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Forum on Economic
Reform In recent decades the alliance of neoclassical economics and neoliberalism has hijacked the term “economic
reform”. By presenting political
choices as market necessities, they have subverted public debate about what
economic policy changes are possible and are or are not desirable. This venue promotes discussion of economic
reform that is not limited to the one ideological point of view. The Reform of Intellectual Property Dean Baker (Center for Economic and Policy Research, USA)
It is remarkable that economists, who
usually view themselves as advocates of free market transactions,
unquestioningly embrace various forms of intellectual property rights,
especially copyrights and patents. Copyrights and patents are government
granted monopolies. They have their origins in the feudal guild system, not
the free market economics of Smith and Ricardo. In fact, at the end of the 19th
century, Switzerland and the Netherlands actually eliminated patent and
copyright protection, with the intent of promoting free market competition.
In spite of their feudal legacy, and their obvious status as forms of
protectionism, few economists ever question the merits of the patent and
copyright systems. This paper details the ways in which
patents in prescription drugs and medical equipment and copyrights lead to
economic inefficiencies.1 It points out that the efficiency losses
from these forms of protectionism are likely several orders of magnitude
larger than the barriers to international trade that receive so much
attention from economists. The paper also outlines alternative
systems for providing incentives for innovation and creative artistic work.
In the absence of deliberate government policy, there probably would be
under-investment in innovation and creative work, but that is not the
relevant question. The relevant question is whether the existing patent and
copyright systems are the most efficient mechanisms for supporting innovation
and creative work. That would be the question that any honest economist would
pose. The
Inefficiency of Drug Patents and Copyrights The basic argument for patents and
copyrights is straightforward. In a free market, without protections for
intellectual property, there will be under-investment in research and
creative activity like writing or recorded music or movies. As soon as an
innovation is made public, others could duplicate the process and sell a
comparable product, without having to bear the costs of the research that
allowed for the innovation. In the case of recorded music or movies, copies
can be made at minimal cost (zero cost in the Internet Age), which means that
in a free market, the original producers could not sell the products at a
high enough price to allow the creative workers to be compensated for their
work. However, the fact that a free market will under-invest in research and
creative work hardly establishes that the feudal institutions of patents and
copyrights are the most efficient way to support such work in the 21st
century. The economics profession has devoted vast
amount of research and textbook space to proving the inefficiency of various
forms of protectionism. The basic story in this work is that protectionism
causes the price to exceed the marginal cost of production. All of this work
is entirely applicable to patents and copyrights, except the impact is at
least an order of magnitude larger than with most instances of protectionism
in international trade. While tariffs and quotas rarely raise the price of
goods by more than 30 or 40 percent, patents on prescription drugs typically
raise the price of protected products by 300 to 400 percent, or more, above
the marginal cost. In some cases, patent protected drugs sell for hundreds or
thousands of times as much as the competitive market price. In the case of
copyrighted material, recorded music and video material that could be
transferred at zero cost over the Internet, instead command a substantial
price when sold as CDs, DVDs, or licensed downloads. Copyrighted software
commands even higher prices. The distortions resulting from these huge
gaps between price and marginal cost should cause an honest neo-classical
economist great pain. At the onset, the lost consumer surplus from patent and
copyright protected pricing is enormous. The basic rule on this issue is that
the size of the deadweight loss is proportional to the square of the gap
between price and marginal cost. The United States alone is projected to
spend $210 billion this year on prescription drugs. In the absence of patent
protection, the same drugs would probably cost no more than $50 billion. (The
savings would be equal to $500 per person for everyone in the country.) The
United States will spend more than $30 billion on recorded music and videos
this year, material that could be available at zero cost on the Internet. By
comparison, many economists felt the need to comment on the NAFTA agreement
in 1993 that reduced tariff barriers on imports from Mexico. At the time,
U.S. imports from Mexico were less than $40 billion a year, and the average
tariff was already less than 5 percent. Of course the deadweight losses are just
the beginning of the story. As the textbooks tell us, monopoly profits
encourage all sorts of anti-social rent-seeking behavior,
activities that we see in abundance in the case of both patent and copyright
protection. Starting with drug patents, the newspapers
are filled with stories about concealed or distorted research findings by
pharmaceutical companies who are trying to exaggerate the benefits, or
minimize the risks, associated with their drugs. The corruption from
companies pursuing monopoly rents permeates the research process. Medical
journals routinely receive and publish ghost written articles, where
prominent researchers have been paid by the industry to lend their names to
company authored papers. In the same vein, the medical experts who provide
guidance to the Food and Drug Administration (FDA)
on drug safety are often receiving payments from the manufacturers of the
drugs they are evaluating. The sales effort to doctors is similarly
corrupted by the pursuit of monopoly profits. According to the industry own data,
more people are employed in sales than in research, as the industry relies on
an army of salespeople to push its latest blockbuster drugs to doctors. Often
this sales effort involves dinners, trips to resorts, and sometimes even
outright kickbacks – all ways in which drug companies share a portion of the
monopoly profit that they earn by selling drugs at patent protected prices. Monopoly profits also distort the
direction of research. According to the FDA's
classification system, roughly 70 percent of new drug approvals are for drugs
that do not represent qualitative improvements over existing drugs. While
there is little social purpose served by developing these duplicative drugs
in most instances, patent monopolies can make the development of copycat
drugs very profitable. A copycat drug can allow a firm to cash in on a
portion of the profits earned by a competitor on a blockbuster drug. In a
world with patents, the introduction of a second drug in the market will have
the beneficial effect of lowering prices to some extent (there is more
competition with two drugs than one drug), however if drugs were sold in a
competitive market, there would be little reason to pursue the development of
most copycat drugs. The fact that most new drugs fall in this copycat
category suggests that a very large share, possible a majority, of patent
supported research is wasted.2 Drug patents also distort the direction of
research by pushing it in the direction of patentable results. Research
directed at finding cures or treatments based on diet, exercise, or
environmental factors will not be pursued in a health care system that relies
exclusively on patent monopolies to finance research. This neglect can be
offset by government funding targeted specifically towards these areas, but
the patent system will direct resources elsewhere. Finally, the granting of patent monopolies
will lead to the development of a gray market, in
which unauthorized versions of patented drugs are sold. The large gap between
the patent protected price and the marginal cost of production creates
opportunities for profit in the same way that the high price of illegal drugs
like cocaine and heroin create opportunities for profit. Since these
unauthorized drugs will be sold outside of regulatory oversight (except when
they are imported from countries with well-developed regulatory systems, like
Canada), there will be limited quality control. Unauthorized drugs are likely
to be less effective than the patented drug, and possibly even harmful. In
either case, the health outcome is far from optimal. To sum up, there are a long set of
complaints against the inefficiencies associated with drug patents, all of
which should jump out of any introductory textbook treatment of protectionism
in international trade. Yet, the economic profession has been virtually
silent on the inefficiencies associated with drug patents.
This silence would be justified if there
were no alternative mechanisms available to support the bio-medical research
that leads to the development of new drugs. However, there are alternatives
and they already exist. The most obvious alternative is direct government
funding of drug research.3 This already occurs on a massive scale.
In fact, the $30 billion that the United States federal government pays each
year to support bio-medical research at its National Institutes of Health (NIH) is approximately 20 percent larger than the $25
billion that its pharmaceutical industry claims to spend on research. While
this research is primarily directed towards more basic science (in order not
to interfere with the efforts of the drug industry), there are many instances
of new drugs being developed almost entirely through NIH
support. It also requires some extraordinary claims about epistemology to
argue that public funding of NIH is an efficient
mechanism for supporting basic research (a contention strongly supported by
the pharmaceutical industry), but somehow would prove to be a boondoggle if
the agency took on the responsibility of developing new drugs and bringing
them through the FDA approval process. The basic numbers are very striking. If
drug prices in the United States were to fall by 70 percent in the absence of
patent protection, it would amount to savings of more than $140 billion a
year, given 2005 spending levels. This is almost six times as much as the
industry claims it is currently spending on research. Since half of this
money may go to research copycat drugs of little social value, the savings
from eliminating drug patents in the United States may be more than 10 times
as large as the spending necessary to replace the useful research performed
by the pharmaceutical industry.4 There are clearly better and worse ways to
structure a system of government financed research. For example, the Free
Market Drug Act, a bill recently introduced in the U.S. Congress, called for
establishing a set of competing government corporations that would be
evaluated at periodic intervals (e.g. 10 years) for the quality of their
work.5 The worst performers would be put out of business with new
ones created to take their place. There are other mechanisms that could be
created to ensure that the funding is spent efficiently, but given the
incredible waste associated with the existing system of patent financed drug
research, it seems that there will be huge payoffs for both the economy and
for public health by investigating alternatives. It is also important to note that this
issue has taken on enormous importance in an international context. One of
the major areas of dispute in recent trade pacts has been the ability of less
developed countries to purchase drugs without paying patent protected prices.
If new drugs were placed in the public domain so that they could be produced
as generics everywhere in the world, then this whole issue would quickly
disappear.6 This would facilitate access to essential medicines
for hundreds of millions of people in the developing world. Copyrights While copyright enforcement may not raise
the sort of life and death issues as do drug patents, it also leads to
enormous economic inefficiency. Furthermore, the extent of this inefficiency
will grow through time, as technology makes it ever easier to transfer
recorded audio and visual material, as well as software. The standard economic texts tell us that
there are large losses of consumer surplus associated with the government
monopolies created by copyright protection. In the case of items like
recorded music, movies, and software, material that could generally be
transferred at zero cost, instead carries a high marginal cost. In addition,
the difficulties of protecting copyrights in an era of digital technology
have led to enormous enforcement costs. These enforcement costs include not only
the costs directly associated with policing against unauthorized uses of
copyrighted material, but also efforts to restrict the development of
hardware and software in ways that could facilitate unauthorized
reproductions of copyrighted material.
There is an additional, less widely noted,
cost of copyright -- it impinges on artistic freedom. In the absence of
government intervention, any writer, musician, movie producer or other
creative worker could take any existing artistic work and modify it in any
way that they chose. This could be done for parody or as a creative extension
of an existing work. (Imagine, for example, writers choosing to write dozens
of different endings for a popular novel or to develop new works building off
its fictional characters.) Copyright largely prohibits this practice, unless
the creative worker has the copyright holders’ approval. It is possible to design a system that
compensates creative workers, while still leaving the choice of material to
individuals (rather than some government commission), and eliminates the
economic distortions associated with copyright. The basic point of such a
system would be to compensate the creative worker at the point where they do
their work, rather than compensating them after then fact for the work. If
the creative worker is compensated at the point where he or she produces the
material, then there is no need for copyright, the work can be transferred as
quickly and freely as technology will allow. One mechanism for this sort of compensation
is a system of individual vouchers, where each adult can be given a fixed sum
(e.g. 50 to 100 dollars a year), which can only be used to support creative
or artistic work. These “artistic freedom vouchers” (AFV)
could be paid out through the tax filing system, so that individuals could
make their payments each year directly through their tax return.7 The system of charitable contributions in
the United States provides an excellent model for such a system. Under the
United States tax code, a wide variety of organizations engaged in charitable
work (this includes religious activity, aid to the poor, and even publicly
oriented think tanks) can register for tax exempt status. This registration
allows individuals to make contributions to these organizations and to deduct
the contribution from their taxable income. The role of the government in this process
is to simply record that an organization engages in some specific activity
that qualifies for tax exempt status. The government makes no attempt to
evaluate the quality or appropriateness of this activity. The only monitoring
involved (in principle) is to ensure that no fraud is being committed,
specifically that financial records by the tax exempt organizations are being
properly kept, and that it is fact engaging in the activities in which it
claims to be engaged. The role of the government in the AFV system would be very similar to its role in
monitoring the system of tax exempt organization. Under the AFV system, anyone wishing to receive money through the
system would be required to register as a creative worker, indicating what
sort of creative work they do. Intermediaries could similarly register to
receive funds by indicating that they support specific types of creative work
(e.g. producing jazz music, writing mystery novels, etc.). This registration
entitles the individual or intermediary to receive money through the system.
(An individual would have to be registered with the system to receive money
through an intermediary.) The one other requirement for any
individual or intermediary registered with the AFV
system is that they would not be eligible for copyright protection. The logic
here is simple, the creative worker is entitled to be compensated once for
their work, not twice. If the worker has received money through the AFV system, then he or she has been compensated in
advance for the work they produce. There is no reason that the government
should then also act to provide this worker or their agent with a monopoly
over the distribution of their product.8 Even a very modest sized AFV could support a vast amount of creative work. For
example, a $50 voucher would make approximately $10 billion a year available
in the United States to support creative workers. If these workers received
average compensation of $40,000 a year through the AFV
system, this money would be sufficient to support 250,000 workers. While there is no apriori
way to know for certain whether the money distributed to creative workers
through the AFV system would be more or less
concentrated than the distribution of earnings under copyrights, there is
good reason to believe that it would be less concentrated. The copyright
system encourages entertainment companies to select a relatively small group
of creative workers and to promote them as stars. The rationale is that it is
costly to promote a singer, musician, or writer to the point where they have
a mass following. Therefore, once they have succeeded in developing a star to
this point, it is far less risky to continue to promote the star than to take
a chance with a new prospect. As a result, the vast majority of promotional
money gets spent promoting a very small group of creative workers. Under the AFV
system, there is likely to be less profit in promoting specific creative
workers. Presumably intermediaries will attract support by demonstrating
their efficiency, which is likely to mean minimizing the money spent on
promotions rather than actually supporting creative workers. However, the most important distinction
between the AFV system and the copyright system is
that all the creative material produced through the AFV
system can be transferred at zero cost. Creative workers would promote the
development of technologies that would allow their work to be spread as
easily as possible, instead of insisting that hardware and software
manufacturers find mechanisms to lock it up, so that those who do not pay
cannot get it. There is also no reason that copyrights
could not co-exist with the AFV system. Creative
workers who remain outside of the AFV system would
have the option of getting copyright protection, just as is the case at
present. The only difference is that the copyrighted material would be forced
to compete against a large amount of creative work that is available at no
cost. But copyright only provides a monopoly on the copyright holder’s work,
it doesn’t protect the copyright holder from competition from free work. Another desirable feature about the AFV system is that it requires minimal enforcement by the
government. If a creative worker takes AFV funds,
and then obtains a copyright for his or her work, in violation of the rules
of the system, the copyright simply becomes unenforceable. Any person can
freely distribute this person’s work as though the copyright did not exist,
since it would not in fact be a valid copyright. In this case, enforcement of
the rules simply requires inaction on the part of the government. This is an
enormous contrast with the current efforts to enforce copyright protection,
which have included F.B.I. raids on college dorm
rooms, prohibitions on the development of technology, and government
propaganda efforts on the evils of copyright infringement. Reforming
Intellectual Property: Getting Away from the Middle Ages The alternatives to patent and copyrights
described above may not be the best ways to promote innovation in biomedical
research or creative and artistic work.9 However, it is probably
even more certain that the current patent and copyright systems fail this
test. Given the large and growing costs associated with patent and copyright
enforcement it is imperative that alternative incentive mechanisms be
explored. Clearly there are very powerful interests
that stand to lose from reform of intellectual property rules, specifically
the pharmaceutical industry, the medical equipment industry, the software
industry, and the media and entertainment industries. These sectors include
many of the biggest and most powerful corporations in the world. But the
strength of the resistance to reform does not affect the intellectual
argument for reform. It would be difficult to identify more harmful economic
policies than the current system of patent and copyright rules. They are few
cases where the application of standard neo-classical economics could have
such beneficial effects. Endnotes 1. There
is a distinct set of issues that arises in a case where a patent is issued
for a product sold directly to consumers and accounts for the bulk of the
product’s price (as is the case with prescription drugs and medical
equipment), compared with a patent on an industrial process. In the case of
patents on industrial processes, the expected outcome is that patent holder
will sell the patent to the user, who will then be able to use it at zero
marginal cost, thereby eliminating the distortions associated with patent
protection. 2. A
study commissioned by the PhRMA, the industry's
lobbying group, found that on average, copycat drugs cost almost as much to
develop as breakthrough drugs (see Ernst & Young LLP.
2001. Pharmaceutical Industry R&D Costs: Key Findings about the Public
Citizen Report. Pharmaceutical Research and Manufacturers of America.
[http://www.phrma.org/press/newsreleases/2001-08-11.277.pdf]). 3. A
fuller account of the economics of this sort of alternative to patent
supported drug research can be found in Baker and Chatani
(2002), (see “Promoting Good Ideas on Drugs: Are Patents the Best Way? [http://www.cepr.net/promoting_good_ideas_on_drugs.htm]). 4. The
industry estimates that approximately 8 percent of its research goes to
studying production and safety issues. This research would be carried through
even if all drugs were sold as generics, and therefore would not have to be
replaced by the government. 5. A full
description of this bill is available on the website of its lead sponsor,
Representative Dennis Kucinich [http://www.house.gov/kucinich/issues/freemarketdrugact.htm]. 6. It
would be desirable to have some sort of international system that ensured
that countries paid their fair share toward supporting biomedical research.
Hubbard and Love (2004) provides an example of such an agreement (see "A
New Trade Framework for Global Healthcare R&D." Plos
Biology, V2, #2. [http://www.plosbiology.org/plosonline/?request=get- document&doi=10.1371%2Fjournal.pbio.0020052]). 7. The AFV system is described in more detail in Baker 2003 (see
“The Artistic Freedom Voucher: An Internet Age Alternative to Copyright”
[http://www.cepr.net/publications/AFV.htm]). 8. It
would be important that this ban on access to copyright protection extend for
a substantial period (e.g. five years) after receiving AFV
funds. The point of the AFV system is to establish
a competitor to the copyright system, not a farm system for the entertainment
industry. If the most successful people in the AFV
system could simply leave and immediately become eligible for copyright
protection, then the system would end up just providing a subsidy to the
copyright protected entertainment sector, since it would screen out less
popular artists for it. 9. It is
likely that some sort of direct funding mechanism would be the most efficient
way to support software development, another area in which patents have led
to massive waste, although a decentralized AFV
mechanism may be appropriate for some types of software, such as video
games. ___________________________ |