How should we pay for medical research ?

by John Quiggin on August 4, 2004

In reading the discussion on my post on pharmaceuticals and the US-Australia Free Trade Agreement, I thought it might be useful to look at the more fundamental question – how should we pay for medical research ? In the framework of neoclassical economics, it’s natural to start by looking at the free-market solution. In the absence of government intervention, firms innovate in the hope of securing above-normal profits by offering a superior product. They discourage imitators using a variety of methods such as branding and trade secrets. While these methods don’t work forever, in some cases they deliver enough profits to finance a satisfactory rate of innovation. But, as far as I know, no-one seriously suggests this is the case in relation to medical research. To finance adequate levels of medical research, we need some form of government intervention. There are three main options

  • Patents
  • Research grants
  • Research rewards

Of these options, patents involve the most intrusive government intervention and the largest welfare costs.

A patent is a temporary grant of monopoly rights[1], imposing civil and criminal penalties on those who produce and market goods that are inconsistent with the terms of the patent. Moreover, since a monopoly is analogous to a narrowly-based consumption tax, it has higher welfare costs than an equivalent sum raised from general taxes. On the other hand, if the product market in question functions well in other respects (in particular, if consumers are well-informed and there are no cross-subsidies), the profit from the monopoly is a good measure of the social value of the innovation, eliminating the need for governments to make judgements on this issue. The problem in the case of pharmaceuticals is that the conditions for an efficient product market are not met. Consumers are largely reliant on the advice of doctors, who face a range of incentives that don’t align well with cost and benefit criteria. In addition, markets are generally riddled with cross-subsidies of various kinds, for example arising from public and private insurance.

Research grants of various kinds are the basis of most fundamental research. This category includes both project-based grants of the kind funded by national medical research agencies and the funding of universities and research institutes to undertake research without specific directions as to the content of that research. In the pure model of grant-based research, the products of research are freely usable public goods. In recent times, it has become common for grant-funded researchers and institutions to seek a second bite at the cherry through patents, though the amount actually raised in this way is much smaller than is commonly imagined.

The least familiar category is that of rewards for successful research. A famous historical instance is that of the Longitude prize. Explicit prizes of this kind are rare nowadays and are mostly privately funded. But in practice, research grants are awarded, at least in part, as a reward for past successes. More importantly, for the purposes of the present argument, the Australian system of purchasing pharmaceuticals is, in essence, a reward-based system. Pharmaceutical companies with new and innovative products offer them to the Australian government, which accepts them if the estimated social benefit of the drug exceeds the price demanded. For a bargain to be struck, the price must be somewhere between the company’s marginal cost and the net benefit to Australia. Where there is a wide gap, a standard bargaining problem arises, with the buyer seeking a price near the lower bound and the seller a price near the upper bound.

Because Australia is a small market, companies can cover most of their fixed costs in other markets such as the US, so that the marginal cost may be quite low. This strengthens Australia’s bargaining position. It is this aspect of the scheme that has attracted most attention in public discussion. If the US followed the Australian example, the resulting price (for both Australia and the US) would be higher. But it seems likely that the average price would be well below that prevailing at present and that the allocation of research effort would be more socially beneficial.

fn1. Historically, the grant of patents on items such as salt and playing cards first emerged as a device for raising revenue and rewarding favourites under the Tudor and Stuart monarchies. The award of patents as a reward for inventors came much later.

{ 76 comments }

1

dsquared 08.04.04 at 11:55 pm

Historically, the grant of patents on items such as salt and playing cards first emerged as a device for raising revenue and rewarding favourites under the Tudor and Stuart monarchies

To salt and playing cards, one might also add the right to run and collect fees for operating a lighthouse, the subject of a famous paper (and infamous Reason interview) by Ronald Coase.

2

Sebastian Holsclaw 08.05.04 at 12:13 am

Do you believe that all three methods are equally good at creating new pharmaceuticals?

“But it seems likely that the average price would be well below that prevailing at present and that the allocation of research effort would be more socially beneficial.”

What factors make this seem likely to you?

Also, do you believe that governments will be able to fund pharma research at the same levels as the private capital markets?

3

Adam Kotsko 08.05.04 at 12:52 am

I think that the government should primarily finance pharmaceutical research, then allow corporations to rip off the government research and make huge profits. In short, privatize the profits, socialize the costs.

I mean, look at what it’s done for health care in the US! It’s like a well-oiled machine!

4

John Quiggin 08.05.04 at 1:05 am

Do you believe that governments will be able to fund pharma research at the same levels as the private capital markets?

As I point out in the post, a government-granted monopoly such as a patent is economically equivalent to a sales. tax. So the government is already funding the research that is supported by patents. It could provide the same funding, with less distortion, through a broad-based sales tax.

5

Jack 08.05.04 at 1:16 am

The current patent system provides all kinds of perverse incentives. It is clearly better to develop a treatment that means dependency than it is to develop an outright cure or preventative therapy. Novel uses of existing, patent free drugs, such as the recent heart cocktail including aspirin have no route to approval. Also the pace of effective innovation is slowing despite rapidly advancing technology.

One area that I am puzzled by is whether or not it is significant that most of the costs of big pharma companies are marketing ones. Are they providing a valuable and important educational service as worthy of protection as the original innovation or is it a form of rent of no worth that only serves to keep a channel open?

6

MQ 08.05.04 at 2:17 am

THANK YOU for making this rather obvious point for the benefit of the libertarians among us. The dogged refusal of most libertarians to consider any alternative to the current patent system is one of the more obvious tip-offs to their true ideological motivations. Often those motivations are not minimizing the burden of government, but defending the structure of currently existing property rights. Nothing necessarily wrong with that, but you shouldn’t sell it as maximizing liberty.

7

Sebastian Holsclaw 08.05.04 at 6:07 am

I don’t get it. How is a patent equivalent to a sales tax? A sales tax doesn’t provide a sliding incentive for better products among other differences. And there is already a sales tax. And sales taxes are regressive.

Isn’t the ‘distortion’ really a sorting mechanism?

How will you determine who gets to research what? Do you believe that the government will be able to apply the same level of sorting ability between good and bad lines of research that the market provides? How will a centralized governmental system get access to the distributed knowledge needed to choose lines of research?

Does it bother you that most drugs are not discovered in universities and public research labs? If they were more efficient why don’t countries with weak patent systems and strong universities have more discoveries?

8

woodturtle 08.05.04 at 6:16 am

Patents: I don’t know how you could take away the patent rights for drug companies specifically. “The profit value of the monopoly is a good measure of the value of the social value of the innovation.” I don’t think that is true. Viagra and a vaccine for a worldwide disease? Which do you think will earn the most money, as a percentage of research costs? Will any other company that produces a health related product that has social value, for example stents for heart patients, also be denied the patent process?

Research grants: I am being pessimistic here but I would be very surprised if research funding goes up, in either a Republican or Democratic administration, given the current budget deficit. The past 10-15 years have seen a lot of scientists in this area going to the private sector for more money, and the research effort of the country is also more privatized, which many scientists see as a negative thing. Total knowledge isn’t being shared the way it used to be.

Universities or professors should not be allowed to get patents on developments made with public money because the public is hiring them, and should get the benefits.

Research rewards: Prizes are good for recognizing achievements, but most scientists would not say that it is the primary motivator for their work. Maybe this is not completely honest. Recognition of individual achievement is not the only model for research (example: human genome project).

Recently, companies in the U.S. have imported drugs from Cuba (hepatitis B vaccine and anti-cancer drugs). I think the drug companies will continue to do research on drugs that can make good profits in the U.S., and will go to second and third world countries that have developed good research programs to find drugs to import, such as vaccines. That way, the money they save on research can be used for the liability lawsuits.

9

John Quiggin 08.05.04 at 7:17 am

I don’t get it. How is a patent equivalent to a sales tax?

Start with competitive pricing yielding equilibrium price p0 at which all firms make zero economic profits. Now suppose
(a) the government grants a monopoly to firm A which sets the profit-maximising price p1
(b) the government imposes a tax at rate p1-p0 and gives the proceeds to firm A

It’s easy to check that the two policies yield the same quantities demanded, the same equilibrium price and the same profit for firm A.

10

John Quiggin 08.05.04 at 7:20 am

“The profit value of the monopoly is a good measure of the value of the social value of the innovation.” I don’t think that is true. Viagra and a vaccine for a worldwide disease?

As I tried to make clear from the post, I don’t think that in the case of health care, monopoly profit is a good measure of social value. So we’re agreed on this point.

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Giles 08.05.04 at 9:40 am

Viewing the Australian system as a reward system is perhaps a bit disingenuous since, as John says, the size of the Australian market is so small that it is hard to imagine that Pfizer is primarily (or even vaguely) motivated by a desire to win this “prize”.

I think it would be truer to say that any outcome produced with a patent could be replicated with a sales tax; this is not the same as saying it is the same as a (simple) sales tax; but I think the prime point is that both impose large welfare costs.

Still I think patents are the least best option and prizes probably the most promising – as the recent X-Prize demonstrates – the desire to win can cut the costs of putting someone on the edge of space by factors of 100.

From a practical point of view there is a constant supply of people ho would want to carry out medical research whether paid 20k or 200k – so super normal profits are probably not necessary to stimulate research – grants might therefore suffice for the funding. Similarly prizes, by stimulating the competitive instinct then probably make research more efficient.

But the problem then is research into unknown unknowns – i.e. ideas that fall outside the governments and prize setting committees comprehension; how should this be encouraged? In my view better protection of trade secrets might suffice.

12

John Quiggin 08.05.04 at 9:46 am

Australia is a small country, but the PBS still spends around $US 4 billion per year. Pfizer’s share, to take your example, is presumably in the hundreds of millions. I agree that the prospect of increasing this would not be a primary motive, but I don’t imagine it’s utterly insignificant either.

Of course, the real issue is what would happen if the US or EU adopted a similar approach.

13

Nicholas Weininger 08.05.04 at 10:57 am

“While these [free-market] methods don’t work forever, in some cases they deliver enough profits to finance a satisfactory rate of innovation. But, as far as I know, no-one seriously suggests this is the case in relation to medical research.”

A comment and two questions:

a. Your list omits private philanthropy, which has been a significant factor in medical research in the past; see e.g. the Rockefeller-funded foundations.

b. Where is the evidence that the free-market methods you list *couldn’t* deliver enough profits to finance innovation?

c. How does one decide, and more importantly *who* should decide, what a “satisfactory” rate of innovation is anyway?

14

JamesW 08.05.04 at 11:18 am

Don’t get fixated on drugs. It’s just as important to support innovation in medical science and treatment protocols, which are not patentable.

Case study: In 1982 Australian doctors (Marshall et al.) found that many ulcers were caused by the endemic bacillus helicobacter pylori, and could be cured by a course of standard antibiotics. The market value of this information is $0. What is its fair value? We can get an idea from the previous best innovation in the treatment of ulcers, the drugs Tagamet and Zantac. During the life of the Zantac patent, Glaxo earned over $10 billion from it. There is no reason to think that patients felt cheated, so we have an a priori reasonable market value. The fair value of Marshall’s discovery must be of the same order of magnitude.

I sugest that scarce public resources should be concentrated on areas where the market doesn’t work: basic medical science, treatment propocols, and orphan diseases suffered by poor people (malaria) and small groups (rare conditions).

15

John Quiggin 08.05.04 at 11:30 am

Nicholas, I need a separate post to deal with the role of non-profit private action. It’s certainly important in relation to health and more generally, but I doubt that it’s sufficient to address the problems of medical research.

On your questions, if (as appears to be the case) no-one is willing to assert that the market level of provision would be adequate, then it doesn’t matter who you choose to make this judgement.

If you want to present an argument that free-market provision would be adequate, please do so, and I’ll do my best to respond.

My estimate is that the level of provision in this case would be close enough to zero that the difference could be disregarded.

16

dsquared 08.05.04 at 1:07 pm

Where is the evidence that the free-market methods you list couldn’t deliver enough profits to finance innovation?

Just to make this clear (I’m not sure Nicholas is confused but I was on first reading), patents are very definitely not a “free market” solution.

17

Giles 08.05.04 at 2:35 pm

“Australia is a small country, but the PBS still spends around $US 4 billion per year. Pfizer’s share, to take your example, is presumably in the hundreds of millions. “

But thats sales – if, as you assert, the Australin system results in lower profits going to big pharma, then profits on these sales will be lower than elsewhere.

So its more probable that sales to Australia are viewed as a “bonus” and do not come into the descision making process at Pfzer. If they did consider the Australina market, then the PBS would know that they were hoping to make some a super normal profit in Australia and so would then demand a lower price. So from a game theory perspective, I think the logical thing is for Pfzer to ignore Australia

18

Sebastian Holsclaw 08.05.04 at 4:36 pm

“(a) the government grants a monopoly to firm A which sets the profit-maximising price p1
(b) the government imposes a tax at rate p1-p0 and gives the proceeds to firm A”

Your definition acts as if the government has discovered the drug and gives it to the company. Is there any distinction between cases where the government discovers a drug and gives it to someone and the actual case?

You also haven’t dealt with the problem of allocation at all. How does the government decide which research gets the tax money? We are back to the problem of distributed knowledge and the fact that governments historically harness it far less well than market systems.

And isn’t that the key problem? If we knew in advance which lines of research were most productive, it might be best to have the government hammer those lines. But we can only take educated guesses based on vast amounts of knowledge which can’t be aggregated well into government decision-making processes. Same problem with government created ‘prizes’. I think they are a great idea for difficult to profit areas like one or two shot preventative vaccines precisely because they fall inbetween the cracks of the patent motivation system.

I guess that is one of my key problems with your analysis. The patent system is not perfect for every possible contigency, yet it does very very well for a very broad number of questions. Unless we have nearly perfect understanding of economics (which I suspect we can agree does not exist at this time), why is it better to try to replace a generally working system, instead of trying to fill the gaps that it doesn’t work well in? Try prizes for vaccines and other areas where the patent system doesn’t provide useful profit. Fill the gaps. But don’t write as if the failure of the long tested and widely successful at creating new technologies patent system to cover every conceivable medical problem means that your untested ideas are broadly superior. Just because they might cover the current holes doesn’t mean they will cover all the things that patents do now.

19

eudoxis 08.05.04 at 5:10 pm

“Research grants of various kinds are the basis of most fundamental research. This category includes both project-based grants of the kind funded by national medical research agencies and the funding of universities and research institutes to undertake research without specific directions as to the content of that research.”

In fact, intramural funds are more specifically aimed than government grants. But all grant appropriations are judged on a merit basis that includes consideration for future significance. There is no funding free from politics.

A couple of other comments:
The focus in many of these posts is directed at the amount of money spent by industry in relation to their profits. However, industry expenditures on R&D make up between 1/3 and 1/2 of all medical research in the US. A large proportion of the incentive for that research is via patent protection.

It is true that universities and other institutions are searching for patent protection for basic research findings. This is a travesty. Basic research knowledge should be public domain. Likewise copy rights to research publications.

It’s absurd to point to distant advances in basic knowledge as forming a basis for present applications. The point of a patent is to support development.

Prizes for successful research would at least direct the focus back to individuals. Most patents are narrow enough for industry to circumvent and industry doesn’t pay enough for broad patents anymore.

20

Dan Hardie 08.05.04 at 5:16 pm

Just to back up what was said by JamesW: given that we know that the US spends a hell of a lot more than most other developed countries on healthcare, what proportion of this is due to higher drug prices? Certainly I understood that a lot of the disparity in say, US-UK health spending could be accounted for by the fact that the NHS is pretty much a monopsonist (ie sole buyer) in the trained health-care labour market, and that wages of UK healthcare professionals are therefore considerably lower than US ditto.

If somebody knows, info would be gratefully received. If not, I will try to dig it out myself.

Re Giles’s point: ‘from a game theory perspective, I think the logical thing is for Pfzer to ignore Australia’ because the profits Pfizer makes in Oz are low compared to elsewhere- I have a possible objection.

If JQ is right, the logic behind the FTA for Pfizer and all other drug firms is that an accepted FTA can act as a ‘wedge’, whereby the US can force through a series of agreements imposing US-style intellectual property laws on countries which currently don’t have them. I know this sounds tinfoil-hattish, but something rather like this does seem to have been one of the attractions of the Mutual Accord on Investment- which was proposed, I believe, under WTO auspices, strongly championed by the US (under Clinton as well as Bush) and eventually dropped in the face of resistance from the likes of France. MAI, as I remember, was less about intellectual property rights and more about forcing signatories to agree to more or less unlimited privatisation and foreign ownership of their public infrastructure, but there is one significant similarity: something which has no real link to ‘free trade’ (certainly no link that Ricardo or Hume would recognise) was being promoted under the free trade banner by a US government and a lot of US big businesses. Dsquared could probably tell me if I’m talking through my hat here.

21

john b 08.05.04 at 5:22 pm

Dan Hardie – the proportion of the difference between US/UK healthcare spending accounted for by drug price differences is much lower than you’d expect. There’ve been several posts at CT and by Matt Yglesias going over this should you have some spare time for Googling.

22

Dan Hardie 08.05.04 at 5:35 pm

‘the proportion of the difference between US/UK healthcare spending accounted for by drug price differences is much lower than you’d expect.’

No – I actually do expect that the US/UK healthcare spending disparity has less to do with drug prices than with wage levels for healthcare professionals. Kieran Healy, Matt Yglesias et al. wrote very interesting posts but didn’t provide figures for this, so far as I remember.

23

dsquared 08.05.04 at 6:11 pm

Dsquared could probably tell me if I’m talking through my hat here.

I could and you’re not. (iirc, MAI stood for Multilateral Agreement on Investment). But yeh, the USA has been engaged in exactly this project for the last couple of years with its bilateral agreements.

24

Brock 08.05.04 at 6:29 pm

“The profit value of the monopoly is a good measure of the value of the social value of the innovation.” I don’t think that is true. Viagra and a vaccine for a worldwide disease?

I wouldn’t trivialize the social value of Viagra. If great sex once a week is worth $50K in happiness, Viagra has been a major boon to our overall well-being.

25

Jason 08.05.04 at 7:11 pm

John, I don’t quite see how a patent is “equivalent” to a sales tax. I can see how it has the same effect as a particular (although impossible to determine) fixed tax, but sales taxes offer considerably more versatility in finding a more socially desirable outcome (by taxing at less than p1-p0).

One thing I’ve often thought about and find mildly annoying is the lack of marketness involved in determining patents. Given the granting of a monopoly is not socially optimal, why not hold some sort of auction before people do the research regarding the patent length? You’ll only produce this research with a 95 year monopoly, well Jones over here will do it with a 5 year one, so he get’s the patent and thanks for playing.

26

Doctor Memory 08.05.04 at 7:40 pm

jamesw notes: Don’t get fixated on drugs. It’s just as important to support innovation in medical science and treatment protocols, which are not patentable.

…yet. I have three words for you: “Business Method Patents.” If govt-funded research into new treatment protocols begins to shift any amount of profit away from Big Pharma, expect a quick and decisive move to make treatment protocols patentable.

27

catfish 08.05.04 at 7:40 pm

Jason,

But don’t you run into the problem of auctioning patents on thing that don’t yet exist? My guess is that many patents are awarded due to the creation of drugs that had not originally been planned. In other words, how would this system account for serendipitious discoveries–something that is not entirely absent for scientific development of any kind? For example, it must be common to create a drug that does X in the process of trying to create a drug that does Y.

28

Sebastian Holsclaw 08.05.04 at 7:47 pm

“Given the granting of a monopoly is not socially optimal…”

Socially optimal at what? At distributing the fruits of the most cutting edge research once such research has already been, or at ensuring that useful new research gets done at very high rate?

29

glory 08.05.04 at 9:18 pm

brad delong and lawrence summers mentioned gov’t patent buyouts in their 2001 paper they presented at the annual fed symposium in jackson hole.

New institutions and new kinds of institutions–perhaps even some that have been tried before, like the French government’s purchase and placing in the public domain of the first photographic patents in the early nineteenth century (see Kremer (1998))–may well be necessary to achieve the fourfold objectives of (a) price equal to marginal cost, (b) entrepreneurial energy, (c) accelerating the cumulative process of research, and (d) providing appropriate financial incentives for research and development. The work of Harvard economist Michael Kremer (1998, 2000), both with respect to the possibility of public purchase of patents at auction and of shifting some public research and development funding from effort-oriented to result-oriented processes (that is, holding contests for private companies to develop vaccines instead of funding research directly), is especially intriguing in its attempts to develop institutions that have all the advantages of market competition, natural monopoly, and public provision.

kremer’s 1998 paper specifically sez, “Patent buy-outs may be particularly appropriate for pharmaceuticals.”

30

John Quiggin 08.05.04 at 9:38 pm

Sebastian & Jason – reread the post and you’ll see that your point about the informational distinction between patents and sales taxes was made there.

Glory – thanks for these useful references

31

Sebastian Holsclaw 08.05.04 at 9:59 pm

“reread the post and you’ll see that your point about the informational distinction between points and sales taxes was made there.”

Maybe I’m not using the jargon, but I don’t understand what you mean by ‘informational distinction’ at all. Aren’t you suggesting that there is no difference to the customer between a patent and a sales tax?

If so (and I realize that might not be what you are saying) that isn’t it my point. My point is to question how the research money which you posit being raised by a sales tax (or frankly any tax) is to be distributed. How will the government gain the highly distributed knowledge necessary to decide which lines of research to follow?

32

John Quiggin 08.05.04 at 11:49 pm

Sebastian, I said “On the other hand, if the product market in question functions well in other respects (in particular, if consumers are well-informed and there are no cross-subsidies), the profit from the monopoly is a good measure of the social value of the innovation, eliminating the need for governments to make judgements on this issue.”

This precisely covers your point

As regards monopolies and sales taxes, I said “a monopoly is analogous to a narrowly-based consumption tax” and explained the analogy. I didn’t say the two were exactly the same – this was your (mis)interpretation.

I don’t want to close off debate, but I’m finding it difficult to conduct a discussion in which you’re simultaneously asking for explanations of simple points in microeconomics and seeking to dispute analysis based on those points.

33

Matt McGrattan 08.06.04 at 12:21 am

“…how would this system account for serendipitious discoveries—something that is not entirely absent for scientific development of any kind? For example, it must be common to create a drug that does X in the process of trying to create a drug that does Y.”

In fact the bulk, or at least a massively large percentage, of all drug discoveries are made this way. The usual process is just to synthesize millions of chemical variants of something of interest and then do gazillions of in vitro and in vivo tests until someone points out that chemical X seems to retard the action of biochemical Q which is implicated in the pathophysiology of disease-condition Y, etc.

I worked for a small bio-pharmaceutical company for a summer job once and one of their people – who used to work for the Medicines Control Agency – gave the new employees a 1 hr lecture on the usual drug development and licensing process. It’s massively more random than you think.

For a huge number of drugs they still don’t know how they actually work years after they’ve gone into widespread use. Drug development often proceeds ‘instrumentally’. This works (on some measure of ‘working’), this doesn’t kill people = this is a good drug. The how and the why are often secondary.

We’re still discovering new and interesting properties of aspirin never mind anything else.

34

baa 08.06.04 at 12:28 am

Prof Quiggin,

One basic microeconomic question. Why does a monopoly have a higher welfare cost than equivalent sum raised from general taxes?

One (perhaps) more substantive issue. It is of course true that if any market functions poorly enough, then non-market based “price-setting” will be superior. You seem to think this is in fact the case in pharmaceuticals. Why more so than in, say, medical devices, software, or media? Or do patents in these markets also return non-socially optimal results?

35

dsquared 08.06.04 at 1:24 am

baa: I’ll leave it to JQ to answer your specific questions (not least because I suspect I might embarrass myself by getting the answers wrong). But in the meantime, note that patents are not part of the normal functioning of the market. If the government decides to pass a law saying that in certain circumstances it will put you in prison for making and selling a particular chemical compound, then that is a political interference with the market just as much as a tax is.

36

John Quiggin 08.06.04 at 2:17 am

baa, to oversimplify a bit, the welfare cost of a tax is roughly proportional to the square of the tax rate, while the revenue raised is proportional to the rate. So, a given amount of revenue will be raised at lower cost by a broad-based tax at a low rate than by a narrowly-based tax at a high rate. A monopoly is like (though not exactly the same as) a narrowly-based tax.

I haven’t thought much about medical equipment, but I think similar arguments probably apply. And I’m very concerned about the possibility of patenting treatment protocols, raised above.

37

neudoxis 08.06.04 at 2:34 am

Treatment protocols as well as diagnostic protocols are already being patented. They’re known as medical process patents and they raise concern in the medical community as well.

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baa 08.06.04 at 3:20 am

Professor Quiggin,

So the idea is that (all things being equal)a high marginal tax rate on some single good perturbs the market more than a low one on many goods? I admit myself perplexed as to why that should be so, but rather than presume on your time, maybe I’ll fetch my old micro books.

D^2, I suppose I’m puzzled as to why intellectual property is not part of the normal operation of the market, but physical property is. I didn’t think neoclassical economists disputed that economic activity occurs in the context of government enforcing contracts, safeguarding property, and what not. Is there some strong disanalogy between IP and “regular” P that you’re arguing for here?

39

John 08.06.04 at 3:22 am

Sebastian wrote:
“How will you determine who gets to research what?”

Peer review.

“Do you believe that the government will be able to apply the same level of sorting ability between good and bad lines of research that the market provides?”

Since most marketed innovations are based on govt-sponsored research, the sorting appears to be better than the Holy Market. But hey, what’s empiricism got when stacked next to your religious beliefs?

“How will a centralized governmental system get access to the distributed knowledge needed to choose lines of research?”

Journals.

“Does it bother you that most drugs are not discovered in universities and public research labs?”

No, because your claim is false. As another poster noted, you are improperly limiting your view to drugs, too. You’re also ignoring that most new drugs are “me too” ones, with such marginal utility that they have to be advertised to death. Does any truly important drug advance need an advertising budget?

“If they were more efficient why don’t countries with weak patent systems and strong universities have more discoveries?”

But they are far more efficient. For a thorough look at how pharma companies depend on NIH-funded research and use patents to reward imitation instead of innovation, check out:

http://www.drugawareness.org/pdf/tnrdrugpiece.pdf

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John 08.06.04 at 3:27 am

Here’s a choice bit from that article:
“A general idea of the relative contribution of the pharmaceutical industry to the underlying medical research that leads to the development of new drugs can be gained from a recent study published in the journal Health Affairs. The study reported that in 1998 only about 15 percent of the scientific articles cited in patent applications for clinical medicine came from industry research, while 54 percent came from academic centers, 13 percent from government, and the rest from various other public and nonprofit institutions. Remember that these are patent applications for all new drugs and medical innovations, not simply for those ultimately judged to be clinically important. Had the data been limited to only major breakthrough drugs, the industry’s role would undoubtedly have looked even smaller.”

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John Quiggin 08.06.04 at 6:11 am

baa, because ideas are public goods, the term IP is completely misleading, as are any intuitions based on ordinary property. A good place to start on the issues is with the work of Larry Lessig

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Jack 08.06.04 at 12:24 pm

Another reason why IP might not fit right into the market is that even physical property rights and laws are not straightforward.

Even for something as basic as Real Estate (simply called Property in the UK) getting the right legal framework is difficult and varies between situations so US law is different from UK law even though they started out the same — The Mystery of Capital/Hernando de Soto has a vivid description of the issues.

To assume that the same (same as which?) system should work well for things which are for example not even scarce is bold indeed.

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Jeremy Osner 08.06.04 at 1:43 pm

Is there anything to this understanding of mine wrt patents and intellectual property in the pharmaceutical industry:

The “natural” way of protecting your monopoly on a drug you invented would be to keep the formula secret for as long as you could. However government regulations have closed off this option to drug companies since they are required to reveal all before the FDA in order to get their inventions licensed for use in the US. So a patent provides a compensation for the government’s taking the drug company’s trade secret.

I don’t know if this makes any sense from a historical standpoint or for that matter from an economic one — it’s just an idea that’s been floating around in my head for a while. I’d be glad to be disabused of it or to have it confirmed. (Or as I expect is likely in this forum, both by different parties.)

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Joshua W. Burton 08.06.04 at 2:27 pm

Isn’t the libertarian approach to attack the distortions that make pharmaceuticals a failed market, so that the patent subsidy is better allocated?

Obvious steps in this direction would include discouraging employer-subsidized insurance, scrapping direct health care subsidies like Medicare and veteran benefits, and deregulating quack nostrums that can then compete on price with real drugs at the hospital bed.

Why should advising what drug to sell me be the monopoly of a learned, trusted and heavily regulated profession, while advising what common stock to sell me is a huckster trade with only just enough self-regulation to keep the marks from rioting? This, it seems to me, is the fundamental market distortion, from which bad patent incentives are merely minor collateral damage.

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Jack 08.06.04 at 3:39 pm

Joshua, I think crack dealers and tobacco companies are one answer. Rush Limbaugh and the other prescription drug addicts might be an even better example.

At the other extreme any treatment for a disease which typically comes by surprise and which is life threatening could be sold for enormous profits since all customers would be desperate.

There are dreadful problems in India where much of the drug market is unregulated and even simple things go wrong, partial courses of antibiotics being an important example.

The final reason is that for many conditions the feedback loop will not work well. The patient may get one chance to get it right. Now this applies to other things people buy but there are extensive laws about selling everything from clothes to houses and certainly food. If similar consumer liability rules were applied to drugs I imagine that pharmaceutical companies would insist that the drugs be administered by experts.

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Joshua W. Burton 08.06.04 at 4:18 pm

_There are dreadful problems in India…._

Oh, certainly. I was merely setting up the true-believer straw man, to bitterly mutter “but _real_ libertarianism has never been _tried!_” as the crows pick the buttons off his coat. With an occasional rueful wave to the Marxist straw man in the next cornfield, of course.

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Sebastian Holsclaw 08.06.04 at 4:34 pm

“baa, because ideas are public goods, the term IP is completely misleading, as are any intuitions based on ordinary property.”

Isn’t this horrifically question begging? If I spend hundreds of man-hours carving and creating an intricate wood desk that is property. It is just as much property as a wood block, but worth more because of the application of skilled labor plus the desirability of the desk.

If I spend many hours creating a beautiful painting, it is property. It is just as much property as a blank canvas and paint, only (hopefully) worth more due to the application of skilled labor plus the desirability of the painting. If I make many cheap copies of the painting and devalue the painting, something has happened which will make creating paintings less likely because I can’t earn much money from it (in an area of work where it is already ridiculously difficult to earn money). Call it what you will. It is closely analogous to property in the desk sense of the word. This is why copyright exists. Extending it indefinitely is non-ideal, but getting rid of it doesn’t sound ideal either.

If I spend millions of man-hours testing various compounds until I find one that is both effective and safe against a particular disease, suddenly that isn’t property? Not even analogous to property? The lack of short-term property-like protections won’t effect the chance that people will spend millions of man-hours? I don’t believe it. You can’t jargon that away.

Sifting through even ‘public research’ and creating new drugs is one of the most intellectually difficult things done by our civilization. Universities don’t do it because they are awful at it. If you don’t believe it, I encourage you to put your money where your mouth is and invest your retirement in pharma stocks that you pick after say 5 years of intensive research.

Speaking of not understanding the jargon, this quote doesn’t mean what you think it means Jack:

The study reported that in 1998 only about 15 percent of the scientific articles cited in patent applications for clinical medicine came from industry research, while 54 percent came from academic centers, 13 percent from government, and the rest from various other public and nonprofit institutions.

That is because private research on drugs is typically not called ‘articles’ and trials are not always published in articles. Not to mention the fact that if you do your own work on something in an application for a patent that you don’t refer to your own ‘articles’ even if you publish LATER because you want to establish the patent first.

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Jason 08.06.04 at 5:33 pm

JQ, My comment was more a recommendation for you to change your language to make the monopoly/sales-tax relationship clearer (as I was sure you understood it). Your wording of “A monopoly is like a narrowly-based tax.” or equivalent could lead to confusion whereby people equate taxes with monopolies.

Perhaps something like “Sales taxes offer more flexibility than monopolies, and there is a specific tax rate that replicates the effects of a monopoly.” whilst longer, may offer more clarity.

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John Quiggin 08.06.04 at 11:31 pm

Sebastian, you should look up begging the question before using this term again.

Coming to substance, are you restating the point that the effort that goes into intellectual work needs to be rewarded or presenting some sort of labour theory of property?

If the first, I agree – the whole point of my post was to ask how we should pay those who undertake research.

If the second, your examples illustrate the problems I alluded to. Does “your” painting belong to you, or the painters whose styles and techniques you are imitating/adapting or to the descendants of some putative Paleolithic inventor of cave painting?

This kind of question is easy to answer in the case of the physical painting, because it’s a rival good. If someone else has it, you lose it. But if you try and apply rival-good reasoning to nonrival goods like ideas, you end up tangled in contradictions.

Of course, if the government, for whatever reason, gives you a monopoly over some commodity, this right is a valuable piece of property to which standard economic analysis can be applied in many respects. But let’s be clear that it’s a monopoly right we’re talking about and not the idea or other public service for which that right is supposed to be a reward.

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John Quiggin 08.06.04 at 11:32 pm

Jason, thanks for your comment. I plan to rewrite this piece and, when I do, I’ll try to clarify the point.

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Jack 08.07.04 at 1:06 am

Sebastian, to what are you referring when you say: “Speaking of not understanding the jargon, this quote doesn’t mean what you think it means Jack:”?

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Jack 08.07.04 at 1:14 am

Sebastian, I think you mean john not quiggin not me.

In any case your point does little to diminish the role of public research. There may be private research that does not appear in those contexts but it is research that cannot appear in those contexts and while valuable is different and requires the sort that can be quoted in that situation so it is not clear to me that john’s point is greatly undermined by your quite valid observation.

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Sebastian Holsclaw 08.07.04 at 6:15 am

I wrote:

My point is to question how the research money which you posit being raised by a sales tax (or frankly any tax) is to be distributed. How will the government gain the highly distributed knowledge necessary to decide which lines of research to follow?

You respond with:

“On the other hand, if the product market in question functions well in other respects (in particular, if consumers are well-informed and there are no cross-subsidies), the profit from the monopoly is a good measure of the social value of the innovation, eliminating the need for governments to make judgements on this issue.”

This precisely covers your point

It doesn’t cover my point at all but I will presume it was because I didn’t frame it correctly.

You are suggesting research grants or prizes because you don’t believe that the patent system is as effective in medical research as research grants or prizes would be. Am I tracking so far?

You suggest an analysis similarity between patent grants and a sales tax.

You then use that as a springboard to suggest that such money could be spent on grants or prizes by the government instead.

If I have any of that wrong, please tell me, because you seem to be saying that I’m not getting it and then repeating the above.

I intended to ask a question about how these grants or prizes would be distributed, but you have responded to my question as if I was asking about patents which your refer to in your response as ‘the monoploy’. I

Your response makes no sense in reference to how grants and prizes will be distributed because your response talks about ‘the monopoly’ of patents while my question is attempting to address how medical research will occur in your theoretical non-patent regime. Unless you are making a logical jump that I just can’t follow, the profit value of a patent doesn’t help us decide which government-funded research will be conducted in a non-patent regime.

So to reiterate, in your theoretical grant or prize regime how does the government gain all the specialized knowledge to decide which areas to fund and which areas not to fund? How does it harness the distributed knowledge of the tens of thousands of people with specialized knowledge who currently contribute to decisions about research. These people currently signal the market with their knowledge by investing. How will the government get all (or even a large percentage) of those inputs. It seems to me that peer review (for example) would include one or even two orders of magnitude fewer of knowledgable inputs than are currently available to sort good ideas from bad. How do you correct for that enormous information loss?

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John Quiggin 08.07.04 at 8:06 am

Sebastian, no-one except you is having such problems understanding the piece. I suggest you read the DeLong and Summers paper linked above, if necessary preceding it with a good public economics text (say Atkinson and Stiglitz). After that, if you have any criticism to make, I’ll be happy to respond.

Also, there’s nothing theoretical or hypothetical about research grants or about the PBS, as several commenters have already pointed out. If you think they work badly, provide some evidence.

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Jack 08.07.04 at 10:23 am

Clearly grants do exist and are allocated with some efficacy and bounties or prizes have done good things from clocks to free software. Things like the PBS also seem to work without the sky falling on anyones head and indeed beter top level indicators. It is also hard to believe that the current system of allocating resources is patently optimal. Nevertheless it does seem sensible to ask how alternative systems would bear extra responsibility. One assumes that grant giving bodies receive some proposals that are obviously worth pursuing and some which are marginal so there must be diminishing returns.

On the other hand how much more valuable would be all that research that drug companies do that doesn’t get pulished if it was? I propose the deciphering of Linear B as an example of how valuable sharing can be, as if one were needed.

It is also worth pointing out that it is not primarliy R&D expenditure that is in practice primarliy protected by patents. In most large drug companies marketing costs are IIRC roughly thre times R&D and that trend is increasing. I’m not sure if that is significant but marketing is much less emotive than R&D to my mind.

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Sebastian Holsclaw 08.07.04 at 11:04 am

“You are suggesting research grants or prizes because you don’t believe that the patent system is as effective in medical research as research grants or prizes would be. Am I tracking so far?

You suggest an analysis similarity between patent grants and a sales tax.

You then use that as a springboard to suggest that such money could be spent on grants or prizes by the government instead.”

At least tell me which statement I have wrong so I know the location of my error. On which point do I go astray?

Thanks for pointing out the Delong paper. I don’t have any trouble whatsoever understanding it. In fact it raises the exact question that I have repeatedly asked:

If the government is to subsidize the creation of information goods, the government needs mechanisms to determine in which directions the subsidies should flow, and government bureaucracies have never been able to choose and assess the directions of applied research and development very well. Mainstream academic economics has long underestimated the importance of Hayekian insights into market competition as a discovery mechanism, of the entrepreneurial advantages of private enterprise, and of the administrative defects of overly-rigid systems of top-down control that come with centralized funding.

He raises this problem earlier in the paper with:

However, forcing prices to be equal to marginal cost cannot be sustained because then the fixed set-up costs are not covered. Relying on government subsidies to cover fixed set-up costs raises problems of its own: it destroyes the entrepreneurial energy of the market and replaces it with the group-think and red-tape defects of admininstrative bureaucracy. Moreover, in a Schumpeterian economy it is innovation that is the principal source of wealth–and temporary monopoly power and profits are the reward needed to spur private enterprise to engage in such innovation. The right way to think about this complex set of issues is not clear, but it is clear that the competitive paradigm cannot be fully appropriate.

These two paragraphs highlight the exact problem I wanted to highlight, but perhaps it is only recognizable to you in jargon. But now that I have found the jargon….

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Jack 08.07.04 at 12:08 pm

Sebastian, JQ has pointed out a number of models for allocating the money — Grants, prizes and systems like the Australian state drug buing system. All these systems certainly provide scope for entrepreneurialism prizes obviously, grants too and if you are going to allow Wal Mart so does the state drug buying model. These might or might not be as efficient as automatically granting temporary monopolies but the discussion ought at this stage to be more specific.

It should be born in mind that a change in system could still be a good idea even if the distribution of research funds were less efficient because the fund raising side is more efficient.

Also that from a free market point of view the monopoly is pretty horrid. All that research not shared. Once the patent is filed behaviour is purely rent seeking which is definitely inefficient. This is actually a broad criticism of economic defences of libertarianism or libertarian coat tail hanging tax policies. Specifically while many tax and redistribution schemes do create deadweight inefficiencies, so does accumulation of wealth and leaving wealth alone in order to preserve incentives ends up producing inefficiencies of just the same nature of its own.

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John Quiggin 08.07.04 at 12:48 pm

Sebastian, Jack pretty much sums up the response I would have made. My post discussed advantages and disadvantages of various mechanisms. The main point was to disabuse readers of the notion the patents were a market mechanism, rather than a particular form of government intervention.

I dealt with the point you made, and quoted from DeLong and Summers, and pointed, in comments, to the sentence where I did so. Reread the post again and I’m sure you’ll see this in the end.

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Sebastian Holsclaw 08.07.04 at 8:07 pm

Well no actually you didn’t. You disparaged my ability to understand your points, when it is now clear that I understood them just fine. My point may not have initially been expressed as an economist would have expressed it, but the very paper you point me to raises the very issues I raise. I point to the issues as raised by the very well known economists that you quote to me, and you still engage in a brush-off.

“My post discussed advantages and disadvantages of various mechanisms.”

Postively lawyer-like. You discussed what you see as the advantages of grants and prizes and the disadvantages of patents. That is technically ‘advantages and disadvantages’ of ‘various methods’ but since you failed to deal with the advantages of patents (which the Delong Paper does) and the disadvantages of your system, (which the Delong Paper does), one can hardly say that you exposed how you come to the conclusion you come to which is–“But it seems likely that the average price would be well below that prevailing at present and that the allocation of research effort would be more socially beneficial.”

If Jack sums up what would be your response, it is no response at all. I have no trouble understanding that you advocate the distribution of funds through grants or prizes. There has never been any confusion on that point. My question has always been how does the government choose which research to fund through grants or prizes and does that do better than the market. Jack’s response is that the government chooses to fund it through grants or prizes, which isn’t the issue at all. Mr. DeLong’s paper, and the paragraphs I quote from it put that very issue into economic-speak, but you still seem to suggest that answering “grants and prizes” is any kind informative response. I knew “grants and prizes” were the delivery method from the first read of your post. I want to know what the choice method is unless you think that all possible research can be infinitely funded–which I suspect you do not.

The Australian scheme may provide an interesting hybrid (though I note that you spend almost all of your time defending grants and prizes) but you brush the problems of applying it locations where the majority of the research is done as if differences in scale of application would be trivial. As noted above, Australia is almost an afterthought market for such research products. The companies would rather make marginal profit there than zero profit if Australia took the patent, but very few (if any) of the major players would expect to gain their sunk research costs from that market.

With respect to the grants and prizes which you make the centerpiece of your argument, Delong’s paper itself suggests quite the opposite from what you suggest:

Moreover, in a Schumpeterian economy it is innovation that is the principal source of wealth—and temporary monopoly power and profits are the reward needed to spur private enterprise to engage in such innovation. The right way to think about this complex set of issues is not clear, but it is clear that the competitive paradigm cannot be fully appropriate.

Note I do not snip the quote at the first sentence where it would appear the DeLong fully agrees with me, I include the sentence where he suggests that methods beyond the patent system might be necessary.

At this point it seems likely that you are one of the academics who, according to DeLong, “…long underestimated the importance of Hayekian insights into market competition as a discovery mechanism, of the entrepreneurial advantages of private enterprise, and of the administrative defects of overly-rigid systems of top-down control that come with centralized funding.” And apparently you are in good company since DeLong refers to that as “mainstream”. But really there is no need to pretend that I couldn’t understand you. I raised the very same issues that DeLong raised, and I did it before you pointed me to his article. Just say that in your economic view DeLong’s understanding above isn’t worth responding to.

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Jason 08.07.04 at 8:59 pm

Sebastian,

Just to answer one small part of your question. A sales tax could be applied after the fact, and thus have no bearing on the research options decided. Of course, there would be bureaucratic issues here (determining and administiring appropriate tax rates), but it is not as if the patent process (thought police) doesn’t have extreme issues of its own.

One good site which spends a reasonable amount of time discussing copyright law theory is lawmeme.org at Yale. If this stuff interests you, maybe pop in there.

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Jason 08.07.04 at 9:01 pm

Perhaps a better link is the following, sorry.

http://research.yale.edu/lawmeme/

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John Quiggin 08.07.04 at 9:34 pm

Ok let’s try one more time. After mentioning some disadvantages of patents, I said

On the other hand, if the product market in question functions well in other respects (in particular, if consumers are well-informed and there are no cross-subsidies), the profit from the monopoly is a good measure of the social value of the innovation, eliminating the need for governments to make judgements on this issue.

Taking the last bit first, this makes the point that under a patent system, governments don’t need to know which innovations are valuable and which are not. That is, I did mention the main advantage of patents. Feel free to add citation to Hayek at this point if you wish.

Looking back at the first part of the sentence, I give the reason this mechanism works – monopoly profit is a measure of consumer surplus – and the conditions under which it will work.

Having mentioned this advantage of patents in general, I make the point that the mechanism is not very satisfactory for medical research.

As regards the DeLong& Summers para you’ve quoted, thery are not talking about patents here. They are making the same point as I did about innovation in the absence of govt intervention (again, feel free to add citation to Schumpeter if you wish). Keep in mind the central point that patents are a form of government intervention

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glory 08.07.04 at 9:45 pm

re: information as public goods, dan kohn has a nice introductory primer and eben moglen goes through some of the legal ramifications

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Sebastian Holsclaw 08.07.04 at 11:02 pm

Jason, you write: “Just to answer one small part of your question. A sales tax could be applied after the fact, and thus have no bearing on the research options decided.”

What? That would be a sales tax on what? The patented product? That can’t be the answer because we are hypothetically not using patents. On all products? That doesn’t let us decide who gets the money from the tax.

And John, I continue to understand that you don’t think the patent system makes the right choices. And my question since the very beginning of this thread is–how will the public funding decisions be made and how will you get around what DeLong talks about the “the importance of Hayekian insights into market competition as a discovery mechanism, of the entrepreneurial advantages of private enterprise, and of the administrative defects of overly-rigid systems of top-down control that come with centralized funding.”?

You don’t deal with any of those issues. In fact you have dismissed them as non-concerns every single time I raised them.

Furthermore you are just flip when you say things like: “Feel free to add citation to Hayek at this point if you wish.” Adding a citation Hayek most certainly does not satisfy the issue, because you immediately follow it up with a dismissal of the importance of such insights when applied to medical innovations. This is especially true because your dismissal seems to be based on informational concerns which can be remedied with measures far less drastic than getting rid of patents for medical properties.

At no point in this conversation have you explained how you intend to harness the information available to the market (See Hayek unless you are claiming that concerns you outline invalidate all or nearly all of the information that would normally be gained by the medical market), how you evade “entrepreneurial advantages of private enterprise” to use DeLong’s phrasing and how you evade “the administrative defects of overly-rigid systems of top-down control that come with centralized funding” to use DeLong’s phrasing and how you deal with the problem that “government bureaucracies have never been able to choose and assess the directions of applied research and development very well” to use Delong’s phrasing.

And on that last phrase, I’m quite (American meaning of the word) sure that DeLong is talking about both patents and research.

You also write:

As regards the DeLong& Summers para you’ve quoted, thery are not talking about patents here. They are making the same point as I did about innovation in the absence of govt intervention (again, feel free to add citation to Schumpeter if you wish).

I quoted two paragraphs from the paper–both of which appear to deal with patents. The first quote I have requoted extensively above and it obviously deals with both patents and the perils of government directed research. The second begins: “Moreover, in a Schumpeterian economy it is innovation that is the principal source of wealth—and temporary monopoly power and profits are the reward needed to spur private enterprise to engage in such innovation.” Since ‘temporary monopoly power’ is the precise term you use to describe patents repeatedly throughout this post, you may forgive me if I have misinterpreted their use of the phrase in precisely the same way. You suggest they are talking about innovation in the absence of government intervention and then in the very next sentence you admonish me to “Keep in mind the central point that patents are a form of government intervention. So what do they really mean?

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Jack 08.08.04 at 1:11 am

Sebastian, the short term monopoly referred to in the Delong & Summers article need not be an artificial one at all. It can be merely first mover advantage as works quite well enough for Amazon or Google.

If the goalpost is now how the choice mechanisms can incorporate market knowledge, you could just say so. In medicine there are clearly areas where an expertise weighted market opinion might do better than a wealth weighted one.

In fact I share your doubts about the efficacy of an institutionalised system but I don’t think the options provided by Professor Quiggin fail to address this.

It is easy to confuse patents with their purpose. Professor Quiggin has already demonstrated the deadweight inefficiencies they cause but there are plenty of other objections to them. For example they only reward the value of the innovation, not its difficulty. That leads to all sorts of spurious results and rent seeking behaviour. There are many instances of people infringing patents with no awareness of the existence of the patent holders work at all. Such chilling effects should not be underestimated. Surely a libertarian would think that the market ought to be able to solve the problem of rewarding innovators without the need for the state to intervene through patent law?

There is also the high cost of obtaining one and the extravagant cost of defending yourself against a well funded opponent. Patent law is not even mostly about Edison and lightbulbs.

My concerns are more aboout the difficulty of persuading institutions to adapt rather than setting one up that can make good decisions. Markets seem quite good at changing incrementally.

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John Quiggin 08.08.04 at 1:53 am

I endorse Jack’s first para. The DeLong & Summers reference is clearly to first mover advantage and not to patents. Patents replace the temporary market-based monopoly derived from being the innovator with a much more durable (still finite under current law, but the IP lobby is working hard on this) government-enforced monopoly.

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Jake McGuire 08.08.04 at 3:36 am

How durable do you imagine the advantage conveyed by being the first-mover would be?

I can imagine anything from three months, if you make drug companies publish the composition of their molecule and let the generic manufacturers prove their similarity to the brand-name drug, to perhaps three years if you allow the drug companies to keep their products a secret and make the generic companies do their own clinical trials. With a little industrial espionage, the market-based monopoly might disappear entirely.

In neither case is it likely to be economically worthwhile to do drug development.

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John Quiggin 08.08.04 at 5:01 am

Jake, I agree that first-mover advantage is unlikely to be adequate. As I said in the original post, referring to various methods of protecting first-mover advantage:

While these methods don’t work forever, in some cases they deliver enough profits to finance a satisfactory rate of innovation. But, as far as I know, no-one seriously suggests this is the case in relation to medical research.

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Sebastian Holsclaw 08.08.04 at 5:27 am

I don’t see why you think patents cannot be implicated in the part I quote since just prior to those sentences is found: “However, forcing prices to be equal to marginal cost cannot be sustained because then the fixed set-up costs are not covered. Relying on government subsidies to cover fixed set-up costs raises problems of its own: it destroyes the entrepreneurial energy of the market and replaces it with the group-think and red-tape defects of admininstrative bureaucracy.” Doesn’t sound like thought about first-mover advantage.

But now you are engaging in wholesale nitpicking while avoiding the central question which is presented by the very paper you cite. Once again–how do you intend to harness the information currently available to the market, how will you evade “entrepreneurial advantages of private enterprise”, how do you evade “the administrative defects of overly-rigid systems of top-down control that come with centralized funding”, and how do you deal with the problem that “government bureaucracies have never been able to choose and assess the directions of applied research and development very well” to use Delong’s phrasing? In layman’s terms: how do you choose what research to fund?

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John Quiggin 08.08.04 at 8:02 am

Sebastian, I think we’re now agreed on the issues that need examining. Patents involve market distortions and intrusive intervention, grants and prizes require governments to decide how research effort should be allocated. In any given case, it’s a question of balancing which of these problems is worse.

In the case of health care I argue (and I haven’t seen you offer any counterargument) patents work less well than in other areas because the market value of a patent is not a good estimate of its social value.

So I conclude that, despite the problems noted above, we would be better off relying more on grants and prizes and less on patents.

Feel free to put contrary arguments.

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BigMac Attack 08.08.04 at 3:18 pm

This will never get read.

Thanks. After some careful reading and some thought(thanks) I can see your point. I think.

But I think it all hinges on my acceptance that given the correct circumstances ‘the profit from the monopoly is a good measure of the social value of the innovation’

Do you generally accept that proposition? That market value = social value? (Which I think is pretty much what that ends up meaning. But please correct me if I am wrong.)

If you do wouldn’t the better solution be to eliminate the cross subsidies and third party payers?

And if you don’t how do we haggle over social value?

I say market value doesn’t equal social value.

I say the market undervalues the social value of the innovation.

So I say keep patents since that leads to the highest price and most innovation/social value.

In fact I say increase the (real)price via subsidies. More public R&D. (We need to keep the patents because governments cannot make final products and that is an important step.)

Did I get that right? Does that make sense?

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Jason 08.08.04 at 6:21 pm

Sebastian, The tax would be given to the inventor of the product, who would presumably file an application that would look like a current patent application (I’m not suggesting this is as good scheme, as I don’t think the current patent scheme a good one). In fact, you could even call the resulting award a ‘patent,’ although it will not have the monopoly aspects of the current scheme.

BigMac, one of the more common ways to think of consumer surplus is to measure the total difference between the ‘willingness to pay’ curve (also called inverse demand) and the price payed. Thus if I am prepared to pay uip to $20 for something and it costs $15, then I’ve made $5 of “profit.” The producer surplus is the actual profit the company makes (including research costs depending on your mood). The total surplus is the sum of these two things.

Once the fixed cost (research?) has been paid, monopolies underproduce and thus the total surplus is lower than that for perfect competition (this is a deadweight loss, and their is further administrative deadweight loss to enforcing patents).

Of course, this is given the fixed cost being paid. The granting of monopoly profits is used to provide an incentive to do research. It works, but only to a lesser extent. Note, that some projects that should be done aren’t (because the monopoly profit is much less than the potential social surplus), and of those that are, almost all of them would be done for much lower reward than the monopoly provides. In addition, there is a worse cascading effect that in fact stifles innovation. You may be restrained from doing certain research because you’ll be forced to pay people who can claim your work is derivative.

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Sebastian Holsclaw 08.08.04 at 8:43 pm

“I think we’re now agreed on the issues that need examining.”

Argh. It is too bad we couldn’t have gotten to this point four days ago instead of spending three and a half days complaining about how dense I was and how little I understood economics. But since we did and this post is about to fall off the front page, I guess we won’t get to talk about the issues.

“In the case of health care I argue (and I haven’t seen you offer any counterargument)”

Well, hmm that may have been because you spent four days pretending I didn’t understand your post and that my points were completely irrelevant until they showed up in the DeLong paper that you threw at me. And even then you dodged for almost two days and multiple posts. And still you are being unusually coy. Do you intend to merely ignore those problems and hope that they won’t be a major factor in your grants and prizes? I still don’t know.

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Russell L. Carter 08.08.04 at 11:18 pm

Postrel over at Reason mag seems to be parrotting Sebastian’s line, and gets taken to school by an expert, who incidentally claims he’s a libertarian:

http://reason.com/amesint.shtml

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Russell L. Carter 08.09.04 at 3:29 am

BTW, the relevant part of the interview cited above is near the bottom, and is completely independent of the prior discussion. This should give you a flavor, but do read the rest:

“Reason: You accept no money from industry.

Ames: No. If I give a talk at Du Pont. I have them send the honorarium to charity.

Reason: So the research money comes from the government?

Ames: My research money all comes from the government. It’s fiercely competitive.

Reason: Over time, the government, especially the federal government, has acquired a near monopoly on the funding of scientific research… “

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BigMacAttack 08.09.04 at 10:07 pm

Jason,

But John doesn’t really seem to be objecting to the deadweight loss. After all a bargaining system would still result in deadweight losses.

He is pointing out that with third party payers, perverse incentives for doctors, and free rider in the area of government funded R&D, help to increase the profits of drug companies, so that the profits they enjoy are far above the social value of the innovations they give us.

So from that prespective it makes sense that for the government to bargain back some of that profit. Very good sense.

(Assuming of course we can trust government not to bargain profits below the social value of the innovation. Below what the profit would be without the distortions.)

At least that is what I think he is arguing.

But course another solution would be to just eliminate the distortions.

And I am really curious if John really thinks the social value of things can be measured by the market.

But since no one will confirm or deny (or maybe you did and I missed it, sorry if you did) my understanding, the answer will have to remain a mystery that will forever haunt me.

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