The announcement by the Center for Medicare and Medicaid Services that ten drugs will be subject to price negotiation under the Inflation Adjustment Act has unleashed a storm of debate. Most observers agree that the negotiations will reduce spending for both consumers and taxpayers. The real dispute centers on whether the prospect of price negotiations will reduce future innovation by shrinking the expected future profits for patented drugs. But this debate sidesteps the larger issue of whether the patent system delivers the value it should in health care.
There is little doubt, and much evidence, that innovators respond to expected future profit. People are drawn to problems for which the rewards are great. We have seen this in our own work; one of us is a health care economist who studies innovation and the other a consultant who advises innovators in the health sector.
However, the incentives in the patent system are often not well aligned with creating economic value for patients and society. The incentives to innovate for important classes of drugs, such as new antibiotics and vaccines for infectious diseases, are inadequate for the need.
Perversely, patents can also create incentives for innovations that create very little value. For example, “life-cycle management” practices in which drug companies use secondary patents and other methods to extend their patents offer little benefit to patients and society. Patent protections can also skew the direction of research in unintended directions, for example away from diseases like early-stage cancers that require longer clinical trials, which effectively reduces the period of monopoly protection.
The heart of the problem is that patents, as they are structured today, are imperfect tools to stimulate innovation in health care. They use time-limited monopoly pricing as the primary incentive for innovation and discovery. But monopoly prices keep valuable therapies priced too high for many consumers, and time limitations skew the choice of disease targets and tempt drug companies to engage in wasteful life-cycle management tactics. The market test inherent in patents — a patent is valuable to the degree that there is a market for the drug — biases innovation toward the health issues of paying customers and rich countries.
The current dispute over drug price negotiations is a good time to consider alternatives to the patent system that may better align the incentives for innovation with the needs of patients and society.
One such alternative, patent buyouts, has been proposed by Michael Kremer, University of Chicago economist and Nobel laureate.
Kremer’s patent buyout proposal — articulated more than two decades ago — was inspired by the example of the patent for daguerreotype photography, which the French government purchased in 1839 and placed without charge in the public domain. As a result, this early form of photography was rapidly adopted worldwide.
Kremer’s plan envisions offering innovators the option of selling their patent rights to the U.S. government at prices equivalent to their estimated private value as determined at auction. The government would then make the innovations available to the public without requiring a licensing fee.
Patent buyouts eliminate many of the distortions that arise from today’s pricing model because the value of the innovation would not need to be recouped through market sales at monopoly prices in a fixed time frame. Under the buyout system, almost all new drugs would be sold and priced like generics. The social gains would thus be greatest for new drugs that would otherwise win a high price in the current system — typically branded drugs with few competitors. Life-cycle management would be a thing of the past. Indeed, this system, as with daguerreotype photography, might accelerate innovation by stimulating follow-up applications of the original discovery.
A patent buyout scheme is no panacea and presents many practical challenges. Auctions would have to be carefully structured to determine the correct price and, in some cases like antibiotics, additional subsidies might still be required to support adequate innovation. The government could misuse its purchasing power and force the sale of patents at confiscatory prices. Financing the purchase of patent rights will also require careful thought. These practical challenges, not to mention the political challenges of reforming the patent system through an act of Congress, are daunting.
However, it took nearly 40 years to authorize Medicare coverage of outpatient prescription drugs and an additional 20 years before CMS began to negotiate drug prices. Great change is often impossible until, suddenly, it is not. With the advent of this new era of drug price negotiation, now is the time to think about the changes needed to keep the engines of innovation in health care running far into the future.
James B. Rebitzer is the Peter and Deborah Wexler professor at Boston University’s Questrom School of Business. Robert S. Rebitzer is a national advisor at Manatt Health. Formerly he was a partner in the health care strategy practice at Accenture and a vice president of UnitedHealth Group. They are the authors of “Why Not Better and Cheaper? Healthcare and Innovation” (Oxford University Press).