Henry G' Grabowski

1
Alternatives to the Patent System Perspectives
from Economics

• Henry G. Grabowski
• Duke University
• May 23, 2004

2
The Cost Structure of Research Based
Pharma/Biopharma Industries

• RD intensity is higher than for other industries
• RD is largely a global, joint cost, sunk at
  launch
• Marginal cost (MC) of production is relatively
  low
• Marginal cost pricing (PMC) will not cover RD

3
Importance of Pharmaceutical Patents

• Many economic studies have found that patent
  protection is a critical factor for
  pharmaceuticals.
• Length of exclusivity period is more important in
  pharmaceuticals than in other high-tech
  industries.
• Basic reason is the costs of innovation are high
  in pharmaceuticals, while costs of imitation are
  low.

4
Costs of Innovation Versus Imitation

• Innovation Process
• Long gestation periods - 10 to 14 years
• Low success rates - only 1 in 5 NCE candidates
  entering clinical testing become marketed drugs
• High RD costs - 400 million per NCE
• Imitation Process
• Short gestation process - 1 to 2 years
• Low RD costs - 1 to 2 million to demonstrate
  bioequivalence

5
Dynamic Competition in the Pharmaceutical Industry

• First introduction in a new class significant
  benefits spillover to patients and payors
• Within class competition emerges in the case of
  most new drugs after a few years
• When patents expire, generic entry pushes prices
  toward marginal cost
• Market power on demand side has been growing

6
Some Important New Drug ClassesIntroduced During
the 1990s
Triptans (migrane) Macrolides (anti-infectives) At
ypical anti-psychotics (schizophrenia) Protease
Inhibitors (AIDS) Neutrophil Growth Factors
(neutropenia) Taxanes (cancer) Cox-2 Inhibitors
(arthritis) SERMs (osteoporosis)
7
Alternatives to the Patent System

• Two main alternatives are discussed in the
  literature
• Prizes
• RD contracts/subsidies
• Some economists advocate parallel approaches
• Voluntary opt-out prize system (Shavell)
• Prizes for new medicines for diseases of LDCs
  (Kremer and Sachs)
• Love and Hubbard (LH) propose a more radical
  solution
• Replacing patents with national global RD
  budgets financed directly or indirectly by taxes

8
Are National Global Budgets Feasible?

• Problematic that countries would agree to
  enforceable treaties with targeted RD
• Many countries would be arguably worse off
• Characteristics of proposed RD targets
• Arbitrary nature
• Tax increases
• Protectionism issues
• Would free riders be denied new medicines?

9
Where Will the Benefits Come From?

• LHs proposal is predicated on the belief that
  there would be large resource savings in terms
  of
• Duplicate and wasteful RD
• Reduction in marketing
• Elimination of profits
• But their approach would be subject to its own
  set of cost inefficiencies and adverse incentives
• Private equity funding of early stage biopharm
  RD would be especially vulnerable

10
RD Contracts and Prizes Some Key Concerns

• RD Contracts
• Information asymmetries
• Principal Agent problems
• Difficulties in closing failed programs
• RD Prizes
• Administrative costs and uncertainties
• Credibility to RD organizations
• Political rent seeking

11
The Atomic Energy Commissions Patent
Compensation Board

• Compared to the value of inventions and the
  profits that might have been earned if exclusive
  patent rights could have been enforced, the Fermi
  and Goddard awards were miserly.
• There is an inherent conservative bias in the
  prizes granted by administrative and
  quasi-judicial bodies.
• It is doubtful whether a generalized award
  system administered in this conservative
  tradition would motivate as much risk bearing as
  the patent system presently does.

F. M. Scherer, Industrial market structure and
economic performance,2nd Ed. p. 458
12
Some Concluding Thoughts

• National RD budgets are fraught with potential
  adverse RD incentive effects
• Prizes and other push/pull incentives have an
  important role in the case of neglected diseases
  of LDCs and related situations
• The Orphan Drug Act has been very successful in
  increasing innovation for rare diseases through a
  set of push/pull incentives