Economics of innovation and access to medical technologies

Key points

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• Knowledge or new, useful information possesses the characteristics of what is commonly called “a public good”.

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• Special challenges in the area of health technologies include the long product development times, the necessarily stringent regulatory burden, the relatively high risk of failure and the comparatively low marginal costs of production.

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• The pharmaceutical sector stands out in terms of its dependence on patents to capture returns on research and development (R&D).

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• Several policy options exist within and outside the patent system to attenuate the negative price and welfare effects of patents, especially on pharmaceuticals.

The past decades have seen more systematic efforts to use the tools of economic analysis to support discussions on health policy. The WHO Commission on Macroeconomics and Health (WHO, 2001a) was a major milestone along this road. This study does not attempt to advance economic analysis and the theoretical understanding of the economics of technology innovation and access issues. Rather, it recognizes the growing importance of economic concepts in policy debate, and it briefly reviews the main economic concepts and the current body of literature dealing with the IP aspects of these issues.

In the economics of innovation and IP, knowledge or new, useful information has been considered to have, to some extent, the classical characteristics of a public good: non-excludability and non-rivalry. Non-non-excludability means that it is not possible to exclude others from using the knowledge once it is made public. Non-rivalry means that one person’s use of the knowledge does not restrict or diminish the amount of it available or its value for use by others. Its non-rivalrous character means that knowledge can be easily shared and replicated. In the absence of some kind of protection against unauthorized sharing or replication, private entities may not invest in the creation of knowledge, since others could benefit for free from their efforts once the knowledge is public. Therefore, for the original private investors, generating a reasonable level of return on their investments might prove difficult.

Consequently, where investments can be recouped only through sales, no protection at all would lead to chronic underinvestment in the creation of knowledge, or, in other words, markets would fail to produce knowledge in socially optimal quantities.

Economists wrestle with the question of how best to finance the creation of new knowledge, particularly when private investment is involved. Special challenges arise in

the area of medical technologies in general and medicines in particular, given the long product development times, the necessarily stringent regulatory burden, the relatively high risk of failure (such as when pharmaceuticals fail tests on safety and efficacy at a late stage in their development) and the comparatively low marginal costs of production.

The patent system can result in a net social benefit.

While patents may increase costs to society in the short term by restricting competition, it is hoped that they generate greater and more dynamic benefits as a result of encouraging more innovation in the long term.

The requirement to disclose the invention in patent applications helps to disseminate scientific and technical information that could otherwise be kept secret. In these circumstances, society benefits from research conducted by those “standing on the shoulders of giants” to create additional new and useful inventions. Patents can also be useful instruments for obtaining finance (venture capital).

Costs associated with research in the pharmaceutical sector are high, but once introduced into the market, it has been relatively easy for other companies to reverse engineer new pharmaceutical compounds and market generic versions at much lower prices. Several studies have shown that when an array of different choices is examined – patents, trade secrets, lead times and other business strategies – the pharmaceutical sector stands out as the one that depends most on patents as a means of capturing returns on R&D investments. This finding has also been borne out by large-scale, multi-sector industry surveys conducted in the United Kingdom (Taylor and Silberston, 1973), the United States (Mansfield, 1986;

Levin et al., 1987; Cohen et al., 2000) and many other countries (WIPO, 2009). However, the advent of biologics is changing the industrial organization of the industry, as biotherapeutics are not as easy to reverse

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engineer as traditional small-molecule innovations. As a result, trade secrecy surrounding the production process has turned into an important protection mechanism for biotherapeutics (Price and Rai, 2015, 2016). While biologic innovator companies regularly seek product patent protection, details of the manufacturing processes that are not covered by those patents may be kept as trade secrets. It has been observed that this combination of protection by patents and trade secrets can complicate achieving sufficiently similar production processes for similar biotherapeutic products (SBPs). In addition, it has been argued that, due to the 12-year regulatory exclusivity period for biotherapeutic products in the United States, companies might rely rather on trade secrets than patent protection, which would lead to a lack of disclosure (Price and Rai, 2016). On the other hand, the view has been held that, in the future, technological advances may further enable reverse engineering even for biological therapeutic products and would reduce the value of trade secrets for manufacturing processes (Weires, 2019).

The period of commercialization of a medicine under patent protection is typically much shorter than the patent term (period between grant and expiry). It has been estimated that the effective patent term of a new medicine, which is the balance remaining in the patent term after obtaining the relevant regulatory approvals, is an average of 8 to 13.5 years in the US market, depending on the source (US Congress, Office of Technology Assessment, 1993;

Grabowski and Kyle, 2007; Aitken and Kleinrock, 2017).

The pharmaceutical sector has a higher accounting rate of profit compared with most other industries, which, according to the US Government Accountability Office, was just over two times the average profit margins for the 500 largest companies in industries other than pharmaceuticals and software in 2015.³⁴⁹ The majority of spending on biomedical R&D is undertaken in only a few countries, while medical innovation benefits patients around the world, when and where it is accessible and affordable (Viergever and Hendriks, 2016). This raises the question of how the R&D expenditures should be equitably shared among countries.

According to the National Science Foundation, US pharmaceutical companies invested three times as much in R&D, relative to their sales, than the average US manufacturing firm in 2015.³⁵⁰ Moreover, most of the investments made in R&D performed by pharmaceutical companies in the United States come from the relevant companies themselves, rather than from outside funding sources, including the US federal government.³⁵¹ In order to understand the effect of pharmaceutical product patents, several attempts have been made by economists to simulate the effect on prices and welfare of the introduction of pharmaceutical patents. One study found that the extent of price reduction after patent expiry varied greatly between products and countries

and concluded that future research should gather more country-specific data (Vondeling et al., 2018). One such study concludes that the introduction of product patents on pharmaceuticals in just one therapeutic subsegment in India would lead to significantly higher prices and welfare losses, which are estimated to range from US$ 145 million to US$ 450 million per year (Chaudhuri et al., 2006). On the other hand, a study using Indian pharmaceutical market data on central nervous system medicines, from 2003 to 2008, showed little evidence of substantial increases in average pharmaceutical prices in this market, but statistically significant price increases of about 12 per cent in one segment of this market, namely, products protected by a compound patent (as opposed to secondary patents) (Duggan and Goyal, 2012). However, these findings are limited by narrow inclusion criteria and failure to account for “mailbox”

patents,³⁵² wherein the Indian post-TRIPS amendments to the Patents Act included a clause that allowed Indian generic companies to continue to manufacture medicines for which patents were granted in India with applications filed since 1995, upon payment of a royalty to the patent holder. Further studies done with data after 2015 will shed light on more systematic effects on prices, as the mailbox patents will have expired.

Price regulation, whether in terms of direct cost-plus or indirect price reimbursement models, including those based on reference pricing, can be efficient means to lower prices, but they have to be worked out carefully in order not to result in medicine shortages in the market.³⁵³ Compulsory licences have also been reported as having resulted in substantially reduced prices of patented medicines during the patent term (see Chapter IV, section C.3(a)(ii)). However, compulsory licences may have limited effectiveness for more complex technologies such as biotherapeutics, as they do not oblige the patent owners to cooperate in divulging trade secrets about production processes, transferring the additional know-how and/or transferring materials that might be required.

Permitting parallel imports does not automatically result in lower prices. The reason is that parallel importing is not determined solely by the IP regime chosen by a country.

Rather, it also depends on the conditions in the individual contract between the manufacturer and the wholesaler, as well as on the differences in the marketing authorization granted, including, for example, the trade name of the product, which may vary from one jurisdiction to another.

Another potential solution is differential or tiered pricing, under which lower prices are applied in poorer countries (see Chapter IV, section A.4(g)). In order to maximize profits, a monopolist selling under different market conditions could use a form of price discrimination based on differing willingness and ability to pay for the product.

One alternative to differential pricing is uniform pricing, whereby the seller sets one price, adjusted for transport,

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distribution and other costs, for all consumers in all countries. It should be noted that parallel importation by design limits the ability to segment markets and employ price differentiation, among countries in which parallel importation is possible and practised.

A medicine protected by patents should, in principle, lend itself to differential pricing. In such circumstances, both consumers in poorer countries and patent-owning companies would be better off. It would also seem that, in these circumstances, the market itself could move closer to solving the problem of equitable sharing of R&D costs.

In order for price discrimination to occur, three conditions would need to be fulfilled:

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ƒ The seller must have some control over price, such as some degree of market power

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ƒ The seller must be able to identify and segregate consumers according to varying price sensitivities

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ƒ The seller must be able to limit resale from low-priced markets to high-priced markets or, in other words, must be able to segment the market (Watal, 2001;

see also Chapter IV, section A.4(g)).

However, in practice, there is little evidence that pharmaceutical companies engage in differential pricing based on per capita income (Scherer and Watal, 2002;

Watal and Dai, 2019 – see Box 2.20). Flynn et al. (2009) showed that, in the case that income distribution in the local economy is unequal, the firm will maximize its revenue by selling a restricted quantity to the wealthy at a high price, resulting in relatively similar prices between countries of different per capita income levels. Danzon et al. (2015) found evidence that income inequality does contribute to relatively high drug prices. Besides, they

found that, in such markets, prices of originator products are only slightly reduced, even after generic entry.

In addition to concerns about the price or affordability of patented medicines, concerns have been raised about delays in the availability of these medicines in other countries from the date of first approval in the first country. One study (Lanjouw, 2005) found that, while for high-income countries, patents unambiguously encourage the introduction of new drugs, companies tend to launch products later where there is price regulation. The picture is mixed for the other countries.

Lanjouw concluded that, for LMICs with a high capacity to manufacture generic versions of new drugs, introducing strong IP protection may mean having fewer new drugs on the market, as patent owners may delay entry due to expectations of low ability to pay, and generic producers cannot enter due to patent protection. On the other hand, while price regulation makes it less likely that new drugs will be available quickly in LMICs, such regulation does not appear to prevent new products from being launched eventually.

This research has been taken further by others, including Kyle and Qian (2014), who examined the effects of patent protection on availability of new medicines and found that patents do encourage launches of these molecules in local markets. Cockburn et al. (2016) also conclude that, while originator companies tend to launch later where there is price regulation, longer and more extensive patent rights accelerate product launch across all countries.

Following these studies, a WTO working paper (Watal and Dai, 2019) studies both the question of availability and affordability with respect to innovative medicines in a post-TRIPS era (see Box 2.20).

Box 2.20: Product patents and access to innovative medicines in a post-TRIPS era

Watal and Dai (2019)³⁵⁴ investigated two questions: (1) How does the introduction of product patents for pharmaceuticals affect the likelihood of pharmaceutical firms launching new and innovative medicines in those markets? (2) For innovative medicines,³⁵⁵ how much do patent owners or generic pharmaceutical firms adjust their prices to local income levels?

Using launch data from 1980 to 2017 covering 70 markets, the study finds that introduction of product patent for pharmaceuticals in the patent law has a positive effect on the likelihood of earlier launch, especially for innovative pharmaceuticals. However, this effect is quite limited in low-income markets. Also, innovative pharmaceuticals are launched sooner than non-innovative ones, irrespective of the patent regime in the local market.

Using a panel data set of originator and generic prices from 2007 to 2017, the study finds evidence of some differential pricing for both originator and generic products. Overall, originators differentiate by about 11 per cent and generics by about 26 per cent. Differential pricing is larger for pharmaceuticals to treat infectious diseases, particularly for HIV/AIDS medicines, than for those to treat NCDs. However, pharmaceutical prices are far from being fully adjusted to local income levels in either case. It is clear that competition, especially that within a particular medicine market as opposed to the market of medicines that treat similar medical conditions, can effectively drive down prices in both originator and generic markets.

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Some countries provide incentives to originator companies to introduce their products soon after first marketing anywhere in the world, by counting the term of test data exclusivity from the date of first approval globally, as opposed to the date of first approval in that country. For example, Chile has implemented such a system following the US–Chile FTA (Fink, 2011).³⁵⁶ For countries with a weak regulatory framework, somewhat delayed introductions, on the other hand, have the advantage of avoiding adverse events associated with withdrawals for safety reasons.

Finally, it is important to note that patents and other IPRs are meant to be market-based instruments. They play a limited role in providing incentives to develop new medicines for “neglected diseases” or “diseases of the poor” in regions where there are small markets.

Thus, the ongoing debate on access to medicines has generated a debate on alternative non-price-linked mechanisms for incentivizing innovations, such as prizes or advance market commitments (AMCs), and it has spawned new business models such as product development partnerships (PDPs).³⁵⁷

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