Of market failure, IPR and competition

The key challenge before us today is the competitiveness of various sectors of the economy. The experience of last 60 years has shown that there are areas which were over regulated, like telecom, after being deregulated, have started to show signs of competitiveness.

Similarly, there are examples, which have proved that if there is no regulation, they can perform even better, e.g. the story of IT sector is a case in point.

The challenge before us is how to promote competitiveness at the firm level, which would create newer and better products, which will create newer and bigger markets. Generally, we have lower innovation capability due to poor business and governance conditions and low educational standards and mediocre infrastructure. These are mainly due to market failure in these areas.

In economic sectors like infrastructure and business, there is no justification for having controls for so many years, which bred inefficiencies into the system. This raises particular challenges for the diffusion of technologies and competitiveness. We need to quickly overcome this.

Basically, market failure occurs when markets do not bring about economic efficiency. Government intervention occurs when markets are not working optimally, i.e. there is a Pareto sub-optimal allocation of resources in a market/industry.

The main problem is the absence of clearly defined property rights in the market. When property rights are not clearly defined, market failure is likely because producers and consumers may not be held accountable.

Both, the Intellectual Property law and the competition policy are supposed to correct market failure in the pursuit of economic efficiency. However, tension between the objectives and instruments of the two systems occurs when the correction of one form of market failure creates another.

Some of the major concerns of competition policy in regard to IP rights relate to the market power that is given by granting of such rights, and the harmful effects that it may cause to consumers by allowing prices to be set higher than are needed to secure cost-effective production.

However, harm to competition should not be viewed from the mere existence of exclusive rights granted by IP law. In fact, the protection may encourage rivals to invest in developing alternatives or substitutes.

So, rather than undermining contestability, it may stimulate it and channel it in directions that can be socially beneficial. Take the case of 'copyright.' Though it gives a far weaker protection than other forms of intellectual property rights, notably patents, it does not preclude independent creation of functionally similar material. In the case of patent rights, however, where conditions of grant are much more stringent than copyright because threshold of originality is higher compared to copyright, protection might start a race to get the first patent which may lead to inefficient allocation of resources leading to market failure.

The inefficiency occurs because the private reward from accruing monopoly profits outweighs the social gain from accelerating the innovation process.

Many provisions of intellectual property law help address this issue. For example, disclosure norms in patent registration requires inventors to fully describe their invention, thereby, helping reduce the cost of subsequent innovators to build on the advances in technology already made.

Intellectual property laws must, therefore, involve some balancing between the incentives to invest in creative effort and the incentives for disseminating material that is the subject matter of intellectual property protection.

Balancing between providing incentives to invest in innovation on one hand and for efficient diffusion of innovation on the other is central to the interface between competition policy and intellectual property laws.

It is essential that the terms of this balance be clearly set out in the intellectual property laws themselves, so that rights owners and users can be certain about the scope and content of the grants being made. However, in real life situations, other policy instruments like competition policy come handy to deal with any imbalance between the two objectives.

In several countries, abuse of IPRs is covered under competition law to ensure the required balance. Drug industries are inducing competition concerns and are facing tough regulations and directions, particularly in US and Europe.

The Federal Trade Commission -- the US anti-trust regulator -- a few years back advised pharma firm GSK, the merged group, to divest one of their products because the merged group would have a dominant position in treatment for a disease. Consequently, Smithkline sold the product, meant to combat irritable bowel syndrome, to Alizyme, a biotechnology company.

Furthermore, the British and the American governments have opened a talk to combat drug barons to crack down on cartels. The arrangement could render British companies vulnerable to punitive damages of the type given against Microsoft recently

However, the British Competition Act forbids the disclosure of the commercially sensitive information without the consent of the company concerned.

On the other hand, the European pharmaceuticals industry is accusing European governments of stifling the sector's competitiveness by implementing shortsighted policies to control the prices of new medicines. They say that they are at a disadvantage to their US competitors.

European companies have, under the new competition rules, a lot more freedom to reach exclusive deals for the sale and distribution of products. The European Commission has removed the need for companies to notify and gain approval for so called vertical agreements between suppliers and distributors, franchisees and industrial partners as long as they fulfill certain criteria.

The new policy means that companies with a market share of less than 30% will be exempt from competition rules that prevent them making potentially anticompetitive deals over distribution.

However, companies involved in the distribution agreements will not be allowed to fix the price at which their products are resold, although they can set maximum and recommended prices. The commission also outlaws so-called non-competitive agreements, requiring the distributors to resell only the brands of one supplier for more than five years.

In India, creating and maintaining competitive markets, therefore, should be the first important objective of economic policy. Through its effect on innovation, the IP system could be a vital factor in shaping and supporting the competitive process.

The government's recent effort, through various IP legislations, to facilitate an environment where IP rights are clearly defined, makes firms accountable for disclosure of their innovation. It makes tech transfers and innovation promotion occur spontaneously, and in those cases where they do not occur spontaneously, how to develop obligations and incentives for tech suppliers and recipients to engage with one another -- be a change agent.

IP laws do put an obligation and incentive on firms to innovate continuously else they face the threat of entry by firms in the competitive markets that are emerging in several sectors of our economy, telecom and IT being the most important one, and pharma and biotech is fast moving in that direction.

This new era in India presents both challenges and opportunities. The new development process requires more knowledge and new entrepreneurial innovation-driven spirit to compete in an environment of intensified global competition.

The opportunities arise from the possibilities of modernization of traditional business practices offered by new technologies. The way  the industrial era in the west had replaced the agriculture era, the same way the traditional manufacturing activity has to give way to the new way of doing business.

Knowledge and other intangible factors will have to replace capital and labor accumulation as the source of economic growth, ushered in by the introduction of IP rights. This is expected to produce results via a larger contribution of the total factor productivity through vigorous interplay of market forces

To achieve 12% manufacturing growth is not difficult if we are able to introduce competition in high technology-intensive industries whose spillover effects will be potentially great for employment generation. It is an issue before us, which will partly determine the speed with which we shift from the technology absorption to the technology creation stage.

It would also determine the type of investment we need to make. The absorptive capacity of our economy would depend on the availability of a skilled labor force, with up-to-date skills and the flexibility to adapt to new technologies and new management styles, where firms reach a level of absorptive capacity that will allow them to attract  FDI because FDI can be a powerful source of technology transfer and trade expansion.

China illustrates the application of a number of policy principles outlined above. It built on strengths, first in attracting FDI for cheap mass production and then manufacturing to move up the value chain (Le Novo's tie up with IBM) to establish gradually an indigenous R&D capability, exploited change agents, such as local communities, top universities, high tech institutes, diasporas, launched pilot operations, e.g. technoparks along the coast.

The framework of IP legislations has laid the ground for innovation-driven manufacturing, and would thus prevent any potential market failure on account of unclear property rights in sectors like pharma, biotech, IT, agrochemicals.

All we need now is effective tools of competition policy based on sound principles of competition. Unfortunately, the enactment of the Competition Act 2002 due to legal challenge in the courts has made the Act operational only partially.

As a result, there is policy vacuum as far as competition policy for the country is concerned. This reflects the distrust of market forces. The Act is designed to regulate the operation and activities of combinations, a term, which contemplates acquisition, mergers, joint ventures, take-overs or amalgamations.

The Act mandates that no person or enterprise shall enter into a combination, which causes or is likely to cause an appreciable adverse effect on competition within India and such a combination shall be void. The Act has so far become operative only partly and the Competition Commission of India has not yet been constituted fully.

The actual impact of the Act will be known only after its substantive provisions viz. sections 3 to 6, come into force.

The government should 'ensure free and fair market process' and should 'facilitate easy movement of goods and services' by adopting rules and regulations so that trade and commerce within the country is free and unhindered. VAT is a big step forward towards a single market for the country.

Another issue is of separation of policy from regulation and operation like in electricity and telecom. In the case of IP policy for sectors like pharma, biotech, agro and food, separation of policy-making, regulation and operation functions becomes imperative to avoid conflict of interests. In the absence of it, IPR laws would give rise to situations of market failure.

However, the delicate balancing of interests of rights holders and the public interests should not be thwarted by government actions. The Telecom Regulatory Authority of India has failed to ensure interconnection among service providers due to an ambiguity in the law. Consequently, growth in telecom services has been accompanied with an increase in inter-network congestion and poor quality of service.

In the case of copyright, the balancing reflects an effort to see that the economic rights of authors or creators do not interfere with the public's need for access to information.

This balancing inevitably involves imposing restrictions on competition. Some of these restrictions arise from the very rights conferred.

For example, restrictions on adaptations of existing works may impede the free flow of ideas. Restrictions on adaptations of artistic works may impede artistic ideas. In addition, and perhaps uniquely in respect of copyright, the exclusive rights granted are often tempered or qualified by a number of exceptions.

These include compulsory licensing schemes, which effectively prohibit refusal of supply, but instead, compensate the rights holder with equitable remuneration and also include defenses to infringement on public policy grounds (e.g. fair use of a reasonable portion of material for study or news reporting where use is not subject to any remuneration to the rights holder).

As a result, the Copyright Act, in its provisions, already takes account of the community's interest in competitive markets. But there are concerns about restrictions relating to market segmentation.

The restrictions on parallel importation can give copyright owners power to control distribution channels. In short, one can identify several areas, which may put restriction on competition, e.g. parallel importing, copyright in packaging and labeling, statutory licenses, collecting societies.

These issues could best be left for competition policy to address. By setting out a clear framework of property rights in the competition policy, government will increase the ease with which intellectual property can be traded, most visibly through assignments and licenses.

This, in turn, would increase the likelihood that technology will gravitate towards those best placed to use it which would create a means for those who are best placed to advance technology, to have access to the existing base of proprietary knowledge by means of contract.

A well-functioning system of intellectual property rights, therefore, encourages efficiency both in the production and in the allocation of knowledge and resources. Restrictions on the ability of rights owners to enter into such arrangements could prevent the deployment of efficient means of working, and reduce both the return to innovators and the incentive value of the IP system.

Competition policy would allow such efficiency-enhancing arrangements to proceed, while deterring those that do not serve a useful social purpose.

The relationship between the objectives of the intellectual property laws on one hand and competition policy on the other is, therefore, complex and multifaceted. There are many complementary elements: the intellectual property system promotes innovation, which is a key form of competition; and competition policy, by keeping markets open and effective, preserves the primary source of pressure to innovate and diffuse innovations.

To sum up, we need to identify areas and enterprises that are our strengths. For example, in biotech, pharma, IT and automotive components manufacturing we need to design and develop realistic policies, which promote innovation at the firm level deriving the benefits of the spillover-effect of global R&D that has started in India in the last 5 years.

With a reasonable local innovative basis, spillover effect may provide long-term benefits to our manufacturing competitiveness. Pharma and biotech sector and IT and automotive components are a good example of innovative policy support from the government in recent years. Our large scientific pool developed in the last 60 years is proving to be useful in supporting the local innovative basis.

This could form the basis for robust manufacturing in the next decade. The framework of legislations, which existed so far, has laid solid foundations of industrial economy. To go to the next level, the government has put in place new  framework of legislations, patent legislation being the most recent one, to suit the requirements of the knowledge economy.

These are expected to promote most needed innovations in each sector.

It would be of crucial importance to see how government is able to achieve separation of policy making from regulation and service providing in the field of IP. This would require providing autonomy to IP offices as service provider like in other countries and vesting regulatory function in respect of price fixing and regulation of market power with an independent regulator to let the firms in key sectors like pharma and biotech benefit from these legislations.

We need to understand whether the strategies followed by government with regard to country's transition to knowledge millennium is bearing fruit and how corporates integrate IP policies in their overall profitability and balance sheets.

This will be useful for a better understanding of the political economy of change and improved government action.

Dr Aditya Trivedi is Director, Abu-Ghazaleh Intellectual Property, India. He looks after the public affairs and, market development issues in IP practice. Prior to this, he was with the FICCI handling intellectual property policy issues and public outreach programmes. The views expressed are personal and do not reflect the opinion of the organisation.