The Real Drug Crisis

August 21, 1999

Dean Baker
In These Times, August 21, 1999

Al Gore’s recent campaign events have been marred by some uninvited guests. The vice president has been heckled by protesters who object to his efforts to pressure South Africa to enforce U.S. patents on AIDS drugs.

On its surface, the issue is a simple case of lives versus profit. In parts of South Africa, 30 percent of young adults are HIV-positive. The most effective combinations of AIDS drugs cost individuals more than $10,000 a year in the United States, but the per capita income of black South Africans is less than $1,000 a year. If the U.S. patents are enforced, the vast majority of South Africans infected with AIDS will not be able to get treatment, and millions will die. However, in the absence of patent protection, these drugs could be profitably produced at prices of less than $200 annually per user. But the industry says if South Africa is allowed to produce AIDS drugs without respecting U.S. patents, then drug manufacturers will have less money to finance future research. Furthermore, if South Africa can get away without honoring U.S. drug patents, other developing nations will surely follow suit, reducing drug company profits even more. And if drugs can be purchased in developing nations for less than 5 percent of their patent-protected price in the United States, how long will it be before these low-cost drugs find their way into this country? In short, if the U.S. patent laws aren’t enforced everywhere, the research process could grind to a halt. The domino theory on patent evasion may overstate the case, but the industry does have a valid point. Patent protection makes research profitable. If firms can’t anticipate making a profit, they won’t do it. While this argument would never justify policies that condemn millions of people to death, it does suggest that the issue of financing research and development needs greater attention.

The patent system is just one method of supporting pharmaceutical research. In many ways, this system is a textbook example of bad economics. It leads to enormous inefficiency in the distribution of drugs, creates perverse incentives in directing research, and results in exactly the sorts of market distortions and corruption that economists expect when the government creates a state-sanctioned monopoly.

The most basic principle in economic theory is that goods should sell at their marginal cost of production (including a normal profit). In the case of patented drugs, prescriptions that are produced for as little as $1 each can sell for hundreds of dollars as a result of patent protection. The rationale for this gap is that the firm has to be able to recover its research costs, which are often quite significant. However, at the point the drug is being produced, the research costs are history. According to economic theory, it is inefficient to try to roll these costs into the price of the drugs. The inefficiency associated with patent protection in pharmaceuticals is enormous. The United States currently spends close to $100 billion a year on prescription drugs. In the absence of patent protection, the cost of these drugs would fall to less than $25 billion. This works out to a savings of more than $500 a year for every household in the country. By contrast, the proponents of deregulation in the airlines, trucking and telecommunications industries put the gains from each of these policies in the neighborhood of $10 billion to $20 billion annually—nowhere close to the potential gains from eliminating patent protection in the pharmaceutical industry.

In addition to leading to enormous inefficiency, the government monopoly provided by patent protection steers research into unproductive areas. Suppose Glaxo Wellcome, a major drug manufacturer, developed a foolproof cure for lung cancer. As soon as this became known, its competitors would immediately shift large sums of research dollars to developing cures for lung cancer to try to get a chunk of the profits that this drug would earn. If a competitor could copy the innovation in a way that evaded Glaxo’s patent, it would stand to make enormous profits, since it too could market a cure. This research would be almost a complete waste from a social standpoint, since a cure for the disease already would have been developed. But the incentives of patent protection ensure that much research of this nature takes place. A 1993 study by the Office of Technology Assessment found that two-thirds of all drug patents fell into this “copycat” category, meaning that they did not involve qualitatively new treatments for diseases. The patent system encourages other types of abuses as well. For example, there have been a series of press accounts in recent years of industry efforts to either falsify or suppress research results that reflected unfavorably on a firm’s products. The extent to which such behavior actually takes place is impossible to know, but clearly the existing system provides enormous incentives to conceal information. At the very least, the industry’s drive for patents often significantly delays the dissemination of research findings. Industry-supported researchers almost always must sign away their right to publish research findings without prior approval. Such approval will generally not be granted until a firm has had the opportunity to file for any patents that might be derived from the research.

The monopoly profits guaranteed by patent protection also provide an enormous incentive for firms to market their drugs aggressively, even in cases where they may not provide the best treatment. According to the industry’s data, it currently employs 40 percent more people in marketing than research. These marketing agents often make aggressive and misleading sales pitches to doctors, who generally lack the time and expertise to verify the industry’s claims independently. In some cases, the sales pitches take the form of bribes, as drug companies pay for lavish vacation “seminars,” in which doctors can learn about the latest medical breakthroughs in Hawaii or Tahiti.

Monopoly profits also encourage the drug companies to spend large sums of money protecting and extending their patents. One of the leading contributors to the political campaigns of both parties, the industry has been pushing not only to have their patent protection extended around the world, but to have the life of specific patents extended beyond their normal expiration date, which is 20 years after a drug is approved by the FDA. For instance, Schering-Plough, one of the nation’s largest pharmaceutical manufacturers, currently is spending millions on a lobbying campaign to have the patent for the allergy drug Claritin extended by three years. According to estimates from Public Citizen, such a patent extension would cost consumers as much as $3.2 billion over the three-year period. Such efforts at ad hoc patent extension have become common in recent years, and they are often successful.

If there were no alternative way to support research, we would have no choice but to tolerate the inefficiency and abuse associated with pharmaceutical patents. However, according to its own data, the pharmaceutical industry funds only 43 percent of medical research in the United States. The federal government funds close to a third of all medical research, primarily through the National Institutes of Health. Universities, private foundations and charities account for the rest. These other methods of funding research have a proven track record. This research has produced a long list of major medical breakthroughs, including the discovery of penicillin, the polio vaccine and AZT (though not its use as an AIDS treatment). In just the past two months, NIH researchers developed a vaccine that will prevent the transmission of AIDS through breast feeding, and a use for aspirin that will reduce the risk of heart attacks and strokes for people undergoing heart surgery.

The industry is presently spending approximately $20 billion a year on research. Some portion of this spending, probably in the neighborhood of one-third, is devoted to researching copycat drugs. But in the absence of the patent system, such research would serve no purpose. This means the amount of research spending that would have to be picked up in the absence of patent protection comes to approximately $13.3 billion a year. This amount is approximately equal to what state and federal governments could expect to save on Medicare and Medicaid payments for prescription drugs in the absence of patent protection. In other words, the government revenue needed to replace the industry’s research spending could come almost exclusively from savings on current government drug payments. This would allow the patented price of drugs to fall to a free market price that on average would be less than 25 percent (and in many cases less than 5 percent) of the patent-protected price. It is difficult to envision a policy that offers larger potential gains.

Of course, patent protection for pharmaceuticals is not going to end tomorrow. The industry has an incredibly powerful lobby and there are serious legal obstacles that would prevent the simple elimination of patent protection. But there are a number of steps in this direction that should sit high on the progressive agenda:

• The U.S. government should not force our patents on developing nations. This is a straight transfer of wealth from the world’s poor to the drug industry. There are few forms of protectionism that are more economically inefficient and morally unjustifiable than this one. In this case, progressives should support free trade.

• No ad hoc extensions of patents should be permitted. If a firm feels that the current patent system doesn’t give them sufficient protection, they should argue their case in the courts, not Congress. They knew the rules when they initially undertook their research. Changing them after the fact is simply a handout from the public.

• Research that is paid for by the government should be owned by the government. There are numerous incidents where the pharmaceutical industry has taken advantage of government research to develop a drug, and then secured the patent for themselves. Congress should insist that the NIH be aggressive in defending the fruits of its research. If the industry wants to profit from NIH research, then it should pay for the right to do so.

• Collective buying arrangements should be promoted wherever possible. The federal government already forces the pharmaceutical industry to provide discounts of more than 15 percent on drugs for Medicaid recipients. Clinton’s Medicare drug plan would establish a similar sort of collective buying arrangement for those who sign up. If collective buying programs were established in the states that did not already have them or at the federal level, it would take some of the excess profits away from the industry and bring prices a bit more down to earth. Finally, there should be some serious testing of alternative paths for supporting research. There are some areas of medical research, such as cancer, where the industry role is still relatively small. If such areas could be parceled off, with the government buying up existing patents and making a commitment, along with private charities and foundations, to support further research, it would be possible to establish a test for an alternative to the patent system. Then researchers could examine the relative importance of the breakthroughs and the cost of achieving them in the two sectors. Patent-supported research may be the superior route. Alternatively, if the open research proved better, we could let the patent system expire as a means of supporting pharmaceutical research.

If the Gore protesters can keep up the heat, perhaps he will end his dependence on drug company campaign contributions in the same way that he earlier kicked a tobacco-growing habit. Maybe then he will be able to reinvent himself as an advocate of a free market in pharmaceuticals.

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