Interaction of the TRIPS PLUS ULTRA PROPOSAL with Price Discrimination
Note: For a preliminary explanation and background to the issue of price discrimination, click HERE. In this post the exhaustion doctrine is explained, and how, by applying it freely as allowed for by the TRIPS Agreement (thus, one of the exceptions to the universal core of patents -in particular a limit to the right conferred by the patent), countries could choose national or international exhaustion of rights (national exhaustion of rights, if set as the global standard, would permit price discrimination, as commented below; international exhaustion of rights, on the other hand, allows for the possibility of parallel imports).
This post is an economic explanation of how the exhaustion of rights regime interacts with the TRIPS PLUS ULTRA proposal’s economic model. The system would work better, if the TRIPS PLUS ULTRA were implemented, and if the standard were national exhaustion of rights, which is typically tied with the developed countries’ view of intellectual property. In fact, it would be very convenient for the developing world to ban parallel imports because if not the patent holder is unable to price discriminate and set a lower price for its products in countries with lower income per capita.
Taken from Application of a Mechanism of Proportional Rewards Towards Global Innovation. Internal citations omitted:
“Price discrimination consists simply in charging a different price for the same product to different consumers. This can be done in a local/national market, as well as in the international market. Its application in the local market is very complicated due to arbitrage practices (purchasing and selling the same good to take advantage of a price difference), but it certainly can be implemented for some products. This practice in the local/national markets, when applicable (which will depend on the nature of the product), contributes to increase the efficiency of the system by reducing deadweight loss (at the same time it reduces consumer surplus).[43]”
“A different solution offered to the deadweight loss problem [different than this one] is price discrimination. For the system to be overall efficient price discrimination should globally work together with proportionality as it is commented in the next paragraphs. “The deadweight loss imposed by a monopolist can be mitigated, and possible eliminated, if monopolist can discriminate prices. […] Price discrimination can go a long distance toward redressing the inefficiency of deadweight loss, but is hard to implement.”[41] If rules to enhance international price discrimination are adopted, the tendency of more deadweight loss in poorer countries in comparison with richer countries commented in previous paragraphs will be diluted. Proportionality will still be needed, though, not to correct this focus of inefficiency, but to make the system more just (an objective on its own, which could per se lead to all the positive things that are mentioned in this paper, as enabling agreements on better enforcement, opening more room for further harmonization, etc.).[42] If such a change is not possible and international price discrimination continues to be limited, proportionality is even more necessary for the overall efficiency of the system.”
“Moreover, if price discrimination could be done in the international markets, deadweight loss could be reduced enormously.[44] Taking on account the model presented a few paragraphs back [HERE], if the patent holder choose to apply price discrimination among different countries taking on account their different purchasing power (charging more in one country than in another), there would not be a difference in price relative to income between the two countries. If international arbitrage is prohibited (the exhaustion regime will determine this), the patent holder could take into account the reality of each country, and set a price that is nominally different but the same in consideration to the purchasing power of each country. Because [in the economic model presented HERE] the “y” axis indicates the average prices paid for technology relative to income (i.e., relative to each country’s average purchasing power), if the patent holder chooses to set prices in relation to the economic capacity of each country, the deadweight loss will be the same for both countries. The tendency of more deadweight loss (and restricted access to innovation) that I argue exist in developing countries in relationship to developed countries will cease to hold water.”
“There are three aspects that must be taken on account in order to properly assess price discrimination in international trade. The first one comes from the essence of intellectual property rights. It is the right of the patent holder to set prices as she wishes with out facing competition (constrained only by market forces, for example, the appearance of a close substitute in the market). The other two are exogenous factors that must be taken on account by the patent holder to make its free decision: smuggling, and the scheme of exhaustion of intellectual property rights chosen by each country. The former is an issue of enforcement. The latter is the regulation choice that each country has to make.[45]”
“The freedom that the patent holder has to set prices means that price differentiation is a possibility, but not necessarily the unequivocal practice. Patents confer its owner exclusivity in the market. In that sense the holder could set whatever price she likes without taking on account competition. If acting rationally, she will set the price that will yield the higher profit. A higher price not necessarily results in profit maximization, if by it the patent holder excludes too many consumers. Conversely, more sales due to low prices not necessarily result in profit maximization either, if the price is to low. The optimal price, with profit maximization in mind, will depend on each product and each market. A patent holder will settle with a combination of price and quantity which yields the bigger profit, taking on account its distribution capacity, the type of consumer (e.g. a firm could have a commercial strategy that comprises establishing a “high end” status for its products), the elasticity of the demand for that product, among many other factors.”
“Moreover the patent holder faces his own product’s competition in a given market, sort to speak, if parallel imports are permitted in that country (if the country has established a international exhaustion of rights regime, as permitted by the TRIPS Agreement).[46] In this case, the application of price discrimination by the patent holder is limited.[47] Lets assume, as economist tent to do to allow analysis, that there is proper customs enforcement, no tariffs, zero transportation cost, no transactional costs, and that the patent holder decided to set an international price discrimination strategy that takes on account countries’ purchasing power. The market of the richest country among those that have chosen international exhaustion (country x) will set the price for patented products for all countries that are poorer that this one (countries y, z), regardless if they chose international exhaustion or not. Since anyone could purchase the product anywhere in the world and legitimately introduce it to that market of country x, if the price is lower in countries y or z many could take advantage of importing the good into country x. With profit maximization in mind, the patent holder would not set different prices. She would have to set an international strategy that, as a tendency, will generate more deadweight loss and less access to the products in poorer countries.”
“The obvious solution is to set national exhaustion or regional exhaustion (like the European market) as the international global standard.[48] This has been suggested in many occasions, but such an agreement has not been possible, because negotiations are currently blocked.[49] Developing countries, which could benefit from such a change, are probably suspicious of the system. In one hand they worry that if they set national exhaustion, their markets will be undersupplied, which could be address with proper regulation. In the other hand, they repudiate the idea (almost as a dogmatic believe) of any more power advantages for the patent holder (poor countries are reluctant to trust in the market and it effect on individual decisions; that the patent holder could practice price discrimination under national or regional exhaustion does not necessarily means she will do it). Price discrimination could certainly be an advantage for the patent holder (more sales could occur and, if well applied, it could lead to profit maximization, that will entail more incentive for innovation), but also and more importantly the overall system will be more efficient. Less deadweight loss and more access could be secured for populations in developing countries. Maybe the only way to change the attitude of the developing world towards patent protection is to renew the justice of the global scheme. Proportionality could lead the way.“
“Lastly, currently patent holders face competition of counterfeited products. If someone infringing the patent produces in a given market a product protected by a patent, there is an unlawful dilution of the monopolistic power. It will also be unlawful if the product is smuggled into the market, even though the product could be legitimately produced elsewhere (where the product is not patented or the patent has expired). Parallel imports generate competition for the patent holder with the patent holder’s own product, thus eliminating the possibility of price discrimination. Smuggling and counterfeiting is a problem of a different nature. It is an enforcement problem, and not a regulatory problem. In strict sense, this problem is not going to be worsened or alleviated by the proportionality proposal.[52] Both a counterfeited and a smuggled product (even though produced legitimately elsewhere) will be unlawful in the jurisdiction where the patent is still enforceable. The solution in both cases is to have better custom control.“