The Welfare Effects of Government Intervention into the Licensing of Standard-essential Patents: An analysis of the Chinese smartphone and SoC markets

The licensing of standard-essential patents (“SEPs”) in the cellular communications field has been a contentious issue. In particular, Qualcomm’s licensing policies for cellular communication standards have been the subject of several lawsuits and episodes of government intervention. We evaluate the impact of the most drastic intervention to date: the Chinese government's 2015 decision to forcibly lower Qualcomm royalty rates by 1.23 – 1.75 percentage points. Using a simple theoretical model, we argue that such an intervention could have ambiguous effects on consumers. To quantify the policy's impact, we construct a structural econometric model of the Chinese smartphone and SoC markets which allows for strategic pricing in the two vertically-related markets. Counterfactual analysis using the estimated model allows us to quantify the intervention’s impact on smartphone manufacturers' marginal costs and product prices. Our simulation results indicate that the intervention caused an unequivocal increase in smartphone manufacturers' marginal costs (1.1 percent on average). However, this was more than offset by smartphone manufacturers' incentive to lower their prices under the reduced royalty rate, leading to a slight reduction in smartphone prices (0.6 percent on average). Taken together, these results suggest that the Chinese government's intervention had the intended effect on social welfare, although its magnitude was fairly limited.