Mandatory prize system fails – worse than patents from a social welfare standpoint, politically unpopular and violates WTO

Currently, we rely almost entirely on the patent system to stimulate and channel drug research.108 What adjustments should we make in the patent system if a prize system were introduced?

There are three possible answers to this question. This first is: none. Neither the content nor the coverage of the patent system should be altered at all. The prize system would thus be cumulative, offering drug developers rewards in addition to those they could receive by patenting their creations.

Several of the proposals we have already encountered take this general form. For example, the Advance Market Commitments advocated by Michael Kremer and others – and recently adopted by the G-8 countries – presume that the developer of a qualifying vaccine would patent it and then earn both the revenues guaranteed by the AMC and revenues from traditional sales of the patented product. Similarly, the new federal statute that will give “priority review vouchers” to the developers of drugs aimed at tropical diseases presume that those drugs would be patented in the usual way. Finally, Doug Lichtman’s ingenious proposal seeks to supplement, not supplant, the patent system.

The major benefit of this approach is political feasibility. Pharmaceutical firms can be expected to endorse proposals of this kind, for the obvious reason that all such proposals provide the firms new sources of revenue without affecting their old sources of revenue. The pharmaceutical firms have enormous political power. It is thus unsurprising that the only prize systems that thus far have made much headway have been cumulative systems of this general sort.

The major disadvantage of this strategy is equally obvious: it is very expensive. All of the costs of the present patent system are retained. To them are added the new costs associated with the prize system. Thus, if possible, we should strive to avoid this approach.

The second answer is that a prize system should replace the patent system with respect to all innovations eligible for the new prizes. The premier example of this approach is the Medical Innovation Prize Fund Act, which grows out of the work of Love and Hubbard. As we have seen, that Act would create a new prize system available to the developers of all new “drugs, biological processes, and manufacturing processes for drugs or biological processes.” It would also withdraw patent protection from eligible drugs or processes.109 Pharmaceutical firms (and the inventors of eligible nonpharmaceutical innovations) would thus have no practical choice but to apply for one of the new prizes; patent protection would no longer be available. Guell and Fischbaum’s proposal, under which the government would expropriate some drug patents, would lead to the same outcome on a smaller scale. Proposals of this type are commonly referred to as “mandatory.”

The third approach would leave the patent system in place, but would force a drug developer to choose between retaining a patent or obtaining a prize. The simplest variant of this so-called “optional” approach would require the developer of a particular drug to decide, prior to introducing it to the market (but after receiving FDA approval and, typically, well after a patent application has been filed), whether to retain full patent rights or to give up some or all of them in return for a prize. The developer would not be permitted to change his mind later. The prize and patent systems would thus be two mutually exclusive paths (although, as we discuss below, the prize system might make selective use of aspects of the patent system to ease its administrative burden).

As a practical matter, a fixed-pot distribution system, of the sort considered in the preceding section, would have to be mandatory. If it were optional, there would be too many opportunities for firms to collude or otherwise to game the system. Suppose, for example, that in a particular year, Firm A and Firm B had each developed a blockbuster drug. If both opted for prizes, they would have to split the pot. It is plainly to their advantage to come to an agreement under which only one of them seeks a prize and the other seeks a patent. Explicit or tacit agreements of this general type would seriously distort the operation of the system. It is thus no accident that Love and Hubbard, the principal advocates of the fixed-pot approach, also support a mandatory system.

So which approach is better? The main advantage of a mandatory regime is that it could be much less expensive to fund, because it would not have to compete with the patent system. Unfortunately, a mandatory system would have three drawbacks. First, as Shavell and Ypersele point out, it would contain no safeguard against valuation mistakes by government officials. Under an optional system, if the prize formula were set too low, firms could opt out and instead obtain patent protection. In a mandatory system, this would not be possible. As Shavell and Ypersele suggest, the result is that a mandatory system could be worse, from a social welfare standpoint, from the current patent regime, with all of its faults.

Second, pharmaceutical firms would fiercely oppose a mandatory system, for the obvious reason that it could leave them worse off. The only reason why they have not mounted an attack on the Medical Innovation Prize Fund Act is that they don’t think it has any chance of passage.

Finally, a mandatory system would likely violate the TRIPS Agreement, which binds the United States as well as the other 152 member countries of the World Trade Organization. Specifically, it would appear to violate Article 27, which provides that “patents shall be available for any inventions, whether products or processes, in all fields of technology, provided that they are new, involve an inventive step and are capable of industrial application” and in particular that “patents shall be available and patent rights enjoyable without discrimination as to the place of invention, the field of technology and whether products are imported or locally produced.”110