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The impact of globalization on income inequality for individuals is a much-discussed affair. Far less attention is paid to how it affects inequality in terms of opportunities for companies around the world. The paper, “Do Institutional Reforms Benefit Strong or Weak Firms: Intellectual Property Rights and Access to International Alliances,” takes a look at the latter.
The paper seeks to answer this question: When globalization opens up a country’s economy, does it hurt or help local firms, especially weaker businesses? The paper is based on the research of Wharton management professor Exequiel (Zeke) Hernandez and Wharton doctoral candidate Sarath Balachandran. Hernandez recently spoke to Knowledge@Wharton about their findings.
An edited transcript of the conversation follows.
Knowledge@Wharton: Can you tell us about your paper? What did you set out to discover in your research?
Hernandez: The broad goal we had was to essentially tackle this debate: If policy efforts open up an economy to global markets, will globalization help or hurt companies from countries that adopt those kinds of policies? Now that is a huge question that can’t be answered in just one study. So for this project we just took a narrow slice of that question.
We explore the efforts that countries have made to reform and improve their intellectual property (IP) rights laws [as part of its globalization efforts]. Has this helped companies have more opportunities … to establish alliances or partnerships with companies from other countries?
We are especially interested in who benefits more [among local companies]. Is it companies that already had access to these partnerships [with other foreign companies], what we will call strong firms? Or is it companies that had a hard time doing so before the reforms, what we will call weak firms? I’ll explain why this is important.
First of all, these alliances or partnerships are really crucial for firms from pretty much any country, but especially for firms from emerging markets that tend to have weak intellectual property rights [laws]. And the reason is that these alliances help firms access foreign markets to sell their products, and they also help firms access new technologies and capabilities that then help them upgrade their knowledge and their products. And so, they help them become stronger firms.
“The question is important because inequality is not just about people, but it’s also about companies.”
Let’s say a firm from Chile can use a partnership with a firm from the U.S. to sell in the American market and it can develop a new technology or product from what it learns from that partnership. It is clear that having more access to these partnerships is good for the Chilean company, but the question is, once Chile improves its IP laws, is it the stronger firms in Chile or the weaker ones that will benefit?
The question is important because inequality is not just about people, but it’s also about companies. So for example, we care a lot about markets functioning competitively, [which cannot happen if one or a few companies dominate the economy]. … In an economy in which few firms control valuable resources, such as the alliances that I just mentioned, that could be harmful. All of this plays into the importance of the law as a way to make the playing field level for both individuals and firms.
Knowledge@Wharton: I am just curious, why did you choose intellectual property rights to examine that question?
Hernandez: There are a lot of different changes that countries can make to globalize their markets. … The reason we chose intellectual property rights is that it is actually one of the most important barriers for companies and for countries in order for them to participate in the global economy.
Let’s say you are a French technology company, and you are considering partnering with an Indian or a Chinese firm to sell your product in India or in China. Now if the IP laws of those countries are weak you would be concerned about whether your technology, the trademark, or brand that makes your company valuable, are protected. If your Indian and Chinese partner does something to, say, expropriate or harm your intangible assets, what recourse would you have? The answer is you have almost no recourse if the IP laws are weak.
Surveys of companies doing business in emerging economies show that this issue of intellectual property rights being weak is often the number one concern they have in operating in these markets. And this becomes increasingly relevant as the assets that differentiate companies are intangible — technologies, brands, trade secrets, etc. So we thought that this was not just a good empirical setting, but also a really timely one as a way to see if intellectual property enhances access to foreign markets.
Knowledge@Wharton: In your paper you refer to what is called the Matthew Effect, which is the idea that the rich, with their capital and connections, get richer, while the poor get poorer. Can you tell us more about this?
Hernandez: The Matthew Effect [which is named after the parable of the talents from the Gospel of Matthew in the Bible] is a phenomenon that has been found in many different settings. … In social science, what has been shown is that essentially an economic actor that starts out with more resources — say it’s capital or social connections or any other asset — over time that actor will accumulate additional resources at a faster rate than an actor that starts out with fewer resources. And that leads to a very uneven distribution of resources. So the rich are getting richer, the poor getting poorer.
Now this applies to our study because we are interested in whether changes in IP laws strengthen or weaken this Matthew Effect when it comes to the ability of companies to access more foreign partnerships with companies. So you could imagine that the IP laws could have two competing outcomes, and it’s not really clear beforehand which will happen.
The first outcome, or the first scenario, is one that actually strengthens the Matthew Effect. What that means is that the strong get stronger, which in our case is that firms that already were able to establish international partnerships now can do it even more after their country improves its IP laws. And that could happen because, say, these firms are more capable, they are more desirable to the foreign partners, and a dynamic like that would lead to an increase in inequality among firms in the economy when it comes to accessing these foreign partnerships.
The other scenario is the opposite, it’s that the Matthew Effect becomes weakened. So here the firms that had a hard time accessing international partnerships benefit the most from the improvement in IP laws, maybe because they lacked the reputation or connections beforehand to attract foreign partners, and the better IP laws now provide a mechanism for them to mitigate the concerns of foreign partners in entering into alliances with these so-called weaker firms. And it is clear that a dynamic like this would lead to a decrease in inequality, because the playing field now becomes more level.
“Intellectual property rights being weak is often the number one concern [companies] have in operating in [emerging] markets.”
Knowledge@Wharton: What were your main hypotheses, and what was the source of your data?
Hernandez: We actually didn’t have a specific hypothesis going into it. Rather, what we had was this idea that there could be these two competing scenarios: The Matthew Effect either becomes stronger or it becomes weaker. Our goal really was just to see which of the two would play out by looking at the data, because it’s hard to predict beforehand which would happen.
In terms of the data, we actually went back about 20 years to the 1990s. And the reason we chose that period is because it was an era of tremendous globalization. In fact, that is the era that seeded everything that happened that is now being debated [in our current political environment]. But it was an era of liberalization, and many countries specifically made efforts to improve their intellectual property laws so that their companies could participate in international markets.
So what we did is we built on some previous research that identified countries that had made meaningful, significant changes in intellectual property rights laws. And from that we identified 13 countries that made credible, meaningful, large improvements between 1991 and 1999. It’s countries like Chile, India, Brazil, Argentina, Thailand.
None of these even today have what we would call an ideal level of IP protection, but during that time they made a significant step improvement. So we identified these 13 countries, and then what we did is gathered data on all of the alliances that firms from these 13 countries established, both before and after the changes in the IP laws. That allowed us to have a very simple research design, which was simply to assess if the number and quality of the alliances they established with foreign companies changed after the improvement in the IP laws compared to the period before.
Knowledge@Wharton: What did you find out?
Hernandez: In a nutshell, what we found is the IP improvements led to a significant and permanent increase in both the amount and quality of foreign partnerships established by firms from those 13 countries, at least on average. But what is more important for our purposes is that we found that this increase in quantity and quality of foreign partnerships was much stronger for firms that had the least access to those partnerships during the period before the IP reforms.
In other words, the benefit was strongest for the weak, which led to the Matthew Effect being weaker, resulting in a more even distribution, or more level playing field, in terms of access to foreign partnerships.
Knowledge@Wharton: You mentioned quality of these international alliances, not just the quantity. Could you talk about that a little bit more? How did you measure quality, and why is that critical?
Hernandez: It is critical. Imagine a scenario where the weak firms get disproportionately more foreign partnership after the reform, but they get the worst, or the least desirable partners — maybe partners from places that aren’t very advanced technologically. That is not a real benefit, that is just an increase in quantity but not quality.
“Emerging countries on net are much better off with strong rather than weak IP rights.”
We felt it was important to actually see if the increase was also one in quality, and who got a bigger increase in quality as a result of these IP reforms. In terms of measurement, [quality] is always a little bit hard to capture at the firm level. So what we did is we used some of the attributes of the countries of the foreign partners as proxies [for the quality of the partners that firms could access across countries].
We used three measures. One measure is the extent to which a country makes high technology exports. Another is the number of science and technology publications in the country. What those two measures have in common is they capture the technological sophistication of the firms from that country, at least on average. And then a third measure is simply the variety or diversity of countries from which firms can find partners. This gets at the ability to access diverse knowledge and ideas through the alliances that these firms establish.
Now regardless of the measure we used, we found something in common: The changes in IP laws led firms to access more partners from these high-quality countries, and partners from a [broader] variety of countries. Again, this effect was strongest for firms that were so-called “weak” during the pre-reform period.
Knowledge@Wharton: Can you talk about the different types of alliances that the companies can enter?
Hernandez: You are referring to a part of the paper where we try to see if the IP reforms led the weak versus the strong companies to increase across specific types of alliances — say partnerships that are about doing R&D, or partnerships that are about marketing or manufacturing. We didn’t really have any hypotheses about this; we just wanted to see if the increase in the number of these different types was different for the strong versus the weak forms.
It turns out that there is no difference, meaning that the weak firms sort of consistently increased more than the strong firms in accessing all kinds of partnerships. So it seems to be that there is some across-the-board benefit of getting access to partnerships for the weaker firms.
Knowledge@Wharton: One of the things that I thought was very interesting in your paper was that you mentioned when these reforms elevated the weak it actually did not also take away from the strong. Can you talk about that a little bit?
Hernandez: This is actually a really important issue, because it would be wrong to interpret our study as showing that IP rights somehow make the weak firms stronger by taking away from the strong firms. That would be some kind of zero sum game where there is no … net gain [in the economy] because you are taking from one to give to the other, which would be kind of a Robin Hood effect. We don’t find that.
“IP laws benefit the weakest firms the most, although they benefit all firms on average when it comes to accessing … foreign alliance partners.”
We find that the weak firms benefit more from the changes in IP laws in a relative sense. That means that relative to the strong firms, the increase in quantity and quality of alliances is greater, but not that the strong firms are hurt. And that is not just important for understanding, say, the distributional aspects of our results. But I think it also is realistic because these so-called strong firms were strong for a reason. And IP reforms don’t weaken those capabilities that made them attractive as foreign partners, it just … creates opportunities for the weak firms. So I suppose that is good news all around.
Knowledge@Wharton: That’s true. Your paper also mentioned that your research has some limitations. Can you elaborate more on that?
Hernandez: The biggest limitation of our work, especially if you think of where we started, was this huge question of the inequality of firms. We really have tackled only a very narrow part of that. And so our claims are also very narrow. Specifically, what we can say is IP laws benefit the weakest firms the most, although they benefit all firms on average when it comes to accessing something very specific, which is foreign alliance partners.
We are really not saying much about a lot of other consequences that IP laws can have, which would have to do with the technological capabilities of firms, their patenting, their ability to create novel products, etc. I am certain that IP laws have some effects that are good and some effects that are not so clearly positive for the economy as a whole. Perhaps there are some consumers that are hurt by IP laws in some cases. And so our findings have to be interpreted as really a small piece of a much larger puzzle.
Knowledge@Wharton: At the end of the day, what are you hoping to do with this research? Are you hoping to influence public policy, for example perhaps encourage governments of emerging countries to adopt strong property rights laws? What are you hoping to achieve?
“In this era of protectionism and skepticism about globalization, empirical facts like these are actually quite relevant.”
Hernandez: The short answer is yes. I hope that the research that we do is impactful. Let’s start with the policy implications. What we found — coupled with a lot of other research that is out there on IP laws — is that emerging countries on net are much better off with strong rather than weak IP rights.
Perhaps to a Western audience [from countries that already have strong IP rights] that sounds like an obvious statement, but there is a lot of debate in emerging economies on whether it is worth formalizing IP rights or not. And I think, again, we are one small piece of the puzzle that says that, yes, on net you are better off doing that.
Knowledge@Wharton: Are there some other practical implications of your research?
Hernandez: I would say two things. Let’s stay more on the policy side for the first one. With the caveat that our paper is addressing a narrow part of a bigger debate, I think it adds one fact in favor of policies that expose firms to global markets and global competition. In this era of protectionism and skepticism about globalization, empirical facts like these are actually quite relevant.
From the standpoint of firms and managers, our study gives them a reason to at least understand that these kinds of policies that expose them to globalization can be good in the long run, and that they don’t necessarily have to have zero sum benefits, that in fact it can make them more competitive. Now of course we need more research to get at that, but I think we start pointing in that direction.