Bad Pharma? Not quite!

Earlier this week there a Treasury Committee discussion regarding Intellectual Property took place, some of which was devoted to issues surrounding patent rights. Now, when people think of patents, they often think of pharmaceutical companies and how “evil” it is that such firms can patent and profit from products that are crucial to improving human health. Such protests can be found in publications as varied as Cracked, The Guardian, The Telegraph, The Washington Post, and The Independent, among others.

However, these protestations and complaints are unjustified. At the outset, it is important to note that patents for pharmaceutical products last, at most, twenty years, and that is to say nothing of the fact that many drugs are subject to off-patent, generic versions long before their patents expire. Hence, any potentially high profits earned by a pharmaceutical firm that owns a patent are only temporary.

Moreover, without the existence of said patent protection, a pharmaceutical firm likely would not invest in researching and developing any drugs in the first place. To see this, suppose that a pharmaceutical firm is considering investing in research and development for a new drug – its investment decision depends on whether the (expected future) revenues it can obtain from its investment exceed the (current) costs of the investment (for now let’s ignore the complications that future revenue streams are uncertain and need to be discounted). Simply put, if the revenues exceed the investment costs, then a pharmaceutical firm will invest in the R&D necessary for the new drug.

How much does it cost to research and develop a new drug for market? The BBC quotes an estimate from the Association of British Pharmaceutical Industry of £1.5bn per drug. Other, even higher, estimates also exist. Nonetheless, this means that for investment in a new drug to be worthwhile, the revenues from said drug must exceed at least £1.5bn.

If patents did not exist, then as soon as the new drug was marketed by the “originator” firm that developed it, rival manufacturers would be able to reverse-engineer their own version (usually within a few years, given the length of time it takes generic firms to produce their own version after patent expiry) without having to incur the large development costs to which the originator was subject. Hence, the rival firms would be able to undercut the price charged by the originator. In other words, without patent protection, an originator would only expect to receive minimal revenues for its investment. Under such a scenario, no rational private firm would incur the costs necessary to develop the new drug.

Under the patent system, however, rival firms are prevented from marketing their own versions for a longer time, thereby providing the originator with a longer amount of time over which it can make revenues. This means that the patent system provides the originator with a much stronger incentive to develop the drug in the first place. As such, it is clear that the existence of the patent system is essential to encouraging the development of new drugs.

However, that is not to say that the patent system is perfect. Indeed, it lacks the ability to incentivise pharmaceutical firms to develop treatments for diseases/conditions that only affect a small number of people. In such instances, the “market” is so small that the revenues obtainable under the existing patent system would not be sufficient to cover costs unless an exceedingly high price was charged (in which case health services probably would not purchase it). In these instances, drugs are not developed despite potentially being highly beneficial to those with the conditions/diseases concerned.

How can this be rectified so that drugs are developed for these “niche” conditions? One way would be for patent rights to be extended in length for drugs developed for these diseases. This would have the benefit of ensuring that the existing structure of research and development institutions is maintained, and that R&D occurs where it can be most efficiently undertaken. However, one downside would be that if a drug was to be developed, then health services would have to pay the “patented price” for that drug for a longer time (but that must be better than there not being a drug in the first place).

An alternative solution would be for a scheme that provides public funding or subsidies for the development of such drugs. If this were done via subsidies for existing pharmaceuticals, such a scheme would not have to provide the full amount of developing the drug from the public purse, but merely enough to make the investment by the private firm profitable. This seems much more feasible than a government taking on the role of a pharmaceutical firm itself – a government would have to incur substantial costs setting up and running its own pharmaceutical research and development unit, which seems needless and inefficient given the existence of such units within pharmaceutical firms already.

Obviously, a scheme to subsidise the development of treatments for niche conditions would give rise to some administrative issues. For example, would the subsidy be paid regardless of whether or not the drug being developed actually came to market? How would the amount of the subsidy be determined? What if the developed drug also had benefits for a more common condition? Nonetheless, these issues do not seem insurmountable, so there could very well be a way forward to developing drugs for niche conditions – either extend patent rights, or provide targeted subsidies to pharmaceutical firms.

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