THREE ESSAYS ON THE ECONOMICS OF AGRICULTURAL BIOTECHNOLOGY DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Denis A. Nadolnyak, M.A. * * * * * The Ohio State University 2003 Dissertation Committee: Approved by Professor Ian M. Sheldon, Adviser Professor Mario J. Miranda ____________________ Adviser Professor Barry K. Goodwin Department of AEDE ABSTRACT This dissertation consists of three essays on the economics of agricultural biotechnology. In the first essay, A Model of Diffusion of Genetically Modified Crop Technology in Concentrated Agricultural Processing Markets - The Case of Soybeans, a dynamic model of diffusion of a genetically modified (GM) crop technology is developed and simulated using the U.S. soybean market data. The model accounts for factors specific to agricultural markets, such as oligopsony power of crop processors, grower characteristics, and identity preservation requirements. Simulation results show how these factors affect the magnitude and distribution of the potential gains from adopting genetically modified crops. In particular, market power of crop processors decreases the equilibrium adoption levels and prolongs the diffusion period. Producer uncertainty and perception of the risks associated with planting GM crops increases equilibrium adoption levels but lengthens the diffusion period, thus making the welfare implications of such a situation ambiguous. Producer heterogeneity with respect to new crop profitability has different effects on the dynamics of the diffusion process, depending on the average profitability and other distribution parameters. The general conclusion is that, if GM crops are safe for human consumption and do not harm the environment, market power of the processors diminishes total surplus generated by the GM innovation. ii The second essay is called Valuation of International Patent Rights for Agricultural Biotechnology. In it, the choices that biotechnology companies make about marketing different genetically modified (GM) crops in different countries with highly uncertain returns are modeled as a real option problem of the entry decision solved at a micro-level by individual firms. The model is aggregated in order to reflect the heterogeneity of different genetic events, as well as different markets, in terms of their (potential) profitability. The solution to the model produces distributions of entry probabilities that are determined by the functional forms, and parameter values, that reflect different market environments and, thus, govern the evolution of stochastic returns from marketing. These proportions are then compared to the actual data on incidences of biotech firms entering foreign markets with different GM crops, and conclusions about the distribution of their patent values, evolution of returns, and efficiency of local intellectual property rights protection are drawn. In the third essay, Patent Policy Analysis for the Case of Agricultural Biotechnological Innovations, certain peculiarities of the process of development of agricultural biotechnological innovations are considered, in particular the distinction between an R&D race for a gene (genetic event) discovery and subsequent competition for developing the discovery’s marketable applications in the form of genetically modified crops. A formal model is specified and analyzed with regard to how different patent protection policies affect firms’ R&D strategies and social surplus from innovations. It is found that inclusive scope patent protection unambiguously encourages more R&D and faster innovation diffusion than the additional scope protection, which, in turn, is superior to length protection (which speaks in favor of U.S. patenting practices as iii compared to those of the European Union). Introduction of licensing into the model either preserves or reverses the ranking of protection regimes depending on the nature of licensing contracts. iv Dedicated to my wife v ACKNOWLEDGMENTS I wish to thank my adviser, Ian Sheldon, for intellectual support, encouragement, and enthusiasm which made this thesis possible, and for his patience in correcting my articles. I thank Mario Miranda for stimulating discussions of the issues pertaining to the second essay and for seriously helping me with the Matlab code for model solution. I am grateful to Barry Goodwin for discussing with me various aspects of my work and for encouragement. This research was supported in part by a grant from the National Research Initiative. I thank Ian Sheldon for his crucial assistance in this respect. I also thank my wife, Dr. Hartarska, for the motivation she provided me with and for the time and effort she spent making sure I was properly focused on my research. vi VITA September 11, 1971 …………………….Born – Nikolaev, Ukraine 1993……………. …………………………B.A. in Shipbuilding Engineering (second major Economics) Ukrainian State Maritime Technical University 1997………………. ……………………..M.A. in Economics (Honors) University of Essex, UK/Central European University 1998………………………………………...Graduate Teaching and Research Associate, The Ohio State University PRESENTATIONS AND PUBLICATIONS 1. Nadolnyak, D.A., and Sheldon I. M. A model of diffusion of genetically modified crop technology in concentrated agricultural processing markets. Working paper presented at the 10th EAAE Congress on Exploring Diversity in the European Agri-Food System in Zaragoza, Spain, August 28-31, 2002. 2. Nadolnyak, D.A., and Sheldon I. M. A Model of Development of Agricultural Biotechnological Innovations. Working paper presented at the Annual Meeting of the American Agricultural Economics Association in Los Angeles, July 28-31, 2002. 3. Nadolnyak, D.A., and Sheldon I. M. Effect of Different Patent Protection Regimes on the Efficiency of Research in Agricultural Biotechnology. Presentation at the Agricultural Economics Seminar, Department of Agricultural, Environmental, and Development Economics, The Ohio State University, May 2002. 4. Nadolnyak, D.A., and Sheldon I. M. Simulating the Effects of Adoption of Genetically Modified Soybeans in the U.S. Paper presented at the Annual Meeting of the American Agricultural Economics Association in Chicago, August 5-8, 2001. vii 5. Nadolnyak, D.A., and Sheldon I. M. Modeling Distributional Effects of Adoption of Genetically Modified Soybeans in the U.S. Paper presented at the Hawaii Conference on Business, Honolulu, June 14-17, 2001. 6. Nadolnyak, D.A. Adoption of GM Crops and Imperfections of Agricultural Markets. Presentation at an Agricultural Economics Seminar, Department of Agricultural, Environmental, and Development Economics, The Ohio State University, May 2001. 7. Nadolnyak, D.A. Oligopsony in Crop Processing Markets and Adoption of GMOs in Agriculture. Presentation at the Agricultural Economics Seminar, Department of Agricultural, Environmental, and Development Economics, The Ohio State University, February 2001. 8. Gonzalez-Vega, C., Graham, D.H., Nadolnyak, D.A., Hartarska, V.M., and Safavian, M. (1999) Financial Experience and Attitudes Towards Regulation of Micro and Small Enterprises in Russia: Preliminary Survey Results from Samara, Occasional Paper, The Ohio State University, September, 1999 (also presented at the FINCA workshop in Samara, Russia). 9. Nadolnyak, D.A. and Hartarska, V.M. (1999) Review of the Legal and Regulatory World for Private Entrepreneurs in Russia, Occasional Paper, The Ohio State University, Rural Finance Program, September, 1999. FIELDS OF STUDY Major Field: Agricultural, Environmental, and Development Economics viii TABLE OF CONTENTS Page Abstract.…………………………………………………………………………………..ii Dedication………………………………………………………………………………....v Acknowledgements……………………………………………………………………….vi Vita………………………………………………………………………………………vii List of Tables……………………………………………………………………………..ix List of Figures…………………………………………………………………………….x Essays: 1. Essay 1. A Model of Diffusion of Genetically Modified Crop Technology in Concentrated Agricultural Processing Markets - The Case of Soybeans…………………………………………………1 1.1. Introduction………………………………………………………………….2 1.2. The Mechanism of Diffusion…………………………………….…………..4 1.3. The Processors’ Game……………………………………………………....11 1.4. Calibration…………………………………………………………………..18 1.5. Simulation Results……………………………………………………….….20 1.6. Summary of the Results.………………………………………………….....31 2. Essay 2. Valuation of International Patent Rights for Agricultural Biotechnology: A Real Options Approach………………………………………………………..33 2.1. Introduction………………………………………………………………….34 2.2. Description of the Model…………………………………………………....38 2.3. Data Description and Analysis………………………………………………43 2.4. Simulation Results…………………………………………………………..52 2.5. Conclusions……………………………………………………………….....60 vi Page 3. Essay 3. Patent Policy Analysis for the Case of Agricultural Biotechnological Innovations……………………………………..62 3.1. Introduction………………………………………………………………...63 3.2. Gene Discovery R&D Race………………………………………………..66 3.3. Application Development and Introduction Stage…………………………70 3.4. Base Case…………………………………………………………………..72 3.4.1. Scope Patent Protection………………………………………….72 3.4.2. Length Patent Protection…………………………………………84 3.5. Extensions………………………………………………………………….89 3.5.1. Heterogeneity of Applications……………………………………89 3.5.2. Licensing………………………………………………………….90 3.6. Conclusions…………………………………………………………………98 Appendix A. technical solution of the dynamic oligopsony game in the first essay….………………………………………………………………102 Appendix B. derivations of the formulae