Editore"s Note
Tilting at Windmills

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January 30, 2008
By: Kevin Drum

PATENT WARS....I've argued before that basic economics suggests that, one way or another, both profit levels and risk-adjusted returns are bound to remain more or less constant in the pharmaceutical industry. Thus, if prices fall in the U.S., they'll rise in Europe. The alternative is that European national governments are both so stupid and such ruthless bargainers (!) that they'll literally drive the pharmaceutical industry into the ground rather than pay higher prices.

Megan McArdle is decidedly of the opposite opinion. And who knows? Maybe she's right. But although I don't feel like arguing the entire big picture question right now, this particular passage struck me:

We cannot forbid pharmaceutical companies to sell into [European countries] at discount prices, because those countries can break the patents and license generic manufacturers to manufacture the drugs. All we would end up doing is removing a small source of profit from the pharma company's books.

It's true that we can't forbid pharma companies from selling into Europe at any price they want, if only because about half the pharma industry is based in Europe in the first place and therefore outside even our theoretical control. But what's this about European countries getting pissed off and just breaking patents willy nilly? That happens occasionally in third world countries, especially with expensive HIV drug cocktails, but has it ever happened (or been threatened) in a developed country with an ordinary pharmaceutical product? Wouldn't that (a) be suicidal (American drug companies would abandon your market), (b) violate all sorts of trade agreements, and (c) set off a massive retaliatory trade war (if they can break Merck's patents, we can break GlaxoSmithKline's)? Maybe I'm missing something here, but a massive, global patent war seems pretty unlikely, doesn't it?

Kevin Drum 1:34 PM Permalink | Trackbacks | Comments (36)

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Comments

you can't fight the Talking Point. it has a life outside the realm of facts.

Posted by: cleek on January 30, 2008 at 1:40 PM | PERMALINK

This is silly. Merck and GSK are subject to the exact same patent laws - all pharma companies have huge international patent portfolios. Merck gets the same European patent that GSK and Novartis do, just as they get the same US Patents that Merck does.

Posted by: Jane Doe on January 30, 2008 at 1:43 PM | PERMALINK

The actual technical location of a Pharma or any major corporation is unimportant.

All these corporations have assets and operations across a variety of countries. They cant break patent law and not suffer damages in America. A court could seize their American assets.

Posted by: jimmy on January 30, 2008 at 1:48 PM | PERMALINK

There's no compelling reason why, if European countries couldn't get discount access to particularly important and/or popular drugs, they couldn't pass their own laws doing what she suggests. It seems unlikely, but could happen if trade relations deteriorate or anti-free trade sentiments continue to rise. Trade agreements get violated all the time, and the drug companies wouldn't abandon Europe -- even under this scenario they could still make money there.

Posted by: Shelby on January 30, 2008 at 1:51 PM | PERMALINK

isn't that what Canada threatened to do in order to get more favorable pricing?

Posted by: pa on January 30, 2008 at 1:53 PM | PERMALINK

Yes. Penalties under the TRIPS agreement would be substantial.

Posted by: Trevor on January 30, 2008 at 1:56 PM | PERMALINK

Megan McArdle ! Honestly do you "big media blogs" have a secret pact to link to each other ?

Posted by: will on January 30, 2008 at 1:56 PM | PERMALINK

Also, she's not right. So far today we have 2 mushy posts giving conservative voices way too much credit. Congratulations GOP, Maybe Megan is right, etc.

Posted by: will on January 30, 2008 at 1:58 PM | PERMALINK

Um, you linked to Megan McArdle and you expected something useful or informative? The very easy explanation is that she's a fool and really you shouldn't take anything she says seriously, as it is bound to have low information content.

Posted by: IMU on January 30, 2008 at 2:00 PM | PERMALINK

Actually, in 2001 the US government threatened to break Bayer´s patent on Cipro if Bayer wouldn´t lower it´s price substantially.
They called it "compulsory licensing" (http://www.fool.com/news/2001/bayzf011025.htm)
.
It happened when the USA was scared about those Anthrax attacks, thinking it was Al Quaida.

European governments have never done anything alike, but given the US example, why shouldn´t they ?

Posted by: StefanS on January 30, 2008 at 2:08 PM | PERMALINK

McMegan... a McIdiot when it comes to patents.

But it didn't go through did it? Compulsory licensing only happens when there is a real emergency, such a flu pandemic or something like an anthrax attack. If the whole patent world is not on your side with compulsory licensing and you are a first world country, then you are going to pay tremendous consequences.

Posted by: MNPundit on January 30, 2008 at 2:15 PM | PERMALINK

They did succeed with their threat: Bayer lowered the price by about 50%.

Posted by: StefanS on January 30, 2008 at 2:17 PM | PERMALINK

Why would anybody ever waste time comparing a McArdle statement with reality? If the two ever correspond it's by pure accident.

Posted by: Steve LaBonne on January 30, 2008 at 2:19 PM | PERMALINK

stefan,

as i understand it, bayer didn't want to ramp up production to meet fed govt's requirements for a cipro stockpile large enough to give every american a course of anti-anthrax therapy.

so feds threatened them with compulsory licensing.

not sure what happened. i think the conflict resolved itself once it became clear we weren't going to need that much cipro.

Posted by: Auto on January 30, 2008 at 2:19 PM | PERMALINK

A good source for the case is here:

http://www.cptech.org/ip/health/cl/cipro/

Posted by: StefanS on January 30, 2008 at 2:19 PM | PERMALINK

Following up, under TRIPS, the relevant agreement, a country breaking patents can be taken to the WTO which can authorize cross-sectoral trade sanctions. That is, the trade retaliation authorized by international law isn't restricted to patents, but can include tariffs and embargoes on all goods.

Not just a patent war, a trade war. Only the war is one-sided. It's not like all of Europe is going to pull out of the WTO.

Posted by: Trevor on January 30, 2008 at 2:21 PM | PERMALINK

If the whole patent world is not on your side with compulsory licensing and you are a first world country, then you are going to pay tremendous consequences.

That is certainly the situation right now.

A massive global patent war seems unlikely given the current pharma business paradigm. But... paradigms have a way of disappearing overnight when the climate gets unstable. I would say that at this point, globalization and improvements to technology are still destabilizing forces for all industries. There are too many opportunities for unexpected developments and unintended consequences to completely rule out a patent war or some other phenomenon with a similar impact.

What happens if the second world countries decide to ignore patents?

What happens if the dollar falls even further?

What happens if America votes for single payer healthcare?

Too many variables to rule this out completely.

After all, "no one could have predicted that terrorists would use airplanes as weapons."

Posted by: lobbygow on January 30, 2008 at 2:28 PM | PERMALINK

StefanS has already cited the relevant historical fact disproving Kevin's thesis.

If a big pharma took a negotiating stance of deciding not to sell to a government buyer, that government would surely take the step of forcing the licensing of said drug. Governments do this and similar things all the time, though this often takes place in other arenas, such as in anti-trust- and it isn't much a stretch to see anti-trust used against a pharma refusing to sell what is, in fact, a government decreed monopoly product.

Would price controls make pharmas more willing to play hardball? Probably not. As Megan pointed out in a related post, drug research isn't the only available line of investment. People assume irrationally that a pharmaceutical company has no choice but to invest in the discovery and production of FDA approved drugs.

If you want the Europeans to pay more, it is the US government that will have to do the negotiating, because it is only the US government that actually has the power of law in its hands to exact meaningful penalties.

Posted by: Yancey Ward on January 30, 2008 at 2:29 PM | PERMALINK

PATENT WARS....I've argued before that basic economics suggests that, one way or another, both profit levels and risk-adjusted returns are bound to remain more or less constant in the pharmaceutical industry.

—Kevin Drum

You mean equal across markets adjusted for transaction and other costs, right?

Posted by: Econobuzz on January 30, 2008 at 2:52 PM | PERMALINK

Yancey, what Stefan said is not what McMegan argued, so it does NOT disprove Kevin's thesis.

If you don't think the PHARMA can convince the U.S. Gov't to take a case to the WTO...

Posted by: bob on January 30, 2008 at 2:55 PM | PERMALINK
You mean equal across markets adjusted for transaction and other costs, right?

I think "transaction costs" are beyond the level of "basic economics" Kevin is referring to.

Posted by: cmdicely on January 30, 2008 at 3:04 PM | PERMALINK

Wouldn't forbidding the sale of a product in a foreign country be an infringement of trade, and illegal under the WTO exposing the US to trade sanctions?

Posted by: Adam on January 30, 2008 at 3:04 PM | PERMALINK

> as i understand it, bayer didn't want to ramp
> up production to meet fed govt's requirements
> for a cipro stockpile large enough to give every
> american a course of anti-anthrax therapy.

Since it took Bayer 80 years to track down and buy back all the assets the US Government seized in 1917 I have a hard time thinking that they would refuse any such request from the USG. They of all pharmas know what can happen in that situation.

Cranky

As Ezra Klein notes today, this question is a bit moot: the blockbuster drug pipeline is empty. Lipitor will go generic in 2012 (IIRC) and after that there isn't much left for pharma to milk.

Posted by: Cranky Observer on January 30, 2008 at 4:34 PM | PERMALINK

McArdle seems to be operating under the common conservative delusion that all drug companies are American and all drug development happens in the U.S., neither of which are true.

Posted by: Mnemosyne on January 30, 2008 at 5:18 PM | PERMALINK

after that there isn't much left for pharma to milk

Oh, I don't know. I bet their looking for a combination diet pill/erectile dysfunction/sleep aid as we speak. Napstiphanlene will be the generic form.

I understand Rush Limbaugh is being courted as spokesperson.

Posted by: lobbygow on January 30, 2008 at 5:38 PM | PERMALINK

"That happens occasionally in third world countries, especially with expensive HIV drug cocktails, but has it ever happened (or been threatened) in a developed country with an ordinary pharmaceutical product?"

Yes, Compulsory Licensing was used in Canada 1917-1993.

It was used against Bayer in the United States.

"Wouldn't that (a) be suicidal (American drug companies would abandon your market)"

Why would that be a problem? If they bail out, just have someone else make their drugs. It isn't hard to do.

"(b) violate all sorts of trade agreements"

use the national health/emergency exception to avoid that.

Posted by: Sebastian Holsclaw on January 30, 2008 at 6:44 PM | PERMALINK
....I've argued before that basic economics suggests that, one way or another, both profit levels and risk-adjusted returns are bound to remain more or less constant in the pharmaceutical industry. Thus, if prices fall in the U.S., they'll rise in Europe. The alternative is that European national governments are both so stupid and such ruthless bargainers (!) that they'll literally drive the pharmaceutical industry into the ground rather than pay higher prices.

This is true only under rather ideal conditions but for whatever conditions between the markets allow them to violate the similarly ideal law of one price.

But "basic economics" doesn't cover patented products that don't have acceptable substitutes, which are by definition monopoly-supplied items. Imposed limits on the monopoly rents that can be charged in one market ought to have negligible impact on monopoly rents charged in other markets. As long as the marginal price in each market is above marginal costs, its still worth doing business there; if one market has imposed limits that take the price below marginal costs, you abandon that market. In any case, as long as you have a monopoly, the forces that would normally bring eliminate economic profits (which aren't the same as financial profits) in a competitive market don't exist, and those are the forces that dictate that, if you have a segmented market, a decrease in prices that can be charged in one segment must be offset with an increase in some other segment. With those forces absent, there is no reason to expect imposed price changes in one market to be reflect in another market.

But what's this about European countries getting pissed off and just breaking patents willy nilly? That happens occasionally in third world countries, especially with expensive HIV drug cocktails, but has it ever happened (or been threatened) in a developed country with an ordinary pharmaceutical product?

"It hasn't happened" doesn't mean "it can't happen".

Wouldn't that (a) be suicidal (American drug companies would abandon your market),

The whole point of nullifying patents is so that you don't need American drug companies to get the drugs that those companies have patents on, so that's not "suicidal". If you nullify their patents, there is little cost (to you) to the American drug companies abandoning your markets. Of course, the market prices in those markets aren't going below the marginal cost to produce the drug, which presumably is no higher for the manufacturer that developed it and is already tooled up for it than others, so, given that abandoning the European market won't make their monopolies elsewhere any more profitable, why abandon the meager profits that can be made in the competitive markets there?

(b) violate all sorts of trade agreements,

Like arms control treaties (e.g., the ABM Treaty), trade agreements can be abrogated. Also, they frequently have extreme condition exceptions which might be invoked.

(c) set off a massive retaliatory trade war (if they can break Merck's patents, we can break GlaxoSmithKline's)?

Abstractly, that's possible. OTOH, the same investors and, often, the same business partners that would be hurt by them breaking Merck's patents would be hurt by us breaking GSK's. While corporations are creatures of governments, governments (or the public of the countries to whom they are notionally accountable) are not the primary beneficiary of corporate success. So who is the constituency for the retaliatory trade war policy?

Posted by: cmdicely on January 30, 2008 at 7:24 PM | PERMALINK

"set off a massive retaliatory trade war (if they can break Merck's patents, we can break GlaxoSmithKline's)?"

Isn't it just as possible that seeing the low prices in Europe, the people in the US will say "why can't we lower the prices to what they have?"

That is in fact what is happening with respect to Canada and below-cost-of-research prices right now. So why should that be considered an unlikely possibility?

Posted by: Sebastian Holsclaw on January 30, 2008 at 7:29 PM | PERMALINK

Why would the U.S. government demand that the pharmaceutical companies quit selling at reduced prices in the first place? We shouldn't care whether or not any company is selling at reduced prices as long as we get those same prices.
Now, getting the prices to match on both sides of the Atlantic might require some government-mandated audits to see just how much of a profit margin these companies are making and, of course, it just isn't permitted that uninitiated heathens should be allowed to view the Holy Books.

Posted by: Doug on January 30, 2008 at 7:31 PM | PERMALINK

"We shouldn't care whether or not any company is selling at reduced prices as long as we get those same prices."

Exhibit A.

Posted by: Sebastian Holsclaw on January 30, 2008 at 7:50 PM | PERMALINK

The best way to circumvent high drug prices is to comb your email for bargains. I have been able to enlarge myself 20% on drugs available over the internet.

Posted by: Luther on January 30, 2008 at 8:13 PM | PERMALINK

Kevin, McMegan's argument is negligible, but I'm surprised at your first paragraph. It seems to boil the industry situation down to two and only two possibilities:

a) national healthcare reduces drug profits in the US, and pharma raises prices in Europe to make up for it; or
b) European governments keep pharma from raising prices in Europe, and pharma is "driven literally into the ground" - I assume that means huge losses.

Look, pharma is one of the most profitable industries around. If government action reduces its profits to something more average, that's not a catastrophe, it won't run them into the ground. (And as we should all know, the money they make doesn't lead to better products - it leads to more marketable products.)

Posted by: Minivet on January 30, 2008 at 8:40 PM | PERMALINK

If the pharmaceutical industry saw its profits drop by one-third, it would still be wildly profitable. There is a right wing argument that says in essence: if the big pharmaceutical companies cannot make whatever profit they can squeeze out of consumers, then innovation will disappear and no more miracle cures will appear. There is an unexamined assumption underlying this argument, which is that those incredibly expensive clinical trials really need to be that expensive. Under a more controlled system of payouts to the healthcare professions, the cost of clinical trials would be lower in the same way that the cost of everyday medical care would be lower. Another point is that our antitrust rules unintentionally result in huge waste because each giant pharma company has to develop its own statin (ie: cholesterol lowering pill), sleep aid, and so forth.Meanwhile, the taxpayers pay for the basic research that builds the foundation for each new class of drugs -- the biochem textbook I used for teaching back in the '90s explained the mechanism of the as-yet-nonexistant statin drugs and predicted their entrance in the market. At the Endocrine Society (and other) meetings, learned scholars point out particular enzymes and/or biochemical pathways that are potential targets for drug intervention.

In brief: the pharmaceutical giants have been getting a free ride on lots of taxpayer funded basic research, and they ought to be paying some royalties back to the governments that have been funding those studies.

Posted by: Bob G on January 31, 2008 at 4:41 AM | PERMALINK

Bob G, you've mentioned 3 things that won't fly. For one, you're implying that costs would be decreased by doctor price controls, which would more likely than not lead to rationed clinical trial support, since you would decrease the financial viability of running the trials (which is a huge money maker for people, including academic medical centers). Second, you're actually calling for trusts in developing drugs, if only to better control them. While this argument isn't unusual (Michael Moore implied this much in Sicko), I think it would end up with more profiteering than anything Big Pharma can do now. Third, as I say this as someone who makes a living working in scientific research, it's not that easy to take basic research into workable product. Sure, government funded research tells what could reasonably be a product, but it takes a lot of blood, sweat and tears to make it into something useful.

Posted by: Todd on January 31, 2008 at 7:22 AM | PERMALINK

Megan Mc = in need of - or - on far too many pharmaceuticals. un-reliable/ believable

Posted by: m1key on January 31, 2008 at 7:52 AM | PERMALINK

"If the pharmaceutical industry saw its profits drop by one-third, it would still be wildly profitable. There is a right wing argument that says in essence: if the big pharmaceutical companies cannot make whatever profit they can squeeze out of consumers, then innovation will disappear and no more miracle cures will appear."

You're ignoring risk. Pharma work is more risky than opening a McDonalds. If you reduce the profit available per dollar of investment to that of opening a McDonalds, only an idiot would invest in pharma research because your chance of losing everything is at lest one and probably two orders of magnitude higher than investing in a McDonalds.

Posted by: Sebastian Holsclaw on January 31, 2008 at 1:12 PM | PERMALINK




 

 

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