South-Western College Publishing - Economics  
Road trip to Canada for drugs!
Subject Seeking alternatives to patent protection for innovation
Topic Market Failure, Regulation and Public Choice
Key Words

patent, profit, prescription drugs

News Story The current U.S. system of rewarding drug companies with patents for innovation is drawing significant criticism. While new medications are extremely cheap to produce, they are very expensive to research and create. The government provides firms with incentives to reward drug companies for their work--patents. Patents grant these companies virtual monopolies on production for a specified period of time, allowing the companies to then charge premium prices to recoup their investment in the drug. This system serves to significantly increase new drug prices, and gives drug companies incentives to produce - and patent - drugs that offer only marginal improvements over currently available medications. Indeed, the Food and Drug Administration has deemed that only 20% of the drugs developed over the last 10 years are truly groundbreaking. The FDA thus argues that the current system is inefficient and overly costly.

Some alternatives to the current patent system suggest that the government completely subsidize drug research, much as it partially does now through grants made by the National Institute of Health. The government could create a system in which it would buy patents from drug companies and then make the medications available at much lower prices to the public. Effectively, advocates for change argue that this would not lead drug companies spend less to develop drugs, but to spend the money more intelligently, creating more innovative drugs for new illnesses.

Some argue, however, that any form of change is likely to disrupt the system. Rather than change the patent system, others critics of the current system want to simply provide everyone with prescription drug insurance coverage. At the same time, having the government engaging in patent purchases could be just as inefficient and wasteful, with the potential for misallocating research dollars for fruitless enterprises.

Given that the U.S. legislature is considering purchasing drugs from Canada - subject to Canada's price control formula - it is clear that politicians know something must be done to curb skyrocketing medical costs, especially for older Americans. However, it is currently unclear just how reform should take place.

Questions
1.

If the market for prescription drugs were to become more competitive (that is, if the patent system were eliminated), what do you think would happen to the level of new drug innovation? Why?

2. What are the economic advantages of having the government purchase patents from drug companies? What rules would need to be in place to make this kind of system work?
3. Based on the information in the article, would simply providing prescription drug coverage to all Americans eliminate the basic problem seen by the critics of the patent system? Why or why not?
Source Eduardo Porter. "Do new drugs always have to cost so much?" The New York Times, 14 November 2004.

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