Estimating IPRs

Numerous variables impact a country’s choice in IPRs. A country’s choice in IPRs may depend not only on their level of development (or per capita GDP), but also on their level of openness and institutional quality. Proxies for each of these factors are included as regressors in the IPR equation and will be discussed further in a moment. In addition, a country’s choice in IPRs may vary depending on their regional association. Latin American and the Caribbean, sub-Saharan Africa, and Eastern European Transitional Economies (including China and Vietnam) are the three regions with unique links that have already been discussed.21 Dummy variables for these regions are therefore included in the fully specified model. Finally, time fixed effects are also included so to capture variation in the IPR choice related to a certain year. To summarize, the full specification of the IPR equation is as follows:

IP Rit=β1log(yit) +β2[log(yit)]2+β3log(opennessit) (2.8) +β4log(institutional qualityit) +β5Latini+β6Africai+β7Transitionali+εit.

Openness

The impact of openness to trade on a country’s level of IPRs is ambiguous. It is possible that the more open a country is to trade, the stronger IPRs will be in order to entice high technology goods. On the other hand, greater openness may occur in hopes of imitating high technology goods, which would result in expectedly weak IPRs.

A country’s level of openness to trade depends on such things as tariffs, quotas, and exchange controls. However, it is difficult to measure openness in a way that is not endoge- nous with per capita GDP. The “Freedom to Trade Internationally” Index mitigates the possibility of endogeneity. “Freedom to Trade Internationally” is a subindex included in the 21_{China and Vietnam are included in regional classification for Transitional Economies as all these countries}

Fraser Institute’s Economic Freedom of the World Index (to be discussed in more detail in the below section on institutional quality). “Freedom to Trade Internationally” is estimated using equally weighted data on the following five areas: (1) taxes on international trade, (2) regulatory trade barriers such as non-tariff barriers, (3) the actual size of the trade sector compared to expected trade sector, (4) the difference between the official exchange rate and the black market rate, and (5) international capital market controls. Thus, this measure of openness captures many desirable aspects that are often difficult to quantify without using per capita GDP.

Institutional Quality

Institutional quality is a term used to describe a country’s ability to sustain sound economic practices given their economic and political environment. Institutional quality is sometimes approximated using a broad measure for economic freedom. This has been the case in past literature analyzing IPRs.

There are two widely used indices of economic freedom: (1) TheEconomic Freedom of the World Index created by the Fraser Institute, and (2) The Index of Economic Freedom

created by the Heritage Foundation and the Wall Street Journal. Chen and Puttitanun (2005) used the former in their previous research into the U-shape. The Economic Freedom of the World Index accounts for five different factors: (1) size of government as measured by expenditures, taxes, and enterprizes, (2) legal structure and security of property rights, (3) access to sound money, (4) freedom to trade internationally, and (5) regulation of credit, labor, and business.22 The index ranges from zero to ten, with ten embodying complete economic freedom. Beginning in 1995 a measure for intellectual property right protection was included in the calculations of group 2. Therefore, using the Economic Freedom of the World Index as a regressor in my estimation equation would be erroneous.

In addition to having a limited data range (with data available only beginning in 1996), the Heritage Foundation’s Index of Economic Freedom also perpetuates simultaneity with the IPR measure. The Index of Economic Freedom is comprised of ten freedoms: Busi-

ness, Trade, Fiscal, Freedom from Government, Monetary, Investment, Financial, Property Rights, Freedom from Corruption, and Labor Freedom. While the Heritage Foundation is not specific about what goes into their calculations for property rights, the sources they use to comprise data in this category are similar to those used in the Economic Freedom of the World Index. This fact is a red flag that using either of these two indices of eco- nomic freedom would bias my estimates. Using an index that, in part, measures a country’s IPRs to approximate that country’s IPRs violate the non-collinearity assumption among independent variables.

It is now apparent that, due to the breadth of categories included in economic freedom, such a measure will likely be correlated with a country’s choice of IPRs. As a consequence, it is better to narrow the focus of institutional quality from the wide-ranging concept of economic freedom to those components of institutional quality that directly impact IPRs. These include rule of law, physical property rights, and the existence of a sound business environment.

Rule of law and physical property rights will have a clear consequence on a country’s IPRs, but likely not the other way around. A country will only have incentive to implement IPRs if they know such laws will be adequately enforced and not overpowered by corruption. In addition, laws for physical property rights provide the precursor for laws for intellectual property rights. Thus stronger physical property rights suggest the onset of stronger IPRs. (Note, the direction of casualty is from physical property rights to IPRs.) Measures for rule of law and physical property rights can be calculated by removing the IPR measure from “legal structure and property rights” component of the Economic Freedom of the World

Index.

A sound business environment supports innovation and IPR related growth.23 _Without

sound business environment, firms’ ability to innovate, as well as the benefits from innova- tion, will be stunted. Component 5 of the Economic Freedom of the World Index, which measures the “regulation of credit, labor, and business” effectively captures the sound busi-

23

PCIPD recognizes the importance of a sound business environment and institutions in reaping potential benefits for strong IPRs in developing countries; PCIPD, page 4.

ness environment critical to institutional quality. Thus, the measure of institutional quality used in the empirical estimations of this paper combine rule of law, physical property rights, and business environment.