Broken System Allows Pharmaceutical Companies To Sell Drugs at Prices That Are Typically Several Thousand Percent Above Their Free Market Price
Outlawing items such as marijuana or alcohol invariably leads to black markets and corruption. Since there is much money to be made by selling these products in violation of the law, many people will follow the money and break the law. They will also corrupt the legal system in the process, making payments to people in law enforcement and elsewhere in the legal system.
The old line from economists on this problem is to take the money out, by making marijuana and alcohol legal. If people can buy these items in a free market, then no one is going to have any big incentive to make payoffs to police officers or judges, there would be no reason.
We should think the same way about the pharmaceutical industry and patent monopolies. Patent monopolies and related protections allow pharmaceutical companies to sell drugs at prices that are typically several thousand percent above their free market price. In this context, economic theory predicts they will bend or break the law to extend and expand their protection as widely as possible.
The latest example of this story of corruption was a front-page New York Times piece on the arthritis drug Humira. Humira is an extraordinarily effective arthritis drug taken by tens of thousands of people in the United States. Its main patent was due to expire in 2016, which would have in principle opened the door to generic competition.
At the time, Humira was being sold at $50,000, for a year’s treatment. In principle, generic competition would have lowered the price considerable. However, as the piece points out, AbbVie, the drug’s manufacturer took out dozens of other patents on Humira. According to the piece, AbbVie applied for a total of 311 patents on the drug, 165 of which were granted.
Many of these patents are of dubious legal status. The U.S. patent office is notorious for being lax in its standards, having once granted a patent on a peanut butter and jelly sandwich. However, the threat of patent suit was enough to discourage potential competitors from entering the market. According to the piece, all the would-be entrants signed agreements with AbbVie delaying entry, with the first competitor just entering the market this year. In the meantime, AbbVie raised the price of Humira to $80,000 for a year’s treatment.
As the piece points out, this practice of taking out dozens, or even hundreds of patents, has become a standard practice for the pharmaceutical industry. There is a fundamental asymmetry in a patent infringement suit that will always favor the patent holder.
The patent holder is suing for the right to sell its drug at a monopoly price. The would-be competitor is trying to get the right to sell its drug at the free market price. The potential profits from keeping the monopoly dwarf the profits that a generic competitor might hope to earn. For this reason, the patent holder will typically be prepared to spend far more money to protect a patent claim than a generic producer would be willing to spend to challenge it. As a result, the effective patent duration for many big-selling drugs is often long beyond the 20 years specified in the law.
Sometimes pharmaceutical companies don’t even go the bogus patent route to discourage generic competition. Outright payoffs also can do the trick. While a direct payment would likely be an antitrust violation, awarding a lucrative manufacturing contract to a generic producer for a different drug can accomplish the same goal and be all but impossible to detect, unless someone is foolish enough to use the quid pro quo in writing.
Lying About Safety and Effectiveness
Unfortunately, extending patent life is not the only abuse caused by the lure of patent monopoly profits. When drug patents allow drugs to sell to many thousand percent above the free market price, drug companies have an enormous incentive to promote their drugs as widely as possible. This means exaggerating their effectiveness and downplaying safety risks. This could mean people get improper care or take drugs that harm them.
There are endless examples where companies have misrepresented the safety or effectiveness of drugs. The Alzheimer’s drug, Aduhelm, is a prominent recent case. The Food and Drug Administration was persuaded to approve the drug in spite of weak evidence for its effectiveness and also evidence of seriously harmful side effects in some patients.
Biogen, the drug’s manufacturer, had plans to sell it for $56,000 for a year’s treatment. It turned out Biogen’s representatives had met frequently with officials at the FDA, a fact that was not properly documented by the agency. Fortunately, protests from experts in the field, including the resignation of several members of an FDA advisory commission, managed to ensure that the approval was far more limited than the open-ended approval sought by Biogen.
The arthritis drug Vioxx, which Merck sold, is another prominent case where a drug company sought to mislead the medical community and the public about the safety of its drug. It was alleged that the drug increased the risk of strokes and heart attacks for people with heart conditions. Since there is considerable overlap between people with heart conditions and those suffering from arthritis, this is a serious problem for an arthritis drug.
According to allegations, Merck had evidence from its clinical trials of this risk but concealed it from regulators. Merck paid $4.85 billion to settle a lawsuit and withdrew the drug from the market.
Perhaps the most egregious example of concealing evidence of a drug’s potential harm is with Oxycontin and the new generation of opioid drugs that were developed in the 1990s and 2000s. Purdue Pharma and other opioid manufacturers pushed their drugs widely, concealing evidence that they were highly addictive. The lure of monopoly profits was likely a substantial factor in creating the opioid crisis of the last two decades.
In addition to instances where drugs may be altogether ineffective or harmful, there is the more general problem of drug companies promoting their drugs for uses not approved by the FDA. While doctors can prescribe a drug for non-authorized use, it is illegal for drug companies to promote their drugs for unauthorized use. Nonetheless, they routinely find ways around this prohibition, for example by paying doctors to write about or lecture on their drugs. Medical journals and regulators have sought to restrict such practices, but it is difficult to effectively police this behavior when there is so much money at stake.
Patents Can Interfere with the Research Progress
In addition to making drugs expensive, and providing incentives to misrepresent the safety and effectiveness of drugs, patent monopolies can also slow the development process itself. When researchers, or their employers, are concerned about maintaining patent rights, they may refuse to take part in potentially useful collaborations.
In a feature article on Katalin Kariko, one of the leading mRNA pioneers, the New York Times wrote that at one point she was unable to arrange a collaboration with another researcher because they were concerned that her university affiliation might complicate patent claims. Similar issues could arise in many other contexts, for example, if drugs might best be used in tandem, as with the AIDS cocktails, it would be necessary to make arrangements on intellectual property claims before going through with clinical trials.
Similarly, if research points to the potential effectiveness of an old drug or a non-pharmaceutical treatment for a condition, such as diet or environmental changes, the patent system provides no incentive to pursue it. If the treatment is not patentable, the system provides no incentive to do the research.
Patent Protected Drug Prices Complicate the Lives of People with Medical Issues
The fact that we look to recover the cost of research, plus healthy profits and overhead costs, from the patients, rather than paying it upfront, creates needless problems for people with health issues. Paying tens of thousands of dollars for a life-saving drug is a huge burden for almost anyone. While most people may be able to get an insurer or the government to pick up most of the tab, this is hardly the end of the problem.
Insurers do not want to pay out $50,000 a year for a patient’s drugs. If they can find a way to avoid having to make the payment, they will. This often means extensive documentation requirements, and possibly even requiring a second opinion. An insurer may even opt to refuse to make a payment even if they know it should be covered.
After all, this is pretty much a no-lose proposition from their standpoint. If the patient believes that the insurer should cover the drug, and presses their case, the insurer ends up having to make a payment that they would have made in anyhow. However, if the patient believes the insurer is correct in turning down the claim and doesn’t pursue it further, the insurer could save tens of thousands of dollars by turning it down. The only risk the insurer would face in this story is if turning down valid claims becomes so common that their patients are able file a successful class action lawsuit.
In addition to creating needless hassles for people with medical problems, patent protected drug prices add to the cost of healthcare by increasing the administrative costs of insurers. We will spend around $560 billion this year on prescription drugs, roughly $4,300 per household. These drugs would likely sell for less than $100 billion in a world without patent monopolies or related protections.
This additional cost creates the incentive for insurers to carefully police expenditures. If a year’s treatment with a drug costs $500, an insurer likely would trust a doctor’s assessment that a patient needs it. When the drug costs $50,000, the insurer has a strong incentive to find an excuse to turn down a claim or insist that the patient use a cheaper alternative.
Insurers’ net administrative costs (profits and wages) will be close to $270 billion this year. Roughly 20 percent of the spending that goes through insurers will be for prescription drugs. If we assume that the administrative costs are proportionate to spending, this means patent protected drug prices add another $54 billion to our healthcare bill due to the increased expenses and profits accrued by insurers.
While some drug payments may still go through insurers even if drugs were sold in a free market without patent monopolies, they would result in much less scrutiny. Medicare did not cover prescription drugs when it was established in 1965 because drugs were not a major expense at the time. In a patent-free world, that would still be the case.
Patent Monopolies are Not Necessary to Finance Research
It is possible to read this indictment of patent monopoly financing for prescription drugs and still insist that the system is a net positive because it is needed to finance the life-saving innovations in technology we have seen in recent decades. This would be a reasonable argument if patent monopolies were the only way to finance successful research. But why would we think that the only way to motivate people to innovate is to give them a patent monopoly?
Through government funding, we have had many great research breakthroughs, including most of the work developing mRNA technology. The National Institutes of Health spends more than $50 billion a year on biomedical research. Nearly everyone, especially the pharmaceutical industry, says this money is very well spent. While most of this funding goes for more basic research, some has gone to develop drugs like the AIDS drug AZT (originally developed as a cancer drug) and Taxol. Nonetheless, it would take some considerable leaps of logic to argue that the government can effectively finance basic research, but if they funded downstream research it would be the same thing as throwing money in the toilet.
To my view, we would want to alter the funding system if we looked to replace the patent monopoly-supported research. I recommended that we look to parcel out funding to long-term prime contractors. For example, a pharmaceutical company may win a contract to research liver cancer drugs for 12 years. The condition of getting the contract would be that all research findings would be posted on the web as soon as practical and all patents are placed in the public domain so anyone can use them.
We would have lots of room to play around and still come out ahead. If all drugs were sold at free market prices, we would likely save close to $400 billion a year on prescription drugs (a bit less than half of the Defense Department budget). The industry currently spends bit more than $100 billion a year on research, so even if it took $150 billion to replace research that is patent-financed, we would still see massive savings.
Can We Debate the Patent Monopoly Financing System?
Of course, the extent to which direct funding could be an effective alternative to patent monopoly financing is a debatable point. There are also other possible mechanisms. For example, we could have a patent buyout system, where the government pays some sum for the rights to useful drugs, and then places the patents in the public domain so they can be produced as generics.
But the key point is that there are enormous problems with the system of patent monopoly financing. It is absurd that we use the power of the government to make life-saving drugs that would sell for hundreds of dollars in a free market, instead sell for tens or even hundreds of thousands of dollars. That is a cruel and inefficient system that invites corruption. We can do better.
 I describe this system in somewhat more detail in my book Rigged, chapter 5 (it’s free).
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