May 30, 2019
(This post first appeared on my Patreon page.)
I write about the possibility of producing drugs without patent monopolies frequently for several reasons. First, drugs can be essential for people’s health or even life. It should not be a struggle for people to pay for them. Second, there is a huge amount of money at stake, way more than in almost any other realm of public policy. Third, it is such a great example where government intervention, in the form of patents and related monopolies, creates the problem. This is not a story where we need the government to correct an inequity created by the market, we need the government to stop intervening in a way that creates tremendous inequities and inefficiencies.
I find that people (I mean people engaged in public policy work, not random people grabbed off the bus) have a hard time even understanding what the market for prescription drugs looks like in the absence of patent and related monopolies,[1] so I thought I would devote a blogpost to describing my view of such a world.
The first and most basic point is that in nearly all cases drugs would be cheap. Drugs are very rarely expensive to manufacture. They are expensive for patients because drug companies have patent or related monopolies and they use these monopolies to charge very high prices to the people who need their drugs. If there were dozens of competing manufacturers producing the same drug, they would be no better positioned to get away with charging incredibly high prices than a supermarket could get away with charging incredibly high prices for food. (We need food to survive, too.) They would be welcome to try, but almost everyone would simply turn to a competitor, likely driving them out of business.
We know that drugs are cheap in the absence of patent monopolies for two reasons. First, because generic prices in the United States are much less than brand prices. In addition, many of the high priced drugs sold with patent protection in the United States are sold as generics elsewhere in the world, in some cases for less than one percent of the price in the U.S.
According to data from the Association for Accessible Medicines, the trade group for the generic industry, brand drugs accounted for 74 percent of spending even though they were only 11 percent of the prescriptions sold. By contrast, generic drugs accounted for just 26 percent of spending even though they were 89 percent of sales. This implies that the average generic prescription cost just 3.6 percent of the price of the average brand prescription, or $29.70 per prescription in 2017. This figure would mean that we could save 96.4 percent of the money spent on brand drugs if we immediately got rid of protections and allowed them to be sold as generics.
But even this comparison understates the savings from eliminating patent and related protections. Many generics sell for high prices because they still benefit from some type of protection, most importantly, the first generic in the market has a six-month period of exclusivity in which no other generic can be introduced. This raises the average price of generics considerably, as the sole generic drug in a market is likely to sell for a price that is not too far below the price of the brand drug. Even after this period of exclusivity ends it will take some period of time for competition to push down the price to its true competitive level. By contrast, if the only protections involved the necessary safety approval by the Food and Drug Administration, or some equivalent foreign safety agency, newly approved drugs would quickly see substantial competition, pushing down their prices.
Internationally, some of the most expensive drugs are often available as generics in India or other developing countries, where the patents of U.S. or European companies were not considered valid. For example, in India, at a time when the Hepatitis C drug Solvadi (sofosbuvir) was selling at an average price of almost $50,000 per treatment, a generic was available for just $324. With some new drugs and treatments now costing in the hundreds of thousands or even millions of dollars, the generic equivalents may be less than one-tenth of one percent of the protected price in the United States.
This is a really huge deal, since no one would have to debate whether to take the best drug or available treatment if they carried price tags in the hundreds of dollars. Cost does become a serious issue when we are talking hundreds of thousands of dollars. If the gain is just months or a year in additional life expectancy, arguably an insurer or the government should not pick up the tab, but this issue becomes a no-brainer when drugs are sold in a free market.
We know that we have to pay for the research involved in developing drugs, which is costly. I’ll come to that shortly, but first we have to recognize the enormous problems that are needlessly created by the patent monopoly mechanism for financing research. We would not be struggling to find ways to make drugs affordable if they were available in a free market.
This is analogous to paying for firefighters when they show up at your burning house with your family inside. In that case we would all pay the firefighters whatever we had to in order to save our families, and of course we would be happy they were there to do it. But no one thinks that is a sensible way to pay for fire protection, and it is not a sensible way to pay for research that was typically already done long ago.
And, there is huge money at stake here. In the case of prescription drugs alone the United States will spend more than $460 billion in 2019 for drugs which would almost certainly sell for less than $80 billion in a free market.[2] The difference of $380 billion is more than five times annual spending on food stamps. It is almost 9.0 percent of the federal budget. It is very rare that we have a policy debate over an issue involving this much money. By comparison, the Trump tax cut came to around $150 billion a year.[3]
In addition, we also prop up the prices of non-prescription drugs, medical supplies, and medical equipment. Removing patent monopolies in these other medical related areas would almost certainly save at least $100 billion more annually relative to current spending levels. Here too, the monopoly pricing distorts medical decisions. Perhaps an MRI would be the best scan for a patient, but since the charge can be ten times higher than a simple X-Ray, a doctor orders the latter to save a patient (or insurer) money. Of course, if there were no patent monopolies there would be little difference in the cost of the latest scanning technology and the cost of an X-Ray, so the doctor would presumably order the one they thought would be best under the circumstances.
Patent Monopolies Give Incentives to Lie
I was going to use a more polite term than “lie,” but why not be accurate? The idea of a patent monopoly is that being able to sell a product at a price that is far above the free market price provides an incentive to innovate. This is true, but it also provides a huge incentive to push a drug even in circumstances where it is not the best treatment. It gives an incentive to push drugs even in situations where they could be harmful, as is alleged to be the case with Purdue Pharma and OxyContin.
While the story with OxyContin is an extreme case, it is hardly an exception. It is a routine practice for drug companies to push their drugs as widely as possible, often concealing evidence that they may be less effective than promised or even harmful in some circumstances. To push drugs, pharmaceutical companies routinely make payments to doctors to promote off-label uses of their drugs. (This is illegal if done explicitly, but there are many ways around the legal ban.) They also pay doctors to be fronts for articles submitted to journals that they didn’t write.
Take away the patent monopoly and you take away the incentive to deceive doctors and patients about the effectiveness and safety of drugs. Furthermore, if drug research was publicly financed and paid for upfront, all the findings and clinical test results would be in the public domain, so any researcher, clinician, or even a knowledgeable patient would be in a position to evaluate the merits of particular drug.
Public Financing, the Alternative to Patent Monopolies
The drug companies, and many economists, would have us believe that we could not get productive research into the development of new drugs without patent monopolies. The idea that people would work for money, instead of patents, strikes them as bizarre.
Being an old-fashioned economist, I am still inclined to think that medical researchers might be persuaded to work for money. Here is what a system of publicly financed research could look like.
We can have sizable master contracts (e.g. $1-$5 billion annually) with a limited number of prime contractors who commit themselves to doing research in specific areas (e.g. cancer treatments, heart disease, etc). This is similar to the way the Defense Department puts out contracts. A condition of getting the money is that all results are posted on the web as soon as practical and all patents are held by the government to be available on copyleft rules.[4] The master contractors could freely contract out work with smaller companies or start-ups, but the rules on posting results and copyleft patents would apply to them as well.
Note that a huge advantage in financing biomedical research this way, as opposed to research on weapons systems, is that there is no excuse for secrecy. There is a legitimate argument for not posting the latest weapons research on the web. Military contractors routinely exaggerate the need for secrecy, which creates an opportunity for much of the fraud corruption we see in defense contracting. It is worth noting that even with these problems, the U.S. is still able to develop very good weapons systems through this mechanism.
While the master contracts would allow considerably leeway to companies to pursue areas they considered promising, they would have incentive to produce real results, since presumably they would want their contract renewed and expanded when they reached their end dates. In this case, the results would mean not only successful drugs, but also discoveries that were later used by others to produce successful treatments. In the current system, the party that gets the key patent will get the big money, but there is little reason to believe that this is also the party that made the most important scientific breakthrough.
The U.S. industry currently spends around $70 billion a year on research worldwide according to data from the National Science Foundation. Presumably we would need to spend roughly the same amount on publicly funded research to get comparable results, in addition to the $45 billion we now spend each year on research through the National Institutes of Health (NIH). This is less than one-fifth of the savings I calculate from having drugs available at free market prices. It is also very possible that a publicly funded system will be more efficient because of its openness (we usually think that science advances more quickly when it is open), but that should not be assumed in planning.
The path to free market drugs is also not an all or nothing story, we can get there piecemeal. The government could allocate a smaller amount of funds for developing drugs in specific areas, such as treating cancer or diabetes, with the rules of open research and copyleft patents. (In fact, if some billionaire philanthropist ever took an interest in public health, they could do this themselves.)
In this case, the industry would be totally free to continue with their current path. They would just face the risk that the next time they bring a new drug to the market it will be competing with a new generic that is as good or better and selling for one percent of the price. Their argument against the public contracting route is that research supported this way would prove useless because somehow public funding is the same as throwing money in the toilet. Of course, they argue that the funding for NIH is money very well spent. Somehow when the research money is intended to compete with them rather than subsidize them, it becomes useless.
We would naturally have to develop some method for sharing research costs internationally. This will be difficult, but anyone familiar with trade negotiations over the last quarter century knows that the current system also faces problems in international negotiations.
Conclusion
It is absurd to expect people in bad health and/or their families to come up with the money to pay for research that was done long ago. There is no way on earth that anyone designing a mechanism for financing drug research would come up with anything like the patent monopoly system that we have today.
We should move away from it as quickly as possible to a system of upfront funding for open research. While this can be done piecemeal, it does require some new thinking, and in policy circles that is unfortunately very rare.
[1] Patent monopolies are the most important form of government granted protection for prescription drugs, but there are a variety of other mechanisms that the government also uses. The most important of these is data exclusivity, which prevents generic, or biosimilar drugs in the case of biological drugs, drugs from gaining approval based on the test data of the brand drug. The government will also grant a six-month period of additional exclusivity for a drug, if the company performs a pediatric trial. For a blockbuster drug, this could mean hundreds of millions of dollars in addition for a trial that may involve less than 100 children.
[2] Data on drug spending can be found in the National Income and Product Accounts, Table 2.4.5U Line 121.
[3] There have been some well-publicized incidents of companies jacking up the price of generic drugs. While there are definitely some issues where the government has allowed excessive concentration in the generic industry, there is little doubt that the overwhelming majority of spending is on brand drugs. But even without government-granted patent monopolies, we still need anti-trust policy.
[4] This means that anyone can freely use the patents as long as anything they produce is itself in the public domain or has a copyleft patent.
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