Price controls and more regulation are the wrong answer to higher drug costs; reducing patent strength could bring down prices.
Following hedge-fund manager Martin Shkreli’s controversial decision to dramatically hike prices for Daraprim, an orphan HIV drug for which he recently acquired the intellectual-property rights, 2016 presidential candidate Hillary Clinton began a capricious war on pharmaceutical companies, vowing to place blanket controls over prescription drug prices.
Congressional Democrats have taken this message to heart by seeking a subpoena of pharmaceutical giant Valeant over prescription-drug prices. That action caused the company’s stock to plunge by 17 percent on Monday, in addition to creating stock-market volatility for many companies within the biotech and pharmaceutical sectors.
While surging prescription-drug prices are certainly a cause for concern, more regulations — including price controls — as advocated by Hillary Clinton are not the answer. The right policy solution should be rather to loosen the strength of patents on pharmaceuticals, which create monopolies like the one Shkreli has now acquired over his orphan HIV drug.
Hillary Clinton’s plan, which would create a $250 cap on out-of-pocket expenses for prescription drugs, would likely have the opposite effect of relaxing patent strength by stifling innovation in the pharmaceutical industry. Clinton allies such as Ezekiel Emanuel, who advocate government intervention in pharmaceutical-drug prices, accurately observe that the net profit margins of 30–50 percent of pharmaceutical giants such as Pfizer and Merck, as well as those of biotech giants such as Amgen and Biogen, are high compared with those of other companies.
However, this ignores the fact that much of the total cost of producing new pharmaceutical drugs is the initial outlay on the research and development required to test the drug and navigate the FDA approval process. That is, while the marginal costs of producing pharmaceutical drugs become minuscule after regulatory approval, the cost of creating the drug and getting it to market can run to the millions of dollars.
Clinton’s plan also would prevent competitors from replicating already established drugs by requiring that new drugs be proven to be a “substantial improvement” over existing drugs. Discouraging competition to produce substitute drugs would invariably raise prices. Imagine how much higher cold pill prices would be if Motrin (manufactured by Johnson & Johnson) was barred from FDA approval because it did not meet the vague conditions of Hillary’s “substantial improvement” test over Advil (produced by Pfizer) simply because both drugs are Ibuprofen derivatives.
This type of misguided regulatory logic in the Clinton plan would also strip the tax deductibility of direct-to-consumer advertising and threaten to revoke R&D tax credits if companies fail to spend a certain percentage of revenue on research and development each year as Megan McArdle notes at BloombergView.
While it is true that we need patents to incentivize innovation, making them too strong creates monopolies that ultimately discourage innovation.
Ultimately, intellectual-property laws restrict drug makers from creating cheaper generic copy-cat versions and artificially prop up pharmaceutical-drug costs by creating monopolies. Because of strict patent laws, a competitor cannot create an alternative cancer drug and compete on price until the patent on the original drug runs out.
Patent protections in the U.S. are arguably so strong that relaxing them would actually create more innovation. The documented explosive growth of “patent trolls” and non-practicing entities — which acquire patents without further developing or producing the product — demonstrate that patent strength in the U.S. is stifling innovation (and not only in the pharmaceutical industry).
While it is true that we need patents to incentivize innovation, making them too strong creates monopolies that ultimately discourage innovation and potentially prevent valuable lifesaving drugs from coming to market. As Austin Frakt at The Upshot points out, research from MIT economist Benjamin Roin finds that “pharmaceutical companies systematically screen their drug candidates to exclude the ones lacking strong patent protection.”
Other research from his MIT colleague and newly minted MacArthur Fellow Heidi Williams finds that, in practice, innovation in the medical field is “cumulative.” In other words, creating optimal patent policy that leads to new discoveries that are ultimately affordable depends in part on how patents on existing technologies affect follow-on innovation.
A classic example illustrating how relaxing intellectual-property laws can have an incredible impact on creating lifesaving drugs at a low cost is the history of the invention and introduction of insulin to the broader market.
University of Toronto scientists Frederick Banting, J. J. R. Macleod, and Charles Best, who co-discovered insulin in the 1920s, partnered with Eli Lilly Co. under the condition that they would relax any legal claims made through their own patent.
Ultimately, the relaxed patent strength created incentives for Arnold Kadish and Dean Kamen to invent the first insulin pumps in the 1960s and 1970s, innovating on top of the initial work done by the University of Toronto team and brought to scale by Eli Lilly Co. The loosened approach to intellectual-property protection in the medical field contributed to the affordability and wide-spread availability of insulin to diabetics in modern times.
Dampening the strength of patents in the area of pharmaceutical drugs — rather than imposing price controls — could have a similar effect of reducing prescription-drug prices by busting the gargantuan monopolies that our existing patent laws have created.