Pharmaceutical Patent Lengths
Apr 14, 2011

Pharmaceutical Patent Lengths

Obama's recently announced deficit reduction proposal includes the reduction in patent lengths for brand name pharmaceutical drugs from 20 to 7 years. Let us step back and consider the case for such patents and how we might determine an optimal time length.

The reason we have pharmaceutical patents is for a single purpose: to create incentives for research into new drugs. When the drug company knows that its discovery will give them a temporary monopoly and hence high profits they are motivated to invest in research. Pharmaceuticals compared to other industries presents a particularly compelling case for patents because they have a very large ratio of investment costs to reproducibility costs. The research, testing and approval process are all very expensive but a secondary company could cheaply copy and reproduce the drug such that without the patents the profit motive is substantially reduced. For small patent lengths, a marginal increase in length results in a marginal increase in incentives to innovate.

However, one cannot make the lengths too long. Firstly there is diminishing returns for incentive to innovate beyond a certain threshold. That is, if a company already has a very long patent on a drug that is sufficient at curing some particular disease they have little incentive to expend a lot of money on researching a superior drug even if their past experience ideally positions them in the market for this research. More importantly, however, as the artificial monopolies exist for longer, the costs to consumers increases. Indeed, patents expiring mean the drugs reduce to slightly above the production costs of generics.

There thus remains a trade off between wanting to optimally encourage research and innovation and between wanting to reduce costs to consumers. At this general level it is hard at first glance to measure whether patents have become too long or too short. However, we have a reasonable proxy by which to measure this namely the profitability of pharmaceutical companies. Should the industry not make much of a profit it is reasonable to assume increasing that profitability through increased patent lengths will increase investment. However if the industry is very profitable then the motive to heavily invest already exists and increasing it will make a small difference. The diminishing returns is such that the marginal increase in investment for an increase in profitability declines considerably.

As it turns out, the pharmaceutical industry is one of the most profitable industries out there with an enormous average profit margin of 17%. Economic sectors with lower barriers to entry consistently have much lower profit margins and the increased patent times create, through temporary monopoly, barriers to entry that allow for this excessive profit. This rate reflects the fact that patent times - as an industry average- are too long and that extra costs to consumers (the profits) dominate the change in investment rate which we can expect to be fairly stagnant with a mild decline in profitability. Of course, this argument only establishes the upper bound that 20 years seems to be too much given the excessive profitability. It may well be the case that 7 years is too little, but lower bounds for this counterfactual must be addressed separately. 

Thoughts on this post? Comment below!

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1 comment:

Anonymous said...

7 years is really two short because it takes 10-12 years to bring something to market(unless it is a mee2 drug then 7 years is fine). So if you only have seven years on a completely new drug there is almost no way you could develop it and expect to be able to sell under the patent.

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