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Abstract
This paper develops a North-South trade model to examine the effect of the enforcement of intellectual property rights (IPR) in the South on inward foreign direct investment (FDI) by taking into account international licensing and the informational advantage of FDI. The focus of this paper is on the strategic influence of international licensing on the optimal entry mode of firm N. The main findings of this paper are as follows. First, the optimal entry mode for firm N in the absence of IPR protection is FDI when the innovation size is large but the variance of demand and the fixed setup cost are small, while selecting exporting otherwise. Second, the enforcement of IPR in the South can promote FDI when the innovation size is small, while discouraging FDI when the innovation size is moderate and large. Third, the enforcement of IPR protection will most likely decrease the total output and the welfare level in the South under international licensing, while the reverse may occur as a result of changing the firm N’s entry mode from FDI to exporting.
Notes
1. Mailath (Citation1993) examined informational asymmetries by assuming that the uninformed firm is limited to producing in period 2 while the informed firm can choose to produce either in period 1 or in period 2. Mailath found that the signaling Stackelberg game, where the informed firm moves first, is the unique equilibrium outcome. Normann (Citation1997) extended Mailath’s (Citation1993) model to the situation where both informed and uninformed firms can choose to produce either in period 1 or in period 2. Normann proved that only the Stackelberg equilibrium emerges endogenously with the uninformed firm serving as the Stackelberg leader and the informed firm acting as the Stackelberg follower. Thus, the assumption that the multinational firm is a Stackelberg leader under exporting is consistent with the results of Normann (Citation1997).
2. Spencer and Brander (Citation1992) is the first paper to take into account demand uncertainty in analyzing the issue of flexible manufacturing and R&D investment.
3. To abide by the antitrust law, we assume that r ≥ 0 and f ≥ 0. The optimal licensing contract is regarded as pure royalty licensing when f = 0, pure fixed-fee licensing when r = 0, and mixed licensing when r and f > 0.
4. By substituting the lower bound of the demand uncertainty, into (1.2) and letting firm S’s output be non-negative, we can derive the restriction,
. Next, by using
and
we can manipulate the above restriction and obtain that σ2 ≤ (a − c − 2ɛ)2/12 and ɛ ≤ (a − c)/2.
5. The same result can be found in Wang, Wang, and Liang (CitationForthcoming).
6. The detailed procedures are available from the authors upon request. They can also be found in Wang, Wang, and Liang (CitationForthcoming).
7. Given the positive output restriction, σ2 ≤ (a − c − 2ɛ)2/12, we can observe that this royalty rate is greater than the innovation size, i.e. .
8. It can be found from Figures that the analysis of the innovation size in the range is missing, in which line UV will cross line AB. We ignore this analysis because the result is similar to those in Figures , depending upon the magnitude of the innovation size.
9. Please refer to the following website for the criticisms and the definition of artificial scarcity: https://en.wikipedia.org/wiki/TRIPS_Agreement.
10. We can prove that firm N will choose exporting (FDI) under no licensing in the presence of a tariff, if the sign of is positive (negative).
11. The intuition behind this result is the same as that in Poddar and Sinha (Citation2010) and Wang, Liang, and Chou (Citation2013), in which the lower that the licensee’s marginal cost is relative to that of the licensor post licensing, the more likely it will be that the insider licensor will choose fixed-fee licensing. In addition, they also obtain that the insider licensor will choose pure royalty licensing if the difference in the marginal costs between the licensee and the licensor post licensing is small. Therefore, when the tariff rate is low, the difference in marginal costs between the licensee and the licensor post licensing is so small that firm N will choose pure royalty licensing.
12. The proofs are available from the authors upon request.