Patent protection in India: Impact on innovation, pricing and competition

When stronger patent laws were introduced in India, there were fears that it would lead to higher prices without substantial gains in innovation. This article provides evidence that stronger patent protection increased the number and quality of patents, and R&D spending among manufacturing firms. While process innovations and output growth led to lower production costs, these cost savings translated into higher price-cost margins rather than lower consumer prices.

There has been a long-standing interest in the effects of patent protection on firms and consumers (Boldrin and Levine 2013). On the one hand, the prospect of exclusive rights through stronger patents would encourage firms to invest in research and development (R&D) (Arrow 1962). On the other hand, strong patents can lead to greater market power (Bloom et al. 2019). The net gain from stronger patent protection is theoretically ambiguous. Existing evidence on the effects of patent protection on R&D investment is rather inconclusive and often limited to very specific markets (Bryan and Williams 2021). Further, we know relatively little about the impact of patent protection on market power and the underlying mechanisms.

In recent research (Gupta and Stiebale 2024), we rely on cross-industry differences in the use of patents to study the effect of stronger patent protection on both innovation activities and market power of domestic firms across all manufacturing industries in India.

India’s patent policy reform

In the wake of a balance of payment crisis in 1991, India found itself obliged to become a member state of the World Trade Organization (WTO), and consequently moved towards a stronger patent regime in compliance with the Trade Related Intellectual Property Rights (TRIPS) agreement.

The adoption of the reform was met with staunch opposition in the Indian Parliament and created prolonged uncertainty about the timing and nature of the policy change (Reddy and Chandrashekaran 2017). The eventual adoption of reforms for pharmaceuticals and chemical industries in FY1999-00, and all other industries in FY2002-03, occurred unexpectedly, and can be regarded as a natural experiment. The reform relaxed several restrictions on product and process patents in the pharmaceutical and chemical industries. It also extended the duration of exclusive rights for patent-holders from 14 to 20 years for all industries and, among other things, allowed for methods and processes of manufacturing to be patented.

Data and empirical strategy

To study the effects of the patent reform, we source data on Indian manufacturing firms from the CMIE (Centre for Monitoring Indian Economy) Prowess database, which provides the registered name of the firm, accounting information and the price and quantities of products produced by it annually. Using firm names, we identify the patent applications filed by Indian firms at the Indian Patent Office, and thus obtain a measure that allows us to check if the reform had its intended effect. To study the effect on market power, defined as the ability of firms to set prices above marginal costs, we follow De Loecker et al. (2016). We obtain estimates for markups, defined as the wedge between prices and marginal costs, for each product produced by a firm annually.

To empirically study the effect of the patent reform on innovation and market power, we use a difference-in-differences design¹. We rely on the insight that there is large variation in the extent to which industries rely on patents to protect their inventions, even within broad sectors (European Patent Office, 2013). By looking at the mix of products a firm produced before the reform, we calculate how much each firm was exposed to the patent reform. In other words, firms producing products heavily reliant on patents were more exposed to the reform than those producing less patent-intensive products. Our empirical design thus tests whether firms and industries with high patent intensity were more affected by the reform compared to those with lower patent intensity We find that our measure of exposure to the patent reform shows little correlation with pre-reform firm growth and other reforms, such as India’s trade liberalisation.

Effect on patenting and R&D

We find that stronger patent protection was associated with an increase in the number of patents filed by a firm, the number of firms that patent, and also their R&D expenses – suggesting that the reform increased the private returns from investing in innovation. Figure 1 shows the effect of the reform up to five years before and eight years after the reform. The results indicate that firms did not anticipate the reform, and that post-reform, the growth of patenting and R&D investment gradually increased and persisted for several years. Moreover, three indicators of patent quality – the number of patents renewed by a firm, the number of inventors per patent, and the number of patents filed internationally – show that the surge in number of patents was accompanied by an increase in high-quality patents.

Figure 1. Patents and R&D: Dynamic effect

Notes: (i) The outcome variables ‘Patent applications’ and ‘R&D expenditure’ measure relative differences in the number of patent applications and R&D expenditure of a firm in a given year, relative to event time -1, respectively. (ii) ‘Patent Intensity’ is the firm-level exposure to the reform defined using the pre-reform product mix of firms. (iii) The horizontal axis shows time relative to the year of the reform (indicated by the dashed line). (iv) The points show coefficient estimates for the relative difference in the outcome variable for firms in industries with patent intensity one relative to firms in industries with patent intensity zero. The bars around the coefficient indicate the 95% confidence interval. A 95% confidence interval means that if you were to repeat the experiment over and over with new samples, 95% of the time the calculated confidence interval would contain the true effect.

Effect on markups, prices, and marginal costs

A major concern of stronger patent protection is that it allows inventors to charge a higher markup or exert higher market power. We find that the average markups increased within firm-products that were more exposed to the reform. The increase, however, was mainly driven by a decline in marginal costs, while average prices did not change significantly in any period after the reform. Figure 2 shows a gradual and persistent increase in markups a few years after the initiation of the reform.

Figure 2. Dynamic effects on markups, prices and marginal costs

Notes: (i) The outcome variable ‘Markups’ is the log of firm-product markups, ‘Prices’ is the unit price reported in CMIE Prowess for each product sold by a firm, and ‘Marginal costs’ is the difference of log of prices and log of markups. (ii) ‘Patent intensity’ is the number of patents filed per 1,000 employees for each four-digit National Industrial Classification code as reported by EPO (2013).

Mechanisms behind declining marginal costs and rising markups

We present evidence for two possible explanations for the drop in marginal costs. First, disaggregating patents into process and product patents, we estimate a disproportionate increase in process patents after the reform. Given that process patents are often geared towards developing cost-saving processes, a surge in such patents explains why marginal costs would decline after the reform. Second, we find that, in industries with scale economies, exposure to stronger patent protection was associated with an increase in output and relatively large cost reductions. Our results indicate that incomplete pass-through of cost savings accounts for a substantial part of rising markups.

Conclusion

With India spending much less on R&D compared to many emerging economies, it is important to understand how policy can promote investment in innovation without adversely affecting markets. Our research focuses on the impact of stronger patent protection as one such policy tool and provides strong evidence that the patent reform fostered innovation with limited price effects for the average industry in India.

However, due to increasing markups, the gains from patent protection have predominantly accrued to producers rather than consumers. Our findings highlight that cost-saving innovations play a key role in the technology-driven rise in markups, thereby presenting important implications for policymakers that aim to redistribute gains from technological growth.

Notes:

1. Difference-in-differences is a technique used to compare the changes in outcomes over time between a group that is affected by an intervention and a group that is not.