The Agenda

Tyler Cowen on the Medicare Prescription Drug Benefit

Cowen, no apologist for the Bush administration, notes that the Medicare prescription drug benefit has been strikingly successful. He cites a 2007 paper by Neeraj Sood and Darius Lakdawalla, the abstract of which reads as follows:

In spite of its relatively low benefit levels, the Medicare Part D benefit generate $3.5 billion of annual static deadweight loss reduction, and at least $2.8 billion of annual value from extra innovation. These two components alone cover 87% of the social cost of publicly financing the benefit. The analysis of static and dynamic efficiency also has implications for policies complementary to a drug benefit: in the context of public monopsony power, some degree of price-negotiation by the government is always strictly welfare-improving, but this should often be coupled with extensions in patent length.

Note the wording of the last sentence: price-negotiation can prove valuable provided there is compensation in the form of an extension of patent length. This reminds me of Michael Kremer’s case for patent buyouts, which Alex Tabarrok summarized for the Independent Institute in a longer essay on drug prices:

Harvard economist Michael Kremer explains patent buyouts in his chapter in the new book Entrepreneurial Economics: Bright Ideas from the Dismal Science (Oxford University Press). Kremer argues that the government, or a wealthy non-profit foundation, should buy pharmaceutical patents and turn over the rights to the public for free. Patent buyouts would reduce pharmaceutical prices by 60 to 70 percent because instead of having to wait a decade or more for the patent to expire, generic-drug manufacturers could immediately begin to sell the new drugs in a competitive market.

Patent buyouts would not impede innovation because the innovating firm would be well paid for its research. Indeed, the patent buyer could easily increase the incentive to innovate by raising the buyout price.
But suppose a patent buyer does not know how much the rights to a new drug are worth? What is to stop the patent buyout from becoming a wasteful subsidization of low-quality research? Kremer offers an ingenious solution to this problem: invite patent holders to tender their rights in an open auction. Open and competitive bidding for the rights to the new drug would establish a good estimate of its true value. The government could then use information from the bids to buyout the patent – perhaps with a bid somewhat higher than the top auction bid.

Sadly, I have a hard time imagining an idea like this taking hold, particularly in a climate in which the pharmaceutical industry is seen as sinister.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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