Katonomics 6: the Economics of IP in Pharmaceuticals

"Perhaps it does kill fleas", said Smokey,
"but I've never heard it tick"

In this, the sixth post in this series of Katonomics, the IPKat weblog's resident Katonomite, Dr Nicola Searle, addresses a subject which is about as close to a red rag to the proverbial bull as one gets in IP law --the long and menacing shadow of economics. But is it a threat, or merely a shadow, and does it darken the horizon or provide welcome shade against the heat of assertions of public policy?  Read on:

Economics of IP in Pharmaceuticals No IP topic presses quite so many buttons for economists (and IPKat readers) as pharmaceuticals.  Patents for medicine touch on the economics of development, health, law, innovation and political economy.  Couple that with key international agreements and widely available data, and you’ve got a hot topic. 

 As early at 1791, Fichte noted the relevance of pharmaceuticals to IP analysis and recounted a tale, in which an alleged infringer of a pharmaceutical patent argues,

“I sell the nostrum much more cheaply than the plaintiff; the lowliest man can thus afford to procure it, unlike at the high price demanded by the monopolist. … Could I but paint a vivid picture for Your Majesty of the groans of the suffering, the rattling throats of the dying, who have been saved by the physic they bought from me!”

 The impact of IP on pharmaceutical innovation is a classic case of marginal analysis of the effect of incentives.   Economic models and policies are evaluated at these margins to assess the power of incentives to influence the marketplace.  For example, some will switch to solar power when it is subsidised.  These are the cases at the margin where the incentive of the subsidy changes decisions. 

 Analysis of the pharmaceutical industry argues just that – that development of medicine only occurs with these incentives.  The high costs of developing new medicines and their easily-copied nature mean that IP protection is necessary. Without the strong incentive of IP protection, these medicines wouldn’t exist but, with IP protection, they do. 

 Society has an interest to incentivise new development as medicines provide important benefits.  This fits nicely into social contract theory.  Society grants medicine companies temporary monopolies to recover the costs of development in return for improved medicines that eventually become generic. 

 Unfortunately, it’s never that simple.  Public and humanitarian interests in improved health mean that medicine development may occur without IP protection.   Boldrin and Levine note that, of the British Medical Journal’s top 15 medical and pharmaceutical discoveries, only two had patent protection.  The other 13 occurred without the incentive of IP protection. 

 Like many IP-related statistics, the cost of developing pharmaceuticals is also debated (here and here).  Each successful medicine must recoup the costs of all the unsuccessful projects, compliance with regulations, clinical trials, marketing, etc. 

 Marketing costs form a large part of the industry’s expenditures and don’t lead to medical advances.  As the daughter of two medical professionals, I enjoyed many a shrimp cocktail courtesy of pharmaceutical companies and their swag kept me well stocked throughout my school years (my Kwell pen made me popular).  Gagnon and Lexchin have calculated that, in the US, pharmaceutical companies spend 24% of their sales on promotion and 13% on promotion.  As Christine Greenhalgh and Mark Rogers note in their book, two of the top three firms in terms of Community trademarks registrations are pharmaceutical companies. 

 Further debate occurs in the economic development aspects of IP and pharmaceuticals.  Healthy populations, with access to medicines, make for improved economies.  Traditional knowledge may lead to sources of revenue or accusations of biopiracy.  In countries with weak institutions, the regulatory structure of IP could provide a boon to innovation and encourage Foreign Direct Investment.  However, for medicines, the enforcement of IP can result in the decline of the generics industry (as in India) and in reduced access to medicine. To assuage these concerns, TRIPS incorporated compulsory licensing.  

 Even without IP, there are incentives to develop medicines for richer markets. The US and other developed countries are the dominant markets for medicines.  Diseases common in developed countries, such as obesity, receive more attention.  Diseases which might make a huge difference to an economy as a whole, such as malaria, do not enjoy the same market power and potential profitability. 

 Strategic behaviour by pharmaceutical firms to increase the profitability of their medicines via IP makes analysis even more interesting.  When faced with a patent cliff, firms may patent a slow-release version.  Or, to get creative, firms may combine the regulatory system with the IP system to gain monopoly rights over existing medicines, as in this case. 

 The late Jean Lanjouw devoted her career to analysis of pharmaceuticals and economic development. In a Brookings Institute paper, she suggests that pharmaceutical companies be granted patents in developed or developing countries, but not both.  Effectively, they would have to choose their markets. 

 However, a challenge to price differentiation based on geographical location is that of arbitrage through parallel imports.  If there are large price differences between countries, the law of one price suggests that the prices will converge.  This might reduce the ability of pharmaceutical companies to recoup cost and encourage trade in counterfeits. 

 So, dear readers, please chip in.  Is the pharmaceutical industry the poster child for intellectual monopoly?  Should companies have to choose between IP protection in developed and developing countries?