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 Journals 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?
Katonomics 6: the Economics of IP in Pharmaceuticals Katonomics 6: the Economics of IP in Pharmaceuticals Reviewed by Jeremy on Monday, December 12, 2011 Rating: 5


  1. This is a tiring debate.

    Let those who believe patents bad and/or unnecessary go out into the big wide world and create lots of new medicines to treat the world's ills at miniscule cost and zero profit. There are an infinite number of new compounds that can be created so there is plenty of chemical space outside of that monopolised by the greedy, evil, criminal pharmaceutical industry.

    I've said this recently on this blog (possibly another) that the majority of deaths from disease in poor countries can be treated using unpatented treatments that cost pennies. DO NOT WHINGE about pharma patents if you are not prepared to pay a few pence for rehydration therapy to save the life of a child suffering from diarrhea.

    Boldrin and Levine? - (summary) "Patents for medicines in Italy introduced 1978. From 1961 to 1980, 9.28% new drugs came from Italy. From 1980 to 1983 only 7.5% came from Italy. Things have become worse, not better, since introduction of patents."

    1. This was written ca 2005, yet they didn't have any data for post-1983!
    2. What is the likelihood that the introduction of patent protection in 1978 had a detrimental effect on new drugs launched between 1980 and 1983, when those drugs would have been in development long before?

    Price differential between rich and poor countries is essential and so parallel trade should be blocked in order to assist this. There would be lower cost access today if this trade did not exist, even within the EU.

    Accept that there is a cost to R&D which must be met. Accept that the profit making pharma model has worked (though now struggling - discuss!). Accept that wealth creation in a society obligates individuals/companies/countries to give back to others via taxes to subsidise a minimal acceptable level of healthcare for all.

  2. With apologies to Cole Porter:

    My story is much too sad to be told
    But practically everything written by academics leaves me totally cold...

    When I'm out on a quiet spree, fighting vainly the old ennui
    Then I suddenly turn and see
    The benefits of IP!

  3. Correction: "pharmaceutical companies spend 24% of their sales on promotion and 13% on promotion" should be "24% of their sales on promotion and 13% on development." My fault!

  4. Boldrin and Levine hardly supports your thesis that "Public and humanitarian interests in improved health mean that medicine development may occur without IP protection" as you imply: the list of 15 medical discoveries includes x-rays, public sanitation, germ theory and computers. Hardly relevant to the topic of "medicine development". Moreover, there have been thousands of patents relating to x-rays, public sanitation and computers. Boldrin and Levine's statement is patent nonsense, and I'm afraid your selective quotation only compounds the inaccuracy!

  5. I came across the Baldrick and Latrine nonsense a while ago. This is peddled out like an old metaphor I can not be bothered to remember.

    It was even cited at a recent conference I attended on pharma IP by Matt Fisher (one of those academics). Matt, if you are reading this, then I was going to comment at the time. Unfortunately, the time for questions ran out, but rest assured, your use of the most spurious of sources and evidence did not go unnoticed!

    Is it just a coincidence that this source is being used again so soon after?

  6. The Law of the Single Price? What we need for pharmaceuticals is Ramsey pricing. Under this, everyone pays for the drug they need exactly what it's worth to them - no more, no less. The minimum price is the marginal cost of production. This is completely fair, if obviously totally impractical, but it serves as a thought experiment. It's as far from a single price as you can get. It does show the advantages in variable pricing. A single price must be higher than the marginal cost of production - thus cutting out the poorest who can't afford this. So there is a case for market segmentation, and against international exhaustion.

  7. It appears to me that the 'Ramsey pricing' (I am no expert on that) would be applicable to the generic industry as there are no R&D costs (significant) to recuperate with failed projects to compensate for.

    For new products these costs must also be taken into account and so the Ramsey pricing model would still produce prices that the majority of poor countries could not hope to afford.

    I've spent a lot of time in pharma R&D, but I do not know the true breakdown of costs for the development, production and marketing of the truly expensive drugs we see today. If it was just the biotech drugs that cost thousands per dose I would understand why. I'm intrigued to know the cost breakdown on the expensive 'small molecule' drugs. Are the high prices related to the cost of development and size of market, or are they more expensive to manufacture? Cost of manufacture can be reduced by process innovation, whereas the cost of R&D is what it is (subject to using cheaper labour etc).

  8. Do Italian patents have to encourage innovation in Italy? No. The point is to encourage innovation anywhere so that your citizens get new and useful things. The more countries that provide the incentive the more more expensive and risky development projects will be funded and the more we will have new and useful things.

    Also, what is wrong with spending money on marketing? A patent does provide incentive to research but also to bring to market. If you do not spend on the marketing all you will have is a clever product that no-one knows about. If I were a GP I would want to be more carefully convinced to switch my patients to a new but better acting medication than to buy for myself a coffee machine that said it was more energy efficent. Hence pharmaceutical marketing is expensive and the more so for new drugs.

  9. Anon at 1:40 is correct.

    A country can take advantage of a lack of patent protection just as India has done with pharmaceuticals. That doesn't mean the lack of such protection encourages innovation. It just means the other countries are parasites.

    Marketing of pharmaceuticals is very expensive, but unfortunately, it is also necessary. I have a treatment for cancer in a test tube in front of me but no-one is banging down my door (except for the bailiffs, but that's another story).

  10. On Boldrin and Levine....

    Much as I'd love to start bashing patent abuse by big pharma, the Boldrin and Levine article doesn't make a huge amount of sense! Glossed over is the implication that the prize of patent protection in other countries can stimulate innovation in a country like Italy or Germany, irrespective of domestic policy towards patents.

    And what innovation is mentioned is mostly in the context of mimicing or recreating inventions protected by patents - in this case the patents to be circumvented have in fact stimulated innovation!

    However I would like to know why off-patent drugs can apparently be replaced by "me-too"s, with no option for the consumer to opt for the off-patent version.

  11. To clarify, "me-too"s are not generic versions of an innovators branded product, but are compounds developed by a competing pharma company acting at the same receptor, and having a comparable, though ideally superior pharmacological profile. Good examples are cimetidine (Tagamet)and ranitidine (Zantac).

    Such "me-too"s cannot be substituted as described, if one of them has been prescribed by a doctor.

    Re: substitution of a branded product by a generic:

    The rules (don't ask me which ones, I believe, state that doctors must prescribe drugs using their generic name. I also think that their computer software may also enforce this. Additionally, it may be the case that pharmacists can substitute for a generic version.

    There isn't anything wrong with this practice, as once a drug is off-patent, usual market competition rules apply and price is king.

    Individuals can plump for the branded version if they get a private prescription, or if medicines are available over-the-counter, then they can buy what they want.

    The dirt-cheap aspirin from Tesco's is just as effective as a brandd version for a couple of pounds. Nurofen is my choice over bog-standard ipubrofen, however, because I can be certain it has a nice shiny coating to make them easier to swallow.

    When it comes to generic Viagra (sildenafil), on the other hand, then there must be a psychological effect or at keast more kudos on going for the real thing!

    There are real issue to be had in years to come with generic biotech drugs, because they really are different and this is a huge issue for generic industry, particularly in the USA, at the moment. Innovative biotech companies are probably a little happier, particularly their investors.

  12. I find it interesting that nobody has placed great weight on the role of the National Insitute for Clinical Excellence (NICE) and the NHS in all this. We don't just have a set of individual monopolies on patented drugs to deal with, we also have a monopoly on purchasing and approving drugs in the mix. The NHS's purchasing decisions are controlled by NICE, those decisions decide where the profits go, and therefore decide where research budgets which are derived from those profits go. In effect we have a state monopoly on drug research funding... but we don't use it to our benefit. The NHS simply trusts the drug companies to take their profits and invest them in research. We sort of prohibit spending our investment on marketing by making the advertising of prescription drugs if not actually illegal but so regulated that it is barely comprehensible (remember Pele very carefully not mentioning any particular product in that rather 'nudge nudge, wink wink' Pfizer advert?), but we make no effort to stop it going overseas, or being used for other purposes.

    Couldn't we get a lot more bang for our buck if we moved from the NHS indirectly funding UK drug research, and let them choose where the funding goes directly?

  13. The NHS buy a product and negotiate to agree the price. NICE just decides whether the NHS can spend money on a product that has already been approved for use. I don't quite understand how the NHS are going to determine where the drug companies are going to spend their research budgets? The UK market is not big enough to justify any drug research spending alone.


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