Patents no longer efficient for biomedical research

As the cost of developing new medicines shoots upwards, so do the economic distortions and wasteful rent-seeking behaviour associated with pharmaceutical patents, states a recent US study which accordingly advocates a system of publicly funded drug research.

by Chakravarthi Raghavan

GENEVA: With ever-increasing costs - $802 million in 2000 for a drug - for biomedical research and development and bringing useful drugs on to the market, rewarding innovation through limited-duration monopoly rights has now become economically wasteful, encourages rent-seeking behaviour and works against the public interest by increasing the costs of medical care, according to a briefing paper and study by a Washington-based research centre and public interest group.

The study and briefing paper from the Centre for Economic and Policy Research (CEPR), in working out estimates of the relative costs and benefits of the current methods and other alternatives for pharmaceutical research, suggests a policy option of government intervention - switching to a system of public/non-profit research by direct funding, placing the research findings in the public domain, and private firms using that research and competing in the same way that generic producers do at present.

The study, “Promoting good ideas on drugs: Are patents the best way?” (October 2002), is authored by Dean Baker, co-director of CEPR, and Noriko Chatani, a research associate. (The full text in PDF format can be found at

The study necessarily focuses on a subject of hot domestic political debate in the US because of the rising Medicare costs and the financial difficulties faced by elderly citizens, which have aroused pressures on Congress and the administration.

Nevertheless it is of much relevance to the global debates on this issue, including the role of the intellectual property system in promoting innovation in this area, public health issues, and the costs to the developing world of being forced to accept the global monopolies created for big pharmaceutical corporations through the WTO’s TRIPS Agreement and the World Intellectual Property Organization’s (WIPO) agreements and attempts to expand them.

That the attempts to force global standards - and the monopoly rights that go with it - whether under the TRIPS (Trade-Related Aspects of Intellectual Property Rights) Agreement or the systems of the WIPO, ill serve the developing world has been brought out recently by the UK independent Commission on Intellectual Property Rights (see TWE #289). That Commission’s report has brought out that of the 1,393 drugs approved between 1975 and 1999, only 13 were specifically indicated for tropical diseases. Other studies have also brought out that most of the innovations patented are not “new” nor do they “involve an inventive step” (two of the three primary requirements for patenting under Article 27 of the TRIPS Agreement). According to these studies, many new patents claimed or granted involve merely small additions to the “molecules” of existing drugs whose patents have expired or are expiring, and “additions” that do not even add any therapeutic value.

The UK Commission, while carefully couching its language, has come out against the global monopolies provided through the TRIPS/WIPO regimes.

The debates though still proceed on the basis that there are benefits through the intellectual property system in the industrialized countries, and the problems relate to the poor countries and the resource transfers that the system effects from the South to the corporations of the North, and that some of the negative effects could be handled by the industrial world through competition and welfare policies.

Such dogmatic views emanate not only from the big corporations benefiting from the system, but even from the UN system and its agencies, where the underlying theory of patents and the need for limited-period monopolies are accepted and propagated without question. The CEPR study challenges even these assumptions.

At a time when the talk of patents and the monopoly rights and norms that go with them are entering the global discourse somewhat unchallenged, with statements verging on slogans like “intellectual property protection is important for the development of new medicines” (paragraph 3 of the Doha WTO Ministerial Declaration on the TRIPS Agreement and Public Health), the CEPR study provides an antidote, backed by data and calculations and estimations for a cost-benefit analysis.

The argument in economic theory with regard to publicly funded vs private research with public aid is that if private research would cost, say, $100 million, public research (whether of government undertaking the research or contracted out to firms) would cost more - $125-150 million. By allowing the private sector to carry through the process of research and development, after the basic research is done (by government funding or by non-profit organizations), and with the private sector recouping the costs through the patent system and its limited-monopoly profits, there is an overall cost efficiency.

This means that if a country saves $50 million by leaving the research to the private sector, it will benefit from the system only if the distortions resulting from patent protection are less than $50 million. If the distortions are more than $50 million, the public will be better served by having the government carry through the development of the drug, even if this be less efficient than the private sector in the research.

Through the TRIPS Agreement, the US, Europe and Japan have been able to shift more of the costs on to the developing world, by creating an international regime of global monopoly, where resource transfer takes place from the South to the Northern corporations.

As the true costs and lack of benefits of such a regime have begun to be realized in the South and by civil society groups in the North, the multilateral trading system, which was created to govern cross-border trade according to agreed rules, has come under increasing strain and challenges on the ground. The inherent danger to any system in such a situation has begun to cause concerns among free-trade advocates, some of whom are even backing away from their initial support for expanding the GATT/WTO system to TRIPS, services and now other proposed new areas.

That patents result in rent-seeking behaviour - firms engaging in wasteful behaviour from the standpoint of the economy as a whole - is well accepted by economists. Such wasteful expenditures include sales promotion to expand the rentier income through advertisement campaigns targeting consumers, direct contacts with physicians by salespeople and elaborate systems to educate doctors about the benefits of a new drug, ranging from hospitality and other costs of conventions to plain discounts and cuts for medical personnel and administrators in some cases. Other ways include payments to private charities (e.g., the American Cancer Society) to make use of their names for promoting drugs (a practice that has now come under public investigation by some states in the US). Such expenses are said to be quite large and grouped under R&D.

The rent-seeking behaviour also results in attempts by the firms to keep their research findings secret until they can exhaust all possible patents based on their research, and the more scandalous recent behaviour in the US (with some legislative and administrative support till recently) to extend the life of a patent by entering an objection to generic drug producers seeking marketing rights and authorization.

In countries like India, where there is a big controversy over this, attempts are made to get the government to change the law to protect as “undisclosed information” the field test data submitted to the government by a patent holder of a drug to secure marketing approval.

However, economists argue that governments have sufficient countervailing power and instruments to punish such activities and reduce the incentives.

The UK IPR Commission came to the conclusion that developing countries cannot exercise such countervailing power given their many weaknesses and institutional and administrative gaps.

Efficient research

The CEPR briefing paper refers to “a widely publicized analysis” of pharmaceutical research (DiMasi, 2002, Tufts Centre for Study of Drug Development) and its finding that the cost of developing new drugs “is rising far more rapidly than the rate of inflation”, with research costs rising at more than 10% annually between 1987-2000. That study estimated the R&D costs in 2000 at $802 million per drug. As such costs rise, says CEPR, it becomes even more important for research to be carried out in the “most efficient possible manner.”

Nearly half of biomedical research spending in the US is supported by either the government or the non-profit sector; however, the bulk of the research involved is in actually carrying drugs through the clinical testing process needed to gain Food and Drug Administration (FDA) approval. This work is carried on by the pharmaceutical industry and financed through patent protection.

“While patent protection may have once been the most efficient way to support this research, this does not mean it necessarily will continue to be the most efficient means to support research as costs continue to increase. It is possible that alternative methods - for example, direct contracting to develop drugs or vaccines, as some firms advocated in response to the Anthrax scare in the US - may prove more efficient, given current and future economic considerations.”

In such an alternative system, research findings would be placed in the public domain and firms would be able to compete in the same way as generic producers do at present, the CEPR paper says.

It points out that basic economic theory indicates that as research costs rise, they will eventually reach a point where public/non-profit funding will be more efficient than patent-supported research. The reason for this is that patents effectively allow private firms to charge an excise tax - the markup allowed by the patent monopoly - on prescription drugs.

The economic distortions associated with such a tax “are proportional to the square of the markup.” Therefore, if drug companies have to charge twice as high a markup in order to cover their research costs, then the size of the economic distortions will be multiplied fourfold.

This means that even if patent-supported research is somewhat more efficient than public/non-profit supported research on a dollar-for-dollar basis, at some point the distortions created by the patent markup must eventually offset this greater efficiency.

Economic theory also predicts that patent protection will lead to wasteful rent-seeking behaviour by firms as they attempt to maximize their patent rents. The CEPR paper notes six important ways in which patent rents in the pharmaceutical industry lead to wasteful or harmful behaviour:

(1)  In a world with patent protection, copycat drugs can reduce prices by providing competition. However, in the absence of patent protection, most of this research would serve little purpose, since there would be little benefit from developing second and third drugs when a first one has already been shown to be effective.

According to a recent study commissioned by the Pharmaceutical Manufacturers and Researchers of America (PhRMA), the drug industry association, copycat drugs may account for more than 70% of all research spending.

(2)  Patent rents provide firms with a large incentive to try to persuade doctors and patients to use their drugs. “These sales efforts can even go as far as outright bribes to doctors to prescribe drugs, as happened recently in Germany,” says CEPR. According to PhRMA, the industry employs nearly twice as many people in sales and marketing as in research and development.

(3)  The industry has strong financial incentives to prevent the disclosure of its research findings until it has filed for all the patents that could prove profitable. This slows scientific progress.

“There is also evidence that the industry has on occasion attempted to keep secret research findings that suggest its products are ineffective or possibly harmful.”

(4)  The industry employs large numbers of lawyers to secure and enforce its patents. These costs can also include side-payments to generic producers to keep competition out of the market.

(5)  In the US, the pharmaceutical industry typically ranks near the top in campaign contributions. It has also begun financing “grassroots” lobbying efforts by people afflicted with specific diseases and their friends and relatives.

(6)  The existence of large patent markups provides a strong incentive for the production of unauthorized versions of drugs (sometimes abroad), just as is the case with illegal drugs like marijuana or cocaine.

Economic theory predicts that the waste associated with each of these forms of rent-seeking will increase at a rate that is proportionate to the square of the increase in the patent markup.

The paper produces a set of estimates of the amount of additional public money (net of current spending and tax credits) that would be needed to replace the patent-supported research currently being conducted by the pharmaceutical industry.

Depending on the portion of current research wasted on copycat drugs, and the relative efficiency of public/non-profit supported research and patent-supported research, the paper has estimated that it would have taken additional expenditures of between $4 billion and $27.6 billion in 2000 to replace the $25.8 billion that the industry claims to have spent on research.

The paper then estimates the savings that the government and consumers would have experienced in 2000 if drugs had not been subject to patent protection. It estimates that the gross savings would have been between $72.8 billion and $89.6 billion.

The savings net of the additional research spending needed to replace the industry’s spending would have been between $39.2 billion and $85.0 billion.

Finally, the paper uses forecasts of prescription drug spending from the Health Care Financing Administration to project the future savings and economic gains that would result from switching to a system of public/non-profit supported research. These projections show that most, if not all, of the additional funding for research could be taken directly from the government’s savings due to lower prescription drug costs for Medicaid, Medicare and other government-supported purchases.

This means that there would be little, if any, need for new tax revenue to support publicly funded drug research. The gains to the private sector from lower drug prices would be substantial. By 2024, when the full impact of the switch to publicly supported research will be felt, the private sector will be saving between $560 billion and $670 billion a year due to lower prescription drug prices, an amount equal to 1.7-2.0% of GDP.

This decline in drug prices would also be expected to have substantial secondary impacts on the economy. In effect, it leads to a substantial increase in the real wage, which would create a large number of new jobs. It should lead to an increase in annual GDP of approximately 2.6 to 3.0 percent. This would be associated with an increase of between 3.8 and 4.5 million jobs.

There are few possible economic policy changes that could potentially have an impact of a comparable magnitude, says CEPR. (SUNS5219)              

From Third World Economics No. 293 (16-30 November 2002)