A cyber-friend wrote to me asking what was “the rationale behind giving monopoly rights to big-global-drug-companies in India (by the way of patent protection).” He said that this was “leading to prohibitively expensive life saving cancer drugs (Rituximab at 1.3 lakhs/dose is actually daylight robbery and murder) … India is an insignificantly small (revenue % wise) part of global drug market … the unrealistic pricing shows that drug firms are not even bothered about us. India would be much better off if it produces (at fair prices) some of the life saving drugs and tries to save/elongate lives of some of its 5 lakh people who die of cancer every year.”
The argument for patent protection is fairly simple and reasonable. It says that absent protection accorded by the patent, firms will not invest in the research and development required to produce the drugs in the first place. Because of the legally imposed ban against copying a patented drug, the discoverer of the drug has ex ante assurance that the cost of the discovery will be recovered. Once the drug is discovered, there may be an incentive to renege on the promise to provide the firm with patent protection. But then firms will appropriately adjust their expectations and refuse to incur the cost of drug discovery.
There is a trade-off in this situation but then there are very few, if any, situations in life that do not involve a trade-off. By disallowing the copying of a life-saving drug, there is a welfare loss incurred. That loss has to be considered in relation to the welfare cost of the drug not being discovered at all. In an ideal world – what I call a “first best world” – a firm could produce stuff costlessly and people would take whatever they needed without having to economize. Our world unfortunately is a “second best world” where there is no such thing as a free lunch.
Patent protection is a specific example of a more general notion called “intellectual property rights,” or IPR. Just like you have property rights over physical property – you paid for that car and it is yours – so also you have rights over non-material property such as the recipe for biriyani that your family has used for generations (which is a trade secret that you don’t disclose to anyone) or the poem you wrote (which is given copyright protection.)
Why should India honor patents that protect multi-national drug firms that sell life-saving drugs at prohibitively expensive prices? That is part of the trade-off that a country faces. By trading with the rest of the world, India gains. But it has to agree to abide by international trading rules which include the protection of intellectual property rights. India too has an interest in supporting IPR since India has IP itself. I suppose if one has no property, it is easy for one to disregard the whole notion of property rights.
Coming back to drug patents. The protection is for a limited time, generally around 17 years. The idea is that the monopoly power it provides is sufficient for the discovery costs to be recovered. It is to be expected that firms could cheat by making trivial changes to an existing drug which is about to go off patent and then apply for additional protection. Those sort of matters are dealt with at the courts and the outcome depends on a political bargaining process. Oftentimes the pharmaceutical firms have high-paid lobbyists and successfully buy their way into additional protection. The system, in other words, is far from perfect. But then given human imperfection, it is unreasonable to expect any human scheme to be perfect.
Are there alternatives to the patent protection in the drug business? Some have been proposed. One way would be for the government to buy the drug discovered by paying the discovering firm a fair price, and then to release the drug into the public domain for any firm to produce and sell competitively. This has the obvious advantage that once the drug is discovered, the public will have access to the drug at prices that reflect the actual cost of producing the drug and does not include the cost of discovering the drug or the markup above cost that any monopolist would include.
On the other hand, there are two problems. First, the government will have to fund the buying of the drug formula from the firm which discovered it. That purchase has to be funded from tax revenues. Taxes always introduce welfare losses and these welfare losses have to be considered in relation to the welfare losses associated with the firm’s monopoly supply of the drug. The second problem is how one arrives at a fair price at which the government will buy the drug. Let us suppose that the idea is to pay for the actual cost of drug discovery plus a reasonable amount to compensate the firm for the risk it took to discover the drug. The firm will have an incentive to inflate its costs. Furthermore, the firm can withhold selling the drug at a reasonable price and charge a monopoly price to the government itself. There lie major complications.
All the above was in the context of a single economy. What happens when you foreign firms? The story complicated. What if the consumers in the home country are poorer than the consumers of the foreign country (and the firm is a foreign firm)? Then it is possible for the foreign firm to “price discriminate” – sell the drug at a lower price in the poor country and at a higher price at home.
One can argue that this is possible and indeed welfare improving. Generic versions of branded drugs do precisely that.
I am sure that I have merely scratched the surface of this matter. Hope it somewhat answers the questions that my friend raised.