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No. 4: Foreign Direct Investment and Market Framework Policies: Reducing Frictions in APEC Policies on Competition and Intellectual Property

by Ronald Hirshhorn, October 1996


Summary

The rapid expansion of foreign direct investment (FDI) and the growing role of global corporations are creating new challenges for the design of market framework policies. Between 1988 and 1993, the worldwide stock of FDI almost doubled. Multinational enterprises (MNEs), which have been the agents for this investment growth, are distributing their activities globally to fully exploit available production and organizational economies.

It has long been recognized that policies aimed at achieving national goals may conflict with the requirements for growth and welfare maximization in an interdependent world. Framework policies can distort the allocation of FDI and reduce the extent to which countries benefit individually and collectively from the activities of MNEs. Co-operative arrangements can help prevent policy conflicts, reduce resource misallocation and create an international environment that is more favorable to long-term business planning.

These issues deserve attention by APEC because FDI has been an important integrating force in the region and an important vehicle for promoting growth and spreading industrialization. Intraregional flows of FDI have brought host economies capital, along with much needed technology and management skills, while allowing home economies to share in the benefits from MNEs' access to lower cost labour and material inputs. The significant liberalization of foreign investment policies that has occurred in recent years (and that, among other things, has resulted in the emergence of China as an important host economy) suggests that policymakers have come to appreciate the general nature of these benefits. But, while some of the most direct and significant obstacles to the growth of MNEs have been eliminated, the process of reforming market framework policies has only begun. APEC policy-makers must now turn their attention to other potentially important sources of system friction, which include (but are not restricted to) competition and intellectual property (IP) policies.

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Competition Policy

Competition policy comprises the body of laws and regulations through which countries protect and preserve the role of open and competitive markets as a primary means for allocating economic resources. Effective competition policy promotes increased efficiency, which should be reflected in greater consumer choice, lower prices and improved product quality. The goal of open and competitive markets is served by liberalized policies that encourage international trade and investment. But while competition policy and FDI are complementary in principle, they may collide in practice.

There are a number of concerns relating to the potential impact of the competition policies of APEC economies on FDI and the gains from economic integration. First, a number of economies – Hong Kong, Indonesia, Malaysia, the Philippines, Singapore and Thailand – do not have competition legislation. Foreign trade and investment have limited the potential for anticompetitive practices in Hong Kong and Singapore, and to a lesser extent, other economies. In a number of these APEC economies, however, there is reason to question whether the benefits of FDI are being adequately realized. This question has become more important as sectors have been deregulated and privatized, and FDI has spread into service sector activities. Some ASEAN economies have recognized these concerns and are now preparing to enact competition laws.

Second, divergences in competition policy have, on occasion, been a source of friction between economies, and of higher costs for firms doing international business. There are some broad similarities in the policies of those APEC economies with competition laws. These include: the use of independent administrative and enforcement agencies; the classification of some offences as criminal and some, civil; and the distinction, in all countries, between clearly anticompetitive practices that are prohibited outright, and restrictive agreements that may have some offsetting economic benefits and require examination on a case-by-case basis. But, at the same time, there are some significant differences in approach within APEC. The strong attachment of the United States to open competitive markets contrasts with the recent, very tentative movement towards competitive markets by the People's Republic of China. Chinese Taipei and Mexico have also only recently enacted competition laws. While certain anticompetitive practices (naked price-fixing, bid-rigging and related agreements to restrict competition) are prohibited outright in the United States, they are prohibited elsewhere only if they lessen competition "unduly" (Canada) or "substantially" (Australia). Traditionally, there has been a wide difference in the approach of the United States and Japan towards various potentially restrictive agreements. Differences remain, although the gap has narrowed as a result of both changes in attitude towards competition in Japan and a greater appreciation in the United States of the potential efficiency gains from certain horizontal arrangements ( i.e., joint ventures) and non-price vertical restraints (i.e., exclusive dealing agreements).

The competition laws of APEC economies give recognition to the importance of encouraging innovation, but in some member economies there is a greater sensitivity to abusive activities by those holding intellectual property rights. In most economies, technology licensing agreements may be permitted subject to the results of a case-by-case review. Licensing restrictions are assessed according to detailed guidelines in Japan, and according to the provisions of the Monopoly Regulation and Fair Trade Act in Korea.

Differences in the nature and stringency of enforcement have added to the potential for conflict. The enforcement of U.S. law is relatively vigorous by comparison to most countries. This is partly because treble damage awards allowed under U.S. law have encouraged private enforcement actions. The most serious differences over the implementation of competition policy have been between the United States and Japan. The United States has focused particularly on the application of Japan's competition policy to linked groups of Japanese companies known as keiretsu, which are seen to impede U.S. export sales in Japan. The Japanese Fair Trade Commission has strengthened enforcement and increased penalties in recent years, but the United States and Japan are still involved in discussions aimed at resolving differences over the application of competition law.

Third, although export agreements and other anticompetitive practices may impact heavily on other economies, they tend to be assessed almost entirely in terms of their impact on domestic residents. This problem could exist even if economies had identical competition laws. Moreover, the resulting potential for conflict increases as economic interdependence increases. The United States has reacted to the extrajurisdictional impact of restrictive practices by applying its competition policies extraterritorially. Economies have also tried to resolve interjurisdictional issues through agreements, such as the Competition Policy Agreement signed by Canada and the U.S. in August 1995, which sets out a procedure for notification and consultation where one party's enforcement affects the other party's interests.

Fourth, the implementation of competition policy suffers from the absence of arrangements whereby economies can coordinate their response to issues with broad international implications. This increases the potential for conflicts to arise and important issues to remain unaddressed.

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Intellectual Property

Intellectual property rights in the form of trademarks, copyrights, patents, and industrial design rights, are the means by which governments protect brands, literary and artistic works, and new products and processes. Intellectual property laws that deal with industrial property (mainly patents) have the same broad objective as competition policy, namely to improve economic efficiency. But whereas competition policy addresses various possible sources of increased efficiency, IP policies are aimed mainly at achieving the dynamic efficiency gains that are the result of higher rates of innovation and technological change.

While considerable progress has been made in resolving disagreements in recent years, IP has been the source of considerable friction among APEC economies over most of the past decade. These tensions partly reflect differences in perspective between net exporters and net importers of goods that embody IPRs (IPRs). Through pressure backed by the application of its trade laws (especially the "Special 301" provisions contained in the Omnibus Trade and Competitiveness Act of 1988), the United States succeeded in increasing IP protection for U.S. firms in most developing and newly industrialized APEC economies over the latter half of the 1980s. These initiatives, however, did not create the level playing field in IP policy that is conducive to efficient international commerce. Considerable progress on the latter has now been achieved through the inclusion of an agreement on IP in GATT, now the World Trade Organization (WTO). The Uruguay Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) signed in 1994, attempts to establish minimum international standards of IP protection and to provide effective support for these standards through the application of GATT-style enforcement procedures and dispute resolution mechanisms.

While APEC members have implemented some important IP changes in recent years, a number of economies still have some distance to go to meet international requirements. Some differences in the interpretation of the TRIPs provisions have also emerged. As well, there are some potentially contentious issues that were not addressed by the agreement, such as the question of IP owners' rights to control parallel imports of products embodying their IPR. While considerable progress has been achieved in reducing infringement, there are still gaps in some areas of IP enforcement within APEC.

Evidence suggests MNEs are less likely to transfer or license advanced technology to firms in economies with less effective IP protection. Firms are more likely to transfer older technology to economies with weaker IP policies.

IP policies are not the only, nor necessarily the most important, government policy affecting innovation. The ratio of patents to real research and development expenditures in the United States and elsewhere has been declining. Meanwhile, other policies designed to promote innovation have become important sources of policy friction. One example is government policies on procurement of technologically advanced products. Another example is government policies towards foreign participation in government-subsidized research consortia. In both areas, conflicts have arisen because of the perception that governments have tilted their programs to foster the growth of indigenous firms. With the pressure on countries to foster the development of internationally competitive enterprises, innovation policies in general have become a significant source of international friction.

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Implications

APEC economies have a common interest in reducing frictions and creating an environment that is conducive to the efficient movement of capital and technology. To harness this common interest, there is a need, first, to gain agreement on some reasonable objectives. Policy harmonization would be an unrealistic objective, given the substantial economic, social and cultural differences among APEC economies. Harmonization around specific rules could also give rise to a rigid system that is difficult to change in response to new research findings on policy impacts. A more reasonable objective would be an agreement on certain standards or benchmarks. These could pertain to: minimum baseline standards, in terms of the scope and coverage of competition and IP laws; the need for, and elements of, a system of effective enforcement; the basic principles that must be respected in the design and enforcement of competition and IP policies; and the process for addressing disputes among APEC members.

In IP, there has been considerable progress towards meeting these objectives. Although there are still some potentially troublesome issues to be addressed, APEC economies have significantly strengthened their IP policies in recent years. With the exception of Chinese Taipei, the People's Republic of China, and Papua New Guinea, all APEC economies have signed on to the principles worked out in the TRIPs agreement. There remains scope, however, for consultation and cooperation in implementing TRIPs, resolving issues that were not addressed by the agreement, and developing more effective enforcement practices.

In competition policy, efforts to work out principles of convergence at the international level are only beginning. APEC members can benefit, however, from the groundwork being undertaken at the OECD. This indicates that some common principles tend to guide the implementation of competition policy in OECD-member economies, and that there is considerable agreement among economies with respect to analytical tools, enforcement practices, as well as some aspects of legislation. APEC can also learn from, and build upon, the programs of technical assistance implemented at the international level, most notably by UNCTAD.

In terms of institutional arrangements, existing agreements illustrate a variety of options. Some agreements, such as the Treaty of Rome with its establishment of a supranational competition authority and the Australia–New Zealand Closer Economic Relations Trade Agreement with its harmonization provisions, are not immediately and directly relevant to APEC. Over time, as APEC evolves, these options may merit closer examination. For now, the experience of those countries that have signed agreements or memoranda of understanding to abide by a set of principles and cooperative procedures in applying competition policy is more instructive. Such agreements can contribute to reducing conflicts. It is worth exploring whether there is sufficient support within APEC to begin laying out a strategy that would ultimately lead towards some degree of policy convergence.

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