What Causes International Technology Transfer?

 

 

 

JEL Classification:  F20, O30

Keywords:   international technology transfer, comparative advantage, growth.

Technical Paper Submitted to

the Department of Economics, Oregon State University

Date: October 11.   1999

Abstract

In this paper, a simple model is developed to explain why international technology transfer is prevalent. Initially, two firms operate in separate countries and each has a monopoly in its home market. With the introduction of free trade between these two countries, the firms are assumed to compete in output simultaneously. Under this model, the firm that has an absolute advantage and a comparative disadvantage can benefit from transferring its technology to the foreign firm. This mechanism can help explain the productivity growth in opened Asian countries.

1. Introduction

The relation of economic growth and openness has been the major topic in international economics. The main concern is whether openness can give a positive effect on economic growth. This controversy continues today. Until recently theoretical models had been unable to link trade policy to faster equilibrium growth. (Edwards, 1998) These researchers do only empirical works. They use cross-section or panel data on growth rate. They make an indicator measuring openness. And they regress. If the result is positive, they say openness has a positive effect on growth rate. But these empirical works have no theoretical base. We have need to suggest any theory to support these empirical works.

On the other hand, IO theorists study firms' choices among foreign direct investment(FDI), licensing, joint venture, and export. IO theorists make explicit use of game theory to model international investment in an oligopolistic setting. Horstmann and Markusen (1987) model multinational firms' behavior. In their model, the key determinant is the relationship between plant scale economies (a force for geographic centralization) and multiplant economies plus transport costs (leading to multinationality). Their model predicts that multinational enterprise production arises when a firm-specific and transportation costs are large relative to plant scale economies. Smith (1987) focuses on how a foreign firm operating in a host market might choose to become a multinational rather than exporting its product. Smith considers tariff in addition to what Horstmann and Markusen (1987) consider. He thinks much of how firms' choice may be influenced by government policy, tariff. Motta (1992) analyze a game in which a foreign multinational chooses between direct investment in and exporting to the host country, while a domestically based potential entrant decides whether or not to enter the domestic market. By adding the possibility of domestic firm's entrance, contrary to Horstmann and Markusen (1987) and Smith (1987), no simple relationship emerges between the cost variables and the "direct investment versus export" choice.  The existence of a tariff may cause a shift away from foreign investment or else induce tariff-jumping investment. Ethier and Markusen (1996) assume the complete absence of protection for intellectual property in the host country and the early loss of the value of its knowledge as a result of producing abroad. When a firm chooses among costly exporting, licensing and making a subsidiary, this possibility of knowledge dissipation makes an important role.

We need a theory that says openness increases economic growth. International technology transfer is that a firm transfers its technology to a foreign country. If international technology transfer is inevitable in open international economy openness can increase economic growth and productivity. The worse technology is substituted by the better technology by international technology transfer. Naturally, the productivity improves.

But existing IO theories say when and how firms do international technology transfer. International technology transfer is only an alternative in existing IO theory.

I try to suggest a model in which international technology transfer is inevitable. If we can prove there is a situation under which international technology transfer is unavoidable in open international economy, we might give a theoretical base to the empirical researches that says openness and economic growth have a positive relation.

2. Model

I use partial equilibrium analysis. I assume through the paper that wage of labor, and exchange rate do not change. I analyze only two goods (x, y) among many goods. There are two countries, developed country A and developing country B. Developed country A has the more advanced technology(knowledge) in the production of both goods than developing country B. Labor has the same quality in both countries. It is assumed that the wage is higher in developed country A than in developing country B. There is neither entrant nor potential entrant to the markets of x and y. The firm which has absolute and comparative advantage in developed country A is assumed to produce only in developed country A. This means that state-of-the-art products are developed only in developed country. For example, high-tech products are mostly produced in US.

Demand of developed country A is larger than that of developing country B.

The production of x and y requires two inputs, knowledge and labor. Marginal cost of production is constant. Average cost is constant. There is only one firm which produces x in each country. There is only one firm which produces y in each country. So before trade the markets of x and y are monopoly.

Let's assume there are neither transportation costs nor tariffs.

[Specific Example]

Here I use a specific example for simplicity. The monetary unit of country A is $ and that of country B is ￦. The exchange rate is 1$=1.5￦

The inverse demands for x and y are p($)=60-q in country A and p($)=40-q in country B. The wage is $60 in country A and $40 in  country B.

Production functions and MC(marginal cost) are as follows. The difference of coefficients in production functions is caused by the level of knowledge.

the firm which produce x in country A(firm Ax):

 Q_x=6L,   MC=AC=10 ($)

the firm which produce x in country B(firm Bx):

 Q_x=1.5L,    MC=AC=40/1.5 ($)

the firm which produce y in country A(firm Ay):

 Q_y=20L,    MC=AC=3  ($)

the firm which produce y in country B(firm By):

 Q_y=15L,    MC=40/15 ($)

Country A has absolute advantage in both x and y. Firm Ax produce 6 unit of x from one unit of labor. Firm Bx produce only 1.5 unit of x from one unit of labor. Firm Ay produce 20 unit of y from one unit of labor. Firm By produce only 40/1.5 unit of y from one unit of labor.

Country A has comparative advantage in x industry. Firm Ax produce 6 unit of x from one unit of labor. Firm Ay produce 20 unit of y from one unit of labor. So country A's opportunity cost of producing x is 20/6 y. Firm Bx produce 1.5 unit of x from one unit of labor. Firm By produce only 15 unit of y from one unit of labor. So country B's opportunity cost of producing x is 15/1.5 y. 20/6 is less than 15/1.5. It means country A has comparative advantage in x industry. Country B has comparative advantage in y industry.

3. The Structure of Game in y Market

In this model only firm Ay has the incentive of producing abroad. The production cost is lower in B than in A. The quality of labor is equal. Knowledge can be moved easily to another country.

Firm Ax is assumed to produce only in country A. Firm Bx and firm By have no incentive of producing abroad since there are no transportation cost and no tariff. If the firms of country B produce in country A, then the cost of production increases since the wage is higher in A than B.

There are two players in this game, firm Ay and firm By. Firm Ay's strategies are export, FDI, and cooperation with firm By. Export means that firm Ay produces only in country A. FDI means that firm By makes a subsidiary in country B and the subsidiary supplies in country B. Cooperation means that firm Ay and By make a company and this company becomes a monopolist in county A and B. This new company produces in country B, with the knowledge of firm Ay and labor of country B. Cooperation can be fulfilled by licensing or joint venture.

Firm By's strategies are cooperation with firm Ay, and no cooperation.

Let's consider two dynamic games, the case of firm Ay's moving first and the case of firm By's moving first. It is assumed that when two firms do not cooperate market equilibrium is determined by Cournot competition.

Let's see the payoff of each strategy.

① There is no cooperation and firm Ay does export.

There are two suppliers, firm Ay and firm By, in each country. Firm Ay produces in country A and firm By produces in country B. Each firm exports to the other country. Each firm's profit is the sum of the profits from markets of country A and country B. Firm Ay's profit is 506.17 and firm By's profit is 527.14.

② There is no cooperation and firm Ay does FDI

There are two suppliers in each country. In country A, firm Ay and firm By supply. In country B, firm By and the subsidiary of firm Ay supply. Firm Ay does not export. Each firm's profit is the sum of the profits from markets of country A and country B. Firm Ay's profit including the profit of its subsidiary is 548.54 and firm By's profit is 506.17.

③ cooperation

There is only one supplier in goods y market. The profit of this monopolist is 1260. This profit is divided between firm Ay and firm By.

4. Subgame Perfect Equilibrium

① If Ay moves first, then Ay can enjoy 754 and By can enjoy 506.

If cooperation (licensing or joint-venture) between Ay and By fails, Ay chooses FDI. So Ay can enjoy up to 754 ( = 1260:joint profit - 506: By's profit when Ay chooses FDI)

② If By moves first, then Ay can enjoy 548 and By can enjoy 712.

If cooperation (licensing or joint-venture) between Ay and By fails, Ay chooses FDI. So By can enjoy up to 712 ( = 1260:joint profit - 548: Ay's profit when Ay chooses FDI)

5. conclusion

Ay and By want to cooperate by licensing or joint-venture regardless of the first mover. If the cooperation fails, then Ay's choice is foreign direct investment. In any case, country B's productivity grows by the advanced technology of firm Ay.

Most of the innovations take place in advanced countries. But the innovation is not balanced among industries. There are the sectors in which the innovation is trivial and the sectors in which the innovation is substantial. The former sectors lose comparative advantage to the firms of developing countries. If they move to developing countries they can minimize the profit loss. This mechanism helps the productivity growth of the opened developing countries.

In this term paper I used a numerical model for simplicity. It is not general. For general conclusion we should use more general functional form. And I used partial equilibrium analysis. If possible, the general equilibrium analysis will be desirable.

Comparative advantage is regarded as decisive only in trade until now. But it is very important in technology transfer too. This paper clarified that comparative advantage affects international technology transfer. Policy implication of this paper is that closed economy cannot enjoy productivity progress from international technology transfer.

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