NBER WORKING PAPER SERIES
FOREIGN COUNTERFEITING
OF STATUS GOODS
Gene M. Grossman
Carl Shapiro
Working Paper No. 1915
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
May 1986
Research support from the Alfred P. Sloan Foundation and the
National Science Foundation is gratefully acknowledged. The
research reported here is part of the NBER's research program in
International Studies. Any opinions expressed are those of the
authors and not those of the National Bureau of Economic Research.
Working Paper # 1915
May 1986
Foreign Counterfeiting of Status Goods
ABSTRACT
We study the positive and normative effects of counterfeiting, i.e.,
trademark infringement, in markets where consumers are not deceived by forgeries.
The fact that consumers are willing to pay more for counterfeits than for generic
merchandise of similar quality suggests that they value the prestige, or status,
associated with brand-name trademarks. Counterfeiters of status goods impose a
negative externality on consumers of genuine items, as fakes degrade the status
associated with a given label. But counterfeits allow consumers to unbundle the
status and quality attributes of the brand-name products, and alter the
competition among oligopolistic trademark owners. We analyze two policies
designed to combat counterfeiting: enforcement policy which increases the
likelihood of confiscation of illegal items, and the imposition of a tariff on
low-quality imports.
Gene H. Grossman
Carl Shapiro
Woodrow Wilson School
Woodrow Wilson School
Princeton University
Princeton University
Princeton, NJ 08544
Princeton, NJ 08544
(609) 452-4823
(609) 452-4847
I. INTRODUCTION
Counterfeit products account for a growing fraction of world trade. The
U.S. International Trade Commission (1984) and Business Week (1985), among
others, have documented the extent of illegal copying of the labels and other
distinguishing trademarks of brand-name products. These copies, often produced
in semi-industrialized countries where labor costs are low and the enforcement of
trademark-protection laws is lax, find an all-too-willing market among some
discount retailers in the developed countries. Trade officials and legislators
in the United States, Japat, and Western Europe have reacted with growing concern
to the expansion of this illegal activity, and are seeking new ways to control
the phenomenon. These countries individually have taken measures to increase
sanctions against importers of counterfeit goods and are bringing pressures to
bear on the governments of the source countries. Collectively, the developed
countries have agreed to make the drafting of an anti-counterfeiting code one of
the priority agenda items for the proposed upcoming round of GATT negotiations.
Despite the evident concern of the business and policy communities about the
increasing incidence of foreign counterfeiting, the practice has attracted little
attention from economists. This is somewhat surprising, in view of the
interesting and insightful crime-theoretic analyses that have been developed of
such related phenomena as smuggling and illegal immigration.1 In this paper,
which complements earlier work reported in Grossman and Shapiro (1986), we
continue our efforts to understand the causes and consequences of counterfeit-
product trade and the efficacy of alternative policies that might be used to
control it.
1.
See, for example, Bhagwati and Hansen (1973), Pitt (1981), Martin and
Panagariya (1984) and Ethier (1986).
-2-
For analytical purposes, we might regard the markets for counterfeit
products as being of two types. In one type of market, consumers cannot readily
observe the quality of the goods that they purchase, nor can they easily
distinguish copies from authentic merchandise. In these markets with
imperfectly-informed consumers, trademarks protect firms' investments in their
reputations, and counterfeiting represents an infringement on a firm's property
rights to its customers' goodwill. This practice, which we term deceptive
counterfeiting, was the subject of our earlier paper. In other markets, however,
consumers often know (or strongly suspect) when they are purchasing a
counterfeit. They distinguish fakes from legitimate, brand-name goods either by
close inspection, or because the legitimate producers can effectively signal
their authenticity by restricting and monitoring the distribution channels
through which their goods are sold. We investigate this type of non-deceptive
counterfeiting in the current paper.2
Why would a consumer knowingly purchase a counterfeit item? One possibility
is that the product offers good value for money in the light of its true quality
or usefulness. But this explanation raises the question of why the
counterfeiters would incur the risks associated with illegal copying, when in a
world of perfect information they could equally well compete for customers
lawfully.3 If the copies really were on a par with legitimate products but were
2.
In practice, of course, it may not be so easy to characterize markets for
counterfeit products as being of one sort or the other. Consumers may differ
in their ability to distinguish fakes, so that the same counterfeit good may be
purchased unwittingly by some but intentionally by others.
3.
Notice that we are drawing a distinction here between counterfeiting,
defined as the illegal copying of a brand-name label or other distinguishing
trademarks, and patent or copyright infringement, where the protected rights to
intellectual property are being violated. In instances of the latter
practices, the pirating firm
would not be able to compete for customers
lawfully, even though the copies may be equal in quality to the originals.
-3-
offered at a lower price, then consumers would prefer these to the branded
merchandise. In fact, counterfeits generally are of much lower quality than the
authentic goods that they imitate (see U.S. House of Representatives Committee on
Energy and Commerce, 1983). So the counterfeiters often compete instead in the
submarkets for low-quality goods. But there they suffer a cost disadvantage
relative to producers of generic products (i.e., those not associated with a
well-known manufacturer), who do not face the extra expenses associated with
mimicking the design and label of the brand-name goods and with any potential
penalties from being caught.
An alternative explanation is that the label and identifying design
characteristics (e.g., a logo, or a distinctive fabric pattern) are themselves of
value to consumers. Such is the case for status goods, i.e., those goods for
which the mere use or display of a particular branded product confers prestige on
their owners, apart from any utility deriving from their function. The
counterfeiting of status goods, then, deceives not the individual who purchases
the product, but rather the observer who sees the good being consumed and is duly
(but mistakenly) impressed.
The counterfeiting of status goods has a number of implications for the
functioning of these markets. First, counterfeiters unbundle the status and
quality aspects of the product, and thereby allow some consumers to purchase the
former who would not be willing to pay the high price of purchasing the two
together. Counterfeiters also dilute the market power of the producers of what
are, by definition, differentiated products. At the same time, the illegitimate
producers impose an externality on trademark holders by reducing the snob appeal
of their products. Legitimate firms are unable to offer their customers the
prestige associated with a small, select network of users, when a fringe of
imitators allows consumers with less discerning tastes to enter the club. These