Dealing with Patent Monopolies and High Prices

Government-granted patent monopolies have become pretty much sacred in the United States. In fact, when high drug prices become a political issue, most discussion, including from progressives, turns reality on its head. The standard story is that the market creates high drug prices, the issue is whether the government should intervene through some type of negotiation or price control to bring prices down.

Government-granted Patent Monopolies Are the Cause of High-Priced Drugs

In fact, in almost all cases, drugs are cheap to manufacture and distribute. The reason that drugs can be expensive is that the government grants patent monopolies that prevent companies from entering the market.[1] When a single company has a legal monopoly on a drug that is essential to some people’s health or life, they can charge a large amount of money. It is the government-granted monopoly that makes the drug expensive, not the free market.

President Biden proposes to limit the legal monopoly given to at least some drugs, by using the provision of the Bayh-Dole Act that requires inventions that rely on government-funded research be made available at a reasonable price. The Bayh-Dole Act is a measure passed by Congress in 1980 that formalized the process whereby private companies could secure patents on publicly funded research.

It had a huge impact on research generally, but nowhere is its impact clearer than in the case of prescription drugs. From 1960 to 1980, when the bill was passed, spending on prescription drugs was around 0.4 percent of GDP (around $100 billion a year in today’s economy), with no clear upward trend. After the bill was passed spending on prescription drugs began to rise rapidly. It now stands at more than $500 billion, or 2.0 percent of GDP. If we add in non-prescription drugs (the distinction is not necessarily very useful), it comes to $630 billion or 2.3 percent of GDP.

If these drugs were sold in a free market, without patent monopolies or related protections, we would likely be paying less than $100 billion a year. The difference of $530 billion between the patent-protected price and the free market price, comes to more than $4,000 per family.

The issue here is more than just money. People need drugs when they have health problems. This is not a good time to force someone to have to dig up some vast sum of money to pay for a drug to treat cancer or some other serious illness. Even if they are lucky enough to have insurance, no insurer is happy to pay out tens of thousands of dollars for a drug. It is likely to force a patient to jump through all sorts of hoops to get an expensive drug covered. Again, this is not the sort of thing a person with a serious health problem needs.

The high prices are almost entirely a consequence of protection. A recent study found that prices fall by 80-90 percent after a drug has been subjected to a period of generic competition. In the cases of the highest-priced drugs, the drops can be even more dramatic. When the Hepatitis C drug Solvadi was first introduced it sold for $80,000 in the United States for a three-month course of treatment. At the same time, high-quality generic versions were available in India for $900, just over 1.0 percent of the U.S. price.

It would be a struggle for anyone to come with $80,000 to pay for Sovaldi and no insurer is happy to pay that sort of money. The generic price of $900 is a very different story.

The huge gap between the protected price and the free market price also provides an enormous incentive for corruption. Drug companies want to push their drugs as widely as possible, encouraging people to use them even when they may not be the best course of treatment or could even be harmful.

The most dramatic instance of such abuse is the opioid crisis, where Purdue Pharma and other manufacturers paid out billions of dollars in settlements over allegations they deliberately misled physicians and the general public about the addictiveness of the new generation of opioid drugs. The opioid case is extreme in its consequences however, this sort of abuse happens all the time.

Medical journals have to constantly develop new tactics to ensure that the articles they publish are actually written by the people who appear as their authors, and that they have not been paid to put out claims that may not be accurate. In a recent case, intensive lobbying by a drug manufacturer got the FDA to approve an Alzheimer’s drug, Aduhelm, over the objections of its advisory panel. There was little evidence of the drug’s effectiveness and it did have harmful side effects. The drug was slated to sell for $55,000 for a year’s dose.

For these reasons, it is likely that lowering drug prices will actually result in better health outcomes. If there is no one who has a major incentive to mislead the public about the safety and effectiveness of a drug, we are more likely to get accurate information about the usefulness of different drugs for treating various conditions.

Who Pays for Research?

The pharmaceutical industry always screams bloody murder over any measure that will lower drug prices and reduce its profits. They claim that this will be a huge hit to their research spending, and then we won’t get any new drugs.

There will undoubtedly be some negative effects on research spending if profits fall, but the industry hugely overstates the impact. The industry spends roughly $120 billion a year on research and development. This money comes from the gap of more than $500 billion a year between the revenue from selling their drugs and what it costs to manufacture and distribute them.

Over $100 billion of this is profits, but there are many other uses of the money obtained through patent rents. A substantial chunk goes to the pay of CEOs and other top executives. For example, Pfizer’s CEO was paid $33 million last year. He would have been paid considerably less if the company’s drugs were selling at one-fifth of their current price. The bloated pay goes well beyond the CEO, patent rents lead to considerably higher pay for several layers below the top echelon of employees.

In addition, the huge patent rents lead to large payments for marketing drugs. When drugs can be sold at markups of 500 or 1000 percent above their production costs, it makes sense to spend a lot of money trying to promote them widely. For this reason, drug companies spend tens of billions of dollars every year marketing their drugs. This includes not only the ads they run on TV (which had been illegal until a few decades ago) but also money paid to the drug detailers who push the drugs directly to doctors.

Drug companies also pay out vast sums to lawyers, as intellectual property law is one of the most lucrative areas of law. If you’re suing someone over a patent worth billions of dollars, it is a good investment to spend hundreds of millions pushing your case. And, there are the billions of dollars they have to pay out when they lose a case, as was the situation with Purdue Pharma and the other major opioid makers.

All of these payments can be reduced, rather than cutting research spending, when the pharmaceutical industry’s profits dip as a result of lower prices. There is also another area where savings can be found rather than reducing important research into new drugs.

Much of the industry’s spending goes to drugs that largely duplicate existing drugs. The logic is that if one company is earning large patent rents on a particular drug, say the weight loss drug Wegovy, it makes sense from the standpoint of maximizing profit to try to produce a competitor that can share in these rents.

This is actually desirable in a world where drugs are selling at patent-protected prices. Having two, three, or four drugs that are largely similar, all of which have patent protection, will still help to bring prices down. There is also likely to be some health benefit, since patients react differently to the same drug, so having the option to take a different drug will be valuable to some patients. However, as a general rule, research dollars would likely be better spent trying to develop drugs for conditions where no effective treatment currently exists rather than trying to duplicate the function of existing drugs in order to get a share of patent rents.

In 2021, the most recent year for which the data are available, the FDA rated more than 56 percent of its drug reviews as “standard,” meaning that the drugs did not represent a qualitative breakthrough over existing drugs already on the market. It would not in general be a major loss to public health if the research spending on these duplicative drugs was reduced as a result of lower drug prices and profit margins.

Government Spending on Research

But even if the reduction in industry profits will only be reflected in a limited way in reduced research spending, there is no doubt that the companies will be spending somewhat less on money on developing new drugs. This doesn’t have to mean a reduction in total spending on research.

The federal government already spends well over $50 billion a year on biomedical research, primarily through the National Institutes of Health, but also through BARDA, the CDC and a number of other government agencies. This money primarily goes to more basic research, but many drugs have been developed on public money and often tested as well. The most famous recent example was the Moderna COVID vaccine, where Operation Warp Speed paid for both the development and the clinical trials needed for the vaccine’s approval, but there have been many others.

Public funding can serve as a substitute for industry funding. Recent research indicates that increased NIH funding can be a very effective substitute for industry funding. In fact, it suggests that dollar for dollar, NIH funding may be far more effective, with a 10 percent increase in funding (roughly $5 billion a year at present) leading to a 4.5 percent increase in the number of drugs developed. This result, taken crudely, implies that for $110 billion in additional spending, we could fully replace the spending done by the industry, with no loss in the number of new drugs developed.

Of course, the world is far more complicated than this sort of simple multiplication would imply, but most of the complications likely mean the cost of replacing industry research would likely be lower rather than higher. To start with, if we were financing research with the goal of advancing health rather than seeking patent rents, we would likely see much less money wasted in duplicative research.

Again, not all of this money is wasted. It is very often helpful to have a second or third drug to treat a condition, since people react differently to drugs and some drugs interact badly with other drugs a patient may be taking. But the search for patent rents is likely to misdirect much research spending compared to a scenario where the focus is public health.

A second reason we may get more health benefits per buck with direct publicly supported research is that there may be many instances where non-patentable items offer the greatest health benefit. For example, there is some research indicating that vitamin deficiencies may be an important factor in many conditions. Drug companies have little incentive to research this possibility since they can’t get a patent on vitamins that have been known for many decades.

The same applies to older off-patent drugs. If there is some evidence Aspirin can provide important benefits in treating a condition, Pfizer or Merck is not going to spend large sums exploring that possibility. If it turns out to be true, they will not be able to recoup their research expenses selling a drug that has long been available as a cheap generic.

But the most important reason that publicly funded research might be more effective on a per-dollar basis is that we can make openness a condition of getting funding. This means that rather than having an incentive to squirrel away findings, in order to avoid allowing a competitor to get an advantage, we can require that the results of publicly funded research be posted on the Internet as soon as practical.

This means that all researchers can benefit from quickly learning of new breakthroughs as well as being warned off dead ends. This openness requirement would also largely eliminate the risk of drug companies misrepresenting research findings to push their drugs as widely as possible.

Not only would we be removing the incentive by taking away the patent monopoly, we would also be removing the opportunity, since the community of researchers would all have access to the same research. We can’t eliminate all mistakes – some mistakes are inevitable – but we can prevent the sort of deliberate misrepresentation of evidence that had such terrible consequences in the opioid crisis and in many other situations.

Patent Monopolies and Inequality

It is common for people in policy circles to assert that the enormous increase in inequality over the last half century was primarily the result of technology. The story is that technology has developed in a way that has benefited people with more education and disadvantaged those with limited education. This is not true.

It is more than a bit absurd to claim that patent monopolies and related protections are necessary for the development of new drugs or to achieve progress in other areas, and then claim that inequality is the result of technology. Our rules on patents and other forms of intellectual property are policy matters, they are not determined by technology.

This point matters hugely in discussions of inequality, since it is policy that determines who benefits from technology and how much. We saw this clearly in the case of Moderna and its development of a COVID vaccine. The contract it signed with the government both paid for the development of the vaccine and then allowed Moderna to keep control of the vaccine.

As a result of this contract, Moderna is selling its boosters for well over $100 a shot, even though it would likely only cost it around $5 a shot to produce and distribute the vaccine. The Moderna contract allowed the company to generate at least five billionaires by the summer of 2022.

The Moderna contract is an extreme case, but it does provide a clear example. How we structure laws around patent monopolies and other protections determines the winners from technology.

It is obviously convenient for the gainers from this upward redistribution to pretend that it was just a natural outcome from technology, but it is not true. If we write the rules differently, we can have much less inequality.

Where Do the Administration’s Bayh-Dole Measures Get Us?

I have long argued for looking to displace the system of patent-supported research for prescription drugs with one of direct public funding. My preferred route is a system of long-term prime contracts, loosely modeled on the sort of prime contracts that the Defense Department awards for military research, where companies would engage in a process of competitive bidding for research in specific areas, such as cancer or heart disease. (I outline this in Chapter 5 of Rigged [it’s free].)

The Biden administration’s proposal is not my proposal for radically overhauling the system of financing the development of prescription drugs. It does, however, raise the issue of how much we will allow pharmaceutical companies to benefit from the patent monopolies we grant them at the expense of the general public.

It allows the government to take advantage of the provision in the Bayh-Dole Act requiring that innovations based on government-funded research be available to the public at a reasonable price. This is a big step forward, since it means that we will not hand drug companies a monopoly on life-saving drugs and then let them charge patients (or insurers or the government) whatever price they feel like. This can save the public and the government billions of dollars each year.

While this measure is important in establishing that patent monopolies are not absolute, it is limited in that it only applies to a limited set of drugs, only those where government-funded research played a direct role in its development. That may seem fair in some ways, but drug companies often don’t acknowledge that they relied on government research in developing a product.

If a drug company relied on another company’s research in developing a drug, it can count on a patent infringement suit, but the government is generally not aggressive in forcing companies to list government patents that played a role in developing a product. The executive order also does not give clear guidance on what constitutes reasonable pricing. It could, for example, have specified that a reasonable price is some average of prices charged in other wealthy countries, like Germany and Canada, but it backed away from this step.[2]

There are of course other modest steps that the Biden administration could take to lower drug prices, some of which it already has. For one, it capped the out-of-pocket payments for insulin, although this has the government picking up the tab, so that is not a measure that costs the pharmaceutical industry money. It is also moving to negotiate the prices that Medicare pays for a number of important drugs, this will save the program and beneficiaries billions of dollars in coming years.

But there are also limited steps that it could take that would push the agenda further. Drs. Peter Hotez and Maria Elena Bottazzi and their team at Texas Children’s Hospital developed an effective open-source COVID vaccine. This vaccine, Corbevax has already been used by over 100 million people in India, Indonesia, and elsewhere.

If this vaccine was approved by the FDA, it would mean that people would have a cheap alternative (likely less than $5 a shot) to the vaccines now on the market, which are selling for over $100 a shot. If the vaccine were available here, it would also mean that people have an alternative to the mRNA vaccines produced by Moderna and Pfizer. While there is little basis for the fears of mRNA technology, if these fears prevent people from getting a vaccine that could protect them from COVID, we should be allowing them an alternative.

Getting a cheap vaccine developed outside the patent system would also provide proof of concept. No one cares that I or others claim that we can produce drugs or vaccines without relying on patent monopolies, they need to see proof in the form of facts on the ground that we can have effective products that don’t depend on these monopolies. Corbevax can be an important fact on the ground. (Many people may not be aware of the enormous savings with this vaccine, since in most cases, the government or private insurers will pick up the cost of COVID boosters.)

A Very Important Step

It is always possible to complain that a particular measure does not go as far as it should, but it is very rare that major change is brought about by a single bill or executive order from a president. The question is whether the measure is a step forward and if it opens the door for future progress.

By this standard, the answer is certainly yes. We can think of this executive order as being comparable to the Inflation Reduction Act (IRA). The provisions of the IRA are nowhere near large enough to address the problem of global warming, but they are a huge foot in the door. In the same way, President Biden’s actions on Bayh-Dole are an important step in reining in drug prices and creating a path for further actions in the future.

Notes.

[1] There are other forms of exclusivity that can be as important as patent monopolies in blocking competition, most notably “data exclusivity.” This means that when a drug company produces data showing a particular drug is safe and effective, another company cannot rely on this data to establish that its own drug is also safe and effective, even if it can be shown to be chemically the same or similar in the case of biological drugs.

[2] This write-up from Knowledge Economy International provides useful background on some of the issues raised by the Biden Administration’s executive order.

This first appeared on Dean Baker’s Beat the Press blog.