Investment agreements between nations can boost the innovation transfer of knowledge, also known as innovation diffusion, between the two parties by as much as 40 per cent, new research finds. 

According to a new study titled “Cross-Border Property Rights and the Globalization of Innovation,” bilateral agreements that protect investors investing in foreign jurisdictions have a tangible impact on the transfer of knowledge and collaboration between countries. On the flip side, limiting such agreements can have lasting negative consequences that ripple through the global economy and ultimately reverberate back home. 

The study, which was co-authored by Rotman School of Management assistant professor of finance Ting Xu, analyzed 67 million patents filed across more than 100 patent offices around the world. They studied the impact of bilateral investment treaties (BIT) — a package of laws that helps protect foreign investments between countries — to determine how those policies influenced innovation diffusion. 

Such agreements typically spell out the rights of foreign investors, outline how disputes related to foreign intellectual property (IP) will be handled, and make clear what technologies, research and development (R&D) labs and employees can move freely between the countries.  

 “We found a very large effect,” Xu says. “After two countries sign a BIT, we see a 25 to 40 per cent increase across different measures [of innovation diffusion].” 

That is especially true among countries that cannot offer a high degree of protection to foreign investors. “If we're talking about a developing country that has weak institutions, then this international protection matters more,” Xu says. 

Bilateral investment treaties encourage more direct collaboration 

The researchers looked at three different stages of cross-border innovation, which require varying degrees of interaction between countries.  

The first level, “adoption,” looked for patents that are filed in two countries in quick succession for the same underlying invention, suggesting the invention has spread from its place of origin into a new market. “You're not inventing anything new,” Xu says. “You’re just adopting existing knowledge from another country.” 

The second stage, “sourcing,” looks at foreign citations in domestic patent filings, suggesting that ideas from one jurisdiction were built upon those that originated elsewhere. 

“Another way to measure ‘sourcing’ is when the patent inventor is coming from a foreign country — say, the U.K. — but the patent is filed in the U.S.,” Xu adds. “Usually this happens when the firm has an overseas R&D team, or purchased the patent from a foreign inventor, so the company is sourcing knowledge from another country.” 

Finally, the researchers looked for examples of more direct collaboration, based on patent applications co-filed by multiple inventors from different countries. 

When two countries sign a bilateral investment treaty, the researchers found growth across all three stages of cross-border innovation — with the strongest impact on direct collaboration, followed by sourcing, and the smallest (though still significant) impact on adoption.  
That suggests that the deeper the cross-border interactions, the more sensitive they are to policies that reduce frictions between them, Xu says. 

“When you actually collaborate — building a joint venture together in a foreign country — then there are more legal frictions and more things to contract on, hence more opportunities for expropriations; that’s when these treaties are most valuable,” he says.

Implications for investors, businesses and policymakers 

By analyzing data from 1980 to 2016, the researchers suggest that cross-border collaboration peaked sometime in the ‘90s and has since been in decline.  

“In recent decades, many countries start to introduce these protectionist policies that essentially restrict foreign investment — either inward or outward — to protect their own technology, often in the interest of national security or global competitiveness,” Xu says. “We’re essentially showing that there’s a big cost to that. Even if you prevent leakage of key information abroad, you make it harder for you to adopt and learn from technologies in other countries.” 

In other words, the research suggests that protectionist policies, which are designed to improve a country’s global competitiveness in the short-term, have the opposite effect in the long run, making countries less able to learn from and build upon foreign innovation. 

“Different countries specialize in different areas, and may have natural advantages in different fields,” Xu says. “We need to think about innovation from a planetary perspective, and these protectionist policies are not optimal for the collective progress of technology and science around the world.” 

The research also suggests that attempts to shut down foreign competition by restricting investment only moves collaboration elsewhere, making countries that engage in protectionism less competitive in the long run. 

For example, Xu suggests that restricting the sale of Chinese electric vehicles in Canada and the United States might protect domestic automakers in the short term but will likely make the North American auto industry less competitive over time. 

That’s because automakers in Europe and Asia, for example, will be able to adopt Chinese battery technology, build on it and even collaborate on future improvements.  

“Shutting international competitors out might make it look like you’re doing better domestically, but it’s not good for your long-term competitiveness on the international stage, because you prevent knowledge inflow into your own country,” Xu says. “You’re protecting yourself in one area at the expense of access to knowledge and talent in another area, and that might not happen until years later, but it can create long-term issues.”