Free ridin’

Todd Seavey from the American Council on Science and Health has himself worked up into a lather about Thailand’s willingness to break drug company patents to cut its spending on AIDS drugs: (Drug Patent Violations, Knock-Offs Harm Us All)

Contrary to the assertions of the Thai government and Doctors Without Borders.. violating drug companies’ patents and making knock-offs of their drugs is not in the long-term best interest of patients. Just as letting people shoplift today can drive stores out of business tomorrow — and just as price controls make customers happy for a day but produce long-term shortages — so too do patent violations gut the incentive to invest millions in researching the even better drugs of tomorrow…Economically and scientifically ignorant moves like this could shrivel or destroy the pharmaceutical industry, and that will not make the Thais or anyone else healthier in the future.

(Actually, the drug companies have a lot more to fear from today’s Supreme Court decision that will make it harder for them to patent obvious inventions for extended release formulations.)

But let’s examine Seavey’s arguments for a minute:

  • Is breaking a patent like shoplifting? Will it “drive stores out of business”?
  • Will moves like Thailand’s “shrivel or destroy the pharmaceutical industry”?

Shoplifting hurts stores because they get zero revenue for goods they paid for. It raises their cost of doing business by forcing them to pay for security measures and to raise prices to make up for their losses. I’m not sure what the “stores” are in Seavey’s analogy. In general, drug wholesalers and pharmacies are pleased to stock and sell generics, which tend to be as or more profitable than branded products. (Drug stores don’t tend to allow shoplifting of generic or brand drugs.)
Thailand isn’t going to be stealing pills from Abbott, it’s just not going to place any orders.

Thailand’s moves aren’t going to affect whether companies continue to develop new drugs and certainly won’t destroy the industry. That would only happen if the US, Europe or Japan eliminated patents. Thailand doesn’t factor into the go/no-go decision for pharmaceutical development. Sure, Thailand is freeloading –but look at the benefits they’re already deriving in the form of lower prices from the branded players.

The best hope the drug makers have to keep Thailand and other developing companies from breaking their patents is to find other pressure points besides the unpersuasive (not to mention untrue) argument that they are destroying incentives for drug development. That’s why the pharmaceutical industry pays such close attention to trade legislation.

There’s a self-correcting mechanism that makes Thailand and its ilk less of a threat to the pharmaceutical industry than it may seem. Once a country starts producing substantial intellectual property of its own it begins to be more respectful of patents. That transition is highly correlated with an increase in national wealth that makes a country able to pay for high-priced drugs in the first place.

April 30, 2007

2 thoughts on “Free ridin’”

  1. A common mistake in most people’s economic reasoning is to think that incremental changes don’t matter at all. So, for instance, people will say, “No one’s going to stop working just because his salary falls 5%” or “People aren’t going to stop riding the subway over a ten-cent increase.” Not everyone, but a few people, and more with each incremental change. Every time a country violates patents — decreasing the returns a company can make on the _billions_ of dollars and in some cases _decades_ of scientific research that went into putting a given new drug on the market — it decreases by at least some amount the incentive of companies to be chumps and make that same investment-vs.-payoff calculation again. More disturbingly, each time countries do this and people respond by saying, in effect, “Ah, they’re big, rich drug companies, too big to fail, who cares?” instead of responding by enforcing international law, another, much darker incentive is created — one to keep violating patents, imposing price controls, or otherwise treat drug companies as if rule of law does not apply to them. These predations may seem marginal, but in the eyes of investors — and in the eyes of conglomerates deciding how to invest limited R&D dollars — every little bit hurts. What Thailand gets away with today, Brazil may well get away with tomorrow, and India, and so on. Drug companies won’t just keel over and die, but they can get slower and less profitable and more risk averse, and that’s not good.

  2. You’re quite right on the incremental change point. Part of the reason the drug companies are under price pressure now is that they’ve engaged in this kind of incremental thinking themselves.

    They’ve said to themselves, “It doesn’t matter if France, Canada, the UK etc., etc. squeeze us on pricing. After all we’re still charging much more than our incremental production cost and the US market more than justifies development costs anyway.”

    What they didn’t anticipate was that this price discrimination would become transparent to all buyers and would train the buyers to continue pushing for more. It also angers the buyers (mainly in the US) who are paying the higher prices.

    For most drugs, the incremental behaviors of the developing countries you mention don’t play into the thinking of big pharma, because these countries represent such a small fraction of overall sales. On the other hand, for certain disease areas –and HIV is one of them– it will cause pharma companies to reallocate R&D dollars to diseases that are less of a hassle to deal with. And while big players like GSK and Pfizer will likely stay committed to AIDS, can we be as confident of the next tier (like BI and Roche) or biotech players?

    For Thailand the most rational behavior is probably to make a credible threat to break patents and thereby squeeze Abbott and others down to their absolute minimum price, but I don’t claim such behavior is good for patients in the long run.

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