A prize system is the best way to guarantee widespread dissemination of innovation – a patent system promotes monopoly power

There is today a widespread recognition that drug companies have insufficient incentives to develop medicines for the diseases that afflict the poor, simply because there is no money in those drugs. One of the widely discussed ideas for addressing this problem is a guaranteed purchase fund, where the World Bank or the Gates Foundation would guarantee one or two billion dollars to someone who discovers (and patents) a vaccine or a cure for AIDS or malaria or some other disease afflicting the developing world for the purchase of the drug. In effect, there would be a guaranteed market. The guarantee of purchasing one or two billion dollars of the drug would act like a prize, and a sufficiently large guarantee would motivate research. These guaranteed purchase funds, however, would still maintain the inefficiency of the monopoly patent system. The [*1721] discoverer receives his "prize" - the monopoly profits - by charging monopoly prices. The poor who get the drugs through the guaranteed purchase fund do not, of course, pay the monopoly price. But the funds are limited. When the funds are used up, a government that wants to provide to its citizens, say, the malaria medicine that has been incentivized through the guaranteed purchase fund will have to pay the full monopoly price. Money spent to purchase this drug at the monopoly price is money that cannot be spent on the country's other health needs. It is a transfer payment to the monopolist, beyond what the monopolist may have needed to undertake the research. It is far better to use the money for the guaranteed purchase fund to offer a prize, or to buy the patent, and make it available freely (or to anyone willing to pay a limited licensing fee). In short, in areas where there are well-defined needs (such as the need to develop a malaria vaccine) both the prize system and the patent system can provide comparable incentives to undertake research. Both have as an advantage over government-funded research that no one has to pick who should undertake the research: there is a process of self-selection; those who think that they have the best prospects of succeeding (and are able to finance the research and willing to bear the risk) undertake the project. But the prize system uses the force of competitive markets to ensure the widespread dissemination of the benefits of the innovation; the patent system uses monopoly power, restricting the usage, and often distorting the markets in other ways.