Why medicine wants to be cheap and how we can help

The puzzle

Why so expensive?
Why so expensive?

It is a puzzle in economics to find that the products of human invention, such as certain medicines, do not benefit the population because their prices are not affordable.  The tragic reality in the Philippines is that the services of competent health care professionals are reasonably priced, but the patient typically dies because he cannot afford medicine.  It doesn’t have to be this way.

It is not necessary to have a law that “controls” the price of medicine by government intervention.  Such a law is sadly counterproductive because the medicines targeted for price reduction are protected by patents, which are legal grants of monopoly. As no one else can sell the medicine, a controlled price, if set too low, can simply result in quantities sold also being too low [1].  It is ironic that this time some people will die not because the medicine is “cheap,” but because it has become unavailable.

What matters for the pricing of medicine

An alternative is to recognize that the manufacturing cost of medicine is actually quite low, but that compensation must still be paid to the medicine’s inventors. The manufacturing cost is called “marginal cost” by economists, and the compensation to inventors is called “fixed cost.”  The market will work well enough to make price equal marginal cost if there are many sellers, and if the fixed cost has already been paid for.  The typical example here is when the drug is no longer under patent, such as penicillin. Here, the retail price is quite affordable because the fixed cost is “sunk” and the marginal cost is low.

Making medicine affordable is therefore not difficult. The trick is to pay for the fixed cost of inventing modern drugs. How can we do that?

One is a serious but tongue-in-cheek solution: A Bill Gates or a great philanthropist could buy the patent from the drug company and then donate it to poor countries.  Gates needs only to buy a limited version of the patent – that exercisable in a poor country, so that the compensation to the inventor collected from consumers in rich countries is not affected.

Another, used by Brazil, is to threaten to confiscate the patent, as reported by Chris Anderson in his recent book, Free.  It worked in that case but I do not favor this approach because if it becomes widespread, it may undermine the incentive to invent. Why invent, if some government will take your invention away from you?

A possibly sensible approach is for government to use its powers to buy the patent, paying just compensation, and giving away the patent to local generic manufacturers.  Just compensation is not zero but need not be high if the drug involved has only a limited market in the Philippines.  Such an approach is allowed by the Takings Clause of the constitution.

Possible objections to public acquisition of patents

There are drawbacks to the use of public funds to buy patents, but they are surmountable.  One is that there must already be a domestic generics industry in the Philippines. This seems to be something that is almost already happening.

Another is that the generically produced drugs may not be exported.  It would be necessary to prevent smuggling of local products to rich countries.  Of course, the rich countries will help because they also will want to prevent such transactions.

Yet another is to ensure that the prices are truly affordable.  This requires competition among local manufacturers.  The government should not allow the industry to be dominated by only a few since this opens up a temptation to run a cartel.  This is perhaps the most difficult drawback to overcome because there is great potential for graft and corruption in the rent-seeking game of Limit the Number of Players through unneeded laws and regulations.

Finally, the consumers (doctors and patients) have to be convinced that the local version is effective.  Here, an independent testing facility paid for by independent parties (possibly NGOs or the World Health Organization) would be a crucial element for making the policy work.

What can be done now

Part of the approach sketched above can be implemented even without the use of public funds. Some drugs already in the public domain may be almost as effective as their newer patent-protected versions. Examples of such off-patent drugs are: chloramphenicol for typhoid, methformin for diabetes, and streptomycin for tuberculosis.  Here, all we need is to further develop the generic industry and to promote consumer acceptance.

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[1] Homework question for my economics students:  Is this statement correct?  Explain or defend your answer.

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2 thoughts on “Why medicine wants to be cheap and how we can help

  1. “Gates needs only to buy a limited version of the patent – that exercisable in a poor country, so that the compensation to the inventor collected from consumers in rich countries is not affected.”

    what does limited version of the patent mean? no parallel importation?

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    1. I think it means no parallel exportation. What is produced as a generic in the Philippines (because of what Gates has donated) cannot be exported to another country. Something similar already exists with respect to copyright on textbooks sold as “international student editions.” Such books cannot be exported to the original home country of the author.

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