Beat the Press

Beat the press por Dean Baker

Beat the Press is Dean Baker's commentary on economic reporting. He is a Senior Economist at the Center for Economic and Policy Research (CEPR). To never miss a post, subscribe to a weekly email roundup of Beat the Press. Please also consider supporting the blog on Patreon.

Paul Krugman’s column this morning raises the issue of whether China is on the edge of seeing a real estate bubble burst, in the same way that Japan saw its real estate and stock bubble burst in 1990. Krugman points out that this did lead to slower growth for Japan, but it was not an economic catastrophe, as it still saw rises in GDP, relative to its working-age population, that was comparable to the US. (I would add that one reason why Japan did not see more GDP growth is that, unlike the US, it had a sharp reduction in the length of the average work year over the last three decades. This means workers were taking some of the benefits of productivity growth in more leisure time rather than higher income.)

Krugman points out that China is seeing a similar demographic story, where its working-age population is shrinking and there is no longer a massive migration of people from the countryside to the cities, as well over 60 percent of the population already lives in urban areas. He argues that this will lead to major problems for China, since it currently spends over 40 percent of GDP on investment, compared to just over 20 percent in the US. His point is that there will be much less need for investment with a shrinking workforce and slower growth in the size of cities.

All of this is true, and the points are well-taken, but it is worth thinking more carefully about the nature of the problem being described. Krugman is arguing that China will have little reason to spend 40 plus percent of GDP on investment, given its current demographics. This means that China will have an enormous amount of unused resources, which could translate into mass unemployment in the absence of an effective government response. In short, this is a story of seriously inadequate demand.

One great way to create demand would be to spend large amounts of money shifting to electric cars, clean energy, and other expenditures designed to reduce greenhouse gas emissions. China already leads the world by far in the production of wind and solar energy and the number of electric cars on the road. But, as the world’s biggest emitter of greenhouse gases (on a per-person basis, it still emits around one-third of the US), it can clearly go much further. Whether China chooses to go this route will be a political decision, but the fact that the investment share of GDP is so excessive means that it can hugely increase spending on going green, without requiring any reduction in consumption spending at all.

This gets us to the famous “which way is up?” problem in economics. Economics is usually concerned about inadequate supply. In fact, in the old days, many introductory textbooks began by telling students something to the effect of “economics is the science of allocating scarce resources to competing ends.” (The textbooks may still say that, but I haven’t looked at any lately.)

But the story Krugman is describing for China (and Japan) is exactly the opposite problem. The country is producing more than it knows what to do with, which creates the risk that millions, or even tens of millions, of workers may end up unemployed due to lack of adequate demand in the economy.

Anyhow, it is worth pointing out this distinction. It is also worth noting that insofar as many countries around the world, including the United States, seem to be facing this problem of inadequate demand (a.k.a. “secular stagnation”), spending money on greening the economy is a great way to keep people employed.

Paul Krugman’s column this morning raises the issue of whether China is on the edge of seeing a real estate bubble burst, in the same way that Japan saw its real estate and stock bubble burst in 1990. Krugman points out that this did lead to slower growth for Japan, but it was not an economic catastrophe, as it still saw rises in GDP, relative to its working-age population, that was comparable to the US. (I would add that one reason why Japan did not see more GDP growth is that, unlike the US, it had a sharp reduction in the length of the average work year over the last three decades. This means workers were taking some of the benefits of productivity growth in more leisure time rather than higher income.)

Krugman points out that China is seeing a similar demographic story, where its working-age population is shrinking and there is no longer a massive migration of people from the countryside to the cities, as well over 60 percent of the population already lives in urban areas. He argues that this will lead to major problems for China, since it currently spends over 40 percent of GDP on investment, compared to just over 20 percent in the US. His point is that there will be much less need for investment with a shrinking workforce and slower growth in the size of cities.

All of this is true, and the points are well-taken, but it is worth thinking more carefully about the nature of the problem being described. Krugman is arguing that China will have little reason to spend 40 plus percent of GDP on investment, given its current demographics. This means that China will have an enormous amount of unused resources, which could translate into mass unemployment in the absence of an effective government response. In short, this is a story of seriously inadequate demand.

One great way to create demand would be to spend large amounts of money shifting to electric cars, clean energy, and other expenditures designed to reduce greenhouse gas emissions. China already leads the world by far in the production of wind and solar energy and the number of electric cars on the road. But, as the world’s biggest emitter of greenhouse gases (on a per-person basis, it still emits around one-third of the US), it can clearly go much further. Whether China chooses to go this route will be a political decision, but the fact that the investment share of GDP is so excessive means that it can hugely increase spending on going green, without requiring any reduction in consumption spending at all.

This gets us to the famous “which way is up?” problem in economics. Economics is usually concerned about inadequate supply. In fact, in the old days, many introductory textbooks began by telling students something to the effect of “economics is the science of allocating scarce resources to competing ends.” (The textbooks may still say that, but I haven’t looked at any lately.)

But the story Krugman is describing for China (and Japan) is exactly the opposite problem. The country is producing more than it knows what to do with, which creates the risk that millions, or even tens of millions, of workers may end up unemployed due to lack of adequate demand in the economy.

Anyhow, it is worth pointing out this distinction. It is also worth noting that insofar as many countries around the world, including the United States, seem to be facing this problem of inadequate demand (a.k.a. “secular stagnation”), spending money on greening the economy is a great way to keep people employed.

John Abramson has done much to expose the abuses of the pharmaceutical industry over the years. He played a key role in the investigation of Vioxx and the litigation that eventually led the drug to be pulled from the market, as well as billions of dollars to be paid in settlements by Merck, its manufacturer. He has also helped to expose numerous conflicts of interest between regulators, medical journals and drug companies. His 2008 book Overdosed America, helped to call these and other abuses to the attention of a larger audience.

For this reason, there is good cause to expect that his new book, Sickening: How Big Pharma Broke American Health Care and How We Can Repair It, would make a substantial contribution to the current debate over controlling drug prices. (Unfortunately, its publication date is not until February.) The book is indeed useful in documenting the failures of the pharmaceutical industry, but it comes up painfully short in the remedies.

The first part of the book goes over some of the major scandals of the pharmaceutical industry over the last three decades. It notes the overuse of statins, a drug designed to lower cholesterol. Abramson points out that statins are often prescribed for women, based on clinical trials showing their effectiveness for men. In spite of the lack of evidence of benefit, expensive statins have been prescribed for millions of women over the last three decades.

He also recounts the history of insulin, where a simple and cheap drug, invented almost a hundred years ago, has been repeatedly modified in ways that make it hugely more expensive with limited, if any, benefit for most diabetes patients. He also goes over the story of Vioxx, where the issue was that Merck deliberately withheld evidence that its new arthritis drug could increase the risk of heart attacks and strokes for people with heart conditions. And, he goes through the accounts of how drug companies misrepresented the evidence on the addictiveness of the new generation of opioids, contributing to the opioid crisis the country has experienced over the last quarter century.

The second part of the book gives an account of how drug companies are able to deceive doctors about the safety and effectiveness of their drugs. The gist of the story is that the sources that doctors rely on for information are effectively compromised by their ties to the industry. For example, the FDA committees that make recommendations on a drug’s approval typically include members who have received payments from the company whose drug they are evaluating.

This turns out to be the same for medical journals, which often run articles where the referees and editors do not have full access to the clinical trial data on which they are based. And, researchers at universities and other non-profit institutions are heavily dependent on grants from the pharmaceutical industry.

All the sources that doctors may turn to for reliable information turn out to face considerable pressure to push the industry line. As a result, they routinely end up prescribing expensive new drugs for conditions where they may not be useful and may in any case be no more effective than older, cheaper drugs.

The first two parts of the book are very useful and important, it is the third part, giving remedies, that falls short. Abramson repeatedly blames the pharmaceutical companies’ pursuit of profit for the industry’s problems and sees increased government regulation as the solution.

While all of his proposals would be positive changes, he somehow misses the real story. We should take it as a given that drug companies, like other companies, will pursue profit. The issue is how the government has structured the industry and its ability to make profits.

Specifically, it is government-granted patent monopolies that allow the industry to make large profits by promoting drugs that are ineffective or even dangerous. As long as we leave this structure intact, we will be fighting an uphill battle in containing abuses. We can think of the effort as being analogous to the war on drugs or prohibition. If there is a lot of money to be made by getting around the law, creative and highly motivated people will find ways to do so.

The obvious alternative to patent monopoly financing of research is public financing. It’s not as though the idea of publicly financing of research is alien to Abramson, he talks about the massive contribution of publicly funded research to the development of the mRNA vaccines against Covid in his introduction. But for some reason, the public alternative to patent monopoly financed research is missing from his list of remedies.

There are better and worse ways to structure a system of publicly financed research, but it should be easy to see that this route would eliminate pretty much all of the problems identified in the book. (My preferred route is a system of long-term contracts, similar to the way the Pentagon pays for the development of weapons systems. I discuss this in chapter 5 of Rigged [it’s free].)[1]  

If the research is paid for by the government, a condition of the funding should be that everything is fully public as soon as practical. A great model here is the Bermuda Principles researchers adopted in the Human Genome Project. All results were posted nightly.

This one is very simple and straightforward, if a researcher took the money, the public owns the results. This means both findings from pre-clinical research, as well as results from clinical trials. And, these results mean not just summary data on trial outcomes, but anonymized data on individual participants, so that other researchers can freely examine the results and come to their own assessments.

In this world, since all drugs would be available as generics from the day they are approved, no one would have any incentive to make false claims about the benefits of specific drugs. Doctors could be confident that the articles they are reading in medical journals are not biased by financial interests. Similarly, the FDA would not be facing pressure to approve drugs by someone with money on the line. Manufacturers of generic drugs make profits, but they have little stake in pushing one drug rather than another.

Finally, drugs would be cheap. It’s very rare that a drug is expensive to manufacture and distribute. If all drugs were being sold as generics, we would likely be spending less than 20 percent of the $500 billion we now pay for drugs each year. The savings come to roughly $3,000 a year for every family in the country. Also, patients would not be in a situation where their finances prevented them from getting a drug that was needed for their health.

It is frustrating that someone who has spent so much time researching the pharmaceutical industry and is so aware of its problems, as John Abramson, backs away from the obvious solution. The horrors of the pharmaceutical industry are the predictable result of how we have chosen to structure the market. The solution is to structure the market differently and take away the patent monopolies.    

[1] For those who are thinking of abuses in military contracting, let me make two quick points. While secrecy in military contracts is excessive, there are legitimate grounds for not posting the plans for our latest weapon systems on the web. There are no legitimate grounds for not sharing research on cancer or AIDS drugs. The other point is that we do actually get good weapons systems. So we may pay too much for the latest fighter or tank, but the research does produce the desired outcome.  

John Abramson has done much to expose the abuses of the pharmaceutical industry over the years. He played a key role in the investigation of Vioxx and the litigation that eventually led the drug to be pulled from the market, as well as billions of dollars to be paid in settlements by Merck, its manufacturer. He has also helped to expose numerous conflicts of interest between regulators, medical journals and drug companies. His 2008 book Overdosed America, helped to call these and other abuses to the attention of a larger audience.

For this reason, there is good cause to expect that his new book, Sickening: How Big Pharma Broke American Health Care and How We Can Repair It, would make a substantial contribution to the current debate over controlling drug prices. (Unfortunately, its publication date is not until February.) The book is indeed useful in documenting the failures of the pharmaceutical industry, but it comes up painfully short in the remedies.

The first part of the book goes over some of the major scandals of the pharmaceutical industry over the last three decades. It notes the overuse of statins, a drug designed to lower cholesterol. Abramson points out that statins are often prescribed for women, based on clinical trials showing their effectiveness for men. In spite of the lack of evidence of benefit, expensive statins have been prescribed for millions of women over the last three decades.

He also recounts the history of insulin, where a simple and cheap drug, invented almost a hundred years ago, has been repeatedly modified in ways that make it hugely more expensive with limited, if any, benefit for most diabetes patients. He also goes over the story of Vioxx, where the issue was that Merck deliberately withheld evidence that its new arthritis drug could increase the risk of heart attacks and strokes for people with heart conditions. And, he goes through the accounts of how drug companies misrepresented the evidence on the addictiveness of the new generation of opioids, contributing to the opioid crisis the country has experienced over the last quarter century.

The second part of the book gives an account of how drug companies are able to deceive doctors about the safety and effectiveness of their drugs. The gist of the story is that the sources that doctors rely on for information are effectively compromised by their ties to the industry. For example, the FDA committees that make recommendations on a drug’s approval typically include members who have received payments from the company whose drug they are evaluating.

This turns out to be the same for medical journals, which often run articles where the referees and editors do not have full access to the clinical trial data on which they are based. And, researchers at universities and other non-profit institutions are heavily dependent on grants from the pharmaceutical industry.

All the sources that doctors may turn to for reliable information turn out to face considerable pressure to push the industry line. As a result, they routinely end up prescribing expensive new drugs for conditions where they may not be useful and may in any case be no more effective than older, cheaper drugs.

The first two parts of the book are very useful and important, it is the third part, giving remedies, that falls short. Abramson repeatedly blames the pharmaceutical companies’ pursuit of profit for the industry’s problems and sees increased government regulation as the solution.

While all of his proposals would be positive changes, he somehow misses the real story. We should take it as a given that drug companies, like other companies, will pursue profit. The issue is how the government has structured the industry and its ability to make profits.

Specifically, it is government-granted patent monopolies that allow the industry to make large profits by promoting drugs that are ineffective or even dangerous. As long as we leave this structure intact, we will be fighting an uphill battle in containing abuses. We can think of the effort as being analogous to the war on drugs or prohibition. If there is a lot of money to be made by getting around the law, creative and highly motivated people will find ways to do so.

The obvious alternative to patent monopoly financing of research is public financing. It’s not as though the idea of publicly financing of research is alien to Abramson, he talks about the massive contribution of publicly funded research to the development of the mRNA vaccines against Covid in his introduction. But for some reason, the public alternative to patent monopoly financed research is missing from his list of remedies.

There are better and worse ways to structure a system of publicly financed research, but it should be easy to see that this route would eliminate pretty much all of the problems identified in the book. (My preferred route is a system of long-term contracts, similar to the way the Pentagon pays for the development of weapons systems. I discuss this in chapter 5 of Rigged [it’s free].)[1]  

If the research is paid for by the government, a condition of the funding should be that everything is fully public as soon as practical. A great model here is the Bermuda Principles researchers adopted in the Human Genome Project. All results were posted nightly.

This one is very simple and straightforward, if a researcher took the money, the public owns the results. This means both findings from pre-clinical research, as well as results from clinical trials. And, these results mean not just summary data on trial outcomes, but anonymized data on individual participants, so that other researchers can freely examine the results and come to their own assessments.

In this world, since all drugs would be available as generics from the day they are approved, no one would have any incentive to make false claims about the benefits of specific drugs. Doctors could be confident that the articles they are reading in medical journals are not biased by financial interests. Similarly, the FDA would not be facing pressure to approve drugs by someone with money on the line. Manufacturers of generic drugs make profits, but they have little stake in pushing one drug rather than another.

Finally, drugs would be cheap. It’s very rare that a drug is expensive to manufacture and distribute. If all drugs were being sold as generics, we would likely be spending less than 20 percent of the $500 billion we now pay for drugs each year. The savings come to roughly $3,000 a year for every family in the country. Also, patients would not be in a situation where their finances prevented them from getting a drug that was needed for their health.

It is frustrating that someone who has spent so much time researching the pharmaceutical industry and is so aware of its problems, as John Abramson, backs away from the obvious solution. The horrors of the pharmaceutical industry are the predictable result of how we have chosen to structure the market. The solution is to structure the market differently and take away the patent monopolies.    

[1] For those who are thinking of abuses in military contracting, let me make two quick points. While secrecy in military contracts is excessive, there are legitimate grounds for not posting the plans for our latest weapon systems on the web. There are no legitimate grounds for not sharing research on cancer or AIDS drugs. The other point is that we do actually get good weapons systems. So we may pay too much for the latest fighter or tank, but the research does produce the desired outcome.  

The Biden administration, with the overwhelming support of the foreign policy establishment, seems determined to start a new Cold War with China. A new Cold War is likely to be bad news from the standpoint of inequality, world peace, and the climate crisis facing the planet. As with the last Cold War, it is likely to be driven by misunderstandings and deliberate misinformation. With so much at stake, it is important to head off a new Cold War, most importantly by correcting many misconceptions and laying out an alternative more productive path for future relations with China.

I will briefly go through the history of the economic relationship between China and the U.S. in the last two decades. Then I will describe the implications for inequality for the path Biden seems to be pursuing. The last part outlines an alternative, more cooperative path for relations with China.

The Trade Deficit with China: Donald Trump’s Phony War

China was admitted to the World Trade Organization in 2000 after a major battle in Congress over granting the country Permanent Normal Trading Relations (PNTR), which was necessary for its admission. Much of the opposition came from the labor movement which argued that opening trade to China would lead to a large expansion of the trade deficit, costing manufacturing jobs. Since manufacturing had historically been a source of high-paying jobs for workers without college degrees, this would put downward pressure on the pay of non-college-educated workers more generally.

The mainstream of the economic profession ridiculed the idea that expanding trade with China could lead to any substantial job loss. For example, Gary Hufbauer, a prominent trade economist with the Peterson Institute for International Economics, dismissed the “extravagant claims” from the Economic Policy Institute (my former employer) that PNTR for China could lead to a loss of 813,000 jobs.

“The Economic Policy Institute (http://www.EPI.org) has advanced the most extravagant claims about the US bilateral trade deficit with China. Based on a count of 13,000 jobs lost per billion dollars of manufactured imports, the EPI asserts that current trade with China already costs the United States 880,000 high-wage manufacturing jobs. Then, extrapolating the US ITC’s estimate of the one-time percentage import and export trade changes for 10 years, the EPI asserts another 817,000 US jobs will be eliminated through PNTR and Chinese membership in the WTO.”

This dismissive attitude was common in the profession at the time. PNTR passed by a relatively narrow 237 to 197 vote in the House (the Senate margin was much wider). The near-unanimous support from the mainstream of the economic profession was almost certainly an important factor in determining the outcome of this vote.

Contrary to the predictions of Hufbauer and other mainstream economists, the trade deficit in goods with China did in fact rise rapidly, growing from $68.7 billion in 1999 to $418.2 billion in 2018.[1] The story behind this increase is not complicated. In simple trade stories, when a country is running a large trade surplus with another country, we expect that the value of the currency of the surplus country will rise relative to the value of the deficit country. This makes the items produced in the surplus country relatively more expensive in international markets while making the items produced in the deficit country relatively cheaper.

That sort of currency adjustment did not happen for the simple reason that China’s government did not allow it to happen. China’s central bank bought up several trillion dollars of US government bonds and other dollar assets in the first decade of the century.[2] This propped up the dollar, thereby preventing the sort of currency adjustment that we might expect between a country running a large trade deficit and a country running a large surplus.

At the time, many other developing countries also effectively tied their currencies to the renminbi to maintain their competitive position relative to China. When China raised the value of its currency against the dollar, countries like Vietnam and Thailand also raised the value of their currency. This meant that China’s decision to deliberately maintain an undervalued currency meant that other countries also under-valued their currency relative to the dollar, leading to higher trade deficits with these countries as well.

The explosion in the trade deficit led to a sharp drop in manufacturing employment between 2000 and 2007, before the start of the Great Recession. The country lost more than 3.5 million manufacturing jobs between December of 1999 and December of 2007, the official start date of the Great Recession. (It lost another 2.3 million between December 2007 and February 2010, the employment trough of the Recession.)[3]

While manufacturing had been falling as a share of total employment since the start of the 1970s, actual levels of employment had changed little, apart from cyclical fluctuations, until the 2000s. From December of 1970 to December of 1999 the sector lost less than 30,000 jobs. This is shown in Figure 1. By contrast, the job loss associated with the rise in the trade deficit from 1999 to 2007 amounted to more than 20 percent of total employment in the sector. Autor, Dorn, and Hansen (2016) put the job loss associated with trade with China alone at 2.0 million.

 

The massive job loss in manufacturing had a predictable effect on wages. Many of the higher-paying union jobs were the ones that disappeared as the economy became more open to trade in manufactured goods. In other cases, workers were forced to take pay cuts to keep their jobs. The extent to which manufacturing offered higher-paying jobs for workers (mostly male workers) without college degrees, declined substantially over this period, as both the number of jobs and wage premium fell sharply.

 

Source; Bureau of Labor Statistics.

Figure 2 shows the real average hourly wage for production and non-supervisory workers in the private sector as a whole and for the manufacturing sector. As can be seen, workers in manufacturing enjoyed a 2.7 percent advantage by this measure in 1999. This imbalance flipped as the trade deficit expanded. By 2020, the average hourly wage for production and non-supervisory workers in manufacturing was 7.6 percent below the average for the private sector as a whole.

These numbers measure only money wages and ignore benefits, which still tend to be higher in manufacturing than elsewhere in the economy. However, even when these benefits are factored in, we have almost certainly a sharp decline in the manufacturing premium. In an analysis that attempted to factor in benefits, Mishel (2018) found a 7.8 percent straight wage premium for non-college-educated workers for the years 2010 to 2016, in an analysis that controlled for age, race, and gender, and other factors. That compares to a premium for non-college-educated workers of 13.1 percent in the 1980s.

The analysis found that differences in non-wage compensation added 2.6 percentage points to the manufacturing wage premium for all workers, but the compensation differential may be less for non-college-educated workers since they are less likely to get health care coverage and retirement benefits. Since the ratio of money wages in manufacturing to the rest of the economy has continued to fall sharply in the years since this analysis, the manufacturing wage premium would almost certainly be far less in 2021.

There is one other important point on the quality of manufacturing jobs that is worth noting here. The unionization rates in manufacturing have plummeted over this period. In 2000, 14.9 percent of workers in manufacturing were union members compared to 9.0 percent for the private sector as a whole. The percent of union members in manufacturing had fallen to just 8.5 percent in 2020, only slightly higher than the 6.3 percent average for the private sector as a whole.

Also, the new jobs that have been created in manufacturing since the trough of the Great Recession have overwhelmingly not been union jobs. Until the pandemic hit in March of 2020, we had added back more than 1.6 million manufacturing jobs from the employment trough of the Great Recession in 2010. Nonetheless, the number of union members in manufacturing had fallen by almost 900,000.

This history is important because it shows that trade in general, and with China in particular, did have a very negative impact on the labor market prospects for a large segment of the working class. However, there are two important qualifications to the simple story that Donald Trump and his supporters are inclined to tell.

First, this is not a story of China winning and the US losing. The trade deficit was not about China doing evil things behind the back of the political leadership in the United States. The trade deficit was a story of both US manufacturers outsourcing to take advantage of low-cost labor in China and major retailers like Walmart setting up low-cost supply chains as a way to undercut their competition.

The manufacturers that were able to get cheap labor from China were big gainers from the trade deficit, as were Walmart and other major retailers. Also, workers who were not directly affected by the loss of manufacturing jobs, such as doctors, lawyers, and other highly paid professionals, benefitted from lower-cost manufactured goods, as well as lower-cost services in many areas due to downward pressure on the wages of less-educated workers.

For this reason, it is wrong to treat this period as a story of China winning its trade battles with the United States. China gained from its trade with the United States, but so did the top end of the income distribution in the United States.

The other important qualification is that this history is not reversible. The manufacturing premium for less-educated workers was largely a story of its extraordinary rates of unionization. Now that the sector does not have an especially high rate of unionization, the premium has been largely eliminated. And, as we have added back jobs in manufacturing, they have not been union jobs.

For these reasons, there is little reason to prefer jobs in manufacturing over jobs in any other sector of the economy. In the past, the fact that manufacturing jobs were more likely to be high-paying union jobs was a good reason to focus on preserving them and seeking to make the manufacturing sector a larger share of the economy. This is no longer true.

The Get Tough with China Approach: Protectionism for the Highly Paid

The Biden administration has made clear that it intends to block imports from China in many high-tech sectors. While some restrictions can be justified as necessary to protect military technologies, it is clear that these protections are mainly for economic reasons.

For example, the Biden administration pushed through a bill that would provide more than $50 billion in subsidies to the semiconductor industry over the next five years. It also is planning a program for pandemic preparedness that would spend more than $40 billion over the next decade developing vaccines, treatments, and tests that could be used in future pandemics. It has also left in place a wide variety of tariffs on Chinese imports, including an 18 percent tariff on solar panels, which is not helping the shift away from fossil fuels.

The subsidies for promoting technology in certain sectors are not necessarily bad economic policy. The US economy has benefitted enormously from publicly supported research and development in a wide range of areas including pharmaceuticals, aerospace, agriculture, and computers and software. There is likely to be a large dividend from future spending on research and development.

The key issue here is who will have control over the products developed with this money and how it is being promoted as a competition with China. At this point, there are not clear guidelines on how the Biden administration envisions ownership rights to the publicly funded R&D he is proposing, but there is little reason to believe that he envisions moving away from the current pattern. As it stands, the government puts up the funds for much of the most important, and risky, research, and then private corporations are able to benefit by claiming ownership of the finished product.

This sort of story can be seen most clearly in the case of Moderna and the mRNA vaccine it developed last year. The Trump administration, through Operation Warp Speed, paid Moderna over $400 million to cover the cost of developing a vaccine and its initial Phase 1 and 2 trials. It then paid over $450 million to pay for the larger Phase 3 trials, in effect fully covering Moderna’s cost for developing a vaccine and bringing it through the FDA’s approval process.

It was necessary for Moderna to do years of research so that it was in a position to quickly develop an mRNA vaccine, but even here the government played a very important role. Much of the funding for the discovery and development of mRNA technology came from the National Institutes of Health. Without its spending on the development of this technology, it is almost inconceivable that any private company would have been in a position to develop an mRNA vaccine against the coronavirus.

In spite of this massive contribution from the public sector, Moderna has complete control over its vaccine and can charge whatever price it wants. It is likely to end up with more than $20 billion in profit from sales of its coronavirus vaccine. According to Forbes, the vaccine had made at least three Moderna billionaires by the middle of 2021, with the company’s CEO, Stephane Bancel, leading the way with an increase in his wealth of $4.3 billion. The company’s market capitalization was almost $180 billion on September 22, up from just over $7 billion before the start of the pandemic.

If this is the model for the way public investments in R&D are treated going forward, then we can expect to see many more millionaires and billionaires created as a result of Biden’s spending. Needless to say, there will be no shortage of economists and other policy types insisting that these extremes of wealth are just the inevitable result of technology, just as there was no shortage of policy types anxious to blame the huge loss of manufacturing jobs in the first decade of this century on technology.

There will be some number of manufacturing jobs created as a result of this initiative. Someone has to manufacture the semi-conductors, vaccines, and other products developed with this funding and there is probably a greater likelihood that these factories will be located in the United States as a result of Biden’s policies.

However, this is not much consolation. With manufacturing no longer providing a substantial wage premium for workers without college degrees, there is no more reason to value manufacturing jobs in these sectors than jobs in warehouses, distribution centers, or health care. With the right institutional support, any job can be a high-paying job, there is no reason to especially prize the manufacturing jobs that might be created through this initiative.

In short, this is yet another path for furthering the upward redistribution we have been seeing for the last four decades. It is ironic that our policy elites have managed to flip 180 degrees on their core economic principles to continue the drive for upward redistribution. In the decade from 2000 to 2010, when “free trade” with China cost millions of manufacturing jobs and put downward pressure on the pay of less-educated workers more generally, free trade was a sacred mantra in elite policy circles.

Now that China is in a situation to pose a real threat in our most advanced industries, costing jobs of engineers, biochemists, and other highly educated workers, our elites are gung ho on a protectionist agenda to confront China. And, we are supposed to believe that it is just a coincidence that the main winners on both sides of this flip are those at the top of the income ladder.

It is also important to note that motivating this agenda as a way to confront China inevitably poses risks. As the US seeks to shore up an anti-China economic and military front with its allies in Europe and Asia, there will always be a risk that mistakes and misjudgments can turn a Cold War into an actual war.

While rational people would recognize that any full-scale war between China and the United States would be disastrous for both countries and the world, political actors can get forced into positions from which it is difficult to back down while preserving their careers. The greater the background level of hostility between the two countries, the greater the likelihood that miscalculations can lead to actual war.

A Better Path: Cooperation in Developing Technologies to Save the Planet

We can choose a better path in dealing with China going forward. Instead of wasting resources in military competition, and bottling up technologies in trying to gain economic advantage, we can look to have a path where we try to maximize cooperation between the superpowers, bringing in most of the rest of the world in the process.  

The idea of sharing knowledge, rather than locking it down for private profit with patents, copyrights, and related protections, goes in the exact opposite direction of public policy for the last four decades. Nonetheless, it is important to get it on the table as a pole in public debate. People have to recognize that there is an alternative to the path that Biden appears set on taking the country, which would have very different implications for both our dealings with China and also inequality in the United States.

The cooperative alternative would involve sharing technology, especially in areas where the world has a clear shared interest, such as limiting the damage from global warming and containing the pandemic, a well as health care more generally. The basic logic would be that the United States, China, and other countries we pull into the system would commit to spending a certain amount of money to support research in the designated areas based on their GDP and per capita income.

For example, we could require that a rich country like the United States would contribute 1.0 percent of its GDP to research and development, or roughly $210 billion a year, based on 2021 GDP. Middle-income countries like China might be expected to contribute a smaller share of their GDP, say 0.5 percent. For China, that would come to $130 billion a year (on a purchasing power parity basis) based on its 2021 GDP. Poorer countries might be expected to make a token contribution, or pay nothing at all.

Obviously, it would be necessary to negotiate the exact formulas. There would also need to be some mechanism for dealing with countries that refused to participate, perhaps applying something like patent monopolies to countries that remained outside the network. (I outline some of the issues that would have to be dealt with here and in chapter 5 of Rigged [it’s free].)

There are issues that would be difficult to hammer out in trying to work out arrangements for sharing along these lines, but the process of synchronizing rules on intellectual products is also very difficult now. The Trans-Pacific Partnership almost certainly would have been finalized at least two years sooner if not for the battles over the intellectual property rules that would be included in the pact.

The potential gains from this sort of sharing of knowledge and technology are enormous. Instead of looking to lock up new discoveries behind patent monopolies, a condition of getting funding should be that all results are posted on the web as quickly as possible so that researchers around the world could benefit. The Bermuda Principles of posting results on the web nightly, which the scientists working on the human genome project adopted, would be a useful model.   

The idea that science advances most rapidly when it is open should not seem far-fetched. We benefit from having as many eyes as possible on new discoveries and innovations so that researchers can build on successes and uncover flaws.

We got some great examples for this view in the pandemic. Pfizer reported in February that it had found a way to alter its production process that cut its production time by 50 percent.  It also discovered that its vaccine did not have to be super-frozen at minus 94 degrees Fahrenheit, but instead could be kept in a normal freezer for up to two weeks. It also discovered in January that its standard vile contained six vaccine doses, not the five that it had expected, causing one-sixth of its vaccines to be thrown out at a time when they were in very short supply.

Imagine Pfizer had open-sourced its whole production process. These discoveries would almost certainly have come considerably sooner, allowing many more people to be vaccinated. There are undoubtedly other efficiencies that could be discovered both about Pfizer’s vaccine and the vaccines produced by other manufacturers, if engineers around the world could review their production methods.

Of course, the biggest gain from having open-sourced the technology would have been that manufacturers around the world would have been able to produce all the vaccines. We likely could have had enough vaccines for the whole world by the first half of 2021. This could have saved millions of lives and prevented hundreds of millions of infections.

This logic applies to health care more generally. Why would we not want every researcher in the world to have full access to the latest developments in the areas where they work? Are we worried that a researcher in China or Turkey might develop an effective treatment for a particular cancer or liver disease before researchers in the United States? There doesn’t seem an obvious downside to going this route.

The same applies to climate technology. We should want researchers to be able to quickly build on each other’s innovation in wind and solar energy, as well as energy storage. Slowing global warming is a shared crisis. We should want to do everything possible to develop the best technology and to have it installed as widely as feasible.

There are other areas of research where cooperation may prove more difficult. For example, we may want to keep more control over communications technologies that could have military uses. But, at the very least, health care and climate are two major areas of research where both China and the US, as well as the rest of the world, can benefit from having shared and open research. And, if we can successfully implement a system of cooperative technology development in these two areas, we should be able to find other areas of the economy where we can adopt similar systems.

There also is an important potential side benefit to going this route. Back in the 1990s, when we were debating more open trade between the United States and China, many advocates of the trade path we took argued that China would become more liberal and democratic if it had a strong growing economy. The argument was essentially that there was a link between capitalist economies and liberal democracies.

In retrospect, that argument has not held up very well. China has seen very strong growth for the last four decades. Its economy is more than five times as large as it was when it was admitted to the WTO in 2000.  Yet, China is no one’s image of a liberal democracy. It’s not even clear that it has become more open in the last two decades.

This history should make anyone cautious about making broad claims on political evolution in China as a result of its economic progress, but there is an important difference about the route outlined here. If China were to engage in large-scale exchanges of knowledge and research in health care, climate, and possibly other areas, it would mean that tens of thousands of their researchers were in regular contact with their counterparts in the United States and other liberal democracies.   

Most of the actors in China’s manufacturing export boom in the first decade of this century were low-paid (by US standards) and relatively uneducated workers in factories. In this story of collaborating in some of the most sophisticated areas of technology, the main actors are highly educated and relatively well-paid workers. They will be the parents, siblings, and children of the people holding positions of political power in the country’s government. It is reasonable to believe that they might have more influence in pushing for a more open and liberal society than poorly educated workers in a textile factory.

Again, anyone should be very cautious in making strong claims about how a particular economic policy will lead China to a path of liberal democracy. But it is reasonable to believe that having relatively privileged actors in its economy in regular contact with their counterparts in the West could have a positive impact on the country’s politics from the standpoint of promoting liberal democratic values.

There is one group that is likely to be a loser from going this path of cooperative technological development: the most highly paid scientists and engineers, as well as CEOs and shareholders of the companies that are directly affected. To be clear, under a system along the lines outlined here, there is every reason to believe that accomplished researchers would still be well-paid, with the most successful likely getting high six-figure or even seven-figure salaries. There would still be plenty of profits available to companies that contract to do research in these areas, just as companies that contract to design weapon systems for the Pentagon can make very healthy profits.

However, we would probably not see the vast fortunes that many individuals and companies have earned based on their patent monopolies. For example, we would probably not see scientists earning multi-billion fortunes that the top executives at Moderna were able to pocket in the pandemic. We also would be less likely to see a company’s stock increase more than 2000 percent in a year and a half, adding $170 billion to its market capitalization.

The smaller paychecks at the top, coupled with the elimination of all the waste associated with the patent system, will effectively mean higher paychecks at the middle and bottom. By my calculations, if we sold all prescription drugs in a free market, without patents or related protections, we would spend around $80 billion a year. That is a saving of $420 billion, or $3,000 per family, compared with the $500 billion a year that we now spend on drugs. That translates into a lot of additional money in the pockets of low- and middle-income people as a result of lower health care spending.

In short, going the route of cooperative development of technology with China is likely to not only reduce tensions between the world’s two superpowers, but can be a major factor in reversing the upward redistribution of the last four decades. It can very directly lead to less money going to those at the top end of the income distribution and increased real wages for those at the middle and the bottom.

Another Trade Policy for the Rich? We Won’t Get Fooled Again

In the 1990s and 2000s, the leadership of both political parties pushed trade policies that were quite explicitly designed to redistribute income upward. They put US manufacturing workers in direct competition with low-paid workers in China and other developing countries, while largely protecting the most highly educated workers.

The predicted and actual effect of these policies was to put downward pressure on the wages of manufacturing workers, as it cost millions of jobs in the sector. Since manufacturing had historically been a source of relatively well-paying jobs for workers without college degrees, the drop in pay and loss of jobs in this sector put downward pressure on the wages of non-college-educated workers more generally.

As we move into a new decade, we are being promised a sharp turn to protectionist policies, with the protectionism most directly protecting some of the most highly paid and highly educated workers in the US economy. As a side benefit, we are told that this protection will mean more manufacturing jobs, although the sector no longer provides a substantial wage premium over jobs in other sectors.

Our political elites were able to get their way in pushing their trade agenda in the 1990s and 2000s, with devastating consequences for millions of workers. The consequences of their new agenda could be even more devastating since it is not only a path designed to further the upward redistribution of income, but also a path designed to put us in continual conflict with the world’s other major superpower.

We were fortunate that the first Cold War never lead to direct conflict between the United States and the Soviet Union, although it did lead to proxy wars that killed millions and cost trillions. We should not go down the same path again.  

[1] Many people have argued that the official bilateral trade figures overstate the actual deficit because much of the value-added in goods imported from China comes from other countries. The classic example is an Apple iPhone which might be assembled in China and then imported into the United States. Our trade figures would count the full value of the iPhone as an import from China.

While this does lead to an overstatement of the value of our imports from China, there is also an understatement for an analogous reason. When we import items from Japan, South Korea, or even Europe, it is likely that some of the value-added came from China. It is likely that the overstatement from counting the full value of finished goods imported from China exceeds the understatement from not counting the value-added in goods imported from third countries, it does not make sense to just count one source of bias in determining the size of the trade deficit.  

[2] China’s buying of dollar assets has often been referred to as currency “manipulation.” This word implies that China’s actions were somehow undercover and secretive. In fact, China quite explicitly pegged its exchange rate to the dollar and openly intervened to support this peg. It would be more accurate to say that China “managed” its exchange rate.

[3] There was a bizarre argument in policy circles as to whether the massive loss of manufacturing jobs from 2000 to 2007 was due to trade or technology. This argument was always strange (how can a trade deficit – which is not caused by rapid growth – not imply fewer jobs in manufacturing?), but it has gotten even stranger over time. To believe that the massive job loss from 2000 to 2007 was due to technology, it would be necessary to believe that somehow technology didn’t cause job loss in manufacturing from 1970 to 2000, or in the years since 2010, but somehow in the years when we saw a rapid rise in the trade deficit, technology was causing large-scale job loss in manufacturing.  

The Biden administration, with the overwhelming support of the foreign policy establishment, seems determined to start a new Cold War with China. A new Cold War is likely to be bad news from the standpoint of inequality, world peace, and the climate crisis facing the planet. As with the last Cold War, it is likely to be driven by misunderstandings and deliberate misinformation. With so much at stake, it is important to head off a new Cold War, most importantly by correcting many misconceptions and laying out an alternative more productive path for future relations with China.

I will briefly go through the history of the economic relationship between China and the U.S. in the last two decades. Then I will describe the implications for inequality for the path Biden seems to be pursuing. The last part outlines an alternative, more cooperative path for relations with China.

The Trade Deficit with China: Donald Trump’s Phony War

China was admitted to the World Trade Organization in 2000 after a major battle in Congress over granting the country Permanent Normal Trading Relations (PNTR), which was necessary for its admission. Much of the opposition came from the labor movement which argued that opening trade to China would lead to a large expansion of the trade deficit, costing manufacturing jobs. Since manufacturing had historically been a source of high-paying jobs for workers without college degrees, this would put downward pressure on the pay of non-college-educated workers more generally.

The mainstream of the economic profession ridiculed the idea that expanding trade with China could lead to any substantial job loss. For example, Gary Hufbauer, a prominent trade economist with the Peterson Institute for International Economics, dismissed the “extravagant claims” from the Economic Policy Institute (my former employer) that PNTR for China could lead to a loss of 813,000 jobs.

“The Economic Policy Institute (http://www.EPI.org) has advanced the most extravagant claims about the US bilateral trade deficit with China. Based on a count of 13,000 jobs lost per billion dollars of manufactured imports, the EPI asserts that current trade with China already costs the United States 880,000 high-wage manufacturing jobs. Then, extrapolating the US ITC’s estimate of the one-time percentage import and export trade changes for 10 years, the EPI asserts another 817,000 US jobs will be eliminated through PNTR and Chinese membership in the WTO.”

This dismissive attitude was common in the profession at the time. PNTR passed by a relatively narrow 237 to 197 vote in the House (the Senate margin was much wider). The near-unanimous support from the mainstream of the economic profession was almost certainly an important factor in determining the outcome of this vote.

Contrary to the predictions of Hufbauer and other mainstream economists, the trade deficit in goods with China did in fact rise rapidly, growing from $68.7 billion in 1999 to $418.2 billion in 2018.[1] The story behind this increase is not complicated. In simple trade stories, when a country is running a large trade surplus with another country, we expect that the value of the currency of the surplus country will rise relative to the value of the deficit country. This makes the items produced in the surplus country relatively more expensive in international markets while making the items produced in the deficit country relatively cheaper.

That sort of currency adjustment did not happen for the simple reason that China’s government did not allow it to happen. China’s central bank bought up several trillion dollars of US government bonds and other dollar assets in the first decade of the century.[2] This propped up the dollar, thereby preventing the sort of currency adjustment that we might expect between a country running a large trade deficit and a country running a large surplus.

At the time, many other developing countries also effectively tied their currencies to the renminbi to maintain their competitive position relative to China. When China raised the value of its currency against the dollar, countries like Vietnam and Thailand also raised the value of their currency. This meant that China’s decision to deliberately maintain an undervalued currency meant that other countries also under-valued their currency relative to the dollar, leading to higher trade deficits with these countries as well.

The explosion in the trade deficit led to a sharp drop in manufacturing employment between 2000 and 2007, before the start of the Great Recession. The country lost more than 3.5 million manufacturing jobs between December of 1999 and December of 2007, the official start date of the Great Recession. (It lost another 2.3 million between December 2007 and February 2010, the employment trough of the Recession.)[3]

While manufacturing had been falling as a share of total employment since the start of the 1970s, actual levels of employment had changed little, apart from cyclical fluctuations, until the 2000s. From December of 1970 to December of 1999 the sector lost less than 30,000 jobs. This is shown in Figure 1. By contrast, the job loss associated with the rise in the trade deficit from 1999 to 2007 amounted to more than 20 percent of total employment in the sector. Autor, Dorn, and Hansen (2016) put the job loss associated with trade with China alone at 2.0 million.

 

The massive job loss in manufacturing had a predictable effect on wages. Many of the higher-paying union jobs were the ones that disappeared as the economy became more open to trade in manufactured goods. In other cases, workers were forced to take pay cuts to keep their jobs. The extent to which manufacturing offered higher-paying jobs for workers (mostly male workers) without college degrees, declined substantially over this period, as both the number of jobs and wage premium fell sharply.

 

Source; Bureau of Labor Statistics.

Figure 2 shows the real average hourly wage for production and non-supervisory workers in the private sector as a whole and for the manufacturing sector. As can be seen, workers in manufacturing enjoyed a 2.7 percent advantage by this measure in 1999. This imbalance flipped as the trade deficit expanded. By 2020, the average hourly wage for production and non-supervisory workers in manufacturing was 7.6 percent below the average for the private sector as a whole.

These numbers measure only money wages and ignore benefits, which still tend to be higher in manufacturing than elsewhere in the economy. However, even when these benefits are factored in, we have almost certainly a sharp decline in the manufacturing premium. In an analysis that attempted to factor in benefits, Mishel (2018) found a 7.8 percent straight wage premium for non-college-educated workers for the years 2010 to 2016, in an analysis that controlled for age, race, and gender, and other factors. That compares to a premium for non-college-educated workers of 13.1 percent in the 1980s.

The analysis found that differences in non-wage compensation added 2.6 percentage points to the manufacturing wage premium for all workers, but the compensation differential may be less for non-college-educated workers since they are less likely to get health care coverage and retirement benefits. Since the ratio of money wages in manufacturing to the rest of the economy has continued to fall sharply in the years since this analysis, the manufacturing wage premium would almost certainly be far less in 2021.

There is one other important point on the quality of manufacturing jobs that is worth noting here. The unionization rates in manufacturing have plummeted over this period. In 2000, 14.9 percent of workers in manufacturing were union members compared to 9.0 percent for the private sector as a whole. The percent of union members in manufacturing had fallen to just 8.5 percent in 2020, only slightly higher than the 6.3 percent average for the private sector as a whole.

Also, the new jobs that have been created in manufacturing since the trough of the Great Recession have overwhelmingly not been union jobs. Until the pandemic hit in March of 2020, we had added back more than 1.6 million manufacturing jobs from the employment trough of the Great Recession in 2010. Nonetheless, the number of union members in manufacturing had fallen by almost 900,000.

This history is important because it shows that trade in general, and with China in particular, did have a very negative impact on the labor market prospects for a large segment of the working class. However, there are two important qualifications to the simple story that Donald Trump and his supporters are inclined to tell.

First, this is not a story of China winning and the US losing. The trade deficit was not about China doing evil things behind the back of the political leadership in the United States. The trade deficit was a story of both US manufacturers outsourcing to take advantage of low-cost labor in China and major retailers like Walmart setting up low-cost supply chains as a way to undercut their competition.

The manufacturers that were able to get cheap labor from China were big gainers from the trade deficit, as were Walmart and other major retailers. Also, workers who were not directly affected by the loss of manufacturing jobs, such as doctors, lawyers, and other highly paid professionals, benefitted from lower-cost manufactured goods, as well as lower-cost services in many areas due to downward pressure on the wages of less-educated workers.

For this reason, it is wrong to treat this period as a story of China winning its trade battles with the United States. China gained from its trade with the United States, but so did the top end of the income distribution in the United States.

The other important qualification is that this history is not reversible. The manufacturing premium for less-educated workers was largely a story of its extraordinary rates of unionization. Now that the sector does not have an especially high rate of unionization, the premium has been largely eliminated. And, as we have added back jobs in manufacturing, they have not been union jobs.

For these reasons, there is little reason to prefer jobs in manufacturing over jobs in any other sector of the economy. In the past, the fact that manufacturing jobs were more likely to be high-paying union jobs was a good reason to focus on preserving them and seeking to make the manufacturing sector a larger share of the economy. This is no longer true.

The Get Tough with China Approach: Protectionism for the Highly Paid

The Biden administration has made clear that it intends to block imports from China in many high-tech sectors. While some restrictions can be justified as necessary to protect military technologies, it is clear that these protections are mainly for economic reasons.

For example, the Biden administration pushed through a bill that would provide more than $50 billion in subsidies to the semiconductor industry over the next five years. It also is planning a program for pandemic preparedness that would spend more than $40 billion over the next decade developing vaccines, treatments, and tests that could be used in future pandemics. It has also left in place a wide variety of tariffs on Chinese imports, including an 18 percent tariff on solar panels, which is not helping the shift away from fossil fuels.

The subsidies for promoting technology in certain sectors are not necessarily bad economic policy. The US economy has benefitted enormously from publicly supported research and development in a wide range of areas including pharmaceuticals, aerospace, agriculture, and computers and software. There is likely to be a large dividend from future spending on research and development.

The key issue here is who will have control over the products developed with this money and how it is being promoted as a competition with China. At this point, there are not clear guidelines on how the Biden administration envisions ownership rights to the publicly funded R&D he is proposing, but there is little reason to believe that he envisions moving away from the current pattern. As it stands, the government puts up the funds for much of the most important, and risky, research, and then private corporations are able to benefit by claiming ownership of the finished product.

This sort of story can be seen most clearly in the case of Moderna and the mRNA vaccine it developed last year. The Trump administration, through Operation Warp Speed, paid Moderna over $400 million to cover the cost of developing a vaccine and its initial Phase 1 and 2 trials. It then paid over $450 million to pay for the larger Phase 3 trials, in effect fully covering Moderna’s cost for developing a vaccine and bringing it through the FDA’s approval process.

It was necessary for Moderna to do years of research so that it was in a position to quickly develop an mRNA vaccine, but even here the government played a very important role. Much of the funding for the discovery and development of mRNA technology came from the National Institutes of Health. Without its spending on the development of this technology, it is almost inconceivable that any private company would have been in a position to develop an mRNA vaccine against the coronavirus.

In spite of this massive contribution from the public sector, Moderna has complete control over its vaccine and can charge whatever price it wants. It is likely to end up with more than $20 billion in profit from sales of its coronavirus vaccine. According to Forbes, the vaccine had made at least three Moderna billionaires by the middle of 2021, with the company’s CEO, Stephane Bancel, leading the way with an increase in his wealth of $4.3 billion. The company’s market capitalization was almost $180 billion on September 22, up from just over $7 billion before the start of the pandemic.

If this is the model for the way public investments in R&D are treated going forward, then we can expect to see many more millionaires and billionaires created as a result of Biden’s spending. Needless to say, there will be no shortage of economists and other policy types insisting that these extremes of wealth are just the inevitable result of technology, just as there was no shortage of policy types anxious to blame the huge loss of manufacturing jobs in the first decade of this century on technology.

There will be some number of manufacturing jobs created as a result of this initiative. Someone has to manufacture the semi-conductors, vaccines, and other products developed with this funding and there is probably a greater likelihood that these factories will be located in the United States as a result of Biden’s policies.

However, this is not much consolation. With manufacturing no longer providing a substantial wage premium for workers without college degrees, there is no more reason to value manufacturing jobs in these sectors than jobs in warehouses, distribution centers, or health care. With the right institutional support, any job can be a high-paying job, there is no reason to especially prize the manufacturing jobs that might be created through this initiative.

In short, this is yet another path for furthering the upward redistribution we have been seeing for the last four decades. It is ironic that our policy elites have managed to flip 180 degrees on their core economic principles to continue the drive for upward redistribution. In the decade from 2000 to 2010, when “free trade” with China cost millions of manufacturing jobs and put downward pressure on the pay of less-educated workers more generally, free trade was a sacred mantra in elite policy circles.

Now that China is in a situation to pose a real threat in our most advanced industries, costing jobs of engineers, biochemists, and other highly educated workers, our elites are gung ho on a protectionist agenda to confront China. And, we are supposed to believe that it is just a coincidence that the main winners on both sides of this flip are those at the top of the income ladder.

It is also important to note that motivating this agenda as a way to confront China inevitably poses risks. As the US seeks to shore up an anti-China economic and military front with its allies in Europe and Asia, there will always be a risk that mistakes and misjudgments can turn a Cold War into an actual war.

While rational people would recognize that any full-scale war between China and the United States would be disastrous for both countries and the world, political actors can get forced into positions from which it is difficult to back down while preserving their careers. The greater the background level of hostility between the two countries, the greater the likelihood that miscalculations can lead to actual war.

A Better Path: Cooperation in Developing Technologies to Save the Planet

We can choose a better path in dealing with China going forward. Instead of wasting resources in military competition, and bottling up technologies in trying to gain economic advantage, we can look to have a path where we try to maximize cooperation between the superpowers, bringing in most of the rest of the world in the process.  

The idea of sharing knowledge, rather than locking it down for private profit with patents, copyrights, and related protections, goes in the exact opposite direction of public policy for the last four decades. Nonetheless, it is important to get it on the table as a pole in public debate. People have to recognize that there is an alternative to the path that Biden appears set on taking the country, which would have very different implications for both our dealings with China and also inequality in the United States.

The cooperative alternative would involve sharing technology, especially in areas where the world has a clear shared interest, such as limiting the damage from global warming and containing the pandemic, a well as health care more generally. The basic logic would be that the United States, China, and other countries we pull into the system would commit to spending a certain amount of money to support research in the designated areas based on their GDP and per capita income.

For example, we could require that a rich country like the United States would contribute 1.0 percent of its GDP to research and development, or roughly $210 billion a year, based on 2021 GDP. Middle-income countries like China might be expected to contribute a smaller share of their GDP, say 0.5 percent. For China, that would come to $130 billion a year (on a purchasing power parity basis) based on its 2021 GDP. Poorer countries might be expected to make a token contribution, or pay nothing at all.

Obviously, it would be necessary to negotiate the exact formulas. There would also need to be some mechanism for dealing with countries that refused to participate, perhaps applying something like patent monopolies to countries that remained outside the network. (I outline some of the issues that would have to be dealt with here and in chapter 5 of Rigged [it’s free].)

There are issues that would be difficult to hammer out in trying to work out arrangements for sharing along these lines, but the process of synchronizing rules on intellectual products is also very difficult now. The Trans-Pacific Partnership almost certainly would have been finalized at least two years sooner if not for the battles over the intellectual property rules that would be included in the pact.

The potential gains from this sort of sharing of knowledge and technology are enormous. Instead of looking to lock up new discoveries behind patent monopolies, a condition of getting funding should be that all results are posted on the web as quickly as possible so that researchers around the world could benefit. The Bermuda Principles of posting results on the web nightly, which the scientists working on the human genome project adopted, would be a useful model.   

The idea that science advances most rapidly when it is open should not seem far-fetched. We benefit from having as many eyes as possible on new discoveries and innovations so that researchers can build on successes and uncover flaws.

We got some great examples for this view in the pandemic. Pfizer reported in February that it had found a way to alter its production process that cut its production time by 50 percent.  It also discovered that its vaccine did not have to be super-frozen at minus 94 degrees Fahrenheit, but instead could be kept in a normal freezer for up to two weeks. It also discovered in January that its standard vile contained six vaccine doses, not the five that it had expected, causing one-sixth of its vaccines to be thrown out at a time when they were in very short supply.

Imagine Pfizer had open-sourced its whole production process. These discoveries would almost certainly have come considerably sooner, allowing many more people to be vaccinated. There are undoubtedly other efficiencies that could be discovered both about Pfizer’s vaccine and the vaccines produced by other manufacturers, if engineers around the world could review their production methods.

Of course, the biggest gain from having open-sourced the technology would have been that manufacturers around the world would have been able to produce all the vaccines. We likely could have had enough vaccines for the whole world by the first half of 2021. This could have saved millions of lives and prevented hundreds of millions of infections.

This logic applies to health care more generally. Why would we not want every researcher in the world to have full access to the latest developments in the areas where they work? Are we worried that a researcher in China or Turkey might develop an effective treatment for a particular cancer or liver disease before researchers in the United States? There doesn’t seem an obvious downside to going this route.

The same applies to climate technology. We should want researchers to be able to quickly build on each other’s innovation in wind and solar energy, as well as energy storage. Slowing global warming is a shared crisis. We should want to do everything possible to develop the best technology and to have it installed as widely as feasible.

There are other areas of research where cooperation may prove more difficult. For example, we may want to keep more control over communications technologies that could have military uses. But, at the very least, health care and climate are two major areas of research where both China and the US, as well as the rest of the world, can benefit from having shared and open research. And, if we can successfully implement a system of cooperative technology development in these two areas, we should be able to find other areas of the economy where we can adopt similar systems.

There also is an important potential side benefit to going this route. Back in the 1990s, when we were debating more open trade between the United States and China, many advocates of the trade path we took argued that China would become more liberal and democratic if it had a strong growing economy. The argument was essentially that there was a link between capitalist economies and liberal democracies.

In retrospect, that argument has not held up very well. China has seen very strong growth for the last four decades. Its economy is more than five times as large as it was when it was admitted to the WTO in 2000.  Yet, China is no one’s image of a liberal democracy. It’s not even clear that it has become more open in the last two decades.

This history should make anyone cautious about making broad claims on political evolution in China as a result of its economic progress, but there is an important difference about the route outlined here. If China were to engage in large-scale exchanges of knowledge and research in health care, climate, and possibly other areas, it would mean that tens of thousands of their researchers were in regular contact with their counterparts in the United States and other liberal democracies.   

Most of the actors in China’s manufacturing export boom in the first decade of this century were low-paid (by US standards) and relatively uneducated workers in factories. In this story of collaborating in some of the most sophisticated areas of technology, the main actors are highly educated and relatively well-paid workers. They will be the parents, siblings, and children of the people holding positions of political power in the country’s government. It is reasonable to believe that they might have more influence in pushing for a more open and liberal society than poorly educated workers in a textile factory.

Again, anyone should be very cautious in making strong claims about how a particular economic policy will lead China to a path of liberal democracy. But it is reasonable to believe that having relatively privileged actors in its economy in regular contact with their counterparts in the West could have a positive impact on the country’s politics from the standpoint of promoting liberal democratic values.

There is one group that is likely to be a loser from going this path of cooperative technological development: the most highly paid scientists and engineers, as well as CEOs and shareholders of the companies that are directly affected. To be clear, under a system along the lines outlined here, there is every reason to believe that accomplished researchers would still be well-paid, with the most successful likely getting high six-figure or even seven-figure salaries. There would still be plenty of profits available to companies that contract to do research in these areas, just as companies that contract to design weapon systems for the Pentagon can make very healthy profits.

However, we would probably not see the vast fortunes that many individuals and companies have earned based on their patent monopolies. For example, we would probably not see scientists earning multi-billion fortunes that the top executives at Moderna were able to pocket in the pandemic. We also would be less likely to see a company’s stock increase more than 2000 percent in a year and a half, adding $170 billion to its market capitalization.

The smaller paychecks at the top, coupled with the elimination of all the waste associated with the patent system, will effectively mean higher paychecks at the middle and bottom. By my calculations, if we sold all prescription drugs in a free market, without patents or related protections, we would spend around $80 billion a year. That is a saving of $420 billion, or $3,000 per family, compared with the $500 billion a year that we now spend on drugs. That translates into a lot of additional money in the pockets of low- and middle-income people as a result of lower health care spending.

In short, going the route of cooperative development of technology with China is likely to not only reduce tensions between the world’s two superpowers, but can be a major factor in reversing the upward redistribution of the last four decades. It can very directly lead to less money going to those at the top end of the income distribution and increased real wages for those at the middle and the bottom.

Another Trade Policy for the Rich? We Won’t Get Fooled Again

In the 1990s and 2000s, the leadership of both political parties pushed trade policies that were quite explicitly designed to redistribute income upward. They put US manufacturing workers in direct competition with low-paid workers in China and other developing countries, while largely protecting the most highly educated workers.

The predicted and actual effect of these policies was to put downward pressure on the wages of manufacturing workers, as it cost millions of jobs in the sector. Since manufacturing had historically been a source of relatively well-paying jobs for workers without college degrees, the drop in pay and loss of jobs in this sector put downward pressure on the wages of non-college-educated workers more generally.

As we move into a new decade, we are being promised a sharp turn to protectionist policies, with the protectionism most directly protecting some of the most highly paid and highly educated workers in the US economy. As a side benefit, we are told that this protection will mean more manufacturing jobs, although the sector no longer provides a substantial wage premium over jobs in other sectors.

Our political elites were able to get their way in pushing their trade agenda in the 1990s and 2000s, with devastating consequences for millions of workers. The consequences of their new agenda could be even more devastating since it is not only a path designed to further the upward redistribution of income, but also a path designed to put us in continual conflict with the world’s other major superpower.

We were fortunate that the first Cold War never lead to direct conflict between the United States and the Soviet Union, although it did lead to proxy wars that killed millions and cost trillions. We should not go down the same path again.  

[1] Many people have argued that the official bilateral trade figures overstate the actual deficit because much of the value-added in goods imported from China comes from other countries. The classic example is an Apple iPhone which might be assembled in China and then imported into the United States. Our trade figures would count the full value of the iPhone as an import from China.

While this does lead to an overstatement of the value of our imports from China, there is also an understatement for an analogous reason. When we import items from Japan, South Korea, or even Europe, it is likely that some of the value-added came from China. It is likely that the overstatement from counting the full value of finished goods imported from China exceeds the understatement from not counting the value-added in goods imported from third countries, it does not make sense to just count one source of bias in determining the size of the trade deficit.  

[2] China’s buying of dollar assets has often been referred to as currency “manipulation.” This word implies that China’s actions were somehow undercover and secretive. In fact, China quite explicitly pegged its exchange rate to the dollar and openly intervened to support this peg. It would be more accurate to say that China “managed” its exchange rate.

[3] There was a bizarre argument in policy circles as to whether the massive loss of manufacturing jobs from 2000 to 2007 was due to trade or technology. This argument was always strange (how can a trade deficit – which is not caused by rapid growth – not imply fewer jobs in manufacturing?), but it has gotten even stranger over time. To believe that the massive job loss from 2000 to 2007 was due to technology, it would be necessary to believe that somehow technology didn’t cause job loss in manufacturing from 1970 to 2000, or in the years since 2010, but somehow in the years when we saw a rapid rise in the trade deficit, technology was causing large-scale job loss in manufacturing.  

The New York Times had an interesting piece about the prospects for getting Moderna and Pfizer to share the technology for producing their mRNA Covid vaccines. At one point, the piece cites Biden administration officials warning that efforts to use the Defense Production Act to force sharing could end in long legal battles delaying any technology transfer.

“Biden administration officials say that forcing the companies to act is not as simple as it sounds, and that an effort to compel them to share their technology would invariably lead to a drawn-out legal battle, which would be counterproductive.”

Actually, it should be possible to reverse the legal burden. Biden could offer to cover the legal expenses, and any subsequent damages, resulting from lawsuits by Moderna and Pfizer against former engineers for sharing their expertise with companies in the developing world or in other wealthy countries.

These engineers have all signed nondisclosure agreements, which they would likely be violating by sharing this information. However, if they shared the information first, knowing that they would be protected, Moderna and Pfizer could do nothing to prevent the technology transfer. (If they were sharing the technology with another manufacturer in the United States, these companies could probably get an injunction requiring that they stop, which would expose them to criminal sanctions if they continued. But, US courts would have difficulty imposing an injunction against actions taken in another country.)

In short, the Biden administration could find ways around the legal weapons that Moderna and Pfizer might use to block the transfer of the technology they use to produce mRNA vaccines.

The New York Times had an interesting piece about the prospects for getting Moderna and Pfizer to share the technology for producing their mRNA Covid vaccines. At one point, the piece cites Biden administration officials warning that efforts to use the Defense Production Act to force sharing could end in long legal battles delaying any technology transfer.

“Biden administration officials say that forcing the companies to act is not as simple as it sounds, and that an effort to compel them to share their technology would invariably lead to a drawn-out legal battle, which would be counterproductive.”

Actually, it should be possible to reverse the legal burden. Biden could offer to cover the legal expenses, and any subsequent damages, resulting from lawsuits by Moderna and Pfizer against former engineers for sharing their expertise with companies in the developing world or in other wealthy countries.

These engineers have all signed nondisclosure agreements, which they would likely be violating by sharing this information. However, if they shared the information first, knowing that they would be protected, Moderna and Pfizer could do nothing to prevent the technology transfer. (If they were sharing the technology with another manufacturer in the United States, these companies could probably get an injunction requiring that they stop, which would expose them to criminal sanctions if they continued. But, US courts would have difficulty imposing an injunction against actions taken in another country.)

In short, the Biden administration could find ways around the legal weapons that Moderna and Pfizer might use to block the transfer of the technology they use to produce mRNA vaccines.

Now that George W. Bush is back in the news with his attacks on the Trumpist insurrectionists, it might be worth reviving one of the great lines of his presidency. After the September 11th attack, when Bush decided to go after not just the terrorists who planned the hijackings, but all sorts of people around the world he didn’t like, he lumped them together as “evil-doers.” That may not be the most eloquent phrase, but it works well as a description of the modern pharmaceutical industry.

Some may find this description of the pharmaceutical industry abhorrent. After all, they develop life-saving drugs and vaccines, most recently the vaccines against the coronavirus which have saved millions of lives. But the industry’s storyline gives us a very incomplete picture of what it does and how.

Probably the best way to think about the pharmaceutical industry is to imagine an incredibly corrupt fire department. Most of the money that the fire department gets to buy new trucks and other equipment goes right into the pockets of the department’s commissioner and his closest friends. The department may still do its job in the sense that they rush to fires and rescue people trapped by flames, but it costs way more than it should.

The fire department may even occasionally start fires itself so that they can be heroes in putting them out and rescuing potential victims. If that sounds like an over-the-top accusation against the pharmaceutical industry, then you didn’t pay attention to the opioid scandal. Several major drug companies have paid out billions of dollars in settlements over the accusation that they deliberately misled doctors about the addictiveness of the new generation of opioids.

Note that the accusation was not that the industry mistakenly failed to recognize how addictive their drugs were. The accusation was that they knew they were highly addictive, but lied to doctors so that they could sell more prescriptions. This is not very different from deliberating starting fires to drum up business.

Now suppose that there was growing political pressure to cut back the fire department’s budget and clean up its practices. Naturally, it’s not going to just sit back and let someone take away the trough. Our corrupt fire department will do everything in its power to continue the practices that are allowing its top officials to get rich.

In the case of the corrupt fire department, we can anticipate big public relations campaigns where they highlight the fires they have extinguished and the lives they have saved. We can expect to see pictures of adorable children who were saved from burning blazes by the fire department. This of course has nothing to do with the effort to eliminate corruption, but it makes great material for advertisements on the major news shows. And, who knows, maybe these expensive ads will even influence their reporting on the first department’s corruption.

This corresponds to the pharmaceutical industry’s campaign to beat back congressional efforts to lower prescription drug prices and weaken the protection the industry now enjoys with government-granted patent monopolies. Just as the corrupt fire department actually does save kids’ lives, the pharmaceutical industry does produce drugs and vaccines that are hugely important for people’s lives and health.

But that is not the issue, the question is whether there are better ways to get these drugs and vaccines. There is good reason for thinking there is.

Direct Public Funding, an Alternative to Government-Granted Patent Monopolies

The obvious alternative to having drug companies pay for their research costs is through direct public funding of research.  Direct funding can take different forms. We can have a prize system, where the government gives out prizes and then takes ownership of new drugs or vaccines. These are then placed in the public domain so that they can be sold as cheap generics.

My preferred route is a system of long-term contracts, similar to the way the Pentagon pays for the development of new planes, submarines, and weapons systems. This has the big advantage that it can require that all research be fully public all along the way. This means that research findings, as well as results from clinical trials, are posted on the web as soon as practical. This means that researchers all over the country, and in fact all over the world, can quickly benefit from each other’s successes and failures. (I outline this system in more detail in chapter 5 of Rigged [it’s free].)

To my view, this shift to direct public funding has the important result of changing the incentives of the pharmaceutical industry. Under the patent monopoly system, drug companies try to figure out how to maximize the profits they can get as a result of the monopolies the government has given them. This may mean developing drugs that offer little benefit over existing drugs, but which they think they can market effectively.

It can mean finding ways to extend their monopolies, which may be dubious from a legal perspective, but with high-priced lawyers, may buy them another year or two on their patents. And, it may mean lying about the safety and effectiveness of a drug in order to maximize the amount they can sell at patent-protected prices.

These are the incentives provided by the patent monopoly system of financing drug development. If we instead relied on direct public funding there would undoubtedly be underperforming companies and some money would end up being wasted on dead ends. But all drugs and vaccines that were developed would be cheap (they are almost always cheap to manufacture and distribute) and no one would have the incentive to lie to us about their safety and effectiveness.

We can condemn drug company executives as moral monsters for misleading the public about their drugs or for charging high prices that put them out of reach for much of the population, but they are responding to the incentive structure we created. The key issue here is changing the incentive structure so that drug companies don’t do awful things.

 

TRIPS and the Fugitive Slave Act

For those not familiar with US history, the Fugitive Slave Act usually refers to the 1850 bill passed by Congress, which made it easier for bounty hunters to track people who had escaped from slavery in the South into Northern states that banned slavery. These bounty hunters could bring the people who had escaped slavery back to the South. The Act imposed serious penalties on anyone who tried to assist people in escaping slavery or blocked the efforts of bounty hunters. Its provisions were considerably stronger than an earlier Fugitive Slave Act passed in 1793, making it more difficult for people escaping slavery to live freely in the North. It was an important factor in the tensions that led to the Civil War a decade later.

I would not compare TRIPS to the barbarism of a system of slavery that imprisoned tens of millions of people for centuries, but the Fugitive Slave Act provides an example of a truly barbaric law that ostensibly decent people could consider reasonable. We should understand TRIPS also as a horrific provision of an international trade deal, the Uruguay Round of General Agreement on Tariffs and Trade, that was designed to bottle up technology to reduce access in the developing world, even when the issue is access to life-saving medicines or vaccines.

The issue of bottling up technology is central to the story of the massive and unnecessary loss of life in the pandemic. The official death toll worldwide is already over 4.7 million, but we know this is a gross understatement. To take one of the hardest-hit countries, India now officially reports 445,000 deaths from the pandemic, but a study by the Center for Global Development put the number of excess deaths in India, as of July, at 3.4 million and possibly over 4 million. In Mexico, the number of excess deaths is more than 240,000 higher than the official death toll from COVID-19, and in South Africa the gap is 150,000. Clearly, the death toll is several million higher than the already horrific official number.

But the question here is how much did the drug industry’s bottling up of technology contribute to this disaster. The provisions of TRIPS require countries throughout the world to have US-type patent laws. This means that countries like South Africa, Brazil, and India (the world’s largest manufacturer of pharmaceuticals), that might have had the technical expertise to produce the COVID-19 vaccines, as well as treatments and tests, could not simply start shifting production to pandemic related items. They needed to have the authorization of manufacturers who had patent rights.

This applied to manufacturers in wealthy countries as well. For example, Teva, a huge Israeli pharmaceutical company, wanted to produce the Pfizer vaccine by converting existing facilities but was unable to come to an agreement.

The problems with increasing production of vaccines, treatments, and tests go beyond just patents. A couple of months ago, I was on a panel with an industry representative who was anxious to boast that much of the technology needed to produce the mRNA vaccines does not depend on patent monopolies, but is instead held as industrial secrets. He said that he didn’t see how companies could be forced to disclose secret information.

Of course, no company has to disclose secret information, we can just have their top engineers share the expertise they have gained while at Pfizer, AstraZeneca, or Moderna. Surely, for paychecks of millions of dollars per month, many of the most knowledgeable engineers at these companies could be persuaded to share their know-how with pharmaceutical manufacturers in the developing world. The fact that they could also be helping to save millions of lives might also make this work attractive.

The reason this technology transfer is not happening now is that all these companies have nondisclosure agreements with the employees who would have access to this knowledge. If any of them were to begin sharing information with another pharmaceutical company, they would certainly face a large lawsuit from their former employer, who may also be able to get an injunction prohibiting this engineer from providing further assistance. If an engineer were to act in violation of an injunction, they could face imprisonment. In short, the laws on nondisclosure agreements can be used by pharmaceutical companies to block the transfer of the technologies needed to effectively combat the pandemic.  

Governments do not have to make nondisclosure agreements enforceable contracts, especially when so much of the underlying technology, as in the case of mRNA vaccines, was developed with public funds.  Nondisclosure agreements are quite explicitly designed to limit competition. Other contracts designed to restrict competition are not enforceable by the courts. For example, if Apple were to pay Samsung $1 billion in exchange for a commitment not to charge less than $800 for its newest smartphone, no court would sanction Samsung if it violated this agreement. Since the purpose is clearly to limit competition, in direct violation of anti-trust laws, this sort of contract would be unenforceable.

In the same vein, we can think of the laws on nondisclosure agreements as efforts to limit competition, that have no place in a free market. Again, the case for this view is strongest when much of the funding for the development of technology comes from the government, as is the case with the COVID-19 vaccines and most innovations in the biomedical sector.

The proponents of the WTO often talk about it as promoting free trade, but in fact, the TRIPS accord went 180 degrees in the opposite direction. TRIPS is about bottling up technology. A WTO that was actually designed to promote free trade and the transfer of technology would, instead of protecting patent monopolies, would be banning, or at least severely restricting, nondisclosure agreements. Don’t look for that one any time soon.

“Free trade” has always been a flexible concept that the wealthy and powerful have interpreted in ways that advance their interests at the expense of everyone else. The Opium Wars fought between China and the United Kingdom were justified on the basis of free trade. The UK was insisting that people in China had the right to buy opium, which was the one product that it could sell to China in large quantities in order to pay for all the items it wanted to buy from China.

We should think about current rules on intellectual property in the same way. They have no moral or economic rationale. (Yeah, I know we can tell stories about how they are needed for innovation, but they aren’t true.) The laws on intellectual property are designed to make a relatively small number of people very rich. In doing so, they not only make everyone else poorer, but they also cost millions or even tens of millions of lives.  

Now that George W. Bush is back in the news with his attacks on the Trumpist insurrectionists, it might be worth reviving one of the great lines of his presidency. After the September 11th attack, when Bush decided to go after not just the terrorists who planned the hijackings, but all sorts of people around the world he didn’t like, he lumped them together as “evil-doers.” That may not be the most eloquent phrase, but it works well as a description of the modern pharmaceutical industry.

Some may find this description of the pharmaceutical industry abhorrent. After all, they develop life-saving drugs and vaccines, most recently the vaccines against the coronavirus which have saved millions of lives. But the industry’s storyline gives us a very incomplete picture of what it does and how.

Probably the best way to think about the pharmaceutical industry is to imagine an incredibly corrupt fire department. Most of the money that the fire department gets to buy new trucks and other equipment goes right into the pockets of the department’s commissioner and his closest friends. The department may still do its job in the sense that they rush to fires and rescue people trapped by flames, but it costs way more than it should.

The fire department may even occasionally start fires itself so that they can be heroes in putting them out and rescuing potential victims. If that sounds like an over-the-top accusation against the pharmaceutical industry, then you didn’t pay attention to the opioid scandal. Several major drug companies have paid out billions of dollars in settlements over the accusation that they deliberately misled doctors about the addictiveness of the new generation of opioids.

Note that the accusation was not that the industry mistakenly failed to recognize how addictive their drugs were. The accusation was that they knew they were highly addictive, but lied to doctors so that they could sell more prescriptions. This is not very different from deliberating starting fires to drum up business.

Now suppose that there was growing political pressure to cut back the fire department’s budget and clean up its practices. Naturally, it’s not going to just sit back and let someone take away the trough. Our corrupt fire department will do everything in its power to continue the practices that are allowing its top officials to get rich.

In the case of the corrupt fire department, we can anticipate big public relations campaigns where they highlight the fires they have extinguished and the lives they have saved. We can expect to see pictures of adorable children who were saved from burning blazes by the fire department. This of course has nothing to do with the effort to eliminate corruption, but it makes great material for advertisements on the major news shows. And, who knows, maybe these expensive ads will even influence their reporting on the first department’s corruption.

This corresponds to the pharmaceutical industry’s campaign to beat back congressional efforts to lower prescription drug prices and weaken the protection the industry now enjoys with government-granted patent monopolies. Just as the corrupt fire department actually does save kids’ lives, the pharmaceutical industry does produce drugs and vaccines that are hugely important for people’s lives and health.

But that is not the issue, the question is whether there are better ways to get these drugs and vaccines. There is good reason for thinking there is.

Direct Public Funding, an Alternative to Government-Granted Patent Monopolies

The obvious alternative to having drug companies pay for their research costs is through direct public funding of research.  Direct funding can take different forms. We can have a prize system, where the government gives out prizes and then takes ownership of new drugs or vaccines. These are then placed in the public domain so that they can be sold as cheap generics.

My preferred route is a system of long-term contracts, similar to the way the Pentagon pays for the development of new planes, submarines, and weapons systems. This has the big advantage that it can require that all research be fully public all along the way. This means that research findings, as well as results from clinical trials, are posted on the web as soon as practical. This means that researchers all over the country, and in fact all over the world, can quickly benefit from each other’s successes and failures. (I outline this system in more detail in chapter 5 of Rigged [it’s free].)

To my view, this shift to direct public funding has the important result of changing the incentives of the pharmaceutical industry. Under the patent monopoly system, drug companies try to figure out how to maximize the profits they can get as a result of the monopolies the government has given them. This may mean developing drugs that offer little benefit over existing drugs, but which they think they can market effectively.

It can mean finding ways to extend their monopolies, which may be dubious from a legal perspective, but with high-priced lawyers, may buy them another year or two on their patents. And, it may mean lying about the safety and effectiveness of a drug in order to maximize the amount they can sell at patent-protected prices.

These are the incentives provided by the patent monopoly system of financing drug development. If we instead relied on direct public funding there would undoubtedly be underperforming companies and some money would end up being wasted on dead ends. But all drugs and vaccines that were developed would be cheap (they are almost always cheap to manufacture and distribute) and no one would have the incentive to lie to us about their safety and effectiveness.

We can condemn drug company executives as moral monsters for misleading the public about their drugs or for charging high prices that put them out of reach for much of the population, but they are responding to the incentive structure we created. The key issue here is changing the incentive structure so that drug companies don’t do awful things.

 

TRIPS and the Fugitive Slave Act

For those not familiar with US history, the Fugitive Slave Act usually refers to the 1850 bill passed by Congress, which made it easier for bounty hunters to track people who had escaped from slavery in the South into Northern states that banned slavery. These bounty hunters could bring the people who had escaped slavery back to the South. The Act imposed serious penalties on anyone who tried to assist people in escaping slavery or blocked the efforts of bounty hunters. Its provisions were considerably stronger than an earlier Fugitive Slave Act passed in 1793, making it more difficult for people escaping slavery to live freely in the North. It was an important factor in the tensions that led to the Civil War a decade later.

I would not compare TRIPS to the barbarism of a system of slavery that imprisoned tens of millions of people for centuries, but the Fugitive Slave Act provides an example of a truly barbaric law that ostensibly decent people could consider reasonable. We should understand TRIPS also as a horrific provision of an international trade deal, the Uruguay Round of General Agreement on Tariffs and Trade, that was designed to bottle up technology to reduce access in the developing world, even when the issue is access to life-saving medicines or vaccines.

The issue of bottling up technology is central to the story of the massive and unnecessary loss of life in the pandemic. The official death toll worldwide is already over 4.7 million, but we know this is a gross understatement. To take one of the hardest-hit countries, India now officially reports 445,000 deaths from the pandemic, but a study by the Center for Global Development put the number of excess deaths in India, as of July, at 3.4 million and possibly over 4 million. In Mexico, the number of excess deaths is more than 240,000 higher than the official death toll from COVID-19, and in South Africa the gap is 150,000. Clearly, the death toll is several million higher than the already horrific official number.

But the question here is how much did the drug industry’s bottling up of technology contribute to this disaster. The provisions of TRIPS require countries throughout the world to have US-type patent laws. This means that countries like South Africa, Brazil, and India (the world’s largest manufacturer of pharmaceuticals), that might have had the technical expertise to produce the COVID-19 vaccines, as well as treatments and tests, could not simply start shifting production to pandemic related items. They needed to have the authorization of manufacturers who had patent rights.

This applied to manufacturers in wealthy countries as well. For example, Teva, a huge Israeli pharmaceutical company, wanted to produce the Pfizer vaccine by converting existing facilities but was unable to come to an agreement.

The problems with increasing production of vaccines, treatments, and tests go beyond just patents. A couple of months ago, I was on a panel with an industry representative who was anxious to boast that much of the technology needed to produce the mRNA vaccines does not depend on patent monopolies, but is instead held as industrial secrets. He said that he didn’t see how companies could be forced to disclose secret information.

Of course, no company has to disclose secret information, we can just have their top engineers share the expertise they have gained while at Pfizer, AstraZeneca, or Moderna. Surely, for paychecks of millions of dollars per month, many of the most knowledgeable engineers at these companies could be persuaded to share their know-how with pharmaceutical manufacturers in the developing world. The fact that they could also be helping to save millions of lives might also make this work attractive.

The reason this technology transfer is not happening now is that all these companies have nondisclosure agreements with the employees who would have access to this knowledge. If any of them were to begin sharing information with another pharmaceutical company, they would certainly face a large lawsuit from their former employer, who may also be able to get an injunction prohibiting this engineer from providing further assistance. If an engineer were to act in violation of an injunction, they could face imprisonment. In short, the laws on nondisclosure agreements can be used by pharmaceutical companies to block the transfer of the technologies needed to effectively combat the pandemic.  

Governments do not have to make nondisclosure agreements enforceable contracts, especially when so much of the underlying technology, as in the case of mRNA vaccines, was developed with public funds.  Nondisclosure agreements are quite explicitly designed to limit competition. Other contracts designed to restrict competition are not enforceable by the courts. For example, if Apple were to pay Samsung $1 billion in exchange for a commitment not to charge less than $800 for its newest smartphone, no court would sanction Samsung if it violated this agreement. Since the purpose is clearly to limit competition, in direct violation of anti-trust laws, this sort of contract would be unenforceable.

In the same vein, we can think of the laws on nondisclosure agreements as efforts to limit competition, that have no place in a free market. Again, the case for this view is strongest when much of the funding for the development of technology comes from the government, as is the case with the COVID-19 vaccines and most innovations in the biomedical sector.

The proponents of the WTO often talk about it as promoting free trade, but in fact, the TRIPS accord went 180 degrees in the opposite direction. TRIPS is about bottling up technology. A WTO that was actually designed to promote free trade and the transfer of technology would, instead of protecting patent monopolies, would be banning, or at least severely restricting, nondisclosure agreements. Don’t look for that one any time soon.

“Free trade” has always been a flexible concept that the wealthy and powerful have interpreted in ways that advance their interests at the expense of everyone else. The Opium Wars fought between China and the United Kingdom were justified on the basis of free trade. The UK was insisting that people in China had the right to buy opium, which was the one product that it could sell to China in large quantities in order to pay for all the items it wanted to buy from China.

We should think about current rules on intellectual property in the same way. They have no moral or economic rationale. (Yeah, I know we can tell stories about how they are needed for innovation, but they aren’t true.) The laws on intellectual property are designed to make a relatively small number of people very rich. In doing so, they not only make everyone else poorer, but they also cost millions or even tens of millions of lives.  

Roger Lowenstein had a piece in the NYT’s DealBook section defending share buybacks. I actually agree with much of what he wrote (I can’t see the virtues of paying out money as dividends rather than buybacks), but Lowenstein does miss an important point that can be used to justify the tax proposed by Democrats. There is a fundamental asymmetry in the tax treatment of money paid out as dividends and money paid out to shareholders as buybacks.

Suppose a company pays out $2 billion in dividends to its shareholders. If we say roughly half of its stock is held by rich people, outside of tax-sheltered accounts (as opposed to institutional investors like pension funds or 401(k) type accounts), then the government will collect $200 million in taxes on these dividends, since most of these people would face a 20 percent tax rate on dividends.  (That compares to a 37 percent tax rate if dividends were taxed as normal income.)

By contrast, if the company pays out $2 billion to shareholders through buybacks, it is likely to collect considerably less tax revenue. The people selling the stock will have to pay taxes on their capital gains, but the incremental capital gain (the higher capital gain that people get as a result of the buyback, as opposed to the gain they would have received if there had been no buyback) will almost certainly be less than $2 billion.

Furthermore, all the people who did not sell their stock had an increase in the value of their shares roughly equivalent to $2 billion in dividend payouts, but they have to pay zero taxes on this rise in value, in contrast to the taxes they would have paid if the money had been paid out as dividends. As I’ve said before, this benefit can be exaggerated, since shares do trade frequently and even the very rich probably have to sell shares from time to time to maintain their living standards, but it is almost certain that we get less tax revenue from money paid out through buybacks than money paid out as dividends.

For this reason, the Democrats’ plan to impose a 2.0 percent tax on buybacks makes sense in that it tries to treat buybacks and dividends as equivalents from the standpoint of the tax system. Even if buybacks are not the great evil that some have claimed, there is no reason for the government to be encouraging them with its tax policy. It’s reasonable to argue whether the approach the Democrats are looking to is the best route (I would just have the per share expense of buybacks attributed as dividends to shareholders for tax purposes), but trying to equalize the tax treatment of dividends and buybacks is good policy.  

Roger Lowenstein had a piece in the NYT’s DealBook section defending share buybacks. I actually agree with much of what he wrote (I can’t see the virtues of paying out money as dividends rather than buybacks), but Lowenstein does miss an important point that can be used to justify the tax proposed by Democrats. There is a fundamental asymmetry in the tax treatment of money paid out as dividends and money paid out to shareholders as buybacks.

Suppose a company pays out $2 billion in dividends to its shareholders. If we say roughly half of its stock is held by rich people, outside of tax-sheltered accounts (as opposed to institutional investors like pension funds or 401(k) type accounts), then the government will collect $200 million in taxes on these dividends, since most of these people would face a 20 percent tax rate on dividends.  (That compares to a 37 percent tax rate if dividends were taxed as normal income.)

By contrast, if the company pays out $2 billion to shareholders through buybacks, it is likely to collect considerably less tax revenue. The people selling the stock will have to pay taxes on their capital gains, but the incremental capital gain (the higher capital gain that people get as a result of the buyback, as opposed to the gain they would have received if there had been no buyback) will almost certainly be less than $2 billion.

Furthermore, all the people who did not sell their stock had an increase in the value of their shares roughly equivalent to $2 billion in dividend payouts, but they have to pay zero taxes on this rise in value, in contrast to the taxes they would have paid if the money had been paid out as dividends. As I’ve said before, this benefit can be exaggerated, since shares do trade frequently and even the very rich probably have to sell shares from time to time to maintain their living standards, but it is almost certain that we get less tax revenue from money paid out through buybacks than money paid out as dividends.

For this reason, the Democrats’ plan to impose a 2.0 percent tax on buybacks makes sense in that it tries to treat buybacks and dividends as equivalents from the standpoint of the tax system. Even if buybacks are not the great evil that some have claimed, there is no reason for the government to be encouraging them with its tax policy. It’s reasonable to argue whether the approach the Democrats are looking to is the best route (I would just have the per share expense of buybacks attributed as dividends to shareholders for tax purposes), but trying to equalize the tax treatment of dividends and buybacks is good policy.  

Bill Niskanen was the long-time head of the Cato Institute. He was the rarest of all creatures in Washington, an honest libertarian. While I disagreed with him on most issues, I came to realize that if I shut up and listened to what he had to say, I might learn something.

In particular, I remember once debating him on tax policy. He referred to the 90 percent top marginal income tax rate in the 1940s and 1950s, and then added in some other taxes and came up with a number close to, or even above, 100 percent. I shot back something to the effect of “no one paid that.” Niskanen calmly responded that, if you have a tax that no one is paying, it’s probably not a very good tax. I had to acknowledge that he had a point.

I should also mention that Niskanen was a genuine anti-imperialist. Under his leadership, Cato regularly put out papers that called for cutting the military budget by 50 percent. You didn’t see anything like this from most of the liberal think tanks. He also was a staunch opponent of the Iraq War, a position that apparently lost Cato some big contributions.

I mention this as background because I have high expectations from the center that carries his name. As with Niskanen, I don’t expect to agree with everything they put out, but I do expect serious arguments.

For this reason, I am disappointed in their new paper, “Cost Disease Socialism,” written by Steven Teles, Samuel Hammond, and Daniel Takash (THT). It’s not so much that I disagree with the substance of the piece, I would probably back 80-90 percent of their proposals, it’s more the framing that I object to.

The essence of the piece is that we have large sectors of the economy, health care, college education, child care, and housing, where costs are rising far more rapidly than in other sectors of the economy. While this is largely true, the odd part is that THT are blaming this on socialism.

The reason this is strange is that of course we don’t have socialism in the United States. Countries that might more accurately be said to be socialist, or at least social-democratic, for the most part, have costs in these sectors much better controlled than in the United States.

To take the most obvious example, the countries in Europe that have national health care systems all spend a far smaller share of their GDP on health care than the United States. The UK, where the government actually directly provides health care, spends less than half as much as a share of its GDP on health care. That hardly fits the story of cost disease socialism.

But socialism is really not the villain in THT, it’s actually regulations that restrict supply and raise costs. These regulations were not put in place and perpetuated by socialists, but rather by the powerful interest groups that benefit from them.

To take one of the most straightforward examples, we severely restrict the supply of doctors in the United States, both by limiting med school enrollments and also the number of foreign-trained doctors who can practice in the United States. We also limit the extent to which nurse practitioners and other health care professionals can perform tasks for which they are fully qualified. Restricting supply in this way allows our doctors to earn more than twice as much as their counterparts in other wealthy countries. THT are very much on the mark in calling attention to this issue, but what does it have to do with socialism?

There is a similar story with college education. Our universities cost far more to educate students than schools in other wealthy countries. THT identify the main culprit as excessive layers of bureaucracy. I’m sure there is considerable truth to this story, but I would also say that university presidents getting seven-figure salaries, along with high six-figure salaries for other top officials, are also part of the problem. But that aside, where is socialism in this story? 

It’s also worth noting that tuition costs have slowed sharply in recent years.  It will be interesting to see how the increased use of online instruction will affect costs in the years ahead, but in any case, it’s hard to find the fingerprints of socialism.

THT also discuss how zoning restrictions and other regulations have raised housing costs in major cities by limiting construction. This point is largely right, but the perps here are hardly socialists. Rather, these restrictions are kept in place largely by upper-middle-class and wealthy homeowners who are determined to protect their property values.

I will add that I think some of the anti-regulation folks go too far. To steal a line from Yogi Berra, if San Francisco were as dense as New York City, no one would want to live there. An important part of limiting housing costs will be making smaller cities more attractive, something which seems to be happening with the explosion of remote work in the pandemic. In any case, the story really has nothing to do with socialism.

To sum up the story, THT make many useful points in this piece, that progressives should take seriously.  It is unfortunate that they frame it in a way that seeks to make enemies of those on the left. I doubt Bill Niskanen would approve.       

Bill Niskanen was the long-time head of the Cato Institute. He was the rarest of all creatures in Washington, an honest libertarian. While I disagreed with him on most issues, I came to realize that if I shut up and listened to what he had to say, I might learn something.

In particular, I remember once debating him on tax policy. He referred to the 90 percent top marginal income tax rate in the 1940s and 1950s, and then added in some other taxes and came up with a number close to, or even above, 100 percent. I shot back something to the effect of “no one paid that.” Niskanen calmly responded that, if you have a tax that no one is paying, it’s probably not a very good tax. I had to acknowledge that he had a point.

I should also mention that Niskanen was a genuine anti-imperialist. Under his leadership, Cato regularly put out papers that called for cutting the military budget by 50 percent. You didn’t see anything like this from most of the liberal think tanks. He also was a staunch opponent of the Iraq War, a position that apparently lost Cato some big contributions.

I mention this as background because I have high expectations from the center that carries his name. As with Niskanen, I don’t expect to agree with everything they put out, but I do expect serious arguments.

For this reason, I am disappointed in their new paper, “Cost Disease Socialism,” written by Steven Teles, Samuel Hammond, and Daniel Takash (THT). It’s not so much that I disagree with the substance of the piece, I would probably back 80-90 percent of their proposals, it’s more the framing that I object to.

The essence of the piece is that we have large sectors of the economy, health care, college education, child care, and housing, where costs are rising far more rapidly than in other sectors of the economy. While this is largely true, the odd part is that THT are blaming this on socialism.

The reason this is strange is that of course we don’t have socialism in the United States. Countries that might more accurately be said to be socialist, or at least social-democratic, for the most part, have costs in these sectors much better controlled than in the United States.

To take the most obvious example, the countries in Europe that have national health care systems all spend a far smaller share of their GDP on health care than the United States. The UK, where the government actually directly provides health care, spends less than half as much as a share of its GDP on health care. That hardly fits the story of cost disease socialism.

But socialism is really not the villain in THT, it’s actually regulations that restrict supply and raise costs. These regulations were not put in place and perpetuated by socialists, but rather by the powerful interest groups that benefit from them.

To take one of the most straightforward examples, we severely restrict the supply of doctors in the United States, both by limiting med school enrollments and also the number of foreign-trained doctors who can practice in the United States. We also limit the extent to which nurse practitioners and other health care professionals can perform tasks for which they are fully qualified. Restricting supply in this way allows our doctors to earn more than twice as much as their counterparts in other wealthy countries. THT are very much on the mark in calling attention to this issue, but what does it have to do with socialism?

There is a similar story with college education. Our universities cost far more to educate students than schools in other wealthy countries. THT identify the main culprit as excessive layers of bureaucracy. I’m sure there is considerable truth to this story, but I would also say that university presidents getting seven-figure salaries, along with high six-figure salaries for other top officials, are also part of the problem. But that aside, where is socialism in this story? 

It’s also worth noting that tuition costs have slowed sharply in recent years.  It will be interesting to see how the increased use of online instruction will affect costs in the years ahead, but in any case, it’s hard to find the fingerprints of socialism.

THT also discuss how zoning restrictions and other regulations have raised housing costs in major cities by limiting construction. This point is largely right, but the perps here are hardly socialists. Rather, these restrictions are kept in place largely by upper-middle-class and wealthy homeowners who are determined to protect their property values.

I will add that I think some of the anti-regulation folks go too far. To steal a line from Yogi Berra, if San Francisco were as dense as New York City, no one would want to live there. An important part of limiting housing costs will be making smaller cities more attractive, something which seems to be happening with the explosion of remote work in the pandemic. In any case, the story really has nothing to do with socialism.

To sum up the story, THT make many useful points in this piece, that progressives should take seriously.  It is unfortunate that they frame it in a way that seeks to make enemies of those on the left. I doubt Bill Niskanen would approve.       

Greg Mankiw warned New York Times readers about the dangers of adopting the Biden agenda and moving more towards a European-style welfare state. In his piece, titled “Can America Afford to be a Major Welfare State,” Mankiw noted:

“Compared with the United States, G.D.P. per person in 2019 was 14 percent lower in Germany, 24 percent lower in France and 26 percent lower in the United Kingdom.

“Economists disagree about why European nations are less prosperous than the United States. But a leading hypothesis, advanced by Edward Prescott, a Nobel laureate, in 2003, is that Europeans work less than Americans because they face higher taxes to finance a more generous social safety net.”

While Prescott and Mankiw attribute the gap in annual work hours between Europe and the United States to the disincentive created by higher European taxes, there is an alternative explanation: Europeans workers may just want to have more leisure time and they have the political power to impose their will.

Supporting this view is the fact that the European welfare states all mandate far more paid time off than the United States. Germany mandates that workers get 20 days a year of paid vacation, in addition to 13 paid holidays. The Netherlands also mandates 20 days of paid vacation, in addition to 9 paid holidays. Demark mandates 25 days of paid vacation and 9 paid holidays. These countries also all mandate paid sick leave and paid family leave.

In other words, it is not simply that individuals are looking at the tax code and deciding to work less, parliaments are writing laws that guarantee most workers more leisure and less work. This is because politicians win elections based on the promise of more leisure and less work.

It’s true, as Mankiw points out, that Europeans on average have lower incomes than people in the United States, but this is largely because they have made a political decision that they prefer more leisure time to higher incomes. (The gap in income for the typical worker is almost certainly not as large as the gap in the average income, since there is less income inequality in Europe.)

Mankiw may think that it’s better for people to work more and have more money, but apparently people in Europe think otherwise. Since several states and cities have mandated paid family leave and sick leave in recent years, it may be the case that people in the United States also disagree with Mankiw.  

Greg Mankiw warned New York Times readers about the dangers of adopting the Biden agenda and moving more towards a European-style welfare state. In his piece, titled “Can America Afford to be a Major Welfare State,” Mankiw noted:

“Compared with the United States, G.D.P. per person in 2019 was 14 percent lower in Germany, 24 percent lower in France and 26 percent lower in the United Kingdom.

“Economists disagree about why European nations are less prosperous than the United States. But a leading hypothesis, advanced by Edward Prescott, a Nobel laureate, in 2003, is that Europeans work less than Americans because they face higher taxes to finance a more generous social safety net.”

While Prescott and Mankiw attribute the gap in annual work hours between Europe and the United States to the disincentive created by higher European taxes, there is an alternative explanation: Europeans workers may just want to have more leisure time and they have the political power to impose their will.

Supporting this view is the fact that the European welfare states all mandate far more paid time off than the United States. Germany mandates that workers get 20 days a year of paid vacation, in addition to 13 paid holidays. The Netherlands also mandates 20 days of paid vacation, in addition to 9 paid holidays. Demark mandates 25 days of paid vacation and 9 paid holidays. These countries also all mandate paid sick leave and paid family leave.

In other words, it is not simply that individuals are looking at the tax code and deciding to work less, parliaments are writing laws that guarantee most workers more leisure and less work. This is because politicians win elections based on the promise of more leisure and less work.

It’s true, as Mankiw points out, that Europeans on average have lower incomes than people in the United States, but this is largely because they have made a political decision that they prefer more leisure time to higher incomes. (The gap in income for the typical worker is almost certainly not as large as the gap in the average income, since there is less income inequality in Europe.)

Mankiw may think that it’s better for people to work more and have more money, but apparently people in Europe think otherwise. Since several states and cities have mandated paid family leave and sick leave in recent years, it may be the case that people in the United States also disagree with Mankiw.  

According to a draft document being circulated, the Democrats are looking to save $600 billion over a decade by negotiating lower prescription drug prices. The basic story here is that the United States pays more than twice as much, on average, for prescription drugs than Germany, France, Canada, and other wealthy countries. If we paid something closer to what these countries pay for drugs, there would be very large potential savings.

The Democrats are hoping to use these savings to pay for expanding Medicare (possibly also lowering the age of eligibility; 64 would be a good start), free community college, extending the child tax credit, and all sorts of other good things. While there is some skepticism as to whether the government can actually save $600 billion over a decade on prescription drugs, this is actually a very low target. Arguably, the full cost of the $3.5 trillion (1.2 percent of GDP) reconciliation package could be covered by savings on prescription drugs alone.

Projected Spending on Prescription Drugs

There is very little awareness of how much money the country spends on prescription drugs. This is partly due to the fact that most spending is by third parties, either the government or private insurers, rather than directly out of the pockets of patients. There also is little realization of how high drug prices are relative to the cost of manufacturing and distribution.

The figure below shows projected spending on prescription drugs over the next decade. Spending for 2021 is projected to be just over $500 billion, or 2.2 percent of GDP. The growth rates projected by the Centers for Medicare and Medicaid Services (CMS) imply that spending will rise to $894 billion by 2031, or 2.6 percent of GDP.[1] The base for this spending is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. It is considerably higher than the spending data from CMS because it includes spending on drugs in hospitals, nursing homes, and other institutions. The CMS data only measures spending on drugs by patients directly.

 

Source: CMS, BEA, and author’s calculations.

As a target for potential spending, the figure assumes that without patent and related protections, we would be spending 20 percent as much as is currently projected. This is a plausible, and possibly even conservative target.

According to data from the Association for Accessible Medicines (AAM), the trade group for the generic drug 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 prescriptions. 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. 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.[2] (As a practical matter, we would not see generic competition push down prices right away, since it would take several years for a substantial number of competitors to enter the market.)

But even this figure understates the true potential savings from eliminating patents and related protections. The AAM’s data is based on averages, but these numbers are skewed by the fact that many generics sell for high prices in the period immediately after they are introduced. This is due to the fact that they have limited competition, in part by design.

The first generic to enter a market is granted six months of exclusivity, a period in which they enjoy an effective duopoly with the brand drug. For example, a recent analysis found that price declines averaged just over 50 percent in the first year after a generic is introduced. This means that the average cost of generic drugs in the AAM analysis is inflated by the generic drugs that are sold at high prices in the first years after they come onto the market. Also, the price of generics is inflated due to the fact that the generic industry must incur legal costs to contest patent battles with the brand industry. In addition, generic drugs may also be paying royalties on secondary patents that are still in force even after the key patent for a drug expired.

In a world with no patents or related protections, it is likely that generics would cost close to half as much as we now spend since the market would be more fully competitive and the industry would face far lower legal expenses. The table assumes an 80 percent reduction in spending, which is likely a conservative figure. If the average price of a generic drug in a patent-free world was 50 percent of the current price and all drugs were sold as generics, the savings would be more than 85 percent of current spending.

The 80 percent reduction in projected spending would imply savings of $5.6 trillion over the next decade. Of course, the government does not pay for all prescription drugs in the country, so only around half of these savings, or $2.8 trillion, would accrue to the government. Although, since most spending on health insurance is tax-deductible, the government should recoup some of the private sector savings in the form of higher tax revenue. Also, from the standpoint of reducing demand in the economy and limiting the risk of inflation (the purpose of taxation at the federal level), the reduction in private sector spending on drugs is likely to have almost as much impact as the savings to the government.

Research and Development Costs

This picture leaves out the research and development costs incurred by the industry. In 2020, the industry spent $105.7 billion on research and development.[3] If we assume that spending on research increases at the same pace as spending on drugs, then the industry would be spending $1.5 trillion on research and development over the course of the decade, on its current path. (This is in addition to the $45 billion a year that it currently spends through NIH and other agencies.)  If the government had to replace this spending, and we assume that a dollar of government spending has the same value as a dollar of private spending, then we would need to subtract $1.5 trillion from our savings on drug prices to cover these research costs. That would still leave $4.1 trillion in savings.

Whether or not a dollar of government spending has the same value as a dollar of private spending under the patent monopoly system is a debatable point. It could be argued that private companies, with their own dollars on the line, will be more efficient, but there are reasons the story could go the other way. (Moderna, which developed its coronavirus vaccine almost entirely on the public dime, is a great example of public funding being very effective.)

First, there are better and worse ways of doing public funding. In my view, the best route would be to pay out money for research to drug companies on long-term contracts, similar to the way the Defense Department contracts out for major weapons systems. (I describe this more fully in chapter 5 of Rigged [it’s free].) The contractors would have a strong incentive to ensure their money was well spent since presumably, they will want their contracts renewed when they expire.

A big advantage this system would have over military contracting is that everything would be fully open. While there are good reasons for secrecy in designing weapons systems, there is no reason to want to keep research findings on a cancer drug or treatment for heart disease secret. In fact, putting all results on the web in a timely manner should be a condition of getting public funding. This rule would apply not only to contractors but also to all subcontractors. (It is likely that any major drug company winning a contract would contract out for much of the research, just as they do now. Innovative startups are likely to be more efficient with research dollars than large well-established companies.)

If all research is quickly made available to the entire scientific community, we are likely to make progress more quickly than in a world where drug companies are looking to lock up their work behind patent monopolies. Researchers can quickly learn from each other’s research, building on successes and avoiding failures.

In addition, research that is primarily rent-seeking in nature would be largely avoided. In many cases, drug companies look to develop drugs that are not expected to produce major medical benefits over existing drugs, but rather will simply give them a portion of the patent rents earned by a major breakthrough drug. The Food and Drug Administration puts more than 90 percent of its drug approvals in the “standard” category, meaning that they are not a qualitative improvement over existing drugs.

To be clear, duplicative drugs are not of zero value. People may react poorly to a certain drug, whereas they may be fine with another drug in the same class. Also, some drugs do not mix well with other drugs. However, as a general rule, we would probably like to see research dollars spent finding drugs for conditions where effective drugs do not currently exist, rather than developing the seventh, eighth, or ninth drug for a condition.

There also will be some amount of research spending that will be needed to ensure that production standards are safe and efficient. This spending would be necessary even if everything was sold as a generic, since it will be needed for any manufacturer. The government would not need to replace this spending, which is likely in the neighborhood of 10 percent of the total.

The Opioid Scandal and Patent Monopoly Financings

There is one other very important reason for believing that publicly-funded research could be more effective on a per-dollar basis than patent monopoly financing. Patent monopolies give drug companies an incentive to lie about the safety and effectiveness of their drugs.

While it is common for drug companies to be less than completely honest about the safety and effectiveness of their drugs, we saw a very dramatic example of this dishonesty with the opioid crisis. Purdue Pharma and other major opioid manufacturers paid out tens of billions of dollars in settlements in response to lawsuits alleging that they deliberately concealed evidence of the addictiveness of their drugs in their efforts to promote them to doctors.

To be clear, the allegation was not that these companies made a mistake. The claim was that they knew their drugs were highly addictive, but claimed the opposite when they tried to convince doctors to prescribe them to patients.

There will always be mistakes in research, some with very large consequences. But the issue here was deliberate deception. Had it not been for the opportunity to sell their opioids at patent monopoly prices, the drug companies would have had far less incentive to misrepresent their addictiveness.

If we eliminated patent monopolies for prescription drugs, we also eliminate this perverse incentive. This is likely to lead to considerably better care for patients, since doctors will have honest research guiding their decisions in prescribing drugs.  

Drug Savings and Covering the Cost of the Reconciliation Package

If we think clearly about how much we are spending on drugs, compared to the cost of manufacturing and distributing them, it should be clear that the $600 billion savings figure being tossed around by Democrats is very doable. It is plausible to envision savings many times larger, if we are prepared to jettison the patent monopoly system of financing drug research and replace it with something more modern.

Of course, we should be looking to other routes for offsetting the spending in the reconciliation package, most obviously by increasing taxes on the rich and corporations. My favorite in the latter category involves switching the basis for the corporate income tax from profits to returns to shareholders. The latter are simply dividends and capital gains. This can be done on a simple spreadsheet. (That would be a single spreadsheet for all publicly traded companies.) We could put the tax shelter industry out of business since there is no way to hide what is being doled out as dividends or the rise in share price. (To be clear, this is a corporate income tax, not an individual tax – the corporations will be taxed based on the money they made for shareholders.)    

The Democrats in Congress are in a position to make changes that will have a huge impact on the lives of tens of millions of people. Covering the cost should not be a problem. We can get much or all of the way there from savings on prescription drugs alone, but we have many other good options to add to the mix.

[1] The projections in the chart use calendar year 2019 spending on prescription drugs as a base, since the 2020 numbers were distorted by the pandemic. This is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. The numbers for later years use the projected growth rates from the Center for Medicare and Medicaid Services, National Health Expenditure Projections, 2019-2028, Table 2. The spending growth rate for 2027 to 2028 (6.0 percent), is assumed to continue for the next three years.

[2] In the case of some very high-priced drugs, high-quality generic versions are available in other countries for less than 1.0 percent of the price charged in the United States.

[3] National Income and Product Accounts, Table 5.6.5, Line 9.

According to a draft document being circulated, the Democrats are looking to save $600 billion over a decade by negotiating lower prescription drug prices. The basic story here is that the United States pays more than twice as much, on average, for prescription drugs than Germany, France, Canada, and other wealthy countries. If we paid something closer to what these countries pay for drugs, there would be very large potential savings.

The Democrats are hoping to use these savings to pay for expanding Medicare (possibly also lowering the age of eligibility; 64 would be a good start), free community college, extending the child tax credit, and all sorts of other good things. While there is some skepticism as to whether the government can actually save $600 billion over a decade on prescription drugs, this is actually a very low target. Arguably, the full cost of the $3.5 trillion (1.2 percent of GDP) reconciliation package could be covered by savings on prescription drugs alone.

Projected Spending on Prescription Drugs

There is very little awareness of how much money the country spends on prescription drugs. This is partly due to the fact that most spending is by third parties, either the government or private insurers, rather than directly out of the pockets of patients. There also is little realization of how high drug prices are relative to the cost of manufacturing and distribution.

The figure below shows projected spending on prescription drugs over the next decade. Spending for 2021 is projected to be just over $500 billion, or 2.2 percent of GDP. The growth rates projected by the Centers for Medicare and Medicaid Services (CMS) imply that spending will rise to $894 billion by 2031, or 2.6 percent of GDP.[1] The base for this spending is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. It is considerably higher than the spending data from CMS because it includes spending on drugs in hospitals, nursing homes, and other institutions. The CMS data only measures spending on drugs by patients directly.

 

Source: CMS, BEA, and author’s calculations.

As a target for potential spending, the figure assumes that without patent and related protections, we would be spending 20 percent as much as is currently projected. This is a plausible, and possibly even conservative target.

According to data from the Association for Accessible Medicines (AAM), the trade group for the generic drug 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 prescriptions. 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. 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.[2] (As a practical matter, we would not see generic competition push down prices right away, since it would take several years for a substantial number of competitors to enter the market.)

But even this figure understates the true potential savings from eliminating patents and related protections. The AAM’s data is based on averages, but these numbers are skewed by the fact that many generics sell for high prices in the period immediately after they are introduced. This is due to the fact that they have limited competition, in part by design.

The first generic to enter a market is granted six months of exclusivity, a period in which they enjoy an effective duopoly with the brand drug. For example, a recent analysis found that price declines averaged just over 50 percent in the first year after a generic is introduced. This means that the average cost of generic drugs in the AAM analysis is inflated by the generic drugs that are sold at high prices in the first years after they come onto the market. Also, the price of generics is inflated due to the fact that the generic industry must incur legal costs to contest patent battles with the brand industry. In addition, generic drugs may also be paying royalties on secondary patents that are still in force even after the key patent for a drug expired.

In a world with no patents or related protections, it is likely that generics would cost close to half as much as we now spend since the market would be more fully competitive and the industry would face far lower legal expenses. The table assumes an 80 percent reduction in spending, which is likely a conservative figure. If the average price of a generic drug in a patent-free world was 50 percent of the current price and all drugs were sold as generics, the savings would be more than 85 percent of current spending.

The 80 percent reduction in projected spending would imply savings of $5.6 trillion over the next decade. Of course, the government does not pay for all prescription drugs in the country, so only around half of these savings, or $2.8 trillion, would accrue to the government. Although, since most spending on health insurance is tax-deductible, the government should recoup some of the private sector savings in the form of higher tax revenue. Also, from the standpoint of reducing demand in the economy and limiting the risk of inflation (the purpose of taxation at the federal level), the reduction in private sector spending on drugs is likely to have almost as much impact as the savings to the government.

Research and Development Costs

This picture leaves out the research and development costs incurred by the industry. In 2020, the industry spent $105.7 billion on research and development.[3] If we assume that spending on research increases at the same pace as spending on drugs, then the industry would be spending $1.5 trillion on research and development over the course of the decade, on its current path. (This is in addition to the $45 billion a year that it currently spends through NIH and other agencies.)  If the government had to replace this spending, and we assume that a dollar of government spending has the same value as a dollar of private spending, then we would need to subtract $1.5 trillion from our savings on drug prices to cover these research costs. That would still leave $4.1 trillion in savings.

Whether or not a dollar of government spending has the same value as a dollar of private spending under the patent monopoly system is a debatable point. It could be argued that private companies, with their own dollars on the line, will be more efficient, but there are reasons the story could go the other way. (Moderna, which developed its coronavirus vaccine almost entirely on the public dime, is a great example of public funding being very effective.)

First, there are better and worse ways of doing public funding. In my view, the best route would be to pay out money for research to drug companies on long-term contracts, similar to the way the Defense Department contracts out for major weapons systems. (I describe this more fully in chapter 5 of Rigged [it’s free].) The contractors would have a strong incentive to ensure their money was well spent since presumably, they will want their contracts renewed when they expire.

A big advantage this system would have over military contracting is that everything would be fully open. While there are good reasons for secrecy in designing weapons systems, there is no reason to want to keep research findings on a cancer drug or treatment for heart disease secret. In fact, putting all results on the web in a timely manner should be a condition of getting public funding. This rule would apply not only to contractors but also to all subcontractors. (It is likely that any major drug company winning a contract would contract out for much of the research, just as they do now. Innovative startups are likely to be more efficient with research dollars than large well-established companies.)

If all research is quickly made available to the entire scientific community, we are likely to make progress more quickly than in a world where drug companies are looking to lock up their work behind patent monopolies. Researchers can quickly learn from each other’s research, building on successes and avoiding failures.

In addition, research that is primarily rent-seeking in nature would be largely avoided. In many cases, drug companies look to develop drugs that are not expected to produce major medical benefits over existing drugs, but rather will simply give them a portion of the patent rents earned by a major breakthrough drug. The Food and Drug Administration puts more than 90 percent of its drug approvals in the “standard” category, meaning that they are not a qualitative improvement over existing drugs.

To be clear, duplicative drugs are not of zero value. People may react poorly to a certain drug, whereas they may be fine with another drug in the same class. Also, some drugs do not mix well with other drugs. However, as a general rule, we would probably like to see research dollars spent finding drugs for conditions where effective drugs do not currently exist, rather than developing the seventh, eighth, or ninth drug for a condition.

There also will be some amount of research spending that will be needed to ensure that production standards are safe and efficient. This spending would be necessary even if everything was sold as a generic, since it will be needed for any manufacturer. The government would not need to replace this spending, which is likely in the neighborhood of 10 percent of the total.

The Opioid Scandal and Patent Monopoly Financings

There is one other very important reason for believing that publicly-funded research could be more effective on a per-dollar basis than patent monopoly financing. Patent monopolies give drug companies an incentive to lie about the safety and effectiveness of their drugs.

While it is common for drug companies to be less than completely honest about the safety and effectiveness of their drugs, we saw a very dramatic example of this dishonesty with the opioid crisis. Purdue Pharma and other major opioid manufacturers paid out tens of billions of dollars in settlements in response to lawsuits alleging that they deliberately concealed evidence of the addictiveness of their drugs in their efforts to promote them to doctors.

To be clear, the allegation was not that these companies made a mistake. The claim was that they knew their drugs were highly addictive, but claimed the opposite when they tried to convince doctors to prescribe them to patients.

There will always be mistakes in research, some with very large consequences. But the issue here was deliberate deception. Had it not been for the opportunity to sell their opioids at patent monopoly prices, the drug companies would have had far less incentive to misrepresent their addictiveness.

If we eliminated patent monopolies for prescription drugs, we also eliminate this perverse incentive. This is likely to lead to considerably better care for patients, since doctors will have honest research guiding their decisions in prescribing drugs.  

Drug Savings and Covering the Cost of the Reconciliation Package

If we think clearly about how much we are spending on drugs, compared to the cost of manufacturing and distributing them, it should be clear that the $600 billion savings figure being tossed around by Democrats is very doable. It is plausible to envision savings many times larger, if we are prepared to jettison the patent monopoly system of financing drug research and replace it with something more modern.

Of course, we should be looking to other routes for offsetting the spending in the reconciliation package, most obviously by increasing taxes on the rich and corporations. My favorite in the latter category involves switching the basis for the corporate income tax from profits to returns to shareholders. The latter are simply dividends and capital gains. This can be done on a simple spreadsheet. (That would be a single spreadsheet for all publicly traded companies.) We could put the tax shelter industry out of business since there is no way to hide what is being doled out as dividends or the rise in share price. (To be clear, this is a corporate income tax, not an individual tax – the corporations will be taxed based on the money they made for shareholders.)    

The Democrats in Congress are in a position to make changes that will have a huge impact on the lives of tens of millions of people. Covering the cost should not be a problem. We can get much or all of the way there from savings on prescription drugs alone, but we have many other good options to add to the mix.

[1] The projections in the chart use calendar year 2019 spending on prescription drugs as a base, since the 2020 numbers were distorted by the pandemic. This is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. The numbers for later years use the projected growth rates from the Center for Medicare and Medicaid Services, National Health Expenditure Projections, 2019-2028, Table 2. The spending growth rate for 2027 to 2028 (6.0 percent), is assumed to continue for the next three years.

[2] In the case of some very high-priced drugs, high-quality generic versions are available in other countries for less than 1.0 percent of the price charged in the United States.

[3] National Income and Product Accounts, Table 5.6.5, Line 9.

It seems a strange concern, but I suppose it’s what we would expect from a political party that is determined to block every effort to contain the pandemic. According to a NYT article on opposition to President Biden’s plan to increase spending on various social program by $3.5 billion (1.3 percent of GDP) over the next decade:

“To critics, the legislation represents a fundamental upending of American-style governance and a shift toward social democracy. With it, they worry, would come European-style endemic unemployment and depressed economic dynamism.”

Many European social democracies have consistently had lower unemployment rates than the United States. According to the most recent data from the OECD, the unemployment rate in Denmark is now 4.3, in Germany 3.6 percent, and in the Netherlands 3.1 percent. It’s now clear what measure of “economic dynamism” these critics use, but using productivity growth, the measure most often used by economists, the dynamism of European economies is comparable to the U.S. economy.

It seems a strange concern, but I suppose it’s what we would expect from a political party that is determined to block every effort to contain the pandemic. According to a NYT article on opposition to President Biden’s plan to increase spending on various social program by $3.5 billion (1.3 percent of GDP) over the next decade:

“To critics, the legislation represents a fundamental upending of American-style governance and a shift toward social democracy. With it, they worry, would come European-style endemic unemployment and depressed economic dynamism.”

Many European social democracies have consistently had lower unemployment rates than the United States. According to the most recent data from the OECD, the unemployment rate in Denmark is now 4.3, in Germany 3.6 percent, and in the Netherlands 3.1 percent. It’s now clear what measure of “economic dynamism” these critics use, but using productivity growth, the measure most often used by economists, the dynamism of European economies is comparable to the U.S. economy.

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