Gravity for cross-border licensing and the impact of deep trade agreements: Theory and evidence

Abstract

We examine whether deep regional trade agreements facilitate cross-border licensing. A micro-founded gravity equation for each supply mode is derived from a model in which heterogeneous firms choose to supply their goods to foreign markets through export, foreign direct investment or licensing. We present several comparative statics results regarding the effects of changes in the fixed costs of serving the destination country, the freeness of trade, and the strength of intellectual property rights protection on bilateral flows of licensing revenues. We then empirically test our theoretical predictions using data on the cross-border flows of royalties and licence fees for 49 countries in the period 1995–2012. In addition to variables that capture the impact of shallow and deep regional trade agreements, we construct dummy variables that represent subcategories of IP rights-related provisions. Consistent with our theoretical predictions, we find that improved access to the destination market through a deep regional trade agreement and stronger IP rights protection through a regional trade agreement with legally enforceable IP rights and technology-related provisions increase bilateral flows of licensing revenues. Among IP rights-related provisions, the accession to or ratification of existing international IP agreements and the protection of trademarks, patents, or industrial designs are important for facilitating cross-border licensing.