these entry modes let the firm maintain control over its critical intellectual assets, while at the same time increasing bargaining power and profit retention. The author’s empirical results support this finding. In relation to this, Vishwasrao (1994) states that, if a firm had to choose between licensing, exporting, or a direct investment in a country with weak IPR protection, it would often opt for direct investment in the form of a wholly owned subsidiary in order to “circumvent imitation (Vishwasrao, 1994, p. 383).”

(32)

[ 31 ]

relative to affiliate sales and exports. This is because in situations with strong IPR protection, knowledge assets are protected, and thus the firm does not need to integrate all transactions within the firm. In sum, licenses are expected to be the most strongly affected by stronger IPR protection (relative to affiliate sales and exports), followed by affiliate sales (relative to exports), and finally exports. Smith’s (2001) empirical results support all these hypotheses. The OLI framework and its implications for the current study are summarized in figure 1.

Figure 1 OLI framework and its relation to IPRs

Stephan (2011) correctly indicates that FDI may function both as a vehicle for technology transfer, and as a way for Western multinational firms to exploit low labour costs. In order to relate his study to IPR, he argues that it matters whether a multinational firm is seeking location-bound natural resources or location-bound skills and knowledge. That is, in situations where the firm is seeking natural resources, IPRs matter less as the dangers of unintentionally spilling over crucial knowledge and information are lower. Alternatively, in situations where the firm is seeking location-bound skills and knowledge, these dangers are more present, thereby making the level of IPR protection in a country relatively more important. Referring back to Primo Braga & Fink (1998), they discuss how one should make the distinction between knowledge-intensive and less knowledge-intensive stages of production when exploring the relationship between FDI and IPR protection. In other words, less knowledge-intensive stages of manufacturing such as marketing, sales, and distribution outlets are expected to be influenced significantly less by changes in IPR protection than the more

Protect knowledge assets against violation

Location with strong IPRs is preferred over location with

weak IPRs

Weak IPRs increase costs and risks, thus internalization is

(33)

[ 32 ]

knowledge-intensive stages of the manufacturing process. Similar thoughts were expressed by Lee & Mansfield (1996), two years earlier. These articles indicate that the relationship between our measure of FDI flows and innovation output may not exhibit the strong positive results on innovation output that we would expect under controlled circumstances. By way of explanation, if most FDI inflows are of a low cost-seeking nature, strong domestic impulses to innovation rates cannot be expected resulting from these incoming flows of foreign investment.

In a paper that uses CEE countries as its context, Smarzynska (2004) looks at the composition of FDI and the protection of IPRs in transition economies. The OLI paradigm is used to explain the connection between IPRs and entry mode choice. Besides this, the author makes the distinction between the investor’s choice of setting up a production facility or focusing solely on distribution. Her results indicate that weak IPRs form a barrier to all firms, regardless of their industry type. Furthermore, as hypothesized, weak IPR protection encourages firms to focus on distribution of imported products, and not production facilities. Awokuse & Yin (2010b) find that an increase in patent law protection has a significant positive impact on FDI. Interestingly, instead of fully relying on the Ginarte & Park (1997) index of IPR protection, they also use “Annual foreign patent applications as a measure of the strength of IPR protection in China (Awokuse & Yin, 2010b, p. 218).” Quite similarly to Primo Braga & Fink (1998), they mention how the relationship between FDI and IPR protection may be ambiguous. On the negative side of the spectrum, they mention that MNE’s may attempt to maximize profits through reduced output and sales, thereby decreasing their servicing to the domestic market (i.e. the market power effect). Secondly, stronger IPR protection may favour licensing over FDI. The latter is technically not detrimental to innovation rates in host countries as licensing, just like FDI, provides a channel through which technology and knowledge may flow.

Seyoum (1996) shows that IPR protection has a “positive effect on market/export-oriented investments with products/processes that are relatively easy to imitate (Seyoum, 1996, p. 57).“ This essentially offers support for the previously mentioned idea that patent protection matters most for industries with high R&D capital investments and products that are easy to imitate (Mansfield, 1986).

(34)

[ 33 ]

field, she includes the strength of imitative abilities of the country of destination. Therefore, the threat of imitation in a particular country with weak IPRs is moderated by the strength of the imitative abilities of that country. By using this method, Smith (1999) indeed finds that countries with weak IPRs only form a threat to U.S exports as long as their imitative abilities are strong enough. In addition to this result, it is found that the market power effect is pervasive in countries with strong IPRs and weak imitative abilities. In other words, U.S. firms enjoy the benefits of monopoly power in those countries, leading them to reduce their exports to those countries. This is in strong support of the proposition that the impact of IPRs on trade is ambiguous.

Awokuse & Yin (2010a) explore the facets underlying increased imports in China. What makes their particular study stand out is the fact that they distinguish between knowledge-intensive imports and less knowledge-knowledge-intensive imports. In line with the theory of the market expansion effect, they find that an increase in IPR protection increases the amount of knowledge-intensive imports relative to other products. Furthermore, as expected, this effect is more pronounced for imports originating from OECD countries. This is due to the fact that these countries house the majority of knowledge-intensive industries and firms.

(35)

[ 34 ]

(2005) states that misleading results and inadequate policy-making may flow from pooling together results for developing and developed countries with regards to IPRs, innovation and growth.

Finally, regarding licensing, Anand & Khanna (2000) state that it is one of the most important channels through which technology is transferred and diffused between countries. Their results indicate that, as expected, licensing is concentrated in a couple of industries; these are: Chemicals, Electronics, and Computers.

Kim & Clarke (2013, p. 651) describe a licensing agreement as “Under a licensing agreement, a firm purchases the rights to another organization’s technology or patents for an initial lump sum payment and future royalties, with the exact terms depending on the agreement”. Furthermore, they find that, within the EU, the flows of licensing agreements significantly depend upon the strength of IPRs in the country of destination.

Park & Lippoldt (2004) research the impact of patent reforms and increases in patent strength on the flows of receipts from licensing fees and royalties to U.S. firms. As was the case with similar researches, they find that a certain level of IPR protection is required for firms to be convinced to switch their entry mode type from FDI to licensing. Furthermore, they find that stronger IPRs encourage firms to engage in more licensing. Moreover, industry-specific effects are found; that is, industries such as the service, electrical and electronic, and transportation industries were found to be affected by patent rights, while the machinery and wholesale trade industries were not.

Yang & Maskus (2001) propose that the relationship between IPR protection and licensing is theoretically ambiguous. Therefore, the issue must be tested empirically in order to derive meaningful results for real-life practitioners. On the positive side of the spectrum, strong IPR protection reduces imitation costs, thereby increasing rents for the licensor. On the other side, the market power effect may prevail, thereby reducing incentives to innovate and license technology. In the words of Yang & Maskus (2001, p. 61) ”It is conceivable in theory that long-run innovation could slow down because the monopoly effect of stronger patents would reduce R&D effort.”

(36)

[ 35 ]

(BEA) regarding technology licensing fees. Their empirical results indicate that stronger IPRs do in fact increase technology transfers to reforming countries. However, the impact is strongest for firms that value patent reforms the most. Nevertheless, Branstetter et al. (2006) conclude that their results collectively imply that stronger IPRs induce higher technology transfers between U.S. firms and their affiliates.

According to Ferrantino (1993), most of the royalties and license fees transfers between countries are associated with the transfers of internal funds. Thus, once the strength of IPR protection increases in a country, firms are better able to transfer funds internally across borders. Therefore, theoretically, he states that strong IPRs should increase both internal and external transfers of royalties (that is, intrafirm or interfirm). Ferrantino (1993) also advances the idea that foreign governments may have a preference towards certain modes of entry. Therefore, he states that strong IPRs do not solely determine the entry mode choice by themselves. Instead, the government may employ such tools as tariffs to influence the decision of the multinational firms. Hence, the author takes these factors into account when measuring the impact of IPRs on international trade, licenses, and investments. Based upon his results, he derives several major findings. For one, countries that join IPR agreements do not necessarily pursue similar trade or investment policies. What is more, a country’s adherence to IPR agreements has no clear impact on U.S. firm exports or overseas affiliate sales. In general, he concludes that the perception of LDCs and developed countries towards IPRs (i.e. the stronger the better) are “overly simplistic (Ferrantino, 1993, p. 328).”

In sum, the literature regarding FDI, trade, license agreements, IPR and innovation illustrate the importance of IPRs in influencing MNE’s entry mode decisions. Though these entry modes are not directly related to IPRs in the current study, this section does once more emphasize the crucial importance of IPRs in determining MNEs’ decisions regarding entry modes.

2.3.2 Foreign technology transfers and innovation

(37)

[ 36 ]

economies over which knowledge, technology, and capital may flow (Borensztein, Gregorio, & Lee, 1998). Furthermore, through these channels, innovation rates are increased. Subsequently, as proposed and agreed upon by most economists, long-run growth rates of income are enhanced on the premise that technological progress is the main driver of economic growth. In spite of this, FDI may also crowd out domestic investments due to the increased competition offered by MNEs. Hence, as Borenzstein et al. (1998) argue, the sign between FDI and domestic investment could be either positive or negative. Furthermore, these authors find that FDI positively affect economic growth on the condition that the host country’s stock of human capital is of a sufficient level. In other words, countries which exhibit low levels of stock of human capital (i.e. through low education rates for instance) may not benefit as much from FDI inflows. Largely speaking, Borenzstein et al. (1998) conclude that FDI are conducive to economic growth conditional on the quality of the host country’s investment environment (i.e. institutions, policies, human capital stock).

Seeing as most EU-27 countries have greatly increased their attractiveness for foreign firms in the past few years, we would expect flows of technology transfers to have increased alongside. Barrell & Pain (1997) find that FDI inflows do not only benefit developing countries, they also offer major benefits to developed countries. Hence, by including three types of foreign technology flows in our analysis, we hope to present a more complete picture for both high-income EU-27 countries and relatively lower-income EU-27 countries. The following part will explain the roles of FDI and imports in influencing domestic TFP. Also, it will include a small section discussing license agreements.

FDI inflows foster economic growth, as has been widely recognized in the past, but they also form a channel through which technology is transferred between nations (Kalanje, 2002). Much of the benefits associated with FDI are due to the differences in resources, knowledge and technology between developed and developing countries. That is, firms from developed countries generally possess superior technology, resources and knowledge. Through spillovers, domestic firms are expected to benefit largely from these and are thus able to raise their own productivity levels.

(38)

[ 37 ]

others. They end their article by claiming that institutions and policies play a vital role in attracting multinational firms. In this study, focal attention will be placed upon the role of FDI inflows in transferring knowledge and technology between countries.

Drivers of Innovation in Europe: The Importance of Intellectual Property Rights