Drug Prices in Crisis
The Case Against Protectionism
This article is from the May/June 2001 issue of Dollars & Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/2001/0501baker.html
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This article is from the May/June 2001 issue of Dollars & Sense magazine.
In recent years, drug prices have risen to astronomical levels. In the United States, senior citizens are increasingly unable to afford prescription medication, while in developing nations, life-saving drugs are being priced out of reach for tens of millions of people with AIDS. In both cases, there is a single explanation for soaring drug prices: patent protection. If the pharmaceutical industry's patent monopolies were eliminated, most drugs would sell for only a fraction of their current cost.
Remarkably, however, the issue of drug patent monopolies rarely arises in public debate. Patent protection is a form of protectionism, but that's problematic terminology in a political climate where support for "free trade" is considered the only respectable opinion. So the pharmaceutical industry has managed to frame patent protection as a matter of "intellectual property rights" instead. Rarely has an industry been so successful in controlling the language of debate.
The industry has had a lot of help from the economics profession. Mainstream economists have developed an extensive body of research on the expected consequences of protection or monopoly pricing. If they were really as committed to efficiency and free trade as they pretend to be, they would be screaming about drug patents at the top of their lungs. The reason they don't is that they hold the drug industry in much higher esteem than manufacturing workers who might benefit from other forms of protectionism.
Of course, patent protection for prescription drugs, like all forms of protectionism, does serve a purpose—to provide industry with an incentive to research new drugs. If any firm could produce and sell every new drug that was developed, then no company would ever have a reason to spend money on research. However, the fact that drug patents can provide an incentive for research does not mean that they are the only or best way to support research. In fact, most biomedical research is currently supported by the federal government or private foundations, charities, and universities—not undertaken by private companies in anticipation of future sales.
We can only assess the full costs of patent protection if we recognize it as a form of protectionism, and look for all of the distortions that economists would expect protectionism to create. Once we do that, we'll see that the benefits derived from state-sanctioned monopoly protection are not justified by the quality and quantity of research that the pharmaceutical industry undertakes.
The Economics of Protectionism
Patent monopolies are a windfall for the pharmaceutical industry. Under the present system, a single firm gets to control the sale of a drug for the duration of its patent. Evidence from countries without effective protection for patents, or for drug prices after patents expire, indicates that most drugs would only sell for 25% of their patent protected price. In some cases, the difference is much greater. For example, the current state-of-the-art combination of anti-viral AIDS drugs sells in the United States for approximately $10,000 a year, according to the pharmaceutical industry. By contrast, a leading Indian manufacturer of generic drugs believes that it can sell the same combination profitably for $350 per year.
Why the huge gap between the monopoly patent protected price and the competitive market price? Because most drugs are relatively cheap to produce. Drugs are expensive because the government gives the industry a monopoly, not because they cost a lot to manufacture.
The costs of patent protection to consumers are enormous. The industry, which includes such giants as GlaxoSmithKline, Pfizer, and Bristol-Myers Squibb, estimates that it sold $106 billion worth of drugs in 2000. If eliminating patent protection had reduced the price of these drugs by 75%, then consumers would have saved $79 billion. This figure, to put it in perspective, is 30% more than what the federal government spends on education each year. It's more than ten times the amount that the federal government spends on Head Start. And it roughly equals the nation's annual bill for foreign oil.
What do we get for this money? Last year, the pharmaceutical industry, according to its own figures, spent $22.5 billion on domestic drug research (and another $4 billion on research elsewhere). For tax purposes, the industry claimed research expenditures of just $16 billion. Since these expenditures qualify for a 20% tax credit, the federal government directly covered $3.2 billion of the industry's research spending (20% of the $16 billion reported on tax returns). Even if we accept the $22.5 billion figure as accurate, this still means that the industry, after deducting the government contribution, spent just over $19 billion of its own money on drug research.
In other words, consumers (and the government, through Medicaid and other programs) spent an extra $79 billion on drugs because of patent protection, in order to get the industry to spend $19 billion of its own money on research. This comes out to more than four dollars in additional spending on drugs for every dollar that the industry spent on research. The rest of the money went mainly to:
- Marketing—The industry spends tens of billions each year to convince us (or our doctors) that its new drugs are absolutely essential and completely harmless.
- Protecting patent monopolies—Pharmaceutical companies regularly stand near the top in contributing to political campaigns. It's no accident that so many politicians are willing to push their cause.
- Profits—The pharmaceutical industry consistently ranks at the top in return on investment. It pulled in more than $20 billion in profits for 1999.
If spending an extra four dollars on drugs in order to persuade the industry to spend one dollar on research doesn't sound like a good deal, don't worry. It gets worse.
The Inefficiencies of Protectionism
Mainstream economists, who usually love to recite the evils of government protection, have been mostly silent on the issue of patent protection for drugs. But the evils are visible for all to see.
One major source of waste is research spending on imitation or "copycat" drugs. When a company gets a big hit with a new drug like Viagra or Claritin, its competitors will try to patent comparable drugs in order to get a slice of the market. In a world with patent protection, this can be quite beneficial to consumers, since a second drug creates some market competition. However, in the absence of patent protection, the incentive for copycat research would be unnecessary, since anyone who wanted to produce Viagra or Claritin would be free to do so, thereby pushing prices down.
How much do drug companies spend on copycat research? The industry won't say. But the Food and Drug Administration (FDA), in evaluating "new" drugs, considers only one third of them to be qualitatively new or better than existing drugs, while classifying the other two thirds as comparable to existing drugs. This doesn't mean that two thirds of research spending goes to copycat drugs; after all, the breakthrough drugs probably require more research spending, on average, than copycats. But suppose the industry wasted just 20% of its $19 billion in research spending on copycat drugs. This would bring the value of that spending down to $15 billion. That means consumers and the government are paying more than five dollars on drugs for each dollar of useful research.
The evils of protectionism don't end there. Prescription drugs present a classic case of asymmetric information: The drug companies know more about their drugs than the doctors who prescribe them, and far more than the patients who take them. The lure of monopoly profits gives the industry an enormous incentive to overstate the benefits and understate the risks of the newest wonder drugs. A June 2000 New England Journal of Medicine study found that the media consistently offered glowing accounts of drug breakthroughs. According to the study, the main villains in distorting the news were the public- relations departments of the drug manufacturers.
Still more serious is evidence that published research findings may be influenced by the drug industry's support. Last summer, the New York Times cited data showing that drugs, when tested by researchers who were supported by the drug's manufacturer, were found to be significantly more effective than existing drugs 89% of the time. By contrast, drugs tested by neutral researchers were found to be significantly more effective only 61% of the time.
Even if the industry's research could be completely trusted, there is still another problem created by the patent system—secrecy. The industry generally maintains the right to control the dissemination of findings from the research it supports. In some cases, this can mean a delay of months or even years before a researcher can disclose her findings at a conference or in a journal. In April 1996, for example, the Wall Street Journal reported on a British drug company's efforts to suppress a study showing that Synthroid, a drug to control thyroid problems, was no more effective than much cheaper alternatives.
In other cases, the secrecy is even more extreme. When the industry funds studies designed to prove that drugs are safe and effective enough to win FDA approval, it routinely keeps the results secret as proprietary information. This research may contain important clues about how best to use the new drug, or even about other factors affecting patients' health. Generally, however, the scientific community will not have access to it.
By creating incentives to misrepresent, falsify, or conceal research findings, patent monopolies are harmful to our pocketbooks as well as our health. At the very least, consumers may waste money on new, patent-protected drugs that are no more effective than existing drugs whose patents have expired. For example, a recent study estimated that consumers were spending $6 billion a year on a patented medication for patients with heart disease, which was no more effective than generic alternatives in preventing heart problems. As a result of industry propaganda, consumers might also spend money on drugs that could be less effective than cheaper alternatives—or on drugs that could even be hazardous to their health.
Another byproduct of monopoly drug pricing—the underground market—also has detrimental effects. When drugs can be sold profitably at prices that are much lower than their patent protected prices, consumers may seek underground sources for drugs. The most obvious way to do this is to purchase drugs in countries that either impose price controls or don't have the same patent protection as the United States. In recent years, there has been a much-publicized flow of senior citizens to Canada and Mexico in search of lower cost drugs. In the case of people traveling to Canada, the major cost to consumers is the waste of their time. However, when people buy drugs in countries with less stringent safety regulations, the health consequences may be severe.
The Proven Alternative
Listing the problems associated with drug patents would be an empty intellectual exercise—unless there were alternative ways to support research. Fortunately, there are. The federal government currently supports $18 billion a year in biomedical research through the National Institutes of Health (NIH) and the Centers for Disease Control (CDC). (The vast majority of NIH-funded research is carried out at universities and research centers across the country; less than 20% is conducted on the campus of the Institutes themselves.) In addition, universities, private foundations, and charities fund a combined total of approximately $10 billion worth of research annually. Added together, these institutions spend 25% more on research than the pharmaceutical industry claims to spend, and nearly twice as much as the industry reports on tax returns.
Over the years, the research supported by government and non-profit institutions has led to numerous medical breakthroughs, including the discovery and development of penicillin and the polio vaccine. More recently, NIH-supported research has played a central role in developing AZT as an AIDS drug, and in developing Taxol, a leading cancer drug. The NIH's impressive list of accomplishments over the last five decades proves that the government can support effective research.
Traditionally, the NIH has focused on basic research and early phases of drug testing, while the pharmaceutical industry has engaged primarily in the later phases of drug testing—which include conducting clinical trials and carrying drugs through the FDA approval process. However, there is not a sharp division between the type of research done by the NIH and that undertaken by the pharmaceutical industry; the NIH has conducted research in all areas of drug development. There is no reason to believe that, given enough funding, the NIH could not effectively carry out all phases of drug research.
While the idea of a panel of government-supported scientists (most of whom would probably be affiliated with universities and other research institutions) deciding which drugs should be researched may seem scary, consider the current situation. Drug-company executives make their research decisions based on their assessment of a drug's profitability. In turn, that assessment depends on whether the company can get insurance companies to pay for the drug, whether it can effectively lobby legislators to have Medicaid and other government programs pay for it, and whether it can count on the courts to fully enforce its patents against competitors. It is these factors—not consideration of what will benefit the public's health—that dominate the industry's decisions about research. It is hard to believe that publicly accountable bodies that are charged with directing research for the general good would not produce better results.
The arithmetic behind a proposed switch is straightforward. If the federal government spent an additional $20 billion a year to support research at the NIH and various non-profit and educational institutions, it would more than fully replace the useful research conducted by the pharmaceutical industry. The cost to the federal government would be less than the cost of the prescription drug plan that Al Gore advocated in last year's presidential campaign. If patent protection for drugs were eliminated, consumers would save more than $79 billion a year. These savings would increase with each passing year, since spending on drugs is currently rising at more than twice the rate of inflation.
Even assuming that the United States continues to rely on patent protection to support drug research for the immediate future, interim steps can be taken. First, it will be important to sharply restrict the worst abuses of the patent system. At the top of the list, the U.S. government should not be working with the pharmaceutical industry to impose its patents on developing countries. This is especially important in the case of AIDS drugs, since patent protection in sub-Saharan Africa may effectively be sentencing tens of million of people to death. There should also be pressure to allow the importation of drugs from nations where they are sold at lower prices, or even better, the imposition of domestic price controls.
A second priority is to create a greater opening for alternative sources of research. There should be more support for the NIH to carry some of its research through to the actual testing and approval of new drugs. The patents for these drugs should then be placed in the public domain, so that the industry can compete to supply the drugs at the lowest cost. In addition to bringing immediate benefits to consumers, this would allow for a clear test of the patent system's value as a means of supporting research, as compared with direct public support.
Back in the Middle Ages, the guild system was established to protect the secrets of masters from their apprentices. If you tried to make and sell hats but didn't belong to the hatmakers' guild, you'd be subject to arrest. Patents (and their cousin, copyrights) come out of this tradition. While most medieval restrictions have long since been discarded, patents have managed to survive and are now deeply enmeshed in our economic system. Not all forms of patent protection cause the problems associated with drug patents; in some areas, such as industrial processes, it may be reasonable to keep patent protection intact. But the case of drug patents cries out for the free market that economics say they favor, to wipe this feudal relic away.