Competition, IPRs and Development

WIPO-WTO Joint Workshop Intellectual Property Rights and Transfer of Technology Geneva, 17 November 2003 Competition, IPRs and Development Joseph Seon Hur Korea Fair Trade Commission

Contents • Introduction • The Impacts of Competition and IPRs on Innovation and Development • Relationship b/w Competition Policy and IPR Policy • Licensing Practices related to IPR which need Competition Review • Further Debate Needed in Multilateral Framework • Conclusion

Introduction • This presentation focuses on: • How do competition and IPR spur innovation which is vital for development? • What is the characteristic relation b/w CP and IPR? • Contradictory or complementary? • In what condition? • How can CP best respond to IPR related case? • Needs or items for further debate in multilateral contexts

II. Impacts of Competition and IPRs on Innovation and Development • Innovation is vital engine of economic development and consumers’ welfare. • Competition policy and IPR share the identical goal of economic development and consumer welfare through innovation

Competition policy objective of promoting consumer welfare could be achieved by encouraging efficient production (static efficiency) and innovative activity (dynamic efficiency). • Patent law provides patent holder with monopoly right that may lead to some static inefficiency in the hope of promoting dynamic efficiency. • A problem arise here as a conflict b/w static and dynamic efficiency.

Economic studies show that a relatively small dynamic advantage can offset a larger static inefficiency. • For example: • It only takes 5 years for even a 1% annual growth rate in cost efficiency to offset a 5% static loss due to price increase. • An output handicap amounting to 10% of national product from static inefficiency is surmounted in 20 years, if the output growth rate can be raised through more rapid technological progress from 3.0 to 3.5%, just 0.5% point.

Competition, Innovation, and Economic Development • Competition spurs innovation: • Competition to win a patent right drives a race to innovate. • approaching differently, also increasing chance of success • Monopolist who does not feel the threat of entry has less incentive to innovate. • To a monopolist, new products only cannibalize the existing sales • Competitors have more incentive to innovate for acquiring market dominance.

The Long Debate on Schumpeterian Hypothesis • Larger firms innovate more. • Firms in concentrated markets innovate more. • Based on (1) economy of scale of R&D • (2) availability of resources of R&D • Does not seem to reach a final conclusion. • Some argue for non-linear, inverted-U-shaped relation b/w concentration and innovation.

“What is needed for rapid technical progress is a subtle blend of competition and monopoly with more emphasis in general on the competition, and the role of monopolistic elements diminishing when rich technological opportunities exist.” • “There is no simple Schumpeterian relationship across all industries.” • “Industries vary too much for one theory to fit all.” • But Competition alone cannot serve as the sole driver of innovation. • Innovator cannot appropriate full benefits from his innovation without IPR. (problems of free-riding)

IPR spurs innovation in three ways • IPRs enhance appropriability, excluding free-riders. • Patent rights mitigate misappropriability problem by granting exclusive rights in innovations. • IPRs increase incentive to innovate. • When innovation is cumulative, strong patent rights may hinder independent follow-on innovation. • Other appropribility mechanisms, like secrecy, first mover advantage, learning curve advantage, may also protect innovator from free riding.

IPRs facilitate commercialization of innovation. • Innovators sometimes may lack commercial ability. • Patent right enables innovators to contact with investors. • It makes their information a tradable commodity by reducing transaction costs and enabling license. • It also helps to get an advantage of specialization.

IPRs encourage disclosure. • Patent law requires applicants to disclose the inventions. • The purpose of the disclosure obligation is to further innovation by sharing information of innovation. • Issued patent communicates a good amount of information that can help other inventors including rival.

In some case, patent rights to exclude others could confer the innovator a market power. • This patent monopoly leads to: • Reduction of production • Higher price and reduced consumer’s options • Social deadweight loss • Strong and effective entry barriers • To the extent that patent production is not needed to stimulate innovation, the cost of patent may cause unjustified injury to consumers.

Relationship b/w Competition Policy and IPR Policy • IP law and competition law both seek to promote innovation and enhance consumer welfare. • Both share common purpose of promoting dynamic competition and thereby enhancing consumer welfare.

Competition and patent policies work in tandem toward the purpose. • Competition policy understands that effective legal regime of property rights is essential to a competitive economy. • Patent policy recognizes the value of competition by limiting life and breadth of patent to balance the need to encourage innovation and avoidance of monopolies that stifle competition. • In conclusion, competition and patent policy take different means to achieve their congruent goals.

Most Patents do not confer monopoly power to their holder. • Most business conduct with respect to patent does not serve to monopolize power. • Monopoly power which is conferred by patent does not necessarily create anti-competition problem. • However, there are opportunities for conflict b/w competition and patent law and policy.

Most conflicts stem from four principal areas of uncertainty • Extent to which competition policy is about short-run efficiency or long-run dynamic efficiency • Whether market power should be inferred from existence of IPR • Certain distinctive economic characteristics of IPR • Whether a particular contract, license, merger should be regarded as horizontal or vertical

Short run or long run? • When competition authority sees the issue in the short-run perspective, we see the IPR-rendered dominance as a serious anti-competitive, because CA believes that consumer welfare is best served by removing impediments to competition. • But recently this short-run view has been replaced by a longer-run perspective. • Technical Progress contributes at least as much to social welfare as does the elimination of static inefficiency.

Whether market power should be inferred from the existence of an IPR • Strong tendency of CA to treat IP as conferring market power and therefore as antithetical to competition policy. • Recently this tendency seems to be ebbing. • CA doesn’t presume that IP creates market power in antitrust context. • CA focuses on whether there are close substitute that might constrain ability of IPR owner to exercise market power.

Distinctive economic characteristics of IPRs • Fixed cost of producing IPR tends to be very high, whereas the marginal cost is near to zero. • This means the price of patented goods must remain above marginal cost. • Price discrimination, charging different prices to different users may well be output-enhancing and efficient. • Tying and exclusive territories can be efficiency- enhancing. • IPR can easily be misappropriated. • Serious free rider problems • IPR holders may impose exclusive dealing on a license to solve this misappropriation problems.

Distinction b/w horizontal and vertical • IP licensing is a way of bringing together complementary inputs, and transactions involving complementary inputs are essentially vertical in nature. • IPR licensing can nonetheless have a significant horizontal element. • Patent pooling • U.S. guidelines: “The Agencies ordinarily will treat a relationship b/w a licensor and its licensees or b/w licensees as horizontal when they would have been actual or likely potential competitors in the relevant market in the absence of the license.”

The Need for Proper Balance of CP and IPR • Shared goal to enhance the consumer welfare through dynamic competition and innovation. • Competition policy should have an optimal level of enforcement and economically reasonable rationale. • Both over- and under-enforcement of competition law would seriously undermine the incentive to innovate thereby reducing consumer welfare.

Proper application should avoid both (1) excessively stringent enforcement approach which lessen innovation and (2) weak or ineffective application of CL which leads to abusive dominance. • Either approach could have adverse effect on in innovation. • Appropriateness of • Rule of reasons analysis • Use of filter to identify harmful practices • Importance of non-discrimination and transparency

IPR should also have optimal life and breadth of patent protection • Too broad patents may distort incentive to innovate and incur unjustified cost to consumer. • If an invalid patent which is granted by systematic error confers a market power,it can deprive consumers of benefit of competition. • Broader IPRs are producing higher than necessary barriers to entry and encouraging more cross-licensing than is optimal. (Ex: biotechnology, business methods) • Strong IPRs strengthen a market position against independent follow-on innovation which is more pro-competitive and holds major proportion. • Market power in one market could leverage into a position in another market through for example tying.

Competition and patent policy are bound together by the economics of innovation and intricate web of legal rules that seek to balance the scope and effects of each policy. • Errors or systematic bias in the interpretation or application of one policy’s rules can harm the other policy’s effectiveness. • A challenge for both policies is is to find the proper balance of competition and patent protection.

5. Approaches for competition treatments of IPRs • Gallini and Trebilcock (1996) recommend the following set of principles for guiding competition policy toward intellectual property. • P1: There should not be a presumption that an intellectual property rights create market power. • P2: Competition policy should acknowledge the basic rights granted under patent law. • P3: A licensing restriction should be permitted if it is not anticompetitive relative to the outcome that would result if that license were proscribed, otherwise an evaluation of potential efficiency effects of the restriction on the pricing and diffusion of IP should be made.

P1: No presumption that IPR creates market power • Most products face a large number of substitutes. (Only 27% show no alternatives, 29% cases had over 10 competitors) • In case a patent does confer market power, it is not in violation of competition law. • It is same as that IP acquired through superior skill, foresight, and industry should not be condemned.

P2: The basic rights under the patent law should be respected. • Patent law ensures the existence of property rights while competition policy restricts the exercise of those rights. • Where exclusion of others from using IPR extends market power beyond that intended by patent law, then competition policy may intervene. For example, in case that patents are accumulated for the purpose of eliminating competition. • Existence of IPR does differ from exercise of it.

P3: A licensing restriction should be permitted if….. • Acknowledges the roles that competition policy has to play in promoting the efficient diffusion of technology and pricing of goods. • But licensing may not always socially desirable. • Excusive dealing which forecloses the market • Patent pooling that facilitates cartel

Licensing practices related to IPR which need competition review • Horizontal effects • Pooling and cross licensing • Exclusive territories • Grantbacks • Horizontal acquisitions • Vertical effects • Exclusive dealing • Royalties based on total sales • Tying arrangements • Vertical acquisitions

Other enforcement issues • Compulsory licensing • IPRs of dubious validity • Innovation market • Standard setting and networks • Vertical price restriction • Safety zone

Further Debate Needed in Multilateral Framework • The time is ripe for the debate. • Knowledge-based, information based economy prevails. • New economic learning has been challenging the old policy in competition and IPR. • More deepened globalization needs a proper governance of trade. • Danger of new mercantilism • Accumulated experience of member countries in treatment of licensing cases. • Growing number of developing countries are introducing competition laws

2. Some specific issues that needs further multilateral debate • Communication channel b/w competition agency and patent agency • The appropriate scope of patent in the area of over-broadened patent • Special situation of developing countries in technical transfer and licensing • Comparative approach to treatment of licensing arrangement of member countries

The role of IPR in network industries especially refusal to license and essential facility doctrine • New strategy of acquisition of IP to build up entry barrier • The concept of innovation market and potential competition theory • International market segmentation and price discrimination and doctrine of exhaustion in trade.

Conclusion • Both intellectual property and competition policy have important roles to play as cornerstones of a healthy market economy, especially in promoting innovation. • Competition law is needed to prevent certain abusive practices involving IPRs. Countries not having competition laws deprive themselves of an important tool to prevent these abuses. • WTO can play a useful role in promoting understanding of the issues internationally. This would be an important aspect of ensuring that the system keeps up with and is well-adapted to the modern knowledge-based economy.

Competition, IPRs and Development