Tecbnofogy in So&y. Vol. 11. pp. 141-160 (1989) Printed in the USA. All tights mctvcd.

0160-791X/89 $3.00 + .OO Copyright @ 1989 Petgamon Press pk

International Perspectives on Technology and Free Trade

John BeZZ and G. Vichery

ABSTRACT. This paper reviews the importance of trade to economic growth, and outlines trends since World War II, including moves towards@ee trade. This leads to a considera- tion of relations between technology and trade. After reviewing techno/ogy flows and technology-intensive trade, non-tan;ffbar&rs to trade in technology-basedgoods and ser- vices are discussed. Final/y, some conclusions are presented on technology andjkee trade.

Introduction

The commitment of the Organisation for Economic Cooperation and Development (OECD) to lowering barriers to trade and moving towards free trade are well known. From its very beginning, the OECD has been committed to promoting “the expan- sion of world trade on a multilateral non-discriminatory basis in accordance with international obligations. ” Alongside this objective, OECD member countries aim to achieve the highest sustainable economic growth. In the field of science and tech- nology, member countries are committed to promoting development of their resources, encouraging research and promoting vocational training.’ It is against this background that this paper offers some international perspectives on technol- ogy and free trade.

The importance of trade to economic growth is well known. International trade provides opportunities to acquire goods more cheaply through exchange than is pos- sible through domestic production. In the past this was possible for a number of reasons including climatic differences, availability of natural resources and advan- tages stemming from large volume production. However, as technological innovation and capital investment have become more important as factors determining com- petitiveness, the significance of resource endowments has declined.

International trade also provides an additional source of competition to domes- tic firms. It helps to create an environment conducive to economic growth-one in

A chemist by training, Dr. John Be/l was the Head of the Science and Technology PO/icy Division of the Organijation for Economic Cooperation and Deveiopment (OECD) in Park at the time of writing this paper. He ir currently the Head of Policy and Corporate Services Division in the Departnent of Industry, Technology and Commerce in Canberra.

Graham Vickery ir Principal Administrator in the Industsy Division of the OECD, Paris.

The views expressed herein are not necessarily those of the OECD or of its member countries.

145

146 J. Be/l and G. Vickery

which the economy is flexible, where mobility is encouraged, where resources shift in response to improved opportunities, where higher productivity is encouraged and where there is a strong effort to develop and implement new technologies. When domestic markets are not very large, there may not be enough domestic firms to pro- vide an appropriately competitive environment.

The ability to obtain goods more cheaply through trade than through domestic production in itself provides an opportunity for greater efficiency than would other- wise be possible-especially when those products are used for investment or as inter- mediate goods and raw materials in the production process.

In the post World War II period the proportion of OECD countries’ supplies of manufactured goods met by imports has risen from 5 % in 1950 to 25% in 1985. The 1950-73 era was one of strong economic growth and liberalization of trade and capital flows. At the end ofsthe war dutiable manufactured imports into OECD countries faced an average tariff of about 3O%, although trade was determined more by bilateral agreements, preference systems and quantitative restrictions than by import duties. By the early 1960s most of these non-tariff barriers had been removed or relaxed. Average tariffs on dutiable manufactures had been cut to around l3- 18 % . Subsequently, the Kennedy round and the Tokyo round negotiations reduced these average tariffs to 6% or less.

However, since 1973, economic growth has slowed and protectionist pressures have increased. Increasing use has been made of non-tarif bamkrs and some of the benefits of the moves toward free! trade of the 1950s and 1960s have been lost. There has also been a marked increase in d.ctiminatoty restraints on trade, such as “volun- tary export restraints” and “orderly market arrangements. ” These measures distort trade flows and drive up domestic prices. * Uncertainty about the future of trade policies depresses business confidence, discouraging expansion and technological innovation in the exporting countries.

Attempts are often made to justify protectionist measures as a means of protecting employment. Yet such restrictive measures have proved to be an inefficient means of sustaining employment, and usually delay much-needed structural adjustment.3

Protectionist policies reduce growth potential in a variety of ways. By encourag- ing a higher level of economic activity than would otherwise be profitable in high- cost activities, resources are locked into place in those industries that could be used more productively elsewhere .3 When producers believe that firms encountering dif- ficulties will be protected, they have less’ incentive to seek ways to increase the effi- ciency of their operations. In such circumstances, firms may judge it more profitable to spend their resources on seeking protection (and other assistance) rather than attempting to meet foreign competition through the acquisition or development of new technology and new competitive strategies, or exploration of foreign markets.

Free Trade

Free-trade agreements have all recognized that abolition of tariffs is not, in itself, sufficient, and have emphasized the importance of removing non-tariff barriers and of harmonising regulations, laws and administrative procedures which impact on

Intewzationd Perspectives on TecbnoLogy and Free Trade 147

trade. These latter goals are more difficult and take more time to resolve, yet they often create major problems for trade in technology-based goods and services.

There are three free-trade areas* involving OECD countries which are of partic- ular interest as they are, in principle, the forerunners of wider free-trade behaviour and they give insights into the benefits and the problems which could arise in this context. The European Economic Community (presently called the European Com- munity [EC]) was established in 1958 by the Treaty of Rome with six member coun- tries. Its membership has subsequently expanded to 12 countries. The treaty provides for the creation of a single integrated market free of restrictions on the movement of goods. It goes well beyond the abolition of tariffs to require the elimination of quantitative restrictions and other measures having the same effect. The elimina- tion of obstacles to the movement of services and capital, the institution of a sys- tem to ensure that competition is not distorted, and the harmonisation of laws and regulations affecting firms are also covered in the treaty. It took nearly 11 years to eliminate internal tariffs (although the differences in value-added tax which remain can have the same effect). The EC is now working to remove the remaining bar- riers by 1992.*

A number of technology-related trade issues are currently being resolved. One of the problems is where to draw the line between what needs to be harmonised and what can be left to mutual recognition of national regulations and standards. The strategy adopted by the EC is to try to lay down the e.r_rential requirements, con- formity with which will be sufficient to entitle a product to free movement within the EC. Three sectors have been chosen for particular attention: information tech- nology, construction products and food. All three involve technological issues. In information technology, the concern is with compatibility between networks and with telecommunications interconnection standards. In building materials the Com- mission is moving to establish European building codes with the aim of ensuring compatibility between components. In food, there is a continuing effort on addi- tives and labelling.

Differences in intellectual property laws are seen as having a direct negative impact on intra-Community trade. The first step here is the harmonisation of trade mark laws with particular attention to problems in the protection of computer software, microelectronic circuits and biotechnology. Effects of licensing and joint ventures on competition also require further work, since the kinds of agreements that should be allowed but which are potentially anticompetitive have been closely scrutinised in recent years. New efforts are also underway to terminate discriminatory practices in public procurement. *

A recent study evaluating the benefits of creating a single EC market shows that there is a large potential for the rationalization of production and distribution struc- tures, and this rationalization can be expected to lead to improvements in produc- tivity and reductions in costs and prices. 5 Total economic gains are estimated at 4.5-6.5% of GDP or 170-250 billion ECU. The study shows that there continue

*Other free-trade groups and agreements include the Iatin American Free-Trade Association, the Cen- tral American Common Market, and the Association of South East Asian Nations, the Ireland-United Kingdom Free-Trade Agreement, and the United States-Israel Agreement.

148 J. Bed and G. Vzchety

to be substantial unexploited economies of scale in European industry. In more than half of all branches of industry, 20 fnms of efficient size can coexist in a single Com- munity market, whereas the largest national markets can accommodate only four such firms. The study estimates that the achievement of a single Community mar- ket, together with the adoption of certain macroeconomic policies could result in the creation of an additional five million jobs in the EC. The EC’s trading position could be improved by about 1% of GDP. Specific advantages are seen for tech- nology-based firms, mainly through advantages of scale of production, and through rationalization.

The European Free-Trade Association (EFTA) is a group of six small European countries whose goal is the removal of import duties, quotas and other obstacles to trade in Western Europe and the upholding of liberal non-discriminatory practices in world trade. It was set up in 1960 (the Stockholm Convention) by a group of European countries including the United Kingdom which, for political and other reasons, did not want to join the European Economic Community and feared dis- crimination from the common external tariffs of the EC.

EFTA countries achieved free trade between themselves in industrial goods at the end of 1966. In 1972-73 two of the original members, the UK and Denmark, left EFTA and joined the EC. At about the same time, EFTA countries and the EC signed free-trade agreements to create a single European market. Following the final abolition of EFTA-EC tariffs on industrial goods, ministers of the two groups of countries agreed on general guidelines for greater cooperation in 1984 (the Luxem- bourg Declaration). Today, within EFTA, remaining exceptions to free trade amount to only about 3% of exports. 6 In 1984 EFTA countries exported outside the EFTA area about $2838 worth of goods for each EFTA inhabitant. This is the highest fig- ure for any trading area in the world. By comparison, exports from the EC to non- EC countries were equivalent to approximately $905 for each EC inhabitant.

The Australia-New Zealand Closer Economic Relations Trade Agreement was signed in 1982. The objectives include a mutual expansion of free trade and the pro- gressive elimination of barriers to trade. In August 1988 the two countries agreed to create a single market by 1990. The agreement includes manufactured and agri- cultural goods, services and other commercial transactions. It provides for harmoni- sation of business law and customs practices. Technical barriers to trade will be eliminated.’ Partly as a result of this agreement, a New Zealand minister partici- pates as an observer in the Australian Industry and Technology Council, whose members comprise relevant Australian state and federal government ministers. The aim of this council is to promote a consistent and coordinated approach to indus- try and technology policy development.

Most recently, Canada and the United States have proposed the establishment of a free-trade area. The agreement’s objectives include: eliminating barriers to trade in goods and services; facilitating conditions of fair competition within the free-trade area; liberalizing investment conditions; establishing independent and neutral administrative and dispute-resolution procedures; and providing further bilateral and multilateral cooperation. 8 It would be premature to comment on the science and technological aspects of an agreement which only went into effect from 1 Janu- ary 1989.

It is generally agreed that the EC and EFTA agreements have resulted in addi-

International Perspectives on Technology and Free Trade 149

tional trade in manufactures, and that this trade creation has probably exceeded diversion. However, estimates of the amount of additional trade vary widely.9

Within free-trade areas, decisions on location of manufacturing plants are likely to be strongly influenced by the general business climate, by proximity to markets, the availability and cost of transport, labour, and investment funds, incentives, etc., rather than by trade considerations. Technology parks and strong research institu- tions may prove to be particular attractions for technology-based industries.

Technology and Trade

In the last two decades, technological innovation has become a major driving force of economic growth. Technology plays an important role in determining the com- petitiveness of many goods and services.” A growing share of trade is dependent on the speed and mode of technological adjustment in industry. The share of technology-based goods in total OECD manufacturing trade (exports plus imports) is increasing rapidly. 3

In the last 30 years technology itself has conuibuted significantly to the ease and efficiency with which trade is conducted. In the transport sector costs have fallen and more distant markets have become accessible. Bulk transport costs have been halved in real terms and modern packaging has reduced breakage. Air freight has expanded markets in perishables and reduced delivery times. Computers and com- munications technologies have greatly facilitated trade flows.

Unfortunately the growth potential of technology-based industries is accompa- nied by a potential for increasing trade frictions. Technology-based industries are generally characterised by high development costs, high risk and short product life cycles. As a consequence, their products need rapid and wide market access in order to provide an adequate return on investment. Trade barriers narrow the accessible markets, and the slowness of dispute settling procedures under the GATT and asso- ciated MTN codes narrows the “window of opportunity” for some technology-based products. In addition, although average tariffs have been reduced, some individ- ual high tariffs continue to inhibit trade in technology-based products (e.g., in the telecommunications sector).

Starting in 1982, the OECD undertook a series of studies on technology flows and on trade in technology-intensive products. Sector studies completed in 1984 exam- ined trade-related issues in six technology-intensive sectors: industrial robots, telecommunications, machine tools, pharmaceuticals, semiconductors and space products. ‘l-l5 More recently, the increasing internationalisation of technology through interfirm cooperation has been analysed.16 The OECD has also increased its work on trade in services, many of which are strongly dependent on technology. Each of these studies has illustrated the importance of technology flows in relation to the development of technology-based sectors and to economic growth.

Technology Flows

OECD studies of technology flows have not shown any distinct patterns for free- trade country groups. Rather, the evidence which follows tends to illustrate truly international flows dominated by the strongest of the industrialised countries.

IJO J. Be/l and G. ?k#ery

The international spread of new technologies is fundamentally important for all countries and governments. Most new and improved products and production meth- ods are transferred between countries by three methods: through subsidiaries or through joint ventures, through licensing or sale of intellectual property rights and know-how, and through sales of machinery, equipment and “turn-key” plants.

Despite increasing interest in the international flows of technology, there are no widely accepted and uniformly collected measures of these flows. However, some broad trends and developments which are changing the structure of international technology flows can be seen in data on the technological balance of payments, on R&D performed by foreign firms, on foreign direct investment and on high tech- nology trade. i7-19 These are considered separately, although for many firms these activities are interrelated.

Most OECD countries collect data on international payments and receipts for patents, inventions, processes and related items. These transactions, often termed “technology trade,” are the most direct measure of technology flows between coun- tries. However, data are only roughly comparable between countries, in some cases being collected as part of R&D surveys, in others from central banks. Furthermore, they are heavily influenced by foreign direct investment, parent-subsidiary trans- actions and the international operations of firms.

Three quarters of world technology transactions are between OECD countries. However, half of Japan’s technology exports are to developing countries. The pat- tern of technology transactions is similar to the pattern of foreign investment. Most countries are net importers of technology and have a deficit on international pay- ments for patents, licences and technical know-how. The exceptions are the United States, United Kingdom and Switzerland, which have large stocks of overseas direct investment and are the home bases of very active multinational firms.

Technology Licensing

International payments for patents, licences and technical know-how amounted to $12 billion in 1983. In constant terms the volume of payments increased by 2 % per year between 1975 and 1983. Five countries, the United States, United Kingdom, France, Germany and Japan, are the suppliers in 85 % of these transactions. For most importing countries, the United States is the source of between 50% and 75% of technology.

Sales of products manufactured overseas under independent licence are much smaller than sales from foreign direct investment (only about 510%) although the figure in Japan is somewhat higher (about 18 % of manufacturing if petroleum pro- duction is included).

For countries that are major performers of industrial R&D, international receipts and payments for technology are of the order of l&20% of business enterprise R&D expenditures. Countries such as Australia and Portugal, which rely more extensively on foreign technology, make relatively larger payments for technology compared with their R&D expenditures.

Countries with a vigorous and broadly based domestic technological effort are reducing the extent of their direct reliance on foreign technology. Japan has been

International Perspectives on Technology and Eree Trade 151

a major importer of foreign technology licences and has very successfully adapted and developed imported technology. As a result, technology imports have fallen from 25% of the value of R&D expenditures of these firms in the early 1970s to below 10% of their R&D expenditures in 1983.

On a more limited scale the same phenomenon is occurring in Canada. Payments for technology by firms performing R&D have dropped from 30% of the value of Canadian business R&D expenditures in the early 1970s to 20% as R&D expendi- tures have risen sharply in the aircraft, communications and petroleum industries.

Trends in Technology Transactions

Canada, France, Japan, and Korea have been noticeably increasing their technol- ogy transactions (both payments and receipts) in more technology-intensive in- dustries-for Canada over two-thirds of the total, for France and the United States around half of the total. In Canada and France payments and receipts are roughly equal. Germany, Japan and the United Kingdom have a much larger share of imports in technology-intensive industries suggesting a continuing dependence on foreign sources of advanced technology.

Technology transactions are largely between associated firms linked by equity holdings. Those technology transactions between independent firms are predomi- nantly in traditional industries (such as textiles and metal-working) or industries dominated by small firms.

Investment and R&D by Foreign Firms

Foreign direct investment is an extremely important route for transferring technology between countries, although foreign direct investment data are not a perfect proxy for technology transfer. Foreign direct investment in manufacturing is concentrated in technology-intensive manufacturing industries, and is increasing in relative impor- tance in most OECD countries. Today, direct investment is increasingly recognised as a means of tapping the technology potential of foreign countries, particularly investment into the US. Multinational enterprises have been using foreign direct investment as a means of acquiring technology for some time.

The United States has been the most important destination for foreign direct investment flows since the mid-1970s, ‘and the share of total investment going to the US increased dramatically from 1978. In the period 1982-86, more foreign direct investment went to the United States than to all other OECD countries combined. And in the 1982-84 period, Canada, France, Germany, Japan, the Netherlands and the .United Kingdom were each the source of more foreign direct investment than was the United States, although the US again became a strong foreign investor in 1985-86. This is in marked contrast to the situation in the early 1970s when the United States, Germany and the United Kingdom were equally important as des- tinations for foreign direct investment, and the US was consistently and by far the largest source. Many European and Japanese firms are acquiring or setting up lab- oratories as part of their investment in the US and some are moving laboratories to US locations.

R&D performed by foreign firms plays an important role in adapting foreign tech-

152 J. Be// and G. Vickery

nology to domestic markets and in contributing to domestic technological activity. Again, the main trends are international rather than concentrated in free-trade areas. R&D activities follow foreign direct investment-but with a lag. Most OECD coun- tries have between 10 and 20% of their R&D performed by foreign firms except Sweden andJapan, which have relatively little foreign investment and a very low share of R&D performed by foreign firms. Countries which have a large stock of for- eign direct investment and a high proportion of business activities controlled by foreign firms have a relatively large share of business R&D performed by foreign- controlled firms. For example, in 1981, Australia, Canada and Ireland had 40 to 50% of their business enterprise R&D performed by foreign firms.

United States multinationals are the major performers of R&D performed by for- eign firms, and are increasing the amount of R&D that they perform in foreign countries. Two thirds of R&D expenditures of United States affiliates are in Ger- many, the United Kingdom (about 25% each), Canada (about 10%) and France (6%). The importance of R&D performed in Germany by foreign fums is illustrated by the fact that Germany currently receives larger receipts for “technological research and development” carried out by affiliates for foreign parent firms than it does from sales of patents, inventions and processes by German-controlled firms.

In general, parent firms tend to centralise R&D in home countries, to capture economies of scale in research and to ensure the integration of research into their strategic development and management planning. The share of parent firm R&D expenditures outside of the home country is considerably lower than the share of sales, and the expenditures on plants and equipment outside of the home coun- try. For example, in 1982, US firms investing overseas in manufacturing had the equivalent of about one-third of their employment and sales outside of the US, but R&D expenditures by manufacturing affiliates were equivalent to only 10% of par- ent expenditures, and only 15 % of manufacturing R&D employment (R&D scien- tists and engineers) was outside of the US. Swedish multinational firms concentrate their R&D activities in Sweden, and have a much higher share of marketing activities outside of Sweden.

Cooperation Between Firms

The growth of international and domestic interfirm agreements bearing to some degree or another on technology represents a significant and novel development of the 1980s and a major vehicle for the international transfer of technology.

Today, particularly among the most industrialised OECD countries, technology licensing occurs less and less frequently in isolation. It is generally part of a more complex agreement between firms regarding the exchange and joint production of technology.

The range and variety of interfirm agreements bearing on technology are consid- erable. Cooperation and/or technology exchange between firms (or between firms and research institutes) can either take place at a single point in the R&D-to- commercialisation process or cover the whole process. It can concern either the cre- ation of new technology or the acquisition and use of an already existing one, or both, Cooperation can concern R&D exclusively or it may also involve arrangements for market access and joint commercialisation.

InternationaL Perspectives on Technology and Free Trade 153

Interfiim agreements have, of course, always existed to some degree of another. International cross licensing between large corporations, which remains a fairly basic form of technical cooperation in some industries, was already a significant feature of the chemical and heavy electrical equipment industries in the 1920s and 1930s. Similarly, joint ventures have existed for a long time and became increasingly impor- tant from the late 1960s onwards. However, the current wave of interfirm agree- ments involves a much wider and more flexible range of arrangements, which has led a growing number of authors to refer to these agreements as “new. ”

The “new” forms of agreements provide firms with responses to the particular set of phenomena which have characterised the world economy since the late 1970s. The opportunities created by agreements are different from, and often superior to, those associated with domestic vertical or horizontal integration or foreign direct investment. In the face of financial and economic uncertainty, turbulence in the world economy and parallel rapid and radical technological change, the new forms of agreements offer firms a way of ensuring a high degree of flexibility in their oper- ations in a wide variety of situations. When technology is moving rapidly, the flex- ible and tiL shating (or indeed risk displacing) features of interfirm agreements offer firms a wide range of possibilities for acquiring key scientific and technical assets from outside.

In other, somewhat more strictly defined circumstances, interfiim agreements can also provide firms with a possibility of poohg limited R&D resources in the face of rising costs. This is why R&D-oriented agreements have been particularly notice- able in a number of technology-intensive sectors. These international cooperative agreements -often “triangular” in that they involve firms from the US and Europe or Japan -are the most important new element influencing international technology transfers. Of course, programs such as ESPRIT and EUREKA have promoted inter- firm cooperation in technology development within Europe. However, it should be remembered that, in a North American context, this would be equivalent to encour- aging cooperation between firms in California and Massachusetts. The difference is that in Europe the barriers to such cooperation are much higher than they are in the US.

In biotechnology and related areas based on fundamental scientific research, major firms are involved in numerous international contract research arrangements with academic and medical research groups and specialised research enterprises. In the electronics and communications industry agreements are often between leading firms in related but different segments of electronics and communications. Agreements involving Japanese companies are often aimed at marketing or gaining market access.

The strong interest by firms in entering into technology-related cooperative agree- ments with firms in distant economic zones suggests that firms are again taking an international view rather than focusing more narrowly within free-trade zones.

Technology-Intensive Industnks

Technology-intensive industries - often referred to as “high-technology industries” - are involved in a significant and increasing share of international technology trans- actions. In our analysis we use R&D intensity as a proxy for technology intensity. Within the manufactured exports of member countries, the share of goods produced

1,4 J. Bel. and G. Vickery

by high-technology industries (whose ratio of R&D spending to sales exceeds 4%) now ranges up to 40%. I9

The analysis of a limited range of product categories suggests that in the last 10 years, exports of high R&D-intensity products have grown faster than those of medium and low R&D-intensity products. The differences in the trade performance of the two groups of products is particularly striking since 1980.

After representing a stable 13 % of OECD exports through most of the l!X’Os, the share of R&D-intensive products has risen quickly in the 1980s. In 1983 these products represented at least 17 % of the total manufacturing exports of OECD countries. For a number of methodological reasons, this figure underestimates the total contribution of R&D-intensive products to the foreign trade of OECD coun- tries. About 95% of total OECD R&D-intensive exports are supplied by 10 coun- tries. By comparison, these countries supply 87% of all OECD manufactured exports.

I&--ortr to non-OECD countries are also important because these countries rep- resent rapidly growing markets. In 1983, exports of R&D-intensive products to non- OECD countries account for about 40% of all exports of these products from two major OECD exporting countries. The comparable figures for the EC is significantly lower- approximately 20% (excluding intra-EC trade).

Imports of R&D-intensive products from non-OECD countries (mainly the Asian NICs) represent 35 % of US imports of these products, 13 % in the case of Japan and 22% for the EC.

To conclude this section, technology flows appear to be international rather than regional. The most highly industrialised countries are the major sources of technol- ogy, and they trade in technology with other countries both inside and outside free- trade areas.

Non- TarifFactors Influencing Technology-Related Trade

Since the technological development, production and marketing of technology-based products rests in part on the acquisition of foreign technology, significant obstacles to technology transfer will almost inevitably also represent obstacles to trade. As part of our work on technology flows, we invited OECD countries to identify those non- tariff factors which have an adverse impact on trade in technology-based goods. In some cases the issues are seen as constituting real barriers; in others they are con- sidered to merely “tilt the international playing field” in favour of the products of another country.

As tariffs fall, non-tariff factors become more significant. Thus, for free-trade areas, non-tariff factors require particular attention. This section of the paper dis- cusses some of these issues and their implications for trade in technology-based goods and services.

Government-Created Obstades and Distortions

Government subsidies fall in the category of measures which “tilt the playing field.” The magnitude and variety of government subsidies vary significantly from industry

InternationaI Perspectives on Technology and Free Trade 155

to industry and from country to country. Throughout the OECD, governments sub- sidize industry for a variety of reasons: to increase industrial R&D, to promote regional development, to assist industrial adjustment and to encourage exports, to name but a few examples. An additional form of subsidy arises from defense con- tracts which result in civilian spin-offs.

In international trade the problem is not so much one of non-subsidised goods and services having to compete with subsidised ones. Rather, it is more a problem of comparing the net effects of different subsidy regimes. In some technology- intensive sectors, differences in subsidies can lead to significant trade problems. Civil aircraft, integrated circuits and telecommunications services have all been at the cen- ter of trade disputes in the past year.

The GATT Agreement on the Interpretation and Application of Articles VI, XVI and XXIII (the “Subsidies Code”) recognizes that subsidies (other than export sub- sidies) are widely used as important instruments for the promotion of social and eco- nomic policy objectives. The Subsidies Code does not restrict the right of signatories to use subsidies to achieve these and other important policy objectives. One of the objectives of the code is to encourage research and development programs especially in the field of high-technology industries.

The Subsidies Code recognises that such subsidies may adversely affect the interests of other signatories and that signatories should seek to avoid causing such effects through the use of subsidies. However, the code does not distinguish be- tween assistance for R&D and assistance intended to aid in commercial product development.

Governments may attempt to compensate domestic firms for the subsidies of other counuies by raising tariffs. In a free-trade context where such increases are not possible, wide differences between the magnitude and form of different government subsidies can cause obvious problems.

In some countries there are limitations placed on the access by foreign firms to the results of government-sponsored research, even when the foreign firm lies within the same free-trade zone. These countries take the view that, if taxpayers’ funds have been used to assist the development of new technology, then the benefits should be enjoyed by domestic fums. Government grants to assist indusuial R&D are often conditional on the results being commercialized in the same country. However, it is more difficult to impose this condition when subsidies take the form of tax con- cessions. Research agreements between universities and foreign firms often cause political concern, since most university research funds come from public sources. Yet for governments to become involved in scrutinizing individual cases seems hard to justify and would probably discourage such arrangements to the detriment of all concerned.

Spin-offs from defense research and from space programs are also seen as being subsidized by governments. Evidence suggesting the existence of beneficial spin-off effects has been noted in four of the industry studies mentioned earlier.“*‘2*‘4*‘5 While defense contracts are a very inefficient way for governments to subsidize civil technology applications, there is no doubt that defense research has provided the world with some very valuable commercial technologies in the post-war period. On the other hand, armaments comprise a significant fraction of some OECD countries’

J. Be/l and G. Vickety

trade and government involvement distorts this trade, with the effects sometimes spilling over into other sectors. There are some notable examples of firms whose development costs for civil products have been greatly reduced by defense contracts.

Controls on strategic technologies and technology-based products also cause trade problems. In some cases, strategic technologies are those with potentially dual civil- ian and military applications. In other cases the military application is not obvious. In a survey of international technology licensing,*’ 19% of enterprises saw export controls as a disincentive to licensing. While it is generally recognised by OECD countries that national strategic controls are legitimate and essential in many areas of advanced technology, some countries have expressed concern about the uncer- tainty which often surrounds these controls, the burden on frtms which deal in these technologies and the delays in obtaining export approvals.

Discriminatory public procurement can distort and impair trade in technology- based industries. In the telecommunications, semiconductor and space products industry studies,“v’3”6 public sector procurement was found to play an important role in the technological development of these industries. A more recent review of selected OECD countries’ procurement policies and practicies concludes that they can have both positive and negative impacts on the acquisition of foreign technol- ogies . *’ While offset-based procurement policies can provide domestic industry with enhanced access to foreign technologies, the study finds that the cumulative impact of local content rules and preference policies, financing constraints and restrictive tendering procedures can hinder technology flows from other countries.

The MTN Agreement on Government Procurement, which came into effect on 1 January 1981, established an “international framework of rights and obligations in relation to regulations and practices with respect to laws, regulations, procedures and practices regarding government procurement with a view to achieving greater liberalization and expansion of world trade and improving the international frame- work for the conduct of world trade.” The agreement seeks to ensure that domes- tic suppliers are not protected and that foreign suppliers are not discriminated against, It also requires transparency of regulations and procedures regarding public procurement. Government telecommunications agencies are not subject to this agreement, and it does not cover the procurement of services such as R&D.

Differing national practicies in relation to intellectual property rights can also cause trade problems and, as the Commission of the European Communities has stated, “have a direct and negative impact on intra-Community trade and on the ability of enterprises to treat the common market as a single environment. “* One example is the provision of a “grace period” in US legislation, which permits grant- ing of a patent despite prior publication of research results within a limited period. However, the European Patent Convention does not provide for such a grace period. These differences are complicating the development of technologies such as bio- technology, where commercial applications follow closely from the results of basic science.

Differences in the laws and regulations which govern the operations of enterprises may also cause barriers to trade, especially within free-trade areas. The three estab- lished free-trade areas mentioned earlier are all giving attention to this problem. There would be benefits to business and to economic growth from the removal of some regulations and the simplification of others. However, it is not clear how far

Internationd Perspectives on Technology and Free Trade 157

this process can proceed, particularly when the participating countries have different legal systems.

Rules of origin can distort decisions on investment in production and service facil- ities, and on the sourcing of manufacturing inputs. These rules are found in all free- trade agreements. Foreign companies often establish so-called “screwdriver plants” in free-trade areas in order to overcome trade barriers. These plants involve the assembly of mainly imported components. Some very complex rules of origin have been designed in attempts to limit this practice.

Differing safety and environmental controls can also distort trade patterns and decisions on the location of manufacturing facilities. This is one of the reasons for OECD’s efforts to harmonize safety and regulations in biotechnology.**

Standards, testing, and registration procedures can constitute real barriers to trade. In older established industries, where standard tests and registration procedures are well developed, technical barriers to trade are easily identifiable and, in principle, amenable to change. However, in industries which are subject to rapid technological change, the setting of standards often lags behind the technology. In these circum- stances, it is often the large manufacturers who determine the de facto standards.

Harmonisation in these technical areas is seen as particularly important in promot- ing internal trade within free-trade zones. The Commission of the European Com- munities has taken the position that ban of the sales of products cannot be based solely on the argument that an imported product has been manufactured accord- ing to specifications which differ from those used in the importing country.* Both the EC and EFTA have devoted particular attention to the harmonisation of stan- dards and the mutual recognition of tests and certification. Yet regional, as opposed to international, standards may reinforce barriers to firms outside these regions. The OECD study of the pharmaceutical industry13 showed that differing national test and certification requirements constitute a major barrier to trade and added cost to the consumer.

An MTN Code on Technical Barriers to Trade came into effect on 1 January 1980.

It recognises “the important contribution that international standards and certifi- cation systems can make in this regard by improving efficiency of production and facilitating the conduct of international trade.” It therefore has a twofold aim:

to encourage the development of such international standards and certifications systems; [and] to ensure that technical regulations and standards, including packaging, marking and labelling requirements, and methods for certifying conformity with technical regulations and standards do not create unnecessary obstacles to international trade.

Other Issttes

Firms licensing technology generally try to place some constraints in the contractural arrangements to prevent the licensee from becoming a direct competitor.*’ The structure and global strategies of major firms in technology-based industries have led to increasing reliance on foreign technology by countries that lack a strong indigenous industrial technology base, particularly in advanced technologies. Some of the smaller and less industrialised OECD countries report that their firms have difficulty in persuading foreign owners of technology to license it, or to license it

IS8 J. Be// and G. Vickery

under acceptable conditions. These countries are particularly concerned about agree- ments which prohibit the licensee from exporting or which grant the licenser the rights to any improvements made by the licensee, and which require the licenser to obtain raw materials from specified sources. Problems can also arise when firms seek to monopolize technologies or technology-based products, especially those with short product life cycles.

In general, most OECD governments have seen questions of access to technol- ogy as a matter to be left to firms to negotiate. However, some governments have intervened in agreements which they have considered particularly restrictive.

The industrial structures of most of the smaller OECD economies are characterised by a dominance of small- and medium-sized enterprises (SMEs) with few trans- national fums. Technology-based SMEs face problems with rising investment thresh- olds for R&D, and difficulties in establishing and maintaining export markets for specialised products which require world markets in order to achieve satisfactory volumes of sales. 23 The sector studies mentioned earlier confirm that the disadvan- tages of small size are real, both for countries and for firms, and that these disad- vantages are tending to grow, even in industries such as pharmaceuticals or machine tools where small innovative firms represent a significant feature of the industry. For the smaller countries, cooperation in technology-intensive areas can be advan- tageous (e.g. , European space cooperation).

To conclude this section, there are a number of important non-tariff factors which influence technology-based trade. In a free-trade context these factors must receive particular attention from governments.

Cooperation in Science and Technology

Countries which seek more open trading relationships also value openness in inter- national scientific and technological cooperation. The corollary could be that increas- ing openness in such international cooperation will facilitate openness in trading relationships. In April 1988, OECD countries adopted a General Framework of Prin- ciples for International Cooperation in Science and Technology.** This framework notes that barriers may be created by national and regional policies aimed at encour- aging the transfer of scientific and technological knowledge to enterprises.

The framework recommends that member countries promote mutually benefi- cial scientific and technological exchanges and remove barriers which have harm- ful effects on scientific and technological progress and its contribution to economic growth.

Member countries are asked to promote international cooperation in science and technology for economic growth through:

l Promoting international cooperation in research programmes for the transfer of scientific and technological knowledge to enterprises.

l Encouraging the circulation, exchange and trade of technologies as well as cooper- ation between enterprises, including small- and medium-sized enterprises, in particular through improved access to worldwide markets and improved harmoni- sation of standards and regulations.

l Promoting improved universal protection of intellectual and industrial property rights.

International Perspectives on Technology and Free Trade 159

The principles in this framework go beyond cooperation in science and technology to address a number of technology and trade-related issues.

Conclusions

Trade has played an important role in post-war economic growth. In this period, the importance of technological innovation as a factor influencing competitiveness has increased, while the relevance of resource endowments has declined. Trade in technology-based goods and services is a significant and growing component of world trade. Technology itself has facilitated this growth in trade. However, significant trade barriers remain.

Free-trade agreements are an important feature of post-war trade. These agree- ments extend beyond tariff reduction to non-tariff barriers and the harmonisation of laws and regulations affecting firms, public procurement and technical matters. Three OECD countries’ free-trade agreements, EFTA, the European Community and the Australia New Zealand Agreement, have already generated significant eco- nomic benefits to participating countries including significant growth in trade within the free-trade area. As the barriers are reduced, firms seek to rationalize produc- tion facilities, in some cases through mergers and takeovers. Further efforts are required before these areas achieve their free internal market goals.

OECD studies show that technology flows between firms are truly international, and the share of technology-based goods in total OECD manufacturing trade is increasing rapidly. Technology flows follow foreign investment patterns. In partic- ular, the importance of high technology industries in world trade is increasing. There is a new surge in international and domestic interfirm cooperation agreements. How- ever, no evidence has been seen to suggest that flows are stronger within free-trade areas. For countries within free-trade areas, policies aimed at ensuring an attractive business climate and at enhancing the flows of technology from outside the free- trade area may enhance national competitiveness and influence decisions of firms on plant location.

The establishment of free-trade areas has involved an initial emphasis on reducing tariffs. This may favour increased trade within the free-trade area in$nzSedgoods (albeit, with “embodied technology”), rather than the transfer of technology, for the following reasons:

l Established manufacturers can be expected to achieve greater economies of scale through the fuller utilisation or expansion of existing plants.

l There is no longer an incentive to license technology, or to establish foreign affii- ates, in order to overcome tariff barriers.

l While tariff barriers may be reduced relatively quickly, experience shows that other barriers take longer to remove. Some of these other barriers particularly hin- der flows of technology.

Non-tariff barriers create problems for trade in technology-based goods and ser- vices. In free-trade areas, where tariffs are relatively low or zero, non-tariff barriers are of particular importance. They include differences between counuies in relation to government subsidies, limitations on the access by foreign firms to the results of government-sponsored research, cpntrol on strategic technologies, discriminatory

J. Be// and G. Vickery

public procurement, differing intellectual property laws, complex of rules of ori- gin, safety and environmental controls, standards, testing and registration proce- dures. The harmonisation of laws and regulations affecting firms will help to “level the playing fields” within free-trade areas. International science and technology cooperation may facilitate technology flows and encourage openness in trading relations.

Experience to date shows that government subsidies to industries whose goods and services are traded can create particular problems, and in extreme cases lead to a sit- uation where competition between firms is transformed into competition between governments. However, countries joining free-trade associations do not start on an equal footing. Thus there will always be arguments for subsidies to facilitate “catch- up” in technology and competitiveness, since the creation of free-trade areas does not remove the basic economic arguments for government support of R&D- underinvestment because of market failure and externalities (particularly public versus private benefits).

Adnodedgment

The authors wish to thank F. Chesnais for his advice in preparing this paper.

References

1. OECD, Convention on the Organisation for Economic Cooperation and Development (Paris: OECD, 1960).

2. OECD, Costs and Benejits of Protection (Paris: OECD, 1985).

3. OECD, Stnrcturrr/ Adjutment and Economic Per$ormance (Paris: OECD, 1988).

4. Commission of the European Communities, Completing the Internal Market (Brussels: CEC, 1985).

5. P. Cecchini, The European CbaLenge 1992-The Benefit of a Sing/e Market (Aldershot: Wildword House,

1988).

6. EFTA Secretariat, The Eruupean Free-Trade Association, 3rd Edition (Geneva: EFTA, 1987).

7. Commonwealth Department of Trade, Austra&New Zealand CLoser Economic Relations- T&e Agreement

(Canberra: AGPS, 1983).

8. External Affairs Canada, The Cana&-U.S. Free-Trade Agreement (Ottawa: External Affairs Canada, 1988).

9. R.A. Batchelor, R.L. Major, and A.D. Morgan, Industrt&ation and the Basis for Trade (Cambridge: Cam-

bridge University Press, 1980).

10. F. Chesnais, “Science, Technology and Competitiveness,” Si7Review. no. 1 (Paris: OECD, 1986) pp. 85-129. 11, OECD, IndustrLd Robots: Their Role in Manufactun%g Industry (Paris: OECD, 1983).

12. OECD, Telecommunications: Pressures and Policies for Change (Paris: OECD, 1983).

13. OECD, The Pharmaceuticaf Industry: Trade Refated Issaes (Paris: OECD, 1985).

14. OECD, Tbe Semiconductor Industry: Trade RelbtedIssuer (Paris: OECD, 1985).

15. OECD, The Space Industry: Trade RelatedIssues (Paris: OECD, 1985).

16. F. Chesnais, “Technical Cooperation Agreements Between Firms,” STI Review, no. 4 (Paris: OECD, 1988),

pp. 51-119. 17. G. Vickery, “International flows of technology: Recent Trends and Developments,” S27 Review, no. 1 (Paris:

OECD, 1986). pp. 47-84. 18. OECD, STI Indicators News/etter, no. 10 (Paris: OECD. 1987).

19. T. Hatzichronoglou, to appear in a future edition of STI Review. 20. G. Vickery, “A Survey of International Technology Licensing,” S77 Review, no. 4 (Paris: OECD, 1988). pp. 7-

49. 2 1. OECD, Public Sector Procurement Polictis in OECD Member States, unpublished report (Pans: OECD, 1988).

22. OECD, Recombinant DNA Safety Considerations (Paris: OECD, 1986). 23. V. Walsh, “Technology, Competitiveness and the Special Problems of Small Countries,” STI Review, no. 2

(Paris: OECD, 1987). pp. 81-133. 24. OECD, Recommendation of the Council Concerning a General Framework of Princ;P/es for International

Cooperation in Science and Technology (Paris: OECD , 1988).