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.

Both the New York Times and Washington Post reported on the Biden administration’s complaints that China had not followed through on the commitments it had made in a trade deal with Donald Trump to buy large amounts of various US products. While it is reasonable to expect that countries will follow through with promises they made in trade agreements, in this case, China likely did the United States a favor. With widespread supply chain problems due to the pandemic and unusual weather conditions, additional sales to China might well have caused even greater bottlenecks in the effort to meet domestic demand. (China cited the pandemic as the reason its purchases fell short.) For this reason, China likely did the United States a favor by not carrying through with the promised purchases in the trade deal.

It is also worth noting that in the building economic confrontation with China, the Biden strategy seems likely to further increase the upward redistribution of income that we have seen over the last four decades. Thanks in large part to our past trade policies, manufacturing jobs no longer carry a substantial wage premium over jobs in other sectors. This means getting back several hundred thousand manufacturing jobs will not provide any substantial benefit to less-educated workers. 

On the other hand, the sort of protectionist policies being promoted by Biden, which involve protecting our most high-tech industries from Chinese competition, are likely to result in higher prices for the output from the protected sectors (thereby lowering real wages for households) and higher pay for the highly educated workers in these sectors. This is yet another way to use trade policy to redistribute income upward.

Both the New York Times and Washington Post reported on the Biden administration’s complaints that China had not followed through on the commitments it had made in a trade deal with Donald Trump to buy large amounts of various US products. While it is reasonable to expect that countries will follow through with promises they made in trade agreements, in this case, China likely did the United States a favor. With widespread supply chain problems due to the pandemic and unusual weather conditions, additional sales to China might well have caused even greater bottlenecks in the effort to meet domestic demand. (China cited the pandemic as the reason its purchases fell short.) For this reason, China likely did the United States a favor by not carrying through with the promised purchases in the trade deal.

It is also worth noting that in the building economic confrontation with China, the Biden strategy seems likely to further increase the upward redistribution of income that we have seen over the last four decades. Thanks in large part to our past trade policies, manufacturing jobs no longer carry a substantial wage premium over jobs in other sectors. This means getting back several hundred thousand manufacturing jobs will not provide any substantial benefit to less-educated workers. 

On the other hand, the sort of protectionist policies being promoted by Biden, which involve protecting our most high-tech industries from Chinese competition, are likely to result in higher prices for the output from the protected sectors (thereby lowering real wages for households) and higher pay for the highly educated workers in these sectors. This is yet another way to use trade policy to redistribute income upward.

Reporters and politicians have been screaming about our debt and deficits in recent weeks, as the Democrats try to steer their public investment package through the senators from Arizona and West Virginia. The infuriating part of this story is that the whining about debt and deficits, and the reporting on it, literally makes no sense. This is because those involved refuse to do any serious thinking on these issues.

Starting with debt, the ostensible concern is that a large government debt will be a burden on our children. The story goes that in 10 or 20 years, we will be facing a high-interest burden, which will require either higher taxes or less spending in other areas.

The projections for interest payments don’t support this story. Our interest payments are currently around 1.0 percent of GDP, net of money refunded to the Treasury by the Fed. That is projected to rise to somewhat over 2.0 percent of GDP in a decade.

Our interest burden was over 3.0 percent of GDP in the early 1990s. That burden did not prevent us from having a very prosperous decade, especially in the second half.[1]

The more important part of this story is that the conventional calculations of the debt leave out the higher prices that we will pay for items like prescription drugs and computer software because of government-granted patent and copyright monopolies. This is a huge burden, which is many times larger than the debt burden, but policy types and reporters refuse to ever talk about it for some reason.  

This is a simple and logical point. The government can pay for things by writing checks. It typically does this with things like roads, bridges, and teachers’ salaries.  It can also pay for things by giving out patent or copyright monopolies.

When the government gives out these monopolies, it is telling innovators or creative workers to develop a new product or write a new book, and you will be given a monopoly for a period of time. This government-granted monopoly will allow you to charge a price that is far above the free market price.

This point has nothing to do with whether you think patents are a good way to support innovation or copyrights are the best way to support creative work, it is a logical point. If the government will threaten to arrest anyone who produces the Moderna vaccine, Moderna gets to charge a much higher price than if everyone in the world can produce the vaccine.[2]

This brings us back to my question: how can someone who claims to be concerned about the burden of the government debt on our children, ignore the burden, in the form of higher prices, created by government-granted patent and copyright monopolies? If the government were to put a tax on prescription drugs to help cover its debt service, we would all recognize this tax as a burden on households.

Yet somehow, we are supposed to believe that if the government gives out a patent monopoly that allows a drug company to charge a price that is far higher than the free market price, that is not a burden. That makes zero sense.

And this burden is very large. By my calculations, the higher cost due to patent monopolies and related protections comes to more than $400 billion (1.8 percent of GDP) in the case of prescription drugs alone. If we add in the higher costs that we pay for medical equipment, computers, software, and a variety of other items, the burden likely comes to more than $1 trillion a year, or 4.5 percent of GDP.

This is more than four times the burden of the debt, but the folks who complain about the debt burden on our kids never talk about it. This is simply not honest. If we are genuinely concerned about the burdens the government is imposing on our children, then we don’t get to selectively pick which burdens we will talk about.

The Deficit and Patent and Copyright Monopolies

There is a similar story with the deficit and these monopolies. And again, it is a matter of logic, not whether we think they are good mechanisms for supporting innovation and creative work. (I talk about alternatives in chapter 5 of Rigged [it’s free].)

Patent and copyright monopolies are intended to motivate people to innovate and do creative work. This means that they increase spending and GDP. The concern over large deficits is that the government is over-stimulating the economy, that it is demanding so many goods and services that the economy can’t meet both the demand from the private sector and the government.

If this is a concern, why should we not also be concerned about the increased demand created by government-granted patent and copyright monopolies? According to the National Income and Product Accounts (Table 5.6.5, Line 9), the pharmaceutical industry spent $105.7 billion on research in 2020. This has the same impact on demand in the economy as if the government spent another $105.7 billion on research.

How can we be concerned about the inflationary impact of government spending, but not the patent-induced spending by the industry? That makes zero sense.

Is an Honest Budget Debate Possible?

The point here is that we need to have honest discussions about debt and deficit concerns. The current discussions are not remotely honest because they refuse to take full accounting of the mechanisms the government uses to pay for goods and services. Others can debate whether this is due to laziness or deliberate dishonesty, but the media’s reporting on debt and deficits is not serving the public.

[1] The burden would be considerably lower if we adjusted for inflation, but we will leave that one alone for now.

[2] The government doesn’t directly threaten to arrest someone for infringing on a patent or copyright. Typically, the holder of the monopoly would go to court seeking damages and an injunction ordering the person to stop the infringement. If the person ignores the injunction and continues infringing, they could go to jail for ignoring an injunction.  

Reporters and politicians have been screaming about our debt and deficits in recent weeks, as the Democrats try to steer their public investment package through the senators from Arizona and West Virginia. The infuriating part of this story is that the whining about debt and deficits, and the reporting on it, literally makes no sense. This is because those involved refuse to do any serious thinking on these issues.

Starting with debt, the ostensible concern is that a large government debt will be a burden on our children. The story goes that in 10 or 20 years, we will be facing a high-interest burden, which will require either higher taxes or less spending in other areas.

The projections for interest payments don’t support this story. Our interest payments are currently around 1.0 percent of GDP, net of money refunded to the Treasury by the Fed. That is projected to rise to somewhat over 2.0 percent of GDP in a decade.

Our interest burden was over 3.0 percent of GDP in the early 1990s. That burden did not prevent us from having a very prosperous decade, especially in the second half.[1]

The more important part of this story is that the conventional calculations of the debt leave out the higher prices that we will pay for items like prescription drugs and computer software because of government-granted patent and copyright monopolies. This is a huge burden, which is many times larger than the debt burden, but policy types and reporters refuse to ever talk about it for some reason.  

This is a simple and logical point. The government can pay for things by writing checks. It typically does this with things like roads, bridges, and teachers’ salaries.  It can also pay for things by giving out patent or copyright monopolies.

When the government gives out these monopolies, it is telling innovators or creative workers to develop a new product or write a new book, and you will be given a monopoly for a period of time. This government-granted monopoly will allow you to charge a price that is far above the free market price.

This point has nothing to do with whether you think patents are a good way to support innovation or copyrights are the best way to support creative work, it is a logical point. If the government will threaten to arrest anyone who produces the Moderna vaccine, Moderna gets to charge a much higher price than if everyone in the world can produce the vaccine.[2]

This brings us back to my question: how can someone who claims to be concerned about the burden of the government debt on our children, ignore the burden, in the form of higher prices, created by government-granted patent and copyright monopolies? If the government were to put a tax on prescription drugs to help cover its debt service, we would all recognize this tax as a burden on households.

Yet somehow, we are supposed to believe that if the government gives out a patent monopoly that allows a drug company to charge a price that is far higher than the free market price, that is not a burden. That makes zero sense.

And this burden is very large. By my calculations, the higher cost due to patent monopolies and related protections comes to more than $400 billion (1.8 percent of GDP) in the case of prescription drugs alone. If we add in the higher costs that we pay for medical equipment, computers, software, and a variety of other items, the burden likely comes to more than $1 trillion a year, or 4.5 percent of GDP.

This is more than four times the burden of the debt, but the folks who complain about the debt burden on our kids never talk about it. This is simply not honest. If we are genuinely concerned about the burdens the government is imposing on our children, then we don’t get to selectively pick which burdens we will talk about.

The Deficit and Patent and Copyright Monopolies

There is a similar story with the deficit and these monopolies. And again, it is a matter of logic, not whether we think they are good mechanisms for supporting innovation and creative work. (I talk about alternatives in chapter 5 of Rigged [it’s free].)

Patent and copyright monopolies are intended to motivate people to innovate and do creative work. This means that they increase spending and GDP. The concern over large deficits is that the government is over-stimulating the economy, that it is demanding so many goods and services that the economy can’t meet both the demand from the private sector and the government.

If this is a concern, why should we not also be concerned about the increased demand created by government-granted patent and copyright monopolies? According to the National Income and Product Accounts (Table 5.6.5, Line 9), the pharmaceutical industry spent $105.7 billion on research in 2020. This has the same impact on demand in the economy as if the government spent another $105.7 billion on research.

How can we be concerned about the inflationary impact of government spending, but not the patent-induced spending by the industry? That makes zero sense.

Is an Honest Budget Debate Possible?

The point here is that we need to have honest discussions about debt and deficit concerns. The current discussions are not remotely honest because they refuse to take full accounting of the mechanisms the government uses to pay for goods and services. Others can debate whether this is due to laziness or deliberate dishonesty, but the media’s reporting on debt and deficits is not serving the public.

[1] The burden would be considerably lower if we adjusted for inflation, but we will leave that one alone for now.

[2] The government doesn’t directly threaten to arrest someone for infringing on a patent or copyright. Typically, the holder of the monopoly would go to court seeking damages and an injunction ordering the person to stop the infringement. If the person ignores the injunction and continues infringing, they could go to jail for ignoring an injunction.  

Many of us have been giving reporters grief about the constant reference to a $3.5 trillion spending bill (pre-Manchin), without pointing out that this is over ten years and would be just over 1.2 percent of projected GDP over this period.  Also, the intention is to have the bill offset by tax increases and cuts in Medicare drug spending, so the net impact on the deficit would be close to zero. (That’s not my concern, just saying.)

We also need to give them grief on the other side of the picture. I doubt anyone likes generic government spending. On the other hand, most of the specific areas where the government does spend money, like Social Security, Medicare, and education, are very popular. So, describing the bill as simply “spending” is virtually certain to reduce support for it.  

In recent days, reporters have taken to calling it a “safety-net” bill. It’s not clear that is much better. Most of us probably think of safety-net programs as items like TANF or food stamps, programs designed to help people who have fallen on hard times. Most of the proposed spending in the bill really does not have this character.

Much of it is quite explicitly designed to give people more skills and improve their prospects in the workforce. That is certainly the case with making community college free, universal pre-K, and the child care provisions. We know that quality child care leads to better outcomes for the children (as does pre-K), but it also makes it easier for parents of young children to work. The same is the case for the paid family leave provisions.

The child tax credit also fits in this category. By lifting millions of children out of poverty, it will also lead to better labor market and life outcomes when these kids get older. And, at least pre-Manchin, the benefit will be received by people in the upper middle-class. That makes it no more a safety net program than the dependent deduction on personal income taxes.

There are also provisions in the bill designed to increase the availability of housing. And, very importantly, the bill includes funding for moving away from fossil fuels and reducing greenhouse gas emissions.

The bill does include funding that increases access to Medicaid, as well as funding for increased subsidies for middle-income people in the Obamacare exchanges, and improvements in Medicare. We can argue over the extent to which these are safety-net programs, but most of this money will be going to people who are middle-class.

In any case, the bulk of the bill really does not fit into the category of “safety-net” spending. The GI Bill of Rights, passed during World War II, is probably a good comparison in this respect. The bill paid for World War II veterans’ college education, it also gave them low-interest loans to buy houses (a benefit that largely excluded Black veterans because of discrimination in the lending and housing markets), and unemployment insurance.  

That bill helped to give millions of veterans a path to the middle-class, in addition to including the safety-net provision of unemployment insurance. It is unlikely that many reporters at the time described the GI Bill of Rights as a “safety- net” plan. They shouldn’t describe the Democrats’ package this way either.

Many of us have been giving reporters grief about the constant reference to a $3.5 trillion spending bill (pre-Manchin), without pointing out that this is over ten years and would be just over 1.2 percent of projected GDP over this period.  Also, the intention is to have the bill offset by tax increases and cuts in Medicare drug spending, so the net impact on the deficit would be close to zero. (That’s not my concern, just saying.)

We also need to give them grief on the other side of the picture. I doubt anyone likes generic government spending. On the other hand, most of the specific areas where the government does spend money, like Social Security, Medicare, and education, are very popular. So, describing the bill as simply “spending” is virtually certain to reduce support for it.  

In recent days, reporters have taken to calling it a “safety-net” bill. It’s not clear that is much better. Most of us probably think of safety-net programs as items like TANF or food stamps, programs designed to help people who have fallen on hard times. Most of the proposed spending in the bill really does not have this character.

Much of it is quite explicitly designed to give people more skills and improve their prospects in the workforce. That is certainly the case with making community college free, universal pre-K, and the child care provisions. We know that quality child care leads to better outcomes for the children (as does pre-K), but it also makes it easier for parents of young children to work. The same is the case for the paid family leave provisions.

The child tax credit also fits in this category. By lifting millions of children out of poverty, it will also lead to better labor market and life outcomes when these kids get older. And, at least pre-Manchin, the benefit will be received by people in the upper middle-class. That makes it no more a safety net program than the dependent deduction on personal income taxes.

There are also provisions in the bill designed to increase the availability of housing. And, very importantly, the bill includes funding for moving away from fossil fuels and reducing greenhouse gas emissions.

The bill does include funding that increases access to Medicaid, as well as funding for increased subsidies for middle-income people in the Obamacare exchanges, and improvements in Medicare. We can argue over the extent to which these are safety-net programs, but most of this money will be going to people who are middle-class.

In any case, the bulk of the bill really does not fit into the category of “safety-net” spending. The GI Bill of Rights, passed during World War II, is probably a good comparison in this respect. The bill paid for World War II veterans’ college education, it also gave them low-interest loans to buy houses (a benefit that largely excluded Black veterans because of discrimination in the lending and housing markets), and unemployment insurance.  

That bill helped to give millions of veterans a path to the middle-class, in addition to including the safety-net provision of unemployment insurance. It is unlikely that many reporters at the time described the GI Bill of Rights as a “safety- net” plan. They shouldn’t describe the Democrats’ package this way either.

The Democrats have proposed paying for part of President Biden’s Build Back Better plan with $500 billion in savings on what the government will pay prescription drug companies through Medicare and other public programs over the next decade. The country currently pays the pharmaceutical industry over $500 billion annually for its products. If we look at spending over the next decade, and like the news media, ignore that it’s over ten years, we would say that we will give the pharmaceutical industry $7 trillion, double the projected cost of Biden’s agenda.

Naturally, no one expects to be able to get $50 billion a year out of the hide of a huge industry without a serious fight. The pharmaceutical companies surely have all their lobbyists working overtime courting members of Congress (primarily Democratic members) whose votes are needed to pass legislation allowing for Medicare to negotiate the prices it pays. They are also flooding the airwaves with ads telling us the horrors that would face us if the industry got lower profits.

Megan McCardle gave us the essence of their message in her Washington Post column today. McCardle cited a report from the Congressional Budget Office (CBO) that projected that negotiated drug prices in Medicare could save $500 billion over the course of the decade. (The idea is to get our drug prices in line with what Germany, Canada, and everyone else pays.)

CBO also projected that these savings would mean that the industry would have less money to invest in developing new drugs. It projected a decline in new drugs of roughly 10 percent. The industry has been hyping this projection as posing a threat to medical progress. McCardle raises the threat that if the industry was developing 10 percent fewer drugs, then we might not have the vaccines that saved tens of millions of lives in the pandemic.

Contain Your Fear

I know everyone is shivering in their boots now, but let’s get a little perspective here. First, the vast majority of new drugs are not qualitative approvals over existing drugs. Typically, when there is an important new drug that presents a major breakthrough, competitors rush in with their own drug to gain a portion of the patent rents earned by the first drug. The Food and Drug Administration rates drugs’ expected benefits when they go through the approval process. Almost 80 percent of drugs get standard reviews, as opposed to priority reviews, meaning that they are not qualitative improvements over existing drugs.

These duplicative drugs are not of zero value, patients may react poorly to one drug, but be fine with another. And sometimes, the follow-up drugs will actually be qualitative improvements. However, as a general rule, we would probably like to see the industry develop drugs for conditions where no treatment exists than for a condition where five or ten good drugs have already been approved.[1]

But what if one of the drugs that isn’t developed due to our budget savings is in the 20 percent that does merit priority reviews? What if we’re talking about the Covid vaccines?

Well, the choice of the Covid vaccines is an interesting one for this argument, because we actually have several vaccines. We have the two mRNA vaccines, which have proven most effective in reducing the risk of infection, serious illness, and death. However, we also have the Oxford/AstraZeneca (AZ) vaccine, which has been widely distributed in Europe and elsewhere, as well as the Johnson and Johnson vaccine. There are several other US and European vaccines that are at various stages of development. In addition, there are two WHO-approved Chinese vaccines, with a markedly lower level of effectiveness, and a Russian vaccine that was reported to be highly effective in a published journal article.

Suppose the dimwitted cost-cutters had prevented us from having one of these vaccines, maybe even one of the highly effective mRNA vaccines? Well, that would be unfortunate if we lost one of the most effective vaccines, but it hardly seems like a catastrophe. After all, if we didn’t have the Pfizer vaccine, then we could just look to produce more of the Moderna vaccine. And both the AZ vaccine and the Johnson and Johnson vaccine have been shown to be safe and highly effective. So, even in this supposedly disastrous case, it is likely that we would be pretty much exactly where we are in controlling the pandemic.  

It is also important to note that these vaccines were developed with a huge amount of public funding. The mRNA technology was developed almost entirely on funding from the National Institutes of Health. In the case of Moderna, the funding for the actual development and testing of the vaccine came entirely from the federal government through Operation Warp Speed.

Pfizer, Moderna, and the other companies did put up money for research and development, but the point here is that public and private funding are substitutes. If the federal government puts up more money for research and development, we can get the same results with less private money. In fact, President Biden has proposed substantial increases in public funding for biomedical research to make us better prepared for future pandemics. In my view, we should be relying primarily on public funding (see Rigged, Chapter 5 [it’s free]) instead of patent monopoly financing. But even if we stick with the current model, it is important to recognize that we can substitute increased public funding for patent financed research.

For perspective, the Bureau of Economic Analysis reports that the pharmaceutical industry spent $105.7 billion on research and development last year. If we have to replace ten percent of this with public funding, it would mean less than $11 billion a year, far less than the projected $50 billion in annual savings.

There is a final point about our current system of patent monopoly financed research that we should keep in mind. Being able to sell drugs at prices that are far above the free market price doesn’t just give companies incentive to do research, it also gives them the incentive to push their drugs as widely as possible. This could mean not being honest about the safety and effectiveness of their drugs.

If that sounds like a strong charge, then people have not been paying attention to the opioid crisis. Three major drug manufacturers have paid multi-billion dollar settlements based on the accusation that they deliberately misled doctors and patients about the addictiveness of the new generation of opioids. To be clear, the allegation is not that they didn’t recognize how addictive they were. The accusation is that they knew and were not honest about it.

If these opioids were selling as cheap generics in a free market, it is highly unlikely that drug companies would have lied for the modest boost to profits that they might get. But, even if we don’t go all the way to full public funding, it is pretty straight economic theory that if the drug companies get lower prices, they have less incentive to mislead the public about the safety and effectiveness of their drugs.

In the case of opioids, this might have produced an enormous payoff. After all, the impact on peoples’ lives and health from the opioid crisis runs into the hundreds of billions of dollars, if not trillions. While most efforts by drug companies to push their drugs by being less than honest are much less consequential, we should recognize this very important side benefit of lower drug prices. Lower drug prices mean less incentive to lie.

The long and short is that we should expect some impact from lower drug prices on innovation. It is hard to make the case that the likely impact is especially ominous. It is also the case that lower drug prices will reduce the perverse incentives that patent monopolies give them. This is a very good thing.

[1] If we think the prospect of having ten percent fewer drugs approved would be disastrous, then we could ask what is the magic is of the status quo? Perhaps we should increase our spending by $500 billion to get 10 percent more drugs.

The Democrats have proposed paying for part of President Biden’s Build Back Better plan with $500 billion in savings on what the government will pay prescription drug companies through Medicare and other public programs over the next decade. The country currently pays the pharmaceutical industry over $500 billion annually for its products. If we look at spending over the next decade, and like the news media, ignore that it’s over ten years, we would say that we will give the pharmaceutical industry $7 trillion, double the projected cost of Biden’s agenda.

Naturally, no one expects to be able to get $50 billion a year out of the hide of a huge industry without a serious fight. The pharmaceutical companies surely have all their lobbyists working overtime courting members of Congress (primarily Democratic members) whose votes are needed to pass legislation allowing for Medicare to negotiate the prices it pays. They are also flooding the airwaves with ads telling us the horrors that would face us if the industry got lower profits.

Megan McCardle gave us the essence of their message in her Washington Post column today. McCardle cited a report from the Congressional Budget Office (CBO) that projected that negotiated drug prices in Medicare could save $500 billion over the course of the decade. (The idea is to get our drug prices in line with what Germany, Canada, and everyone else pays.)

CBO also projected that these savings would mean that the industry would have less money to invest in developing new drugs. It projected a decline in new drugs of roughly 10 percent. The industry has been hyping this projection as posing a threat to medical progress. McCardle raises the threat that if the industry was developing 10 percent fewer drugs, then we might not have the vaccines that saved tens of millions of lives in the pandemic.

Contain Your Fear

I know everyone is shivering in their boots now, but let’s get a little perspective here. First, the vast majority of new drugs are not qualitative approvals over existing drugs. Typically, when there is an important new drug that presents a major breakthrough, competitors rush in with their own drug to gain a portion of the patent rents earned by the first drug. The Food and Drug Administration rates drugs’ expected benefits when they go through the approval process. Almost 80 percent of drugs get standard reviews, as opposed to priority reviews, meaning that they are not qualitative improvements over existing drugs.

These duplicative drugs are not of zero value, patients may react poorly to one drug, but be fine with another. And sometimes, the follow-up drugs will actually be qualitative improvements. However, as a general rule, we would probably like to see the industry develop drugs for conditions where no treatment exists than for a condition where five or ten good drugs have already been approved.[1]

But what if one of the drugs that isn’t developed due to our budget savings is in the 20 percent that does merit priority reviews? What if we’re talking about the Covid vaccines?

Well, the choice of the Covid vaccines is an interesting one for this argument, because we actually have several vaccines. We have the two mRNA vaccines, which have proven most effective in reducing the risk of infection, serious illness, and death. However, we also have the Oxford/AstraZeneca (AZ) vaccine, which has been widely distributed in Europe and elsewhere, as well as the Johnson and Johnson vaccine. There are several other US and European vaccines that are at various stages of development. In addition, there are two WHO-approved Chinese vaccines, with a markedly lower level of effectiveness, and a Russian vaccine that was reported to be highly effective in a published journal article.

Suppose the dimwitted cost-cutters had prevented us from having one of these vaccines, maybe even one of the highly effective mRNA vaccines? Well, that would be unfortunate if we lost one of the most effective vaccines, but it hardly seems like a catastrophe. After all, if we didn’t have the Pfizer vaccine, then we could just look to produce more of the Moderna vaccine. And both the AZ vaccine and the Johnson and Johnson vaccine have been shown to be safe and highly effective. So, even in this supposedly disastrous case, it is likely that we would be pretty much exactly where we are in controlling the pandemic.  

It is also important to note that these vaccines were developed with a huge amount of public funding. The mRNA technology was developed almost entirely on funding from the National Institutes of Health. In the case of Moderna, the funding for the actual development and testing of the vaccine came entirely from the federal government through Operation Warp Speed.

Pfizer, Moderna, and the other companies did put up money for research and development, but the point here is that public and private funding are substitutes. If the federal government puts up more money for research and development, we can get the same results with less private money. In fact, President Biden has proposed substantial increases in public funding for biomedical research to make us better prepared for future pandemics. In my view, we should be relying primarily on public funding (see Rigged, Chapter 5 [it’s free]) instead of patent monopoly financing. But even if we stick with the current model, it is important to recognize that we can substitute increased public funding for patent financed research.

For perspective, the Bureau of Economic Analysis reports that the pharmaceutical industry spent $105.7 billion on research and development last year. If we have to replace ten percent of this with public funding, it would mean less than $11 billion a year, far less than the projected $50 billion in annual savings.

There is a final point about our current system of patent monopoly financed research that we should keep in mind. Being able to sell drugs at prices that are far above the free market price doesn’t just give companies incentive to do research, it also gives them the incentive to push their drugs as widely as possible. This could mean not being honest about the safety and effectiveness of their drugs.

If that sounds like a strong charge, then people have not been paying attention to the opioid crisis. Three major drug manufacturers have paid multi-billion dollar settlements based on the accusation that they deliberately misled doctors and patients about the addictiveness of the new generation of opioids. To be clear, the allegation is not that they didn’t recognize how addictive they were. The accusation is that they knew and were not honest about it.

If these opioids were selling as cheap generics in a free market, it is highly unlikely that drug companies would have lied for the modest boost to profits that they might get. But, even if we don’t go all the way to full public funding, it is pretty straight economic theory that if the drug companies get lower prices, they have less incentive to mislead the public about the safety and effectiveness of their drugs.

In the case of opioids, this might have produced an enormous payoff. After all, the impact on peoples’ lives and health from the opioid crisis runs into the hundreds of billions of dollars, if not trillions. While most efforts by drug companies to push their drugs by being less than honest are much less consequential, we should recognize this very important side benefit of lower drug prices. Lower drug prices mean less incentive to lie.

The long and short is that we should expect some impact from lower drug prices on innovation. It is hard to make the case that the likely impact is especially ominous. It is also the case that lower drug prices will reduce the perverse incentives that patent monopolies give them. This is a very good thing.

[1] If we think the prospect of having ten percent fewer drugs approved would be disastrous, then we could ask what is the magic is of the status quo? Perhaps we should increase our spending by $500 billion to get 10 percent more drugs.

President Biden efforts to raise taxes on corporations and the wealthy has been getting seriously bogged down in recent weeks. More conservative Democrats have objected to the 28 percent corporate tax rate he proposed. Others seem to have nixed plans for raising the estate tax by making the capital gains held by large estates taxable. And, the Republicans working on the bipartisan infrastructure package were adamantly opposed to increasing the resources available to the I.R.S. so that it could better crack down on tax cheats.

Sometimes, when a particular game is not going well, the best way to turn things around is to change the game. Congress can still do this. The way to do this is to change the basis for the corporate income tax from profits to stock returns.

The key advantage to this switch is that profit is not a well-defined concept. The money that companies pay for things like wages or electricity are treated as expenses that are subtracted directly from income when calculating profits. However, the money they spend building a factory or setting up a new computer system is treated as an investment, which must be depreciated over a number of years.

Determining which spending falls into each category, and the number of years over which an item should be depreciated, are topics that can employ tens of thousands of accountants, tax lawyers, and lobbyists. And, this is just one of the ambiguities in calculating profit.

By contrast, stock returns are very well defined. It’s just a matter of adding up the dividends a company paid out and the amount that its stock price went up over the course of the tax year.  The I.R.S. can get this information from any number of business websites. It then just applies, say a 25 percent tax rate, and it can calculate the tax liability of every publicly traded company on a single spreadsheet. It doesn’t get much simpler than that.

There is an issue that stock prices are more volatile than profits. That one can be easily dealt with by making the basis for the tax an average of stock returns for the prior three or five years. We’re still on the same spreadsheet.

There are companies, like Tesla, that have seen extraordinary runups in stock price that are completely out of line with their profits. These companies would face a substantial increase in their tax liability even if they averaged returns over the prior three or five years.

There is a simple and obvious answer for companies that find themselves in this situation: issue more shares of stock. Of course, these companies will not want to see their stock diluted by additional shares, but that’s life. No one likes paying taxes.   

Most of our major corporations are multinational, which means their profits come in part from other countries. This is also a huge problem under the current tax code. The obvious solution is to allocate stock returns in proportion to sales. If 60 percent of their sales are in the United States, then we tax 60 percent of their stock returns. We’re still on a single spreadsheet.

There is the issue of companies that are privately held, without publicly traded shares. These companies would still have to be taxed based on their profits. But that is not a major problem for this system.

The overwhelming majority of profits are earned by publicly traded companies, so if we have a simple formula for determining their tax liability, we’ve largely solved the problem. Furthermore, we can structure the tax code to give companies an incentive to go public, for example by having a slightly lower tax rate for publicly traded companies.

For companies that are not looking to game the tax system, making stock returns the basis for the income tax should already offer a large benefit in terms of savings on accounting costs. They would not have to keep careful records to send to the I.R.S. at tax time. They just need to calculate their stock returns and send a check.

This simplicity alone should be a big enough advantage to encourage many privately traded companies to go public. Constructing the choice this way also is helpful to the I.R.S. Companies that choose to remain private when they could otherwise save compliance costs by going public are in effect telling the I.R.S. that they are looking to game the system.

The enormous savings on oversight for the I.R.S. on the corporate side should also make it much easier to police individual returns. If Republicans in Congress won’t directly give the I.R.S. additional funds for cracking down on tax cheats, the Democrats can provide the resources indirectly by making the corporate side more efficient.

In short, making stock returns the basis for the corporate income tax is a game where everyone but the tax cheats win. 

President Biden efforts to raise taxes on corporations and the wealthy has been getting seriously bogged down in recent weeks. More conservative Democrats have objected to the 28 percent corporate tax rate he proposed. Others seem to have nixed plans for raising the estate tax by making the capital gains held by large estates taxable. And, the Republicans working on the bipartisan infrastructure package were adamantly opposed to increasing the resources available to the I.R.S. so that it could better crack down on tax cheats.

Sometimes, when a particular game is not going well, the best way to turn things around is to change the game. Congress can still do this. The way to do this is to change the basis for the corporate income tax from profits to stock returns.

The key advantage to this switch is that profit is not a well-defined concept. The money that companies pay for things like wages or electricity are treated as expenses that are subtracted directly from income when calculating profits. However, the money they spend building a factory or setting up a new computer system is treated as an investment, which must be depreciated over a number of years.

Determining which spending falls into each category, and the number of years over which an item should be depreciated, are topics that can employ tens of thousands of accountants, tax lawyers, and lobbyists. And, this is just one of the ambiguities in calculating profit.

By contrast, stock returns are very well defined. It’s just a matter of adding up the dividends a company paid out and the amount that its stock price went up over the course of the tax year.  The I.R.S. can get this information from any number of business websites. It then just applies, say a 25 percent tax rate, and it can calculate the tax liability of every publicly traded company on a single spreadsheet. It doesn’t get much simpler than that.

There is an issue that stock prices are more volatile than profits. That one can be easily dealt with by making the basis for the tax an average of stock returns for the prior three or five years. We’re still on the same spreadsheet.

There are companies, like Tesla, that have seen extraordinary runups in stock price that are completely out of line with their profits. These companies would face a substantial increase in their tax liability even if they averaged returns over the prior three or five years.

There is a simple and obvious answer for companies that find themselves in this situation: issue more shares of stock. Of course, these companies will not want to see their stock diluted by additional shares, but that’s life. No one likes paying taxes.   

Most of our major corporations are multinational, which means their profits come in part from other countries. This is also a huge problem under the current tax code. The obvious solution is to allocate stock returns in proportion to sales. If 60 percent of their sales are in the United States, then we tax 60 percent of their stock returns. We’re still on a single spreadsheet.

There is the issue of companies that are privately held, without publicly traded shares. These companies would still have to be taxed based on their profits. But that is not a major problem for this system.

The overwhelming majority of profits are earned by publicly traded companies, so if we have a simple formula for determining their tax liability, we’ve largely solved the problem. Furthermore, we can structure the tax code to give companies an incentive to go public, for example by having a slightly lower tax rate for publicly traded companies.

For companies that are not looking to game the tax system, making stock returns the basis for the income tax should already offer a large benefit in terms of savings on accounting costs. They would not have to keep careful records to send to the I.R.S. at tax time. They just need to calculate their stock returns and send a check.

This simplicity alone should be a big enough advantage to encourage many privately traded companies to go public. Constructing the choice this way also is helpful to the I.R.S. Companies that choose to remain private when they could otherwise save compliance costs by going public are in effect telling the I.R.S. that they are looking to game the system.

The enormous savings on oversight for the I.R.S. on the corporate side should also make it much easier to police individual returns. If Republicans in Congress won’t directly give the I.R.S. additional funds for cracking down on tax cheats, the Democrats can provide the resources indirectly by making the corporate side more efficient.

In short, making stock returns the basis for the corporate income tax is a game where everyone but the tax cheats win. 

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.  

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