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Privatization in the presence of patent licensing

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Abstract

This paper analyzes the licensing policy for a cost-reduction technology of a foreign R&D institution when it is faced with a domestic monopoly manufacturer. It is found that, due to objective differences, a public domestic manufacturer will be charged higher than a private domestic manufacturer for a certain licensed technology. Accordingly, to save on the licensing payment made to the foreign R&D institution, the domestic government is recommended to (partly) privatize the public manufacturer.

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Notes

  1. According to China’s report of the work of the government (2010), the government encourages enterprises to accelerate technological upgrading and will provide 20 billion yuan to support 4,441 technological upgrading projects. The government’s financial assistance for technological upgrading is also evidenced in Malaysia (see Habaradas 2008).

  2. With Assumption 1 and 2, it can be easily shown that \(q^*\) is positive and finitely valued. Given Assumption 2 and 3, it can be proved that the second-order condition is satisfied.

  3. There is no need to prove that the manufacturer’s equilibrium output under licensing must be positive, i.e., \(q^{**}>0\). Again, the second-order condition of this optimization problem is satisfied given Assumption 2 and 3.

  4. The proof of this result is included in the proof of Lemma 2.

  5. More generally, the marginal social benefit of a new technology is higher than the marginal private benefit.

  6. From 6, Lemma 1, and the fact \(r=0\), it is known that \([p(q)-(c-x)] ( \partial q / \partial \theta )=-\theta p^{\prime }(q)q ( \partial q / \partial \theta )\), which is negative as long as \(\theta >0\). In a market with a public manufacturer, to maximize welfare, the output will be selected such that the marginal production cost equals the benefit of the “last” consumer, i.e., \(c-x=p(q)\). In a market with a private manufacturer, however, the output will be selected such that the marginal production cost equals marginal revenue, i.e., \(c-x=p(q)+p^{\prime }(q)q\). When the inverse demand function is downward-sloping, the marginal revenue lies below the benefit of the “last” consumer. As a result, the output of a private monopoly manufacturer will be lower than that of a public monopoly manufacturer. In the literature, this phenomenon is usually referred to as the deadweight loss. In the context of partial privatization, the deadweight loss will increase when \(\theta \) increases.

  7. That means that, if there is no licensing, it would be optimal for the domestic government to maintain a fully public manufacturer, i.e., \(\theta ^*=0\) when \(x=0\).

  8. Appropriate constrains on the size of parameters are needed to ensure that \(\theta ^* \in [0,1]\). The derivation of \(\theta ^*\) is straightforward and omitted here.

  9. It should be pointed out that both effects are positive does not mean that full privatization is the best choice for the domestic government. The reason is as follows. The analysis in Sect. 4 is conducted under the premise that the break-even constraint is binding. It can be shown that this premise is reasonable only if the level of privatization is not too high. As a counter-example, suppose that the manufacturer is a fully private firm; then, its equilibrium payoff without licensing should be positive. If the break-even constraint is binding, its equilibrium payoff under licensing, however, would be zero. Hence, the manufacturer’s participation constraint can never be satisfied if the break-even constraint is assumed to be binding.

  10. As mentioned in the introduction section, this question is already discussed by Lu et al. (2009), Ye (2012), Mukherjee and Sinha (2014), and Chen et al. (2014), but either under a very specific setting or in a different context. Since this question is not the focus of this paper, its discussion is not explicitly stated in the text. Some readers, however, may be interested in this issue.

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Acknowledgments

I would like to thank the editor Prof. Giacomo Corneo and the two anonymous referees for helpful and insightful comments, which I believe have helped me substantially improve the paper. I am grateful also to the financial support from The Fundamental Research Funds of Shandong University, The Project-sponsored by SRF for ROCS, SEM, and The Fund 14AJL008. I am responsible for all the remaining errors.

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  1. School of Economics, Shandong University, Jinan, 250100, Shandong Province, People’s Republic of China

    Shuai Niu

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Niu, S. Privatization in the presence of patent licensing. J Econ 116, 151–163 (2015). https://doi.org/10.1007/s00712-015-0435-7

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