Prizes as Mechanism to Fund Innovation: We All Lose

September 07, 2012

Dean Baker
Eureka (The Times of London), September 6, 2012

There has been increased interest in prize funds as a way to finance innovation in recent years, especially in the pharmaceutical industry. While a prize fund is preferable to the current patent system, which is also a type of prize system, it is far from an optimal way to finance research.

A prize system has two fundamental problems. The first is that there is little reason to believe that the recipients of the prizes will be the persons who actually most deserve to be rewarded. The second problem is that it creates a structure of incentives that undermines innovation.

On the first point, innovation is inherently a collective process. Each development builds on past work. It may often be the case that the person(s) who make the greatest breakthroughs are not the ones who develop the final product. In the case of prescription drugs, there may have been many crucial discoveries that allowed for an individual or team to successfully develop a useful drug.

The discoveries may have been the complex work, whereas putting together the final drug might have been relatively simple. An all-knowing prize committee may be able to ration the payments appropriately, but in the real world that seems very unlikely. Those who are better connected or better self-promoters are likely to get a disproportionate share of the rewards.

This situation is complicated further by the fact that we may not know the full value of a breakthrough until many years after the fact. Often drugs are developed that are originally touted as great breakthroughs, whereas later research shows them to be of little value or even harmful. Will a prize committee reclaim awards from the recipients or their heirs in these cases?

The other issue is that prize funds encourage secrecy in research. Teams of researchers would have strong incentives to keep preliminary findings to themselves and only release results when they were prepared to claim a prize. Research advances most rapidly when it is open. A system of direct public support, in which complete disclosure is a condition for receiving funding, is likely to lead to much more rapid medical progress.

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