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An elementary proposition concerning parallel imports
Journal of International Economics 56 (2002) 233–245 www.elsevier.com / locate / econbase
An elementary proposition concerning parallel imports q Martin Richardson* Department of Economics, University of Otago, P.O. Box 56, Dunedin, New Zealand Received 12 February 1999; received in revised form 14 December 2000; accepted 26 December 2000
Abstract This paper demonstrates that, when countries individually choose whether or not to prohibit parallel imports, a global Nash equilibrium involves the permitting of parallel importing into all relevant foreign markets i.e. global uniform pricing. This result is sensitive in a straightforward way to the tariff-setting powers of countries and to the specification of a government’s objective function (i.e. political economy considerations). We also show that when countries can prevent ‘parallel exports’ then any Nash equilibrium involves global price discrimination. 2002 Elsevier Science B.V. All rights reserved. Keywords: Grey markets; Parallel imports JEL classification: F13; F15
1. Introduction The phenomenon of parallel imports (or grey markets) — ‘the importation of genuine . . . goods for resale by an agent other than the local authorised distributor’ 1 — is one that has gained increasing prominence in recent years. A number of countries — including Australia, New Zealand and Singapore — have recently liberalised restrictions on parallel importing and the European Union is
q
Or, A black and white result on grey markets. *Tel.: 164-3-479-8654; fax: 164-3-479-8174. E-mail address: [email protected] (M. Richardson). 1 NZIER (1998) at http: / / www.moc.govt.nz / / cae / parallel / parallel-01.html[P227 9191. ] 0022-1996 / 02 / $ – see front matter 2002 Elsevier Science B.V. All rights reserved. PII: S0022-1996( 01 )00110-6
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very active in preventing restrictions on internal parallel imports.2 Scherer (1994) notes that the first major competition policy enforcement in the EC concerned an attempted dealership territoriality within the EC and Malueg and Schwartz (1994, MS henceforth) suggest that, ‘[g]enerally, policies worldwide firmly support parallel imports’ (p. 169).3 The size of the grey market in the US as far back as the mid-1980s has been estimated at $US7b (MS p. 168) and grey market car sales alone in Germany have been estimated at US$6b (Gallini and Hollis, 1999, p. 2). The economics of grey markets are, in principle, straightforward. The literature considers two broad reasons 4 why grey markets might arise: one is to arbitrage away international price discrimination, the other is to free-ride on investments made by intellectual property right (IPR) holders. In the first of these, a holder of an IPR in some good (by definition a monopolist) would like to set different prices in different markets with different elasticities of demand. Parallel imports remove that ability and enforce uniform pricing on the monopolist. It is well known that imposing uniform pricing on a 3rd degree price discriminating monopolist might reduce aggregate welfare if it leads to small markets — that would otherwise be served — being dropped. In what is perhaps the leading theoretical analysis of this issue in an international setting, MS note that uniform pricing may be welfare-reducing, from a global perspective, if demand dispersion is high enough. The losers from uniform pricing are, of course,
2
But a number of recent decisions have supported the view that restrictions on parallel imports originating outside the Union are quite permissible. In Silhouette International Schmied GmbH & Co KG v. Hartlauer Handelsgesgesellschaft GmbH [1998] ETMR 539 the European Court of Justice (ECJ) ruled that a trademark proprietor’s rights in the European Economic Area (EEA) were only exhausted once the goods were placed on the market in the EEA. This was re-affirmed in Sebago Inc and another v. GB-Unic SA [1999] All ER (D) 706 when the ECJ stressed that the relevant part of the European Trade Marks Directive meant that trademark rights were only exhausted when products were placed on the EEA market (although another decision suggests that initial sale outside the EEA can give implied consent for goods to be sold on into the EEA depending inter alia on relevant local laws. See Zino Davidoff SA v. A& G Imports Ltd [1999] All ER (D) 502.) 3 See Maskus and Chen (1999) for a recent discussion of parallel import policy in a number of countries. 4 There are many other explanations too, of course. Frequently, parallel imports simply arbitrage ‘fire sales’ internationally — rather than being a long-run phenomenon, parallel importers specialise in one-off job lots. Another possibility is that international price discrimination reflects differing intellectual property regimes so that in countries that are lenient towards pirating, authentic distributors will optimally charge lower prices. Parallel imports then arbitrage these policy differences, sourcing in the low-price countries to sell in those where pirating is more strictly controlled. And, Maskus and Chen (1999) have recently shown that parallel imports can arise endogenously in a situation of vertical price control between a manufacturer and a downstream distributor: efficient two-part pricing might dictate a low per-unit wholesale price but this makes parallel exporting attractive if it is less than the retail price abroad (less trade costs). They find some empirical support for this argument.
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the small countries 5 that might be dropped. Yet the countries listed above as recent liberalisers of parallel import restrictions — New Zealand, Australia and Singapore — are all small countries (in the sense of international economics).6 Why is this? MS note that a ‘mixed’ system in which countries are grouped and each group faces a uniform price internally will, for appropriately chosen groups, typically welfare-dominate (from a global perspective) any pure system of either global uniform pricing or global price discrimination. But what would we anticipate if we look not at global welfare but rather at the incentives facing individual countries? Would some countries — low elasticity, high price ones — allow grey markets while others do not? This paper considers an international policy-setting game in which countries choose, simultaneously and non-cooperatively, domestic policy on grey markets. In the next section we set up a simple model focusing only on price discrimination as a rationale for parallel imports to argue that any Nash equilibrium to such a game effectively involves de facto global uniform pricing. Section 3 considers some extensions and qualifications of the basic insights looking at tariff-setting, political economy issues and the effects of allowing restrictions on re-exports. A final section concludes.
2. The basic result Consider a world of n 1 1 countries indexed by i 5 0, 1, . . . , n. A monopolist firm in country 0 produces a homogeneous good sold, potentially, in all n 1 1 countries under the canonical conditions of international trade theory: zero transport costs, non-decreasing production costs and full information on (wellbehaved) demand conditions. Demand for the product in country i 5 0, 1, . . . , n is given by x i ( pi ) where pi is the price charged in country i. The firm’s costs are n given by C(X) where X ; o i50 x i , C9(X) . 0 and C0(X) $ 0. Welfare in country i 5 1, 2, . . . , n is simply consumers’ surplus whereas in country 0 welfare includes
5
In their analysis ‘smaller’ corresponds to ‘more elastic demand’ as they look at linear inverse demand curves of the form p 5 a(1 2 q) and look at dispersion in a affecting both the slope and the price intercept of the demand curve. In such a linear model aggregate output is unaffected by a switch from discrimination to uniform pricing so long as all markets are still served so welfare would rise in such a case. 6 To focus on one of these, in May 1998 New Zealand unilaterally removed prohibitions on parallel imports of copyright goods. The US immediately responded by announcing a special 301 out-of-cycle review of New Zealand. While there are some special circumstances in the New Zealand case given the extensive reach of its copyright legislation (see Richardson (1999) and Wood and Scholes (1998)), it is by no means alone in permitting parallel imports.
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the global profits of the monopolist. If we denote by a i the ‘choke price’ in country i (the price at which demand just falls to zero, so a i 5 x i21 (0)) then W0 5 CS0 1 p 5 epa00 x 0ssdds 1 o in50 pi xi 2 CsXd and Wi 5 CSi 5 epaii x issdds for i 5 1, 2, . . . , n. Thus ≠Wi / ≠pi 5 2 x is pid , 0, i 5 1, . . . ,n and ≠W0 / ≠p0 5f p0 2 C9sXdgx 90 , 0 when p0 is chosen to maximise profits. Note too that ≠W0 / ≠pi 5 x i 1s pi 2 C9dx i9 for i . 0. This last expression is zero, either because the country is not served, or by the firm’s FOC. We assume that the firm’s problem has an interior solution for at least some markets: a i . C(0) for some i. Suppose the monopolist can price discriminate across all markets. Let S ;hi: x is p *i d . 0j denote the set of countries that are served in this case where p i* is the price charged to country i under price discrimination: so S is the set of countries in which there are strictly positive sales under global price discrimination. Denote its complement by N so that N ;hi: x is p *i d 5 0j. Suppose that, under global uniform pricing in i 5 0, . . . , n (that is, when the monopolist must charge the same price in every market) it maximises profit by setting pi 5p and sells x] i (p) in country i for ] of countries]that are served in total sales of ] X. Let ]S ;hi: x ispd . 0j denote the set ] this case and denote its complement by N ] so that N ] ;hi: x ispd 5 0j. Finally, we consider first only two policy extremes for countries: either ]parallel imports are permitted with no restrictions or they are prohibited outright. Let Ii be an indicator variable, which takes the value 1 for countries that permit parallel imports and 0 for countries that do not. Our conclusions depend on the following: Key assumption. Consider any two countries, i and j, which are both served under price discrimination and face prices p *i . p j* , respectively. Under our maintained assumptions, if these two were to be treated as a single market they would face a common price p [ [ p *j , p i* ] and welfare in country i ( j) would be weakly higher (lower) than with price discrimination.7 We assume henceforth that x i9 , 0 and x 99 i # 0. This is assumed simply to give a unique global maximum to the firm’s problem. In fact, our propositions will apply in any world where our Key assumption holds (for which these restrictions are sufficient). We consider a simple two-stage game with the following structure: first, all governments simultaneously choose whether to permit or prohibit parallel imports; second, the monopolist sets a price in each country. If this involves a higher price in a country that permits parallel imports than in some other country then arbitrage will occur from the latter to the former (parallel imports) and the monopolist’s
7
See Tirole (1988, pp. 137–138).
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profits will be lower than if it were to set a uniform price that ‘groups’ the two countries together in the sense of treating them as a single market. Suppose, * initially, that either 0 [N We can now state our central result. ] or 0 [S] and p 0 ,p. ] Proposition 1. Consider the one-shot policy game involving the simultaneous and non-cooperative choice of parallel import policy by all countries. In any Nash equilibrium to this game, only countries i [S] are served and pi 5p ;i, j . 0, i, ] j [S. ] Proof. Suppose not. Consider some country i ± 0, i [ M where M denotes the set of countries other than the monopolist’s home country facing the highest price in a discriminating equilibrium: M ;hk: p k* 5 maxh p *1 , . . . , p *n jj. Similarly, let J denote the set of countries facing the lowest price in a discriminating equilibrium: J ;hk: p k* 5 minh p *1 , . . . , p *n jj. While J and M may be singletons, they are clearly non-empty. So no country (other than possibly the monopolist’s home country) faces a higher price than country i or a lower price than any country j [ J. This can only occur if Ii 5 0. Suppose country i were instead to set Ii 5 1 i.e. it were to permit parallel imports. It would then be grouped by the supplier with some country j [ J and treated as a single market. By our Key assumption, welfare in country i would be higher than with price discrimination i.e. Ii 5 0 could not be a Nash equilibrium. Accordingly, all countries i . 0 that are served must face the 8 same price and pi 5 pj ;i, j [S, ] as claimed. Furthermore, Ii 5 1 ;i [S] such that p i* . pi . This result says that we effectively observe global uniform pricing 9 and the intuition behind it is very simple. The countries that would like to permit parallel importing are those that are discriminated against in its absence. So ‘high-price’ countries can ‘undo’ price discrimination. While high-elasticity demand countries
8 A referee has noted that allowing parallel imports is, in fact, a weakly dominant strategy for every country in that a country can do no worse allowing parallel imports than prohibiting them regardless of the policy choices of other countries. 9 Technically there are multiple equilibria here depending on the policy choices of both the countries in N and those in S that would face p i* ,p in the absence of parallel imports (these latter might prohibit ] ] ] parallel imports but with no effect on the equilibrium price). Clearly these equilibria are all equivalent to global uniform pricing. The only exception that might arise is if 0 [S and p 0* . pE where pE ,p is ] ] the uniform price that would be charged to all export markets if 0 [S but country 0 prohibits parallel ] imports. If country 0 then permits parallel imports it will lead to a uniform price of p — lower at home ] but higher in the rest of the served markets than pE . While the sum of consumers’ surplus and profits in its own market must increase with this, if the decrease in profits from the served export markets is substantial it could more than offset this. In that case the source country would prohibit parallel imports. Nevertheless, all foreign markets will still face a uniform price, as in Proposition 1.
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might favour discrimination, in this set-up they cannot enforce it globally when high-price countries permit grey markets.10 We close this section with a final observation. As noted earlier, MS show that world welfare may be higher than with either complete price discrimination or uniform pricing in a ‘mixed’ system in which countries are grouped. The monopolist can then discriminate between the groups but charges a uniform price within a group. Clearly this does not affect the world of Proposition 1.
3. Extensions and qualifications Our initial query was motivated by the observation that real-world practice does not conform to the predictions of economic theory: it is frequently small countries who have pursued parallel import liberalisation most eagerly. This might be attributed to free-rider behaviour in the broad area of intellectual property (see Barfield and Groombridge (1998)) but we have suggested, in a very simple and stylised model, that there is a case for all importing countries, large or small, to permit parallel imports. However, of course, we do not observe this in practice either. In this section we consider three extensions and qualifications to the above analysis: tariff setting, political economy considerations and the effects of ‘parallel export’ restrictions.
3.1. Tariffs and parallel imports The model of the previous section is one in which countries have a single policy instrument: prohibition or permission of parallel imports. In a more realistic setting countries can also choose other instruments such as tariffs. Knox and Richardson (1999) consider a two-country model in which tariffs are also available to governments and show that while permitting parallel imports is always attractive in the absence of tariffs (e.g. due to multilateral or bilateral trade agreements) it may not be attractive at all if even a small country can levy an optimal tariff against the monopoly. In any case, the relative attraction of permitting parallel imports is always greater when tariffs are not available. This does not automatically invalidate Proposition 1, however. While tariffs reduce the return to the
10
This result seems robust to repeated game complications. The usual complication repetition adds to a one-shot full information game is that, while repetition of any Nash equilibrium to the one-shot game is still a Nash equilibrium in the repeated game, there is a much richer variety of strategies agents can play and this can sustain other mutually-beneficial outcomes through appropriately chosen punishment strategies. However, in the simple setting of this section in which the strategic players are governments only, repetition changes nothing. The reason is that no combination of actions by the countries can raise the welfare of the country facing the highest price in any discrimination equilibrium compared to the equilibrium of Proposition 1. Hence, as in Proposition 1, any other outcome ‘unravels’ iteratively.
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monopolist, allowing parallel imports is always attractive to high price countries. Only if the range of prices that would prevail in the absence of parallel imports is not too great will the availability of tariffs disrupt the logic of Proposition 1 (in that a relatively high price country might prefer to prohibit parallel imports).
3.2. Political economy considerations In this model (and in Knox and Richardson (1999)) countries desire to be low-price destinations for the monopolist’s exports. This is based on the government maximising economic welfare as traditionally understood but the reality of trade policy setting in most countries is that it is driven by ‘political economy’ factors. There are a number of complications involved in introducing such issues into the parallel import setting, however. First, many such models are driven by the concerns of import competing producers but, in this setting, the imported product is necessarily produced by a monopoly. Further, internal resistance to parallel imports in practice has typically been expressed by local distributors of IPR goods, not by import-competing producers. As the surplus accruing to distributors can be extracted by the monopolist wholesaler through licensing fees, one might suspect there is little to be gained from lobbying in an equilibrium model where policy is fully anticipated. We show now, however, that in a simple model in the spirit of Grossman and Helpman (1994) (G&H henceforth) parallel imports may be prohibited by active lobbying. Consider a two-country model in which countries A and B both consume a good produced by a monopolist in country B. Suppose that country A faces the higher price if the markets are segmented. The monopolist licenses the sale of the product to a local distributor in country A and charges a license fee, L. The local distributor realises a profit of pA and retains r 5 pA 2 L 2 l where l is a lobbying payment to the government of A. The government in country A seeks, a` la G&H, to maximise UA 5 l 1 g [CSA 1 pA 2 L] where CSA denotes consumers’ surplus in 11 A and g is a weight placed on economic welfare. We suppose that the timing of actions is as follows. In the first stage the monopoly producer sets the license fee, L. The second two stages constitute a G&H-type game: the licensee in A determines its lobby contribution, l, to offer
11 As in G&H this comes from maximising a weighted sum of lobby contributions and economic welfare in which the post-contribution (net) profits of the domestic firm appears, so long as the weight on the former exceeds the weight on the latter. Our model has little of the richness of G&H, note, as we do not consider rival lobby groups due to the nature of the monopoly market considered here. Nevertheless, the timing, objective function of the government and the rationale for lobby payments are much as in the G&H model and the interested reader is referred there for a more complete explanation of the underlying model.
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the government and, in the third stage, the government decides whether or not to permit parallel imports and collects the associated lobby payment, the monopolist provides the good to the distributor and the market clears. If parallel imports are prohibited optimal behaviour by the monopolist is to supply the good at marginal cost (extracting what it can through the license fee); otherwise it supplies it at the optimal uniform price across the two markets, p. We seek a subgame perfect ] 12 equilibrium to this game; accordingly, we solve backwards. Suppose, in the third stage, that no lobbying were done ( l 5 0) so parallel imports were permitted. The payoffs to the monopolist, the distributor and the government in A are then, respectively:
p pi T 5 L 1 pBspd ] pi r 5 pAspd 2 L ] U pi A 5 gfCSAspd 1 pAspd 2 Lg ] ]
(1)
where a pi superscript indicates that parallel imports are permitted and pT denotes the total profits of the monopolist wholesaler. Now suppose, instead, that lobbying occurs and in the third stage parallel imports are not permitted. The corresponding payoffs will then be as follows:
pT 5 L 1 pBs pBd r 5 pA 2 l 2 L UA 5 l 1 gfCSAs pAd 1 pA 2 Lg
(2)
where the lack of superscripts indicates that parallel imports are not permitted and pj denotes the (discriminatory) retail price in country j5A, B. The government in A will prohibit parallel imports iff UA $ U Api i.e. from (1) and (2), if l 1 g (DpA 2 L) $ g (DCS 2 L) where DCS 5 CSA (p) 2 CSA ( pA ) . 0 and DpA 5 pA ( pA ) 2 pA (p) . 0. So in the second stage, given L,] the distributor in A maximises its payoff] ( r in (2)) by minimising l subject to this ‘participation’ constraint for the government,13 implying that the latter holds with equality:
l 5 gsDCS 2 DpAd.
12
(3)
Issues of the government ‘reneging’ — accepting the contribution but then allowing parallel imports anyway — do not arise here as the lobby payment is only made contingent on the parallel import regime chosen: the distributor’s choice in the second stage is simply a (binding) offer — a menu of options for the government. 13 Note that the maximised value of pA is unaffected by the choice of l as the latter is a lump sum payment to the government.
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Having parallel imports barred is only desirable for the distributor if r . r pi i.e. from (1) and (2), if l # DpA or, from (3), if: 14
g DpA $ ]]DCS. 11g
(4)
Subject to this condition (which is purely parametric) in the first stage the monopolist maximises pT in (2) by maximising L given the distributor’s ‘participation’ constraint ( r $ 0) implying that the latter also holds with equality or, from (2): L 5 pA 2 l.
(5)
Violation of (4) implies that there is no value of l that the subsidiary is willing to offer that would induce the government to prohibit parallel imports. So long as (4) does hold, the equilibrium lobby payment and license fee are given in (3) and (5). Consider a linear case in which the monopolist produces at a constant marginal cost c and (inverse) demand in each country is given by: pA 5 a 2 bDA pB 5 a 2 b DB
(6)
Our presumption that A faces the higher discriminatory price now requires a . a and without loss of generality we henceforth set b to unity. It is straightforward to show that bsa 2 ad 2 DpA 5 ]]] .0 4s1 1 bd 2 and
14 An alternative way to solve this problem is to recognise, as noted earlier, that the final two stages constitute a very simple and limiting version of the common agency game adapted by G&H and Konishi et al. (1999) in which there is a single principal only. By Proposition One of Konishi et al. (1999), any coalition-proof equilibrium here will involve a parallel imports policy choice that maximises the joint welfare of the distributor and the government in A. That is, parallel imports will be pi prohibited iff U pi A 1 r A 5 g [CSA (p) 1 pA (p) 2 L] # g CSA ( pA ) 1 (1 1 g )(pA ( pA ) 2 L) 5 UA 1 rA which ] ] can be rewritten as condition (4) in the text. The lobby payment is simply a transfer that affects the distribution of that joint surplus across these two players. Further, the structure of our problem is one of a single principal so it (the distributor) can extract the entire surplus from the lobbying relationship. It will therefore set its lobbying payment such that the government’s surplus is reduced to its reservation level, which gives us condition (3).
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sa 2 ad DCS 5 ]]]2 fbsa 2 ad 1 2s1 1 bdsa 2 cdg . 0. 8s1 1 bd Hence we can rewrite condition (4) as (7):
S
D
2bsa 2 ad g # ]]]]]]]] ;g 2s1 1 bdsa 2 cd 2 bsa 2 ad ]
(7)
Thus if g #g we will observe the prohibition of parallel imports; otherwise parallel imports]will be permitted. Inspection of (7) reveals some intuitive results: a prohibition on parallel imports is more likely, ceteris paribus, the lower is g (the weight on economic welfare), the lower is a (the price intercept in the other country) and the higher is a (the domestic price intercept), c (marginal cost) and b (the slope of the domestic demand curve). The lower is g the more important to the government are lobbying contributions hence prohibition of parallel imports is more likely (although, from (3), the government is no better off in equilibrium with such imports than without: although it receives lobby payments these exactly equal the welfare-weighted loss of consumer surplus and gain in distributor’s profit from prohibiting parallel trade). The other results all follow for the same reason: for instance, a lower a (greater dispersion of the demand curves in terms of choke prices) indicates increased profitability from price discrimination and thus greater lobbying. Finally, from (5), the domestic distributor makes zero net profit in equilibrium here, even though parallel imports are prohibited: the license fee extracts all profit that is not contributed as lobby payments to the domestic government. How does this tie into the model and results of the previous section? This analysis suggests that if governments are motivated by political economy concerns then even high price destinations may choose to prohibit parallel imports. In such a case, of course, Proposition 1 would no longer apply. However, the lower the demand dispersion (in terms of choke prices) the less likely is prohibition of parallel imports in high-price countries (in contrast to the tariff-setting case) because of the reduced gains from discrimination and thus lower lobbying expenditures.
3.3. Parallel export restrictions The third and final extension of our earlier model that we consider relates to what might be called ‘parallel exports’: the re-export of licensed sales from low price countries. Proposition 1 suggests that one set of beneficiaries of parallel import restrictions — countries that face low prices in a discriminatory outcome — cannot do anything to prevent global uniform pricing in equilibrium. As MS note, however, there is one way that countries that are favoured by international price discrimination can encourage it, even when others permit grey markets, and
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that is by prohibiting the re-export of licensed sales. Thus a prohibition on parallel exports could retain international price discrimination. So consider the one-shot policy game involving the simultaneous and non-cooperative choice of Ii by all countries along with the choice of whether or not to prohibit parallel exports. In this case we get the following result: Proposition 2. Consider the one-shot policy game involving the simultaneous and non-cooperative choice of parallel import and export policy by all countries. In any Nash equilibrium to this game, only countries i [ S are served and are charged prices p i* . Proof. If any served countries are grouped together and charged a uniform price then, by our Key assumption, any country in the group which would receive a lower price if discrimination were permitted can obtain that price by prohibiting parallel imports and exports. So no dissimilar countries can be grouped in equilibrium. So now it is ‘low-price’ countries that ‘undo’ uniform pricing and we effectively observe global price discrimination.15 While this is a theoretical possibility, the prohibition of parallel exports is not a policy one sees enacted in practice, perhaps for reasons of policing difficulties, latent mercantilism and a perception that this is a policy that serves private rather than national interests. Our analysis to date has taken the behaviour of the monopolist as essentially passive. And yet one might anticipate that the monopoly manufacturer would desire to take steps to prohibit parallel trade, perhaps through closer integration into or control over distribution channels (as has been suggested in the case of Japan where government policies might permit parallel imports de jure while private practices prohibit them de facto)16 or through explicit controls on re-exports. Indeed, there is evidence that some manufacturers do attempt to control this behaviour (see Michael (1998)).17 Interestingly, however, a recent decision in Spain has questioned such steps — a pharmaceutical company (Glaxo Wellcome) employed a dual pricing system with one price for products sold through Spanish pharmacies and a higher price for those sold to Spanish wholesalers who were deemed to be the source of parallel exports into the rest of Europe. Spanish legal authorities ordered in December 1998 that this dual pricing 15
Again there are multiple equilibria here depending on the policy choices of the countries in N but now they are all equivalent to global price discrimination. I am grateful to a referee for noting, too, that the choice of parallel import regime in this setting is redundant: whether or not countries permit parallel imports, parallel export restrictions ensure that they do not occur. 16 See also the analysis of Maskus and Chen (1999). 17 However, only 18% of respondents in Michael’s (1998) survey of US manufacturers reported that they would prohibit parallel exports of their products under all circumstances, indicating that it can serve international marketing purposes other than simply arbitraging third degree price discrimination.
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scheme be suspended pending a further ruling; since then the European Commission’s competition directorate, DGIV, has notified the company that it perceives this pricing system to be a restriction of competition in violation of European competition rules.
4. Conclusion We began by noting that recent policy reforms by a number of countries have involved relaxing restrictions on parallel imports and that it has frequently been small countries that have liberalised in this fashion. This runs counter to the observation that under uniform pricing it is small countries that might suffer from being ‘dropped’ by a monopolist supplier. In this paper we have argued that, in a simple price discrimination model where countries choose their parallel importing regime simultaneously and non-co-operatively, any Nash equilibrium is effectively one of global parallel importing. This perhaps renders less surprising the observation that policy-makers globally are sympathetic to grey markets, despite their ambiguous consequences for global welfare. Our result begs the question of why we do not then observe all countries permitting parallel imports. One explanation, of course, is that parallel imports may be driven by more than arbitrage across a discriminating monopolist’s markets. Even in such a setting, however, we have examined a number of other qualifications and extensions which would temper the stark and rather stylised result derived here.
Acknowledgements I am grateful to Alan King for a conversation that stimulated this paper and to the editor and two referees for very useful comments. The usual caveat applies, of course.
References Barfield, C., Groombridge, M., 1998. The economic case for copyright owner control over parallel imports. Journal of World Intellectual Property 1, 903–939. Gallini, N., Hollis, A., 1999. A contractual approach to the gray market. International Review of Law and Economics 19, 1–21. Grossman, G., Helpman, E., 1994. Protection for sale. American Economic Review 84, 833–850. Knox, D., Richardson, M., 1999. Trade policy and parallel imports. University of Otago, Dunedin, New Zealand, Mimeo. Konishi, H., Saggi, K., Weber, S., 1999. Endogenous trade policy under foreign direct investment. Journal of International Economics 49, 289–308.
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Malueg, D., Schwartz, M., 1994. Parallel imports, demand dispersion and international price discrimination. Journal of International Economics 37, 167–195. Maskus, K., Chen, Y., 1999. Vertical price control and parallel imports. University of Colorado at Boulder, CO, Mimeo. Michael, J., 1998. A supplemental distributional channel? The case of US parallel export channels. Multinational Business Review 6, 24–35. NZIER, 1998. In: Parallel Importing: A Theoretical and Empirical Investigation. Report to NZ Ministry of Commerce, Contract 1441, February 1998. New Zealand Institute of Economic Research (Inc), Wellington, New Zealand, http: / / www.moc.govt.nz / / cae / parallel / index.html. Richardson, M., 1999. Some observations on parallel imports. University of Otago, Dunedin, New Zealand, Mimeo. Scherer, F.M., 1994. Competition Policies for an Integrated World Economy. Brookings Institution, Washington DC. Tirole, J., 1988. The Theory of Industrial Organisation. MIT Press, Cambridge, MA. Wood, P., Scholes, K., 1998. Parallel importing — the legal and commercial consequences of the Government’s decision to lift the ban. NZ Intellectual Property Journal, 5, August.
An elementary proposition concerning parallel imports q Martin Richardson* Department of Economics, University of Otago, P.O. Box 56, Dunedin, New Zealand Received 12 February 1999; received in revised form 14 December 2000; accepted 26 December 2000
Abstract This paper demonstrates that, when countries individually choose whether or not to prohibit parallel imports, a global Nash equilibrium involves the permitting of parallel importing into all relevant foreign markets i.e. global uniform pricing. This result is sensitive in a straightforward way to the tariff-setting powers of countries and to the specification of a government’s objective function (i.e. political economy considerations). We also show that when countries can prevent ‘parallel exports’ then any Nash equilibrium involves global price discrimination. 2002 Elsevier Science B.V. All rights reserved. Keywords: Grey markets; Parallel imports JEL classification: F13; F15
1. Introduction The phenomenon of parallel imports (or grey markets) — ‘the importation of genuine . . . goods for resale by an agent other than the local authorised distributor’ 1 — is one that has gained increasing prominence in recent years. A number of countries — including Australia, New Zealand and Singapore — have recently liberalised restrictions on parallel importing and the European Union is
q
Or, A black and white result on grey markets. *Tel.: 164-3-479-8654; fax: 164-3-479-8174. E-mail address: [email protected] (M. Richardson). 1 NZIER (1998) at http: / / www.moc.govt.nz / / cae / parallel / parallel-01.html[P227 9191. ] 0022-1996 / 02 / $ – see front matter 2002 Elsevier Science B.V. All rights reserved. PII: S0022-1996( 01 )00110-6
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very active in preventing restrictions on internal parallel imports.2 Scherer (1994) notes that the first major competition policy enforcement in the EC concerned an attempted dealership territoriality within the EC and Malueg and Schwartz (1994, MS henceforth) suggest that, ‘[g]enerally, policies worldwide firmly support parallel imports’ (p. 169).3 The size of the grey market in the US as far back as the mid-1980s has been estimated at $US7b (MS p. 168) and grey market car sales alone in Germany have been estimated at US$6b (Gallini and Hollis, 1999, p. 2). The economics of grey markets are, in principle, straightforward. The literature considers two broad reasons 4 why grey markets might arise: one is to arbitrage away international price discrimination, the other is to free-ride on investments made by intellectual property right (IPR) holders. In the first of these, a holder of an IPR in some good (by definition a monopolist) would like to set different prices in different markets with different elasticities of demand. Parallel imports remove that ability and enforce uniform pricing on the monopolist. It is well known that imposing uniform pricing on a 3rd degree price discriminating monopolist might reduce aggregate welfare if it leads to small markets — that would otherwise be served — being dropped. In what is perhaps the leading theoretical analysis of this issue in an international setting, MS note that uniform pricing may be welfare-reducing, from a global perspective, if demand dispersion is high enough. The losers from uniform pricing are, of course,
2
But a number of recent decisions have supported the view that restrictions on parallel imports originating outside the Union are quite permissible. In Silhouette International Schmied GmbH & Co KG v. Hartlauer Handelsgesgesellschaft GmbH [1998] ETMR 539 the European Court of Justice (ECJ) ruled that a trademark proprietor’s rights in the European Economic Area (EEA) were only exhausted once the goods were placed on the market in the EEA. This was re-affirmed in Sebago Inc and another v. GB-Unic SA [1999] All ER (D) 706 when the ECJ stressed that the relevant part of the European Trade Marks Directive meant that trademark rights were only exhausted when products were placed on the EEA market (although another decision suggests that initial sale outside the EEA can give implied consent for goods to be sold on into the EEA depending inter alia on relevant local laws. See Zino Davidoff SA v. A& G Imports Ltd [1999] All ER (D) 502.) 3 See Maskus and Chen (1999) for a recent discussion of parallel import policy in a number of countries. 4 There are many other explanations too, of course. Frequently, parallel imports simply arbitrage ‘fire sales’ internationally — rather than being a long-run phenomenon, parallel importers specialise in one-off job lots. Another possibility is that international price discrimination reflects differing intellectual property regimes so that in countries that are lenient towards pirating, authentic distributors will optimally charge lower prices. Parallel imports then arbitrage these policy differences, sourcing in the low-price countries to sell in those where pirating is more strictly controlled. And, Maskus and Chen (1999) have recently shown that parallel imports can arise endogenously in a situation of vertical price control between a manufacturer and a downstream distributor: efficient two-part pricing might dictate a low per-unit wholesale price but this makes parallel exporting attractive if it is less than the retail price abroad (less trade costs). They find some empirical support for this argument.
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the small countries 5 that might be dropped. Yet the countries listed above as recent liberalisers of parallel import restrictions — New Zealand, Australia and Singapore — are all small countries (in the sense of international economics).6 Why is this? MS note that a ‘mixed’ system in which countries are grouped and each group faces a uniform price internally will, for appropriately chosen groups, typically welfare-dominate (from a global perspective) any pure system of either global uniform pricing or global price discrimination. But what would we anticipate if we look not at global welfare but rather at the incentives facing individual countries? Would some countries — low elasticity, high price ones — allow grey markets while others do not? This paper considers an international policy-setting game in which countries choose, simultaneously and non-cooperatively, domestic policy on grey markets. In the next section we set up a simple model focusing only on price discrimination as a rationale for parallel imports to argue that any Nash equilibrium to such a game effectively involves de facto global uniform pricing. Section 3 considers some extensions and qualifications of the basic insights looking at tariff-setting, political economy issues and the effects of allowing restrictions on re-exports. A final section concludes.
2. The basic result Consider a world of n 1 1 countries indexed by i 5 0, 1, . . . , n. A monopolist firm in country 0 produces a homogeneous good sold, potentially, in all n 1 1 countries under the canonical conditions of international trade theory: zero transport costs, non-decreasing production costs and full information on (wellbehaved) demand conditions. Demand for the product in country i 5 0, 1, . . . , n is given by x i ( pi ) where pi is the price charged in country i. The firm’s costs are n given by C(X) where X ; o i50 x i , C9(X) . 0 and C0(X) $ 0. Welfare in country i 5 1, 2, . . . , n is simply consumers’ surplus whereas in country 0 welfare includes
5
In their analysis ‘smaller’ corresponds to ‘more elastic demand’ as they look at linear inverse demand curves of the form p 5 a(1 2 q) and look at dispersion in a affecting both the slope and the price intercept of the demand curve. In such a linear model aggregate output is unaffected by a switch from discrimination to uniform pricing so long as all markets are still served so welfare would rise in such a case. 6 To focus on one of these, in May 1998 New Zealand unilaterally removed prohibitions on parallel imports of copyright goods. The US immediately responded by announcing a special 301 out-of-cycle review of New Zealand. While there are some special circumstances in the New Zealand case given the extensive reach of its copyright legislation (see Richardson (1999) and Wood and Scholes (1998)), it is by no means alone in permitting parallel imports.
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the global profits of the monopolist. If we denote by a i the ‘choke price’ in country i (the price at which demand just falls to zero, so a i 5 x i21 (0)) then W0 5 CS0 1 p 5 epa00 x 0ssdds 1 o in50 pi xi 2 CsXd and Wi 5 CSi 5 epaii x issdds for i 5 1, 2, . . . , n. Thus ≠Wi / ≠pi 5 2 x is pid , 0, i 5 1, . . . ,n and ≠W0 / ≠p0 5f p0 2 C9sXdgx 90 , 0 when p0 is chosen to maximise profits. Note too that ≠W0 / ≠pi 5 x i 1s pi 2 C9dx i9 for i . 0. This last expression is zero, either because the country is not served, or by the firm’s FOC. We assume that the firm’s problem has an interior solution for at least some markets: a i . C(0) for some i. Suppose the monopolist can price discriminate across all markets. Let S ;hi: x is p *i d . 0j denote the set of countries that are served in this case where p i* is the price charged to country i under price discrimination: so S is the set of countries in which there are strictly positive sales under global price discrimination. Denote its complement by N so that N ;hi: x is p *i d 5 0j. Suppose that, under global uniform pricing in i 5 0, . . . , n (that is, when the monopolist must charge the same price in every market) it maximises profit by setting pi 5p and sells x] i (p) in country i for ] of countries]that are served in total sales of ] X. Let ]S ;hi: x ispd . 0j denote the set ] this case and denote its complement by N ] so that N ] ;hi: x ispd 5 0j. Finally, we consider first only two policy extremes for countries: either ]parallel imports are permitted with no restrictions or they are prohibited outright. Let Ii be an indicator variable, which takes the value 1 for countries that permit parallel imports and 0 for countries that do not. Our conclusions depend on the following: Key assumption. Consider any two countries, i and j, which are both served under price discrimination and face prices p *i . p j* , respectively. Under our maintained assumptions, if these two were to be treated as a single market they would face a common price p [ [ p *j , p i* ] and welfare in country i ( j) would be weakly higher (lower) than with price discrimination.7 We assume henceforth that x i9 , 0 and x 99 i # 0. This is assumed simply to give a unique global maximum to the firm’s problem. In fact, our propositions will apply in any world where our Key assumption holds (for which these restrictions are sufficient). We consider a simple two-stage game with the following structure: first, all governments simultaneously choose whether to permit or prohibit parallel imports; second, the monopolist sets a price in each country. If this involves a higher price in a country that permits parallel imports than in some other country then arbitrage will occur from the latter to the former (parallel imports) and the monopolist’s
7
See Tirole (1988, pp. 137–138).
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profits will be lower than if it were to set a uniform price that ‘groups’ the two countries together in the sense of treating them as a single market. Suppose, * initially, that either 0 [N We can now state our central result. ] or 0 [S] and p 0 ,p. ] Proposition 1. Consider the one-shot policy game involving the simultaneous and non-cooperative choice of parallel import policy by all countries. In any Nash equilibrium to this game, only countries i [S] are served and pi 5p ;i, j . 0, i, ] j [S. ] Proof. Suppose not. Consider some country i ± 0, i [ M where M denotes the set of countries other than the monopolist’s home country facing the highest price in a discriminating equilibrium: M ;hk: p k* 5 maxh p *1 , . . . , p *n jj. Similarly, let J denote the set of countries facing the lowest price in a discriminating equilibrium: J ;hk: p k* 5 minh p *1 , . . . , p *n jj. While J and M may be singletons, they are clearly non-empty. So no country (other than possibly the monopolist’s home country) faces a higher price than country i or a lower price than any country j [ J. This can only occur if Ii 5 0. Suppose country i were instead to set Ii 5 1 i.e. it were to permit parallel imports. It would then be grouped by the supplier with some country j [ J and treated as a single market. By our Key assumption, welfare in country i would be higher than with price discrimination i.e. Ii 5 0 could not be a Nash equilibrium. Accordingly, all countries i . 0 that are served must face the 8 same price and pi 5 pj ;i, j [S, ] as claimed. Furthermore, Ii 5 1 ;i [S] such that p i* . pi . This result says that we effectively observe global uniform pricing 9 and the intuition behind it is very simple. The countries that would like to permit parallel importing are those that are discriminated against in its absence. So ‘high-price’ countries can ‘undo’ price discrimination. While high-elasticity demand countries
8 A referee has noted that allowing parallel imports is, in fact, a weakly dominant strategy for every country in that a country can do no worse allowing parallel imports than prohibiting them regardless of the policy choices of other countries. 9 Technically there are multiple equilibria here depending on the policy choices of both the countries in N and those in S that would face p i* ,p in the absence of parallel imports (these latter might prohibit ] ] ] parallel imports but with no effect on the equilibrium price). Clearly these equilibria are all equivalent to global uniform pricing. The only exception that might arise is if 0 [S and p 0* . pE where pE ,p is ] ] the uniform price that would be charged to all export markets if 0 [S but country 0 prohibits parallel ] imports. If country 0 then permits parallel imports it will lead to a uniform price of p — lower at home ] but higher in the rest of the served markets than pE . While the sum of consumers’ surplus and profits in its own market must increase with this, if the decrease in profits from the served export markets is substantial it could more than offset this. In that case the source country would prohibit parallel imports. Nevertheless, all foreign markets will still face a uniform price, as in Proposition 1.
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might favour discrimination, in this set-up they cannot enforce it globally when high-price countries permit grey markets.10 We close this section with a final observation. As noted earlier, MS show that world welfare may be higher than with either complete price discrimination or uniform pricing in a ‘mixed’ system in which countries are grouped. The monopolist can then discriminate between the groups but charges a uniform price within a group. Clearly this does not affect the world of Proposition 1.
3. Extensions and qualifications Our initial query was motivated by the observation that real-world practice does not conform to the predictions of economic theory: it is frequently small countries who have pursued parallel import liberalisation most eagerly. This might be attributed to free-rider behaviour in the broad area of intellectual property (see Barfield and Groombridge (1998)) but we have suggested, in a very simple and stylised model, that there is a case for all importing countries, large or small, to permit parallel imports. However, of course, we do not observe this in practice either. In this section we consider three extensions and qualifications to the above analysis: tariff setting, political economy considerations and the effects of ‘parallel export’ restrictions.
3.1. Tariffs and parallel imports The model of the previous section is one in which countries have a single policy instrument: prohibition or permission of parallel imports. In a more realistic setting countries can also choose other instruments such as tariffs. Knox and Richardson (1999) consider a two-country model in which tariffs are also available to governments and show that while permitting parallel imports is always attractive in the absence of tariffs (e.g. due to multilateral or bilateral trade agreements) it may not be attractive at all if even a small country can levy an optimal tariff against the monopoly. In any case, the relative attraction of permitting parallel imports is always greater when tariffs are not available. This does not automatically invalidate Proposition 1, however. While tariffs reduce the return to the
10
This result seems robust to repeated game complications. The usual complication repetition adds to a one-shot full information game is that, while repetition of any Nash equilibrium to the one-shot game is still a Nash equilibrium in the repeated game, there is a much richer variety of strategies agents can play and this can sustain other mutually-beneficial outcomes through appropriately chosen punishment strategies. However, in the simple setting of this section in which the strategic players are governments only, repetition changes nothing. The reason is that no combination of actions by the countries can raise the welfare of the country facing the highest price in any discrimination equilibrium compared to the equilibrium of Proposition 1. Hence, as in Proposition 1, any other outcome ‘unravels’ iteratively.
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monopolist, allowing parallel imports is always attractive to high price countries. Only if the range of prices that would prevail in the absence of parallel imports is not too great will the availability of tariffs disrupt the logic of Proposition 1 (in that a relatively high price country might prefer to prohibit parallel imports).
3.2. Political economy considerations In this model (and in Knox and Richardson (1999)) countries desire to be low-price destinations for the monopolist’s exports. This is based on the government maximising economic welfare as traditionally understood but the reality of trade policy setting in most countries is that it is driven by ‘political economy’ factors. There are a number of complications involved in introducing such issues into the parallel import setting, however. First, many such models are driven by the concerns of import competing producers but, in this setting, the imported product is necessarily produced by a monopoly. Further, internal resistance to parallel imports in practice has typically been expressed by local distributors of IPR goods, not by import-competing producers. As the surplus accruing to distributors can be extracted by the monopolist wholesaler through licensing fees, one might suspect there is little to be gained from lobbying in an equilibrium model where policy is fully anticipated. We show now, however, that in a simple model in the spirit of Grossman and Helpman (1994) (G&H henceforth) parallel imports may be prohibited by active lobbying. Consider a two-country model in which countries A and B both consume a good produced by a monopolist in country B. Suppose that country A faces the higher price if the markets are segmented. The monopolist licenses the sale of the product to a local distributor in country A and charges a license fee, L. The local distributor realises a profit of pA and retains r 5 pA 2 L 2 l where l is a lobbying payment to the government of A. The government in country A seeks, a` la G&H, to maximise UA 5 l 1 g [CSA 1 pA 2 L] where CSA denotes consumers’ surplus in 11 A and g is a weight placed on economic welfare. We suppose that the timing of actions is as follows. In the first stage the monopoly producer sets the license fee, L. The second two stages constitute a G&H-type game: the licensee in A determines its lobby contribution, l, to offer
11 As in G&H this comes from maximising a weighted sum of lobby contributions and economic welfare in which the post-contribution (net) profits of the domestic firm appears, so long as the weight on the former exceeds the weight on the latter. Our model has little of the richness of G&H, note, as we do not consider rival lobby groups due to the nature of the monopoly market considered here. Nevertheless, the timing, objective function of the government and the rationale for lobby payments are much as in the G&H model and the interested reader is referred there for a more complete explanation of the underlying model.
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the government and, in the third stage, the government decides whether or not to permit parallel imports and collects the associated lobby payment, the monopolist provides the good to the distributor and the market clears. If parallel imports are prohibited optimal behaviour by the monopolist is to supply the good at marginal cost (extracting what it can through the license fee); otherwise it supplies it at the optimal uniform price across the two markets, p. We seek a subgame perfect ] 12 equilibrium to this game; accordingly, we solve backwards. Suppose, in the third stage, that no lobbying were done ( l 5 0) so parallel imports were permitted. The payoffs to the monopolist, the distributor and the government in A are then, respectively:
p pi T 5 L 1 pBspd ] pi r 5 pAspd 2 L ] U pi A 5 gfCSAspd 1 pAspd 2 Lg ] ]
(1)
where a pi superscript indicates that parallel imports are permitted and pT denotes the total profits of the monopolist wholesaler. Now suppose, instead, that lobbying occurs and in the third stage parallel imports are not permitted. The corresponding payoffs will then be as follows:
pT 5 L 1 pBs pBd r 5 pA 2 l 2 L UA 5 l 1 gfCSAs pAd 1 pA 2 Lg
(2)
where the lack of superscripts indicates that parallel imports are not permitted and pj denotes the (discriminatory) retail price in country j5A, B. The government in A will prohibit parallel imports iff UA $ U Api i.e. from (1) and (2), if l 1 g (DpA 2 L) $ g (DCS 2 L) where DCS 5 CSA (p) 2 CSA ( pA ) . 0 and DpA 5 pA ( pA ) 2 pA (p) . 0. So in the second stage, given L,] the distributor in A maximises its payoff] ( r in (2)) by minimising l subject to this ‘participation’ constraint for the government,13 implying that the latter holds with equality:
l 5 gsDCS 2 DpAd.
12
(3)
Issues of the government ‘reneging’ — accepting the contribution but then allowing parallel imports anyway — do not arise here as the lobby payment is only made contingent on the parallel import regime chosen: the distributor’s choice in the second stage is simply a (binding) offer — a menu of options for the government. 13 Note that the maximised value of pA is unaffected by the choice of l as the latter is a lump sum payment to the government.
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Having parallel imports barred is only desirable for the distributor if r . r pi i.e. from (1) and (2), if l # DpA or, from (3), if: 14
g DpA $ ]]DCS. 11g
(4)
Subject to this condition (which is purely parametric) in the first stage the monopolist maximises pT in (2) by maximising L given the distributor’s ‘participation’ constraint ( r $ 0) implying that the latter also holds with equality or, from (2): L 5 pA 2 l.
(5)
Violation of (4) implies that there is no value of l that the subsidiary is willing to offer that would induce the government to prohibit parallel imports. So long as (4) does hold, the equilibrium lobby payment and license fee are given in (3) and (5). Consider a linear case in which the monopolist produces at a constant marginal cost c and (inverse) demand in each country is given by: pA 5 a 2 bDA pB 5 a 2 b DB
(6)
Our presumption that A faces the higher discriminatory price now requires a . a and without loss of generality we henceforth set b to unity. It is straightforward to show that bsa 2 ad 2 DpA 5 ]]] .0 4s1 1 bd 2 and
14 An alternative way to solve this problem is to recognise, as noted earlier, that the final two stages constitute a very simple and limiting version of the common agency game adapted by G&H and Konishi et al. (1999) in which there is a single principal only. By Proposition One of Konishi et al. (1999), any coalition-proof equilibrium here will involve a parallel imports policy choice that maximises the joint welfare of the distributor and the government in A. That is, parallel imports will be pi prohibited iff U pi A 1 r A 5 g [CSA (p) 1 pA (p) 2 L] # g CSA ( pA ) 1 (1 1 g )(pA ( pA ) 2 L) 5 UA 1 rA which ] ] can be rewritten as condition (4) in the text. The lobby payment is simply a transfer that affects the distribution of that joint surplus across these two players. Further, the structure of our problem is one of a single principal so it (the distributor) can extract the entire surplus from the lobbying relationship. It will therefore set its lobbying payment such that the government’s surplus is reduced to its reservation level, which gives us condition (3).
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sa 2 ad DCS 5 ]]]2 fbsa 2 ad 1 2s1 1 bdsa 2 cdg . 0. 8s1 1 bd Hence we can rewrite condition (4) as (7):
S
D
2bsa 2 ad g # ]]]]]]]] ;g 2s1 1 bdsa 2 cd 2 bsa 2 ad ]
(7)
Thus if g #g we will observe the prohibition of parallel imports; otherwise parallel imports]will be permitted. Inspection of (7) reveals some intuitive results: a prohibition on parallel imports is more likely, ceteris paribus, the lower is g (the weight on economic welfare), the lower is a (the price intercept in the other country) and the higher is a (the domestic price intercept), c (marginal cost) and b (the slope of the domestic demand curve). The lower is g the more important to the government are lobbying contributions hence prohibition of parallel imports is more likely (although, from (3), the government is no better off in equilibrium with such imports than without: although it receives lobby payments these exactly equal the welfare-weighted loss of consumer surplus and gain in distributor’s profit from prohibiting parallel trade). The other results all follow for the same reason: for instance, a lower a (greater dispersion of the demand curves in terms of choke prices) indicates increased profitability from price discrimination and thus greater lobbying. Finally, from (5), the domestic distributor makes zero net profit in equilibrium here, even though parallel imports are prohibited: the license fee extracts all profit that is not contributed as lobby payments to the domestic government. How does this tie into the model and results of the previous section? This analysis suggests that if governments are motivated by political economy concerns then even high price destinations may choose to prohibit parallel imports. In such a case, of course, Proposition 1 would no longer apply. However, the lower the demand dispersion (in terms of choke prices) the less likely is prohibition of parallel imports in high-price countries (in contrast to the tariff-setting case) because of the reduced gains from discrimination and thus lower lobbying expenditures.
3.3. Parallel export restrictions The third and final extension of our earlier model that we consider relates to what might be called ‘parallel exports’: the re-export of licensed sales from low price countries. Proposition 1 suggests that one set of beneficiaries of parallel import restrictions — countries that face low prices in a discriminatory outcome — cannot do anything to prevent global uniform pricing in equilibrium. As MS note, however, there is one way that countries that are favoured by international price discrimination can encourage it, even when others permit grey markets, and
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that is by prohibiting the re-export of licensed sales. Thus a prohibition on parallel exports could retain international price discrimination. So consider the one-shot policy game involving the simultaneous and non-cooperative choice of Ii by all countries along with the choice of whether or not to prohibit parallel exports. In this case we get the following result: Proposition 2. Consider the one-shot policy game involving the simultaneous and non-cooperative choice of parallel import and export policy by all countries. In any Nash equilibrium to this game, only countries i [ S are served and are charged prices p i* . Proof. If any served countries are grouped together and charged a uniform price then, by our Key assumption, any country in the group which would receive a lower price if discrimination were permitted can obtain that price by prohibiting parallel imports and exports. So no dissimilar countries can be grouped in equilibrium. So now it is ‘low-price’ countries that ‘undo’ uniform pricing and we effectively observe global price discrimination.15 While this is a theoretical possibility, the prohibition of parallel exports is not a policy one sees enacted in practice, perhaps for reasons of policing difficulties, latent mercantilism and a perception that this is a policy that serves private rather than national interests. Our analysis to date has taken the behaviour of the monopolist as essentially passive. And yet one might anticipate that the monopoly manufacturer would desire to take steps to prohibit parallel trade, perhaps through closer integration into or control over distribution channels (as has been suggested in the case of Japan where government policies might permit parallel imports de jure while private practices prohibit them de facto)16 or through explicit controls on re-exports. Indeed, there is evidence that some manufacturers do attempt to control this behaviour (see Michael (1998)).17 Interestingly, however, a recent decision in Spain has questioned such steps — a pharmaceutical company (Glaxo Wellcome) employed a dual pricing system with one price for products sold through Spanish pharmacies and a higher price for those sold to Spanish wholesalers who were deemed to be the source of parallel exports into the rest of Europe. Spanish legal authorities ordered in December 1998 that this dual pricing 15
Again there are multiple equilibria here depending on the policy choices of the countries in N but now they are all equivalent to global price discrimination. I am grateful to a referee for noting, too, that the choice of parallel import regime in this setting is redundant: whether or not countries permit parallel imports, parallel export restrictions ensure that they do not occur. 16 See also the analysis of Maskus and Chen (1999). 17 However, only 18% of respondents in Michael’s (1998) survey of US manufacturers reported that they would prohibit parallel exports of their products under all circumstances, indicating that it can serve international marketing purposes other than simply arbitraging third degree price discrimination.
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scheme be suspended pending a further ruling; since then the European Commission’s competition directorate, DGIV, has notified the company that it perceives this pricing system to be a restriction of competition in violation of European competition rules.
4. Conclusion We began by noting that recent policy reforms by a number of countries have involved relaxing restrictions on parallel imports and that it has frequently been small countries that have liberalised in this fashion. This runs counter to the observation that under uniform pricing it is small countries that might suffer from being ‘dropped’ by a monopolist supplier. In this paper we have argued that, in a simple price discrimination model where countries choose their parallel importing regime simultaneously and non-co-operatively, any Nash equilibrium is effectively one of global parallel importing. This perhaps renders less surprising the observation that policy-makers globally are sympathetic to grey markets, despite their ambiguous consequences for global welfare. Our result begs the question of why we do not then observe all countries permitting parallel imports. One explanation, of course, is that parallel imports may be driven by more than arbitrage across a discriminating monopolist’s markets. Even in such a setting, however, we have examined a number of other qualifications and extensions which would temper the stark and rather stylised result derived here.
Acknowledgements I am grateful to Alan King for a conversation that stimulated this paper and to the editor and two referees for very useful comments. The usual caveat applies, of course.
References Barfield, C., Groombridge, M., 1998. The economic case for copyright owner control over parallel imports. Journal of World Intellectual Property 1, 903–939. Gallini, N., Hollis, A., 1999. A contractual approach to the gray market. International Review of Law and Economics 19, 1–21. Grossman, G., Helpman, E., 1994. Protection for sale. American Economic Review 84, 833–850. Knox, D., Richardson, M., 1999. Trade policy and parallel imports. University of Otago, Dunedin, New Zealand, Mimeo. Konishi, H., Saggi, K., Weber, S., 1999. Endogenous trade policy under foreign direct investment. Journal of International Economics 49, 289–308.
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Malueg, D., Schwartz, M., 1994. Parallel imports, demand dispersion and international price discrimination. Journal of International Economics 37, 167–195. Maskus, K., Chen, Y., 1999. Vertical price control and parallel imports. University of Colorado at Boulder, CO, Mimeo. Michael, J., 1998. A supplemental distributional channel? The case of US parallel export channels. Multinational Business Review 6, 24–35. NZIER, 1998. In: Parallel Importing: A Theoretical and Empirical Investigation. Report to NZ Ministry of Commerce, Contract 1441, February 1998. New Zealand Institute of Economic Research (Inc), Wellington, New Zealand, http: / / www.moc.govt.nz / / cae / parallel / index.html. Richardson, M., 1999. Some observations on parallel imports. University of Otago, Dunedin, New Zealand, Mimeo. Scherer, F.M., 1994. Competition Policies for an Integrated World Economy. Brookings Institution, Washington DC. Tirole, J., 1988. The Theory of Industrial Organisation. MIT Press, Cambridge, MA. Wood, P., Scholes, K., 1998. Parallel importing — the legal and commercial consequences of the Government’s decision to lift the ban. NZ Intellectual Property Journal, 5, August.