Tuesday, July 04, 2006

The Mechanics of Direct Public Funding

by Dean Baker
Jamie has prodded me to take advantage of this new tool to get input on an issue with the Free Market Drug Act system of direct public funding of research. To quickly bring people up to speed, the idea is to have the government directly allocate funding for drug development. All research funded under the system must be available to the public as soon as practical and all patents are copylefted. I have a fuller description on the CEPR site.

One difference between the system I outlined there and I how I would currently envision the system is that I think that the research could best be carried through by private companies (possible started by the government) rather government corporations. (Think of FANNIE MAE and FREDDIE MAC as opposed to TVA.) The advantage would be that it would be desirable to ensure that the companies would act aggressively to protect their patents and ensure that publicly funded research remains in the public domain. Private companies that earn profits can lobby Congress and can be vicious assholes in other ways that are not options for public companies.

The general plan is that a small number of companies would act as prime contractors getting substantial grants for substantial periods of time (e.g. $3 billion a year for 8-10 years). They would have the charge of carrying through research and development to promote the public health in a cost effective manner. Presumably they would follow the current Pharma model of contracting out for most of their research, but they could obviously do it in house, if they deemed that more efficient.

The immediate issue that Jamie and I were discussing was how effective this system would be in competition with the existing system of patent financed research. I consider it to be one of the benefits of this system that it allows the drug companies to just continue with what they are doing. It doesn't prevent anyone from carrying through research and getting a patent, as they do now. However, I argued that few companies are likely to do this for long, because they face the risk that they will have a better drug available soon after their drug hits the market (possibly even sooner) and it will be sold at generic prices. I believe that the risk of this happening would hugely reduce the expected to return to patent financed research (if it happens 50 percent of the time, then the return goes from positive 20 percent to minus 40 percent).

Furthermore, I don't see anything wrong with the firms in the system buying up patents and placing them in the public domain, in cases where important patents are held outside the system. The gains to the public of drugs being sold at their marginal cost would vastly exceed the expected profits to a patent holder, especially when there was a substantial risk of near-term generic competition, so I thought that in general drug companies could be persuaded to sell patents at reasonable prices. (Of course, if most funding for patent supported research dries up, then presumably this will not be an important issue.)

Anyhow, there are many questions/issues to be raised on the feasibility of this system and its merits relative to a prize system, but the immediate one is simply a question of whether it is likely that patent holders would sell important patents at reasonable prices. (I also suggested that after a period of time, the copylefting of patents would be a serious problem for anyone looking to develop drugs under the patent financed system, since they would have to negotiate for the use of these patents, which could make their lives quite difficult.)


James Packard Love said...

There will be some disagreement about the wisdom of having the government choose a limited number of firms that would be expected to invent medicines we need, but with regard to the other question that Dean has raised, the cost of acquiring patents voluntarily, I can see some issues. First, I think there is plenty of evidence that private firms can obtain patents that effectively enclose or even misappropriate the value of government funded R&D. In this reqard, I would look at the low rate of patents in the FDA orange book that identify US government Bayh-Dole march-in rights, despite the government's often key role in the underlying research. Second, I think there is also plenty of evidence that patents on a product will often be sufficiently broad to make it quite difficult to bring a "me-too" medicine into the market in a short period of time, at least for many medical problems. In this case, the cost of the buy-out would be pretty high.

9:27 PM  
Dean Baker said...


why do we think that private corporations that get their money on government contracts would be less effective in protecting their patent rights than private corprations that get their money by directly taking advantage of their patents. Presumably, they would be hiring the same people as patent lawyers and using the same laws.

On the second point, there may be cases where me-toos are difficult to develop, but a company that refused to sell a patent would always face this risk. Furthermore, it is easy to show (I can do a nice little graph, but not here) that the potential gains to society from having the drug sell at marginal cost are vastly larger than the expected profits from holding the patent. (Remember, the profits are what's left after marketing costs and legal expenses associated with protecting the patent.) I suspect that in almost every important case it would be far more profitable for the company to sell the patent. If the patent isn't important, who cares?

7:57 AM  
James Packard Love said...

The proposal you present expands the funding and role of the government in funding the D of R&D, which is fine. But so long as it does not change the current patent system, you are still faced with the problems you see today, namely very high prices for important medicines protected by patents, and the inevitable rationing of access, because of the price.

While it is true that with perfect information, the government would know the true value of patents it wanted to buy, it does not have this perfect information. And even if it did, if the seller knew the value, they would not want to sell on the cheap to the government. If Celgene can charge $200 per day for a new cancer drug, with a 97 percent gross profit, what would change in a voluntary sale of the patent?

If one looks at the experience of the National Cancer Institute, where the government already does a lot of things that Dean proposes (funding late stage D for AIDS and cancer drugs), you don't see much in terms of US government rights in patents. This is pretty important empirical evidence that increasing government funded "D" does not directly translate into ownership of new inventions, given how the patent system now works. This is not an assumption, it is an observation based upon decades of government investments.

9:08 AM  
Dean Baker said...


The difference between what I am proposing and teh NCI is that the NCI is a government agency. I am proposing that the research would be done by private companies.

Your assumption is that a private company that gets its funding from a government contract (directly or indirectly) will be much less efficient than a private company that relies on patent rents. It could be true, but I can't think of any reason why that would be the case.

On the point about buyouts -- the private companies (not the government) does not need perfect information. They need the same sort of business judgement that the people running any successful firm need. That means that can and will make mistakes from time to time (paying too much or not offering enough for patents), so what?

As far as the buyout price, the seller cares only about the expected profit, which would come with a lareg discount, because there are many risks, most importantly the risk of generic competition with a me-too drug. The gain to the public is the whole consumer surplus, which given marketing expenses for the drug company (which also come out of the potential consumer surplus) will likely be several times larger than the expected profit. This is why I think that most companies will sell their patents, but again I don't think it is a disaster if they don't and they just get nailed by a me-too drug selling at generic prices.

11:47 AM  
James Packard Love said...

We will look at 2004 FDA Orange Book data to see what the $28 billion in NIH funding as yielded in terms of government rights in patents.

4:14 PM  
Dean Baker said...

that would interesting, but not in any obvious way more relevant to this proposal than finding out what the $460 billion defense budget yielded in terms of patents.

The question is whether private companies will be less capable of getting useful patents if their fundings comes through government contracts than if it comes from patent rents. I fail to see how NIH's record in getting patents informs you on this topic.

7:58 PM  
James Packard Love said...

Most of the NIH budget goes to third parties -- for profit firms, universities and non-profit research institutions likes Scripps Research Institute. It isn't as if these outfits don't have aggressive approaches to patented medical inventions -- often too aggressive in our view. How could this be irrelevant or unimportant in evaluating your assumption?

8:37 PM  
James Packard Love said...

Ok, we looked at the data. Of 18 products in the Orange Book from 2004 (the 13 antibiotics don't have Orange Book listings), there were 44 patents, but only 3 patents (on 2 of the 18 products) identified US government rights. In 1 of the 2 products, there was 1 Bayh-Dole patent, and 2 that did not identify a government interest.

9:43 PM  
Dean Baker said...


It could be irrelevant because

1) the vast majority of NIH money does not go to direct development of drugs; and

2) the NIH, as a government agency that is not trying to make a profit, does not have the same means to enforce or claim patent rights as a private company.

On the first point, I will note that the pharmaceutical industry has been the biggest lobbyist for increased NIH funding over the last 2 decades. I finf it hard to believe that they would be anxiously promoting increased funding if they actually thought of NIH as a competitor.

I will also point out that they are anxious to assert that NIH does not do drug research. That is what their spokespeople have insisted when I debated them. They even demanded a correction from the NYT because they had an article which stated that NUH does $28 billion of drug research. Pharma insisted that it was basic scientific research -- not drug research. (the author, Eduardo Porter got off because he had said "basic drug research"). Anyhow, if you think that NIH is trying to do the same sort of research as Pfizer and Merck, you are the only person I know who has this view of it.

On the second point, Pfizer sues people who work for them and then get a patent. They sue other companies that infringe on their patents (in their view). Maybe NIH does this with the same frequency, but I am inclined not to believe it.

So given that I am talking about private companies with different missions than NIH, I am not clear what relevance NIH's patent record has. (btw, the division of NCI which actually is more directly involved in drug development does have a damn good track record, given that its total budget over the last 20 years would be about 1/3rd of what the industry claims it costs them to develop a single breaktrhough drug.)

12:05 AM  
James Packard Love said...

If your source of information about the NIH budget is PhRMA, then you need to dig a little deeper.

First of all, the NIH does all sorts of R&D, including late stage clinical trials. It varies by disease, but in areas like AIDS and Cancer, for example, the NIH does a lot of D. 50 of the 1st 77 anti-cancer drugs approved by the FDA relied upon NIH sponsored clinicial trial data, for exammple. I'm sure you won't find that on PhRMA's web page. You will on our web page. We actually spend a fair amount of time looking at the data, as anyone who talks about these issues should.

Second, what is the relationship between early and late R&D and patents? Most of the important patents on medicines *DO NOT* come from funding the clinical trials. Most of PhRMA money is spent on funding clinical trials, but this is not where you get the patents. It is not considered inventive activity. Indeed, they are unlikely to invest in the trials without some prior ownership of the invention in the first place. The patents are obtained doing work quite similiar to what you and PhRMA PR agents call "basic" research, under NIH grants. Certainly NIH funding Medline or something with no specific application is not going to get a relevant patent. But NIH spends billions on projects that are exactly the type of thing that you can get patents for.

And, if you think that NIH recipients (and the NIH itself) does not aggressively pursue patents, and sue third parties, you don't know much about the post Bayh-Dole world. They do.

What I am saying is not that government funded researchers cannot get patents -- they do. I am saying that no matter how much money you give government funded resarchers, you won't get all of the important patents. Patents are fairly cheap to get, and if there are rents from obtaining patents, firms will and do get them, and use them in rent seeking activities. So, if you have a parallel system, and you don't anticipate this very predictable problem, you will have a shock.

7:32 AM  
James Packard Love said...

Dean, why is it so important to you that your proposal co-exists with an un-reformed patent system? Why would it not work even better in a world where the government funded firms competed against the private sector, in a system that replaced the patent's exclusive rights with rewards based upon the impact of inventions on health outcomes?

9:09 AM  
Dean Baker said...


For some reason we keep having "government" appear in my proposal. The firsm doing the research would private as in companies that make profits and have shareholders. So, the argument is not about government vs. private. The argument is whether a company that does research on government contracts, and is maintains these contracts depending on its ability to gain and enforce patent rights, will somehow be less able to gain and hold patent rights than a company that makes it profit directly from exploiting patent rights.

I can't even think of an economic model that would explain why companies could carry on research effectively in situation 2, but not situation 1. And, I'm afraid the fact that NIH, in your quite likely correct view, does not effectively gain and hold patents doesn't shed much light on this question.

As far as Pharma propaganda, I certainly will claim not expertise on this topic, but everyone I have spoken to who is an expert does not see NIH as a competitor with Pharma for patents. Furthermore, I think the fact that Pharma lobbies for NIH funding indicates that they do not see Pharma as a competitor for patents. In this case, their actions certainly are consistent with their propaganda.

I would also point out that (again, correct me if you have information that shows otherwise) NIH has never pressed its case for funding to Congress based on the number of patents it has obtained. Nor do I beleive it to be the case that officials have been firted from NIH because of the failure of the projects they supported to secure patents.

In other words, by all the evidence I have seen, NIH does not appear to be actively pursuing patents in the same way that Merck and Pfizer do. Apparently, you think otherwise. You certainly know far more about NIH than I do, but you are the only person I have come across who ever suggested anything remotely like this.

One final point -- I think the patent is system is a ridiculous anachronism that survives only because of the powerful interests that profit from it, so I wouldn't mind discarding it altogether (at least in the case of consumer products like drugs -- there are different issues in the case of industrial processes). But, as a political matter, I think this would be extremely hard to accomplish politically. It would be very difficult, but I think far more feasible, to get Congress to appropriate a substantial sum to finance research that still operates within the confines of the patent system, while effectively exploding it (e.g. copyleft patents). With public funding for prescription drugs soon crossing the $100 billion threshold, the idea of using $30b to pay for the research upfront, and then save twice that much on drug purchases, doesn't sound implausible.

9:30 AM  
James Packard Love said...


NIH does aggressively seek to obtain patents, and presents data on its patent activites to Congress. But as I have repeated many many times, MOST OF THE NIH MONEY is not spent in-house. It isn't just NIH that makes decisions, it's the thousands of businesses, non-profits and Universities that manage NIH money that also count. These third parties that manage most of the NIH budget are pretty aggressive. I wish they were less aggressive. You should talk to the people who manage the patents http://www.autm.net.

Maybe I should explain a bit more. The US government get rights in patents when ANYONE gets an invention that involved a federal grant. That's why, for example, some of Abbott's Kaletra patents are subject to Bayh-Dole rights, or Columbia's patents on Xalatan (licensed to Pfizer), Yale's patents on D4T (licensed to BMS), or U of Utah's patents on BRAC genes (licensed to Myriad).

I will also say that 90 percent of the people who act as though they are experts on intellectual property rights in government funded R&D don't ever look at data, and know very little about the topic, including the legal issues. Few people seem to care, but you should, because it is highly relevant to your proposal. The 26 year experience with the Bayh-Dole Act is something to deal with. (The importance of the Bayh-Dole Act was how it affected non-federal government recipients of grants and contracts.)

9:48 AM  
Dean Baker said...

Jamie and I are having a parallel discussion via e-mail, but just to present the highlights of my last notes (in case anyone else out there is paying attention), I asked why we would think that private company that does research on government contract would have any greater problems protecting its patents than Pfizer or Merck.

10:42 AM  
James Packard Love said...

Everyone has problems defending patents, dealing with misappropriation of R&D, etc. Everyone sues. The whole patent fight is endless, and pretty expensive. Many biotech firms spend more on litigation than they do on R&D.

I don't think the answer to the current R&D problems that consumers, insurers and taxpayers face is more patent litigation. Rather, I think it is a reform of the incentive system, so that private parties do not have super strong control over access to important new medical inventions, and more important, that the money to stimulate R&D is efficiently directed to areas that are important from the point of view of science and health, that prices for such R&D outcomes are reasonable, and that access is not rationed by price.

11:11 AM  
Aidan Hollis said...

You ask about the price of a buyout. My two cents on this. As I understand your proposal, there would be little incentive for anyone in your government-funded R&D organizations to spend money on marketing.

Suppose that there were two drugs developed at around the same time, Pfizer's Lipitor and gov-financed Zocor. Zocor would immediately end up as a generic drug, and Lipitor would compete at a much higher price point. Pfizer, as at present, would spend a lot of money marketing Lipitor, and would emphasize the differences. Gov-financed R&D organization would do no marketing, since that is really not in its mandate. The generic firms selling the drug would also do little marketing, since they face a free-riding problem.

I predict Lipitor would get 90% of the sales in such a situation, if not more. Just look at the experience of Celebrex and Vioxx: despite not really showing any obvious advantage over generically available Aleve, they made huge sales. Why? Marketing.

Pfizer faced generic competition from a me-too (Aleve) and earned billions from Celebrex. So how much would it have required before giving up that set of patents?

I don't really see how these goverment-funded R&D organizations would compete in our current pharmaceutical market without any incentive to promote their drugs. And givne that, I think that innovators would not be scared by generic competition into selling off their patents cheap.

Maybe I am missing something in your proposal that deals with this issue.

10:52 PM  
Daniel Haszard said...

Eli Lilly is a big drug company that puts profits over patients.

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1:36 PM  

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