Deep Dive Episode 156 – Incentivizing Drug Development: Patents or Prizes?
Medical innovation has made modern life miraculous by historical standards, as demonstrated by the unprecedented medical response to the COVID-19 pandemic. What made this possible? What’s the best way to ensure future innovation in the treatment of viruses like COVID-19, and of other diseases like hepatitis, diabetes, and cancer?
This live podcast explores the legal rules and institutions best-suited to promote the development and commercialization of new drugs and vaccines. One key question is whether to use a prize or patent system to incentivize drug development. Another is whether consumers pay twice for patented drugs developed using funding from the National Institutes of Health. Experts debate these questions and discuss the the legal, economic, and policy considerations at play for efforts to promote new medical innovation.
- Deep Dive Episode 118 – Can Patents and Bayh-Dole Fuel Innovation in the Time of COVID-19?
- How Antitrust Overreach is Threatening Healthcare Innovation
- With biomedical research, taxpayers are getting a great deal
- Overcharged: Why Americans Pay Too Much for Healthcare
- Are We ‘Paying Twice’ for Pharmaceuticals?
- Trump’s move to cut drug prices will crush U.S. innovation
[Music and narration]
Introduction: Welcome to the Regulatory Transparency Project’s Fourth Branch podcast series. All expressions of opinion are those of the speaker.
Jack Derwin: Hello and welcome to The Federalist Society’s Fourth Branch Podcast for the Regulatory Transparency Project. My name is Jack Derwin, and I’m Assistant Director of RTP at The Federalist Society. As always, please note that all expressions of opinion are those of the guest speakers on today’s call.
If you’d like to learn more about each of our speakers and their work, you can visit www.regprogect.org to view their full bios. After opening remarks and discussion between our panelists, we will go to audience Q&A, so please be thinking of any questions you’d like to ask our speakers.
Today, we’re pleased to host a conversation on “Incentivizing Drug Development: Patents or Prizes?” To discuss this topic, we’re pleased to feature David Hyman, Brian O’Shaughnessy, and our moderator, Adam Mossoff. Adam, who will introduce our other two speakers in just a moment, is Professor of Law at George Mason University’s Antonin Scalia Law School. Adam, the floor is yours.
Prof. Adam Mossoff: Thank you, Jack. I’m really delighted to be here today to be moderating this discussion and friendly debate between David and Brian. Just to set off our discussion, I wanted to note that the COVID-19 pandemic has brought to the forefront of many people’s minds something that we often take for granted today in our modern society, which is medical innovation. Our lives today are miraculous by historical standards.
A story I often like to tell is President Coolidge’s teenage son died from a blood infection in 1924 after injuring his toe playing tennis on the White House lawn. Realize, that was less than 100 years ago. He died from a blood infection that is now treated very easily and no one dies from today as a result of modern antibiotics. And of course, in addition to modern antibiotics, we have incredible antiviral treatments, diagnostic tests, and many other medical miracles. And so many diseases that were death sentences even just two decades ago, cancer, hepatitis, diabetes, are now completely manageable conditions thanks to the various therapeutic treatments, drugs, and vaccines that we now have.
And even the COVID-19 pandemic exemplifies this point. We’ve had incredible development of therapeutic treatments like remdesivir, which was originally actually developed to treat Ebola and was found actually to treat the symptoms and conditions for COVID-19. We’ve had three vaccines developed and approved for use by patients in the healthcare market in just one year. As bad as this pandemic is, it will not be a repeat of the Spanish flu pandemic in 1917 that killed literally tens of millions of people around the world.
Now, how best to ensure that innovation like this continues and hopefully grows and expands in the coming years? And to discuss this question, we have two experts today to discuss and debate which works better in achieving this goal, prize systems or patent systems. David Hyman is the Scott K. Ginsburg Professor of Health Law & Policy at Georgetown University, and Brian O’Shaughnessy is a partner at Dinsmore and Shohl and is past president of the Licensing Executive Society of the U.S.A. and Canada.
And in fact, this event, I believe, highlights the marketplace of ideas and the vibrant debate that The Federalist Society promotes, as both David and Brian are both themselves longtime members of The Federalist Society. And each are current members of the Regulatory Transparency Project, David on the healthcare working group and Brian on the intellectual property working group. Now, if you’d like to learn more about their many accomplishments and professional accolades, I recommend googling them because I know you want to hear them speak and answer questions and not listen to me.
So just a quick overview of the format for today. Each speaker will give very brief opening remarks, and then while the audience members queue up to answer questions, we’ll have a few minutes of follow-up questions and answers between them, and then we’ll finish out the last half of the event with questions from the audience. So without much further ado, David, why don’t you kick us off?
Prof. David Hyman: Thanks, Adam, for that introduction and to The Federalist Society for putting this together. I’m looking forward to hearing Brian’s thoughts. It’s interesting that Adam mentions antibiotics and Calvin Coolidge’s son. I actually wrote an article about antibiotic resistance which opens with juxtaposing the case of Calvin Coolidge’s son with, twelve years later, FDR’s son who got a sore throat and then was treated with a first generation sulfa drug and survived. And the children of presidents have access to the best medical care imaginable, and I think the juxtaposition of the two makes clear the importance of innovation and the transformative consequences of innovation for health outcomes.
And the patent system is a key driver of that innovation, and it’s worked really well in lots of sectors of the economy. But in healthcare in recent years, there’s been a lot more controversy, particularly involving pharmaceuticals. Recent events have pushed this issue out of the headlines, but there’s a lot of public dissatisfaction with high drug prices. And I’ll just mention a couple: insulin, the EpiPen, cancer drugs.
There have been efforts at both the state and federal levels to impose price controls and encourage the importation or reimportation of drugs to take advantage of foreign price setting. And these high drug prices have even flipped the typical partners in valence. The Trump administration came out against price controls initially, but then it proposed to use an international price index which it subsequently renamed the most favored nations pricing requirement for drugs covered by Medicare Part B, first in 2018 and then again in 2020.
Now, in healthcare, we’ve got this unique combination of market disfunctions. We’ve got agency problems. We’ve got open-ended reimbursement systems. And we just seem incapable of saying no to things, regardless of how high their price is. And pharmaceutical companies and other providers of healthcare goods and services basically respond rationally to that, setting their prices higher, developing new and exciting things to do to people. And when everyone perceives somebody else is footing the bill, there’s an understandable reluctance to say no to things that might be beneficial.
But the result is affordability and concerns about value have become a real problem in healthcare. I’ve already mentioned cancer drugs where we’ve seen steadily rising prices for many drugs that appear to offer at best marginal clinical improvement. In a normal market where people are footing the bill for their own decisions, value is the driver of purchasing. And higher priced products that offer minimal improvements don’t capture much market share except for the kind of people that go to Neiman Marcus and Saks. Most people are shopping at Walmart and Target and Macy’s.
Antibiotics present a somewhat different problem where we see underinvestment in the sector because, not surprisingly, existing products seem to work reasonably well, and people want to hold new drugs in reserve until such time as existing products fail. The large sums at stake for a successful product also encourage all sorts of gamesmanship to extend the effective lives of patents, sometimes called evergreening. And there’s a wide variety of those we can talk about in the Q&A.
And so in a book I wrote with Charlie Silver called Overcharged: Why Americans Pay Too Much for Healthcare, we surveyed the set of problems that we were experiencing in both the branded and the generic aspects of the pharmaceutical market. And we came up with what we thought were some suggestions of ways of making things better, suggestions that have their own disadvantages. I want to be clear about that. We’re in the world of second or third best, not first best. And we suggest that prizes hold some promise for dealing with some of the problems that we’ve identified. And let me list some of their advantages, then flag their disadvantages, and then I’ll just stop.
So the advantages are you basically put on budget and socialize the costs of drug R&D to the population of taxpayers rather than to those that have the disease and need the drug. And it basically eliminates all of this gamesmanship around manipulation of the evergreening patent extension process. It also allows you to get rid of the various market exclusivity and preferences that we see. And so the net result is you can encourage pharmaceutical R&D in areas where it might be underinvested like new antibiotic development. And you put a price tag on it that’s basically capped at the amount of the prize.
Now, that creates all sorts of problems. Let’s be clear. It’s complicated to figure out how much you want the prize to be, what you want to count as success, and how you coordinate it with an existing patent system. And those are all disadvantages of the system. But we should be clear that we’re going to be comparing a flawed prize system to a flawed, as applied in the healthcare setting, patent system that’s caused a lot of unhappiness.
And if you doubt me, ignore Congress, just look at ads where people are advertising, “Here’s how to get lower priced pharmaceuticals because the drug companies are gouging you.” That’s the popular perception, and that perception is going to lead to bad public policy if we don’t come up with a better strategy than the one that we’ve got. And we suggest prizes as a contender.
So I’ll stop there, and I’ll let Brian explain to me why I’m wrong.
Brian O’Shaughnessy: So Adam, you want me to just go ahead?
Prof. Adam Mossoff: Yes, please.
Brian O’Shaughnessy: Okay, thank you. Thanks, David. That was really informative. I appreciated that trip through the history and whatnot of drug development. And I think that my first response is to the public perception that the pharmaceutical companies are just gouging everybody. I would suggest that the solution is not completely revamping the system. It’s educating the public as to what they’re paying for.
The patent system is perhaps the most potent economic engine ever devised by man, other than the free market itself. It was developed back in the 16th century in Venice when the Doge, a democratically elected leader of the Republic of Venice at the time, decided that the guild system was not working to the advantage of society as a whole, and trade secrets that were inherent in the guild system were actually operating to the public detriment by keeping information secret rather than exposing it. And so in exchange, for a limited exclusive right — inventors were granted a limited exclusive right in exchange for disclosure of their inventions. So we took it out of the shadowy world of trade secrets, and we encouraged people to disclose their inventions.
The American patent system, I think, probably represents the next best iteration of that. England, of course, tried a patent system, but the patent system as implemented in England unfortunately was largely a matter of patronage to members at Court and people in the inner circle. It was not a meritorious-based system. It was based upon whether the Crown thought that you were worthy of a monopoly or not, and they granted what was a true monopoly as opposed to a patent grant of limited exclusive property right for what the person had brought into being.
The patent system, I think, as implemented in the United States is especially noteworthy because it was the first of its kind. It was the first of its kind in the sense that it had to be a new invention. It had to be granted to the inventor, and the inventor then had the right to develop that invention with the benefit of the limited exclusive right. And the limited exclusive right was limited to what the inventor had actually contributed to the public good, to the public realm of knowledge. And so I think this is something that most patent systems in the world, including Britain’s, ultimately came to adopt. It recognized that the benefit, as James Madison said in Federalist No. 43, puts the private interests of the individual and the public interest in perfect alignment and could scarcely be questioned as to its value to society as a whole.
I think the patent system as a whole creates a very virtuous cycle where the inventors are encouraged to invent. They are then given a limited exclusive period of time within which to develop that invention into a useful product. And then, of course, the invention is made available to the public as a whole and without any obligation to the inventor when that limited term expires. And this then creates a benefit for the individual and for the public in the sense not just of having great new products to exploit and to derive benefit from, but to actually contribute to the storehouse of public knowledge.
And so I think that system has worked exceedingly well in all areas of industry, but I think it’s worked exceedingly well especially in the pharmaceutical sector. The pharmaceutical sector, of course, has very peculiar problems relative to other industrial sectors. In most industrial sectors, particularly high technology and basic manufacturing, the concept of an invention very quickly leads to a product which can then very quickly be put on store shelves.
In the pharmaceutical world, it’s a very long term, high risk endeavor that starts off with what may be the discernment of a mechanism of action in the body which then might lead to a serious of compounds that modify that mechanism of action or exploit that mechanism of action to modify biological behavior. And then many, many, many more compounds will be developed. And over the course of perhaps ten years and $2.6 billion worth of investment, you might come out at the end of that pipeline with a pharmaceutical that actually works, that exploits the mechanism of action, and is safe and efficacious. That’s a pretty long term project, and it’s fraught with risk.
And so I think the patent system does an excellent job as it stands in terms of encouraging that risk-taking and encouraging the innovation that’s necessary to get us to useful pharmaceuticals. And with that, I will turn it back over to you, Adam.
Prof. Adam Mossoff: Great, thank you. Fantastic opening remarks. Now, related to the question of the best institutional system for promoting new medical innovation, of course, is a question of funding. One argument for the prize system is that it ensures publicly funded research is made available for free to the taxpayers who paid for it. I believe that David has already intimated this. David, could you perhaps elaborate on that a bit more?
Prof. David Hyman: I don’t know that I’d necessarily frame it quite the way that you did. I want to agree with Brian that drug development is extremely risky and extremely costly, and we need to come up with ways to make that sensible for even risk-preferring pharmaceutical companies to decide to make those investments.
And there are a number of ways of doing that. One is to give them patent rights and then let them charge whatever the market will bear at the back end. The other is to cut them a check for a huge amount of money, and then basically treat the resulting product as a generic that can be manufactured by anybody under a license from the government. And so the financial costs don’t have to be different. They could be different for the pharmaceutical sector, depending upon how you set the prizes and whether you think, on a Goldilocks spectrum, the existing rewards are too big, too small, or just right.
But the access issue for the patients that have the drugs looks very different because under the patent system, they have to look to their insurer or their own pocket to come up with the cost. And under the prize system, the taxes fund the pharmaceutical research and development. So in that regard, it isn’t the public investment that results in it being available at zero cost. I still expect cost of production to be paid for by the people that are taking it. What we’re talking about is socializing or localizing the cost of the pharmaceutical R&D.
Prof. Adam Mossoff: Thank you. That’s what you mean when you sometimes use the phrase that for these and other events that — about the concern about taxpayers paying twice.
Prof. David Hyman: Okay, so that’s — I’m sorry. I’m very literal minded, Adam. I listened to your question.
Prof. Adam Mossoff: That’s all right.
Prof. David Hyman: I’ll try to answer that question in the context. So the paying twice critique is one that we’ve heard a lot of late. And the complaint is essentially, look, the people that take the drug are paying twice, the first time as taxpayers when their funds are used to invest in basic research and sometimes applied research that can result directly or indirectly in pharmaceutical products, and then a second time when they need the drug and they have to pay these — what are perceived to be very high prices for the drug. So that’s the paying twice critique. And the immediate conclusion is, well, we should just stop paying twice. We should just pay once. And that means that if we invested in the initial development of the drug, we ought to be able to get it at cost at the back end.
Charlie Silver and I wrote an article that appeared relatively recently in the Yale Journal on Regulation that’s called something like “Pharmaceutical Pricing When Success Has Many Parents.” And we look at the data about how often government funding is involved one way or another in things that end up being drugs. We heard at the outset Adam talked about the vaccines that have been developed. And that’s a nice example of government being involved in various stages of the process, having — sometimes doing the research itself, sometimes funding the research that’s done, sometimes being involved in the translational efforts as part of Operation Warp Speed.
And so it actually turns out to be a complicated issue to figure out how big a contribution they made, when they made it, and how important it was. Even if we bracket all of those questions, it turns out the government’s involved in lots and lots of drugs at some stage during their development.
But our argument in that paper is that does not mean that the consequence should be reasonable pricing for all of the drugs. You should instead view the government as essentially a co-venturer, an investor in the product process that results in those drugs where the rewards that they ought to capture should reflect the costs and risks that they bore. And we talk about the implications of that. It certainly doesn’t follow that reasonable pricing should be the result. So I want to disassociate myself from that argument. The argument about prizes is separate from that issue.
Prof. Adam Mossoff: Thank you for that clarification. I appreciate it. Brian, what is your view on this position about taxpayers paying twice for medical innovation?
Brian O’Shaughnessy: Well, I would say that it usually misstates and focuses on an aspect that is something that I think is naturally a government responsibility to begin with. The government engages, for the most part, in investment in basic research. And basic research is the exploration of the unknown and is necessarily highly speculative. Anybody involved in invention knows that invention defies timelines, and it is a notoriously nonlinear process.
Basic research really is not tied necessarily to the development of a particular product. It is most often the exploration of the unknown. It is the exploration of basic biological functions, for example, so that we can better learn how we might manipulate those functions. And the gulf that exists between the elucidation of a particular mechanism of action and the identification of a safe and efficacious pharmaceutical is enormous. And as I mentioned, it is a gulf that is spanned in many, many years and many, many billions of dollars.
And while the government and the taxpayer may be supporting some of that early research, that, I think, is the fundamental purpose of government because government recognizes that there are certain endeavors, particularly in the field of basic science, that the private sector just will not invest in. It’s just way too speculative, it’s too far removed from a product, and it’s just not necessarily going to give a reasonable return on investment.
And so it is the function of the government, in fact, in my view, is to support our universities, support the development of scientific talent by funding graduate students and fellowships so that they can do the research and that they can establish their own skills and their bona fides as a scientist. And then they might go out into industry, and they might put those skills to more practical application.
But in either case, that is something that the government does. The government does it for the benefit of the public. And as a result, the public benefits not just from the fruits of the research which are taken by the private sector and developed, but the public also benefits from the establishment of world-class research facilities at universities, the finest universities in the world, and incredible talent coming out of those universities which then, of course, march across the street into the private sector, and they begin working on problems of a more practical nature that actually inure to the public benefit by producing things that people can actually take as a pill rather than spending a week in the hospital. So the benefit is actually very palpable to the public, and that is really — as I say, it is just the function of government.
There is a report that was put out by the Office of Scientific Research and Development back in 1945 at the end of World War II. World War II, frankly, was won largely by the fact that we were able to scale up and do a lot of technological research that, frankly, nobody in the U.S. had been interested in doing until we faced the threat of World War II. Developments, of course, such as nuclear energy and radar, even, were virtually unknown before World War II. And it was only because the exigencies of the situation that we scaled up.
But with that, the government recognized that they needed to invest in scientific research, not just for national security, but for the public good. And so in that report that was produced in 1945, Science, The Endless Frontier, Dr. Vannevar Bush actually writes at length about the role of the federal government and the benefit to the public in supporting basic research.
So I think that the role in funding basic research is very important, but as I say, the gulf between that basic research and the ultimate product is one that’s fraught with risk, investment, and a great deal of time. And that is something that I think the private sector properly takes on, but only when they have the opportunity to do so with the benefits that are afforded by the patent system.
Prof. David Hyman: Adam, can I just add — Brian’s mentioned World War II, and certainly the rise of public investment and all sorts of things including biomedical research in the post-war era is very important. I want to roll the tape at least a little bit forward and point out we’ve been debating these issues certainly since Bayh-Dole in 1980 where the issue was, basically, how do we get this research that’s funded by public dollars out into the marketplace, and what’s the optimal strategy for doing that? And that was heatedly debated in the 1980s, and it continues to be debated. The paying twice debate is essentially the same debate that we were having back in the 1980s when I was much younger and better looking.
Prof. Adam Mossoff: I appreciate and noted the shift in David and Brian’s recent comments in talking more about the R&D pipeline and the role of universities, and even David raising the issue of the Bayh-Dole Act because what was on the forefront of my mind as I was hearing your initial remarks is how does Bayh-Dole fit into this debate in either theory or practice? Which approach, prizes or patents, does Bayh-Dole end up providing more support for? David, since you first mentioned Bayh-Dole, maybe I’ll come back to you and ask you that.
Prof. David Hyman: Why don’t you ask Brian that question and give me time to think about it?
Prof. Adam Mossoff: Okay, all right. Brian?
Brian O’Shaughnessy: Well, I guess my first response, Adam, would be a response to David’s comment that we’re still debating the Bayh-Dole Act. And the fact that we’re still debating it is a never-ending head scratcher to me. I think the Bayh-Dole Act has more than clearly established its value. It’s imitated around the world in a number of different economies. It has produced a tremendous amount of pharmaceuticals that have actually gone into people that previously just did not exist before Bayh-Dole.
Prior to Bayh-Dole, federally funded research leading to pharmaceuticals produced zero products, whereas subsequent to Bayh-Dole, we have over 300 useful pharmaceuticals that are on the shelves today that have been made available only by virtue of the existence of Bayh-Dole. I think a lot of people oversimplify the Bayh-Dole scenario. This is, I think, something that helps span the gulf that I talked about earlier by affording people the patent rights that justify the research and development that’s necessary to take a product from the lab to the marketplace.
There is something in the entrepreneurial community known as the “valley of death.” The valley of death is that time period that exists after an inventor has shown proof of concept. And once proof of concept is shown, well, then federal funding essentially dries up. As far as the feds are concerned, there’s nothing more to prove. You’ve proven this thing actually works, and you’ve proven how it works.
And that’s great, but there’s oftentimes a long stretch between that proof of concept and the proof of a useful product that’s actually desired by the market. And that valley of death is the time from when federal funding dries up. Maybe you’re going to get a little bit of small business loans that might come through, that might trickle through for a little while longer, but eventually, even that dries up. But yet, you’re still far enough away from a product that investors are not ready, willing, and able to come in. And so somehow, innovators and entrepreneurs have to figure out how to get across the valley of death, and that is oftentimes the death knell for many organizations.
And once you get to the point where you’ve actually shown that this thing might be a product, and not just a product that works, but a product that’s demanded and useful in the marketplace, and once you start showing that and you have the promise of a product, well, then investors start snooping around and coming in and giving you a little bit of their money. But they’re not going to do that until they see a fairly clear path to a return on investment.
Not many investors are purely philanthropic with their money, so until you get to that point of having the return on investment, it’s very difficult to get the private investment that’s necessary. And if you don’t have a patent, well, you’re not going to get anything because investors just won’t show up if you don’t have some reasonable expectation that once you develop that product that you’re actually going to be able to exploit it and get some money out of it. And I think that the limited exclusive right of the patent is enough confidence to most inventors that they know that when that product actually comes into being and it’s introduced into the marketplace, they can actually recoup their investment. So I’ll stop there.
Prof. David Hyman: I guess I’d just add in response to Adam’s question that in fairness, I think Bayh-Dole fits more comfortably with a patent approach than with a prize approach. There are ways in which they could be coordinated, but the logic of authorizing colleges and universities to retain ownership of the inventions that result from government funded research, which is essentially the core element of the Bayh-Dole amendments, obviously, ownership sounds a lot more like patents than cashing the check that’s associated with a prize.
Now, there are ways in which you could still have prizes working in a system where the government is going to continue to fund lots of the basic research and some translational research, and those contributions will be important in the ultimate development of the products that we all hope to see as a result of innovation.
The logic of my pointing out, just circling back to the beginning at the outset that, gee, the patent system seems to work pretty well in other sectors of the economy but not so great in parts of the healthcare system is a result of a number of failings in our healthcare system. And you might say, fairly, to me, “Well, Hyman, why are you messing with the patent system if that’s not the source of the problem? The fact it’s working everywhere else should suggest quite the opposite.”
And the answer that we basically spell out here is we don’t seem able to fix those other problems, and so we’re looking for a work-around to the problems that that in combination with the patent system creates by proposing prizes for dealing with branded drugs and innovation because I do think innovation is really important. I went to medical school back in the ‘80s. Things look a lot different in the 2020s, and we’re all the better for it, as long as we can afford the resulting innovation.
Brian O’Shaughnessy: I think a lot of people forget, or at least don’t pay enough attention to, is that Bayh-Dole is really an incredibly potent reinvestment engine. The universities take title to the patents, but those patents are then licensed out to industry. Industry has to pay for those patents, and they usually pay for patents based upon a royalty, based upon how much money they’re making. Now, that money then goes right back into the pockets of the university, which, of course, in every instance is some form or another of a non-profit institution, and therefore, that money gets plowed back into building labs, paying for graduate students, paying for fellowships, paying for research.
A substantial portion of that money—it varies by university—but a substantial portion of that money goes into the pockets of the individual inventors. As a result, inventors have an incentive to come work at universities instead of the private sector. And inventors will come to universities because they have the prospect of making a substantial amount of money on their inventions because the Bayh-Dole actually specifies that some of that money must go back to the inventors.
So the reinvestment engine that Bayh-Dole enables has given us, as I said, a tremendous boost in terms of the amount of talent that’s coming out of our universities who are incredibly well-trained because they have access to the world’s finest laboratories. And oftentimes, there is also sponsored research that comes out of those arrangements. So the private sector is itself plowing money into the research as well as the royalties that they’re paying on the patents. So I would say that the Bayh-Dole Act by itself creates an incredibly successful, virtuous cycle that inures to the benefit of our higher education system, and then to the benefit of the public as a whole.
Then the other point that I would ask is, David, I guess when you say that the patent system hasn’t been successful at fixing the system, I’m not quite sure where the system is broken. Drugs are expensive because they’re incredibly expensive to develop. And I think if we looked at the actual prices and the costs that go into what it takes to produce some of these drugs, as I said, $2.6 billion just in the development cycle, but that’s just the development cycle for a particular drug. That doesn’t take into account all of the failed drugs and the time that it takes to get there.
And so fixing the system is one thing. It’s one thing when your invention pertains to a cell phone and you know how you’re going to modify the chips and the switches that go into that cell phone, but it’s another thing altogether when you’re manipulating actions within the human body with all of the uncertainties that come with that, and then going through the regulatory process to get that approved. That’s an incredibly expensive, time consuming, risky enterprise. So we shouldn’t be surprised that drugs cost a lot of money. They cost a lot of money because they cost a lot to develop.
Prof. David Hyman: So in a market economy, the cost of producing the drug is not irrelevant, but it does not dictate the market price. The market price in a normal market is dictated by the willingness of buyers to pay for it, which is typically a function of the value of the drug. And we see very different phenomena in how we pay for healthcare, pharmaceuticals especially. That’s the first point.
The second point is pharmaceuticals are not unique in having high fixed costs and low variable costs. That’s mostly about small molecules as opposed to biologics, so we can go into those weeds if people are interested. The difficulty is lots of people don’t understand why insulin prices keep going up in lockstep. Even though the specific formulations have changed, the basic decisions and investments were made in the World War II era, and there hasn’t been a dramatic improvement that would remotely justify the price increases.
Now, that’s separate from the launch prices for new drugs. We should talk separately about levels and trends. But there’s an extensive literature that indicates that these very expensive drugs, particularly in the cancer space, don’t remotely result in anything near their value in terms of extending lives or reducing symptoms. And so our willingness to pay for that is in part a function of our reluctance to engage in rationing and, as I said, everyone’s perception that someone else is paying, which are not things that we see when we’re dealing with cell phones. When you buy your new iPhone, you buy your new iPhone, and you bear the full costs.
And so healthcare is complicated in ways that lots of other things aren’t. We ought to pay huge amounts of money for successful innovation, and we shouldn’t pay nearly so much for things that don’t add much value. But that’s not the way our current system is operating.
Prof. Adam Mossoff: This has been a fascinating exchange. We just had a great question posted in the chat, and so I hope he doesn’t mind — it was posted by David Lachmann of BIO, and I hope he doesn’t mind if I just read the question to you guys. I think it would be great to hear your responses because it keys into some of the issues that you’ve just been exchanging on.
David asks, “When we discuss success or failure of the patent system, what is our metric for success? If it is innovation, then the U.S. system of free markets and patents should count as a success. We license more new drugs per year than the rest of the world combined. The record of translating federally funded research into cures reaching patients under the Bayh-Dole Act is similarly impressive. The complaint seems to be less about the robustness of this pipeline than that while on patent, some of these drugs are costly. But drugs are only 14 percent of all healthcare expenditures, and 90 percent of all prescriptions are for generics, which are by definition off patent. So on this basis, how is the patent system deemed to be a failure?”
Prof. David Hyman: I take it that’s mostly directed at me, so let me go first on that. Actually, on the robustness of the pipeline, I don’t want to be heard as conceding that issue. I think it varies very much on whether there’s a large enough market with enough well-insured people to generate the incentives that Brian has been talking about to invest those kinds of sums to develop new drugs.
And again, there’s a pretty extensive body of research indicating, not surprisingly, pharmaceutical companies go where the money is, which is where the patient volume and the well-insured patients are. And that’s perfectly understandable. From a population health perspective, it’s less than optimal. And so we need to come up with some other strategies to motivate people to make investments in that area. I’ve already talked about the problem with antibiotics, so I just want to say that about the pipeline.
Second, that drugs are only 14 percent of all healthcare expenditures, actually, there are some problems with the way in which that number is calculated because it treats all expenditures under Medicare Part B as attributable to physician costs, when actually a significant chunk of them are physician dispensed drugs, which tend to be much more expensive. And so 14 percent is actually a low number. The 90 percent of all prescriptions are for generics statement is accurate the last time I looked, but that’s not the share of spending that’s attributable to branded drugs versus generics because branded drugs are much more expensive.
And then the last issue is on this basis, how is the patent system a failure? I didn’t say it was a failure. I said it’s not working as well as we would like it to be in delivering what we want in the way of affordable innovation. And that’s why I’m suggesting prizes as an alternative strategy.
Brian O’Shaughnessy: Well, I guess I would say that prizes as an adjunct, I would certainly agree with. I think that there is room for philanthropic organizations and foundations to step in and identify underserved populations and say, “We really need more research in this area. If someone can find an answer to this specific problem, we’ll give you a prize.” But that’s a far stretch from suggesting that we could replace the patent system with the prize system.
And then as to the abuses of the patent system, well, any organized system of law and regulation is subject to abuse and will be abused by those who think that they can benefit from it. It just is the nature of the beast, if you will. But in some of those instances, it’s not a problem of the patent system. It’s a combination of the patent system, perhaps, but with the regulation system and the regulatory regime.
David mentioned earlier the EpiPen fiasco. Well, the EpiPen fiasco had everything to do with FDA regulation and approval and absolutely nothing to do with patents. So the fact that some people are using this very — exploiting this very complicated interplay of regimes is not terribly surprising, but it doesn’t mean that we scuttle one of the regimes in favor of another.
Prof. David Hyman: I want to agree that the FDA should take its share of responsibility for the problems that we see. They’re an important part of the reason why we’ve seen runup in the pricing of some generic drugs, their reluctance to move quickly to approve new generics and to allow importation from generics that have been approved and have long been in the market. Martin Shkreli wouldn’t have been able to get away with what he did had the FDA allowed importation of Daraprim from everywhere else that it had been approved.
And the REMS system, the Risk Evaluation and Mitigation System, I used to be at the Federal Trade Commission, and so I saw no shortage of these reverse payments issues and abuse of the Orange Book and the evergreening process. So I welcome Brian’s acknowledgement that there’s bad actors and we ought to go after them.
Brian O’Shaughnessy: Absolutely, which is not to say that the system is broken, however. A friend of mine used to say that the patent system has a Keanu Reeves problem. Everybody has a bad actor, but that doesn’t mean you get rid of the system.
Prof. Adam Mossoff: So this has been a really fascinating exchange. Again, I think it really reflects the value add that The Federalist Society provides in bringing together people who differ but yet are able to engage in a very robust and interesting and data-driven discussion.
And so as we’re coming to the conclusion of our event, I was interested from the perspective of maybe 30,000 feet, more theoretical framing, is there any valence for individuals who believe in limited government, property rights, and the rule of law in choosing between a prize system and a patent system? I think David did a really nice job highlighting some of the pros and cons and maybe even stepping back a little further and surveying those from the broader framing of our underlying fundamental sociopolitical commitments. What do you think, at the end of the day, is really the better system, perhaps?
Prof. David Hyman: Well, I want to say I believe in limited government and property rights and the rule of law, and I’m confident that Brian does as well. But I think we had some disagreements about the circumstances under which the patent system is working as well as it could be to make affordable innovation available to ordinary Americans.
And that suggests to me that there’s not a political valence. Well-informed and well-meaning people that share certain values can disagree on how those ought to be applied in a particular setting. I think patents have an important role to play. And I hear Brian to say it has, at best, a limited role to play in dealing with the sorts of problems that we’ve been talking about.
Brian O’Shaughnessy: Well, I guess I would agree. And I certainly do, as you say, David, I certainly do believe in small government and the rule of law. But I do firmly believe that the patent system is, in effect, the most potent economic engine ever devised.
I believe it has its weaknesses. Adam and I, in particular, are working on several issues where we are trying to identify the weaknesses in the patent system and suggest how those changes might be made to better stimulate innovation and produce a public benefit. The system, unfortunately, has gone a bit off the rails over the last 10 or 20 years due to certain private interests that prefer not to pay for innovation and prefer not to pay for property rights and patents. I think we need to get away from that.
We need to reestablish the notion that America is a country that recognizes property rights, and rewards innovation, and rewards diligence and hard work and creativity. And I think the patent system is the best system that we’ve ever seen in order to do that. But I think we just have to ensure that those rights are prudently granted, but when they are granted, they are reliable, robust, and dependable. And that is the best way to stimulate investment, particularly in risky areas that take a good deal of time to develop into a commercializable product.
Prof. David Hyman: Adam, Brian mentioned James Madison at the outset in his initial remarks, and I know, patron saint of The Federalist Society, but let me add in Mark Twain who memorably wrote in A Connecticut Yankee in King Arthur’s Court that a country without a patent office and good patent laws was just a crab and couldn’t travel any way but sideways or backwards. And I think there’s — look around you. The truth of Twain’s observation is everywhere around you.
Innovation has made all sorts of amazing things possible, and ordinary Americans live lives that were unimaginable for the wealthiest people in Regency England. But my observation is in this part of the healthcare sector, we have some issues that require attention. And Charlie Silver and I wrote this book Overcharged to draw attention to them and trying to suggest some strategies for fixing them.
Prof. Adam Mossoff: Thank you. This has been, I think, a fantastic exchange. David, you were gracious in volunteering to be the first out of the gate at the start of our event, so I think it’s just and perfect for you to have the final word and the say, the final statement at the end of the debate with those remarks.
And thank you to both of you for, I think, a really interesting, as I mentioned, data-driven discussion. And it shows that, yes, people who do share foundational commitments to property rights and the rule of law and limited government can nonetheless have very divergent but nonetheless respectful disagreements and positions on applied policy. And I thank you both for exemplifying the ideals of The Federalist Society in capturing this type of discussion.
Prof. David Hyman: Excellent.
Brian O’Shaughnessy: Excellent. Well, thank you, Adam.
Prof. Adam Mossoff: Thank you. Jack, are there any parting words that you have to do as an administrator?
Jack Derwin: Well, thanks a lot to you, Adam, for moderating today. And once again, thank you to Brian and David as well for lending us your time and expertise for this great discussion. And thank you to our audience for tuning in to today’s call. We welcome any listener feedback by email at email@example.com. And as I mentioned at the beginning, if you’re interested in checking out any more of our speakers’ work, feel free to view that at our website as well. And with that, we are adjourned.
Conclusion: On behalf of The Federalist Society’s Regulatory Transparency Project, thanks for tuning in to the Fourth Branch podcast. To catch every new episode when it’s released, you can subscribe on Apple Podcasts, Google Play, and Spreaker. For the latest from RTP, please visit our website at www.regproject.org.
This has been a FedSoc audio production.
Scott K. Ginsburg Professor of Health Law & Policy
Partner, Dinsmore & Shohl LLP and
Past President, Licensing Executives Society, USA & Canada
Professor of Law
Antonin Scalia Law School, George Mason University