International know-how trade and foreign direct investment

The improved international tradability of services and the better protection of intellectual property rights - both of which have been results of the Uruguay Round - increase the international tradability of know-how This paper investigates the economic impact of this. It is shown that know-how may be under-traded or over-traded. In the first case know-how is not traded although it would be welfare improving, in the second case know-how trade takes place but welfare is reduced. The results depend on the distinction of a productivity effect and a market power effect of international know-how trade. The welfare-increasing productivity effect arises because trade in know-how raises the buyer's productivity without lowering the seller's. The market pou er effect arises because trade in know-how redistributes market power between the buyer and the seller and eliminates the seller's competitive edge. Although a more balanced distribution of market power is positive for welfare, there may be situations where an incumbent acquires foreign know-how mainly in order to keep a potential entrant out of its domestic market. These are situations where know-how is over-traded from the point of view of domestic welfare.