The Distortions from Tariffs and the Distortions from Patent Monopolies
Jim Tankersley had a very interesting piece in the NYT on how clothing manufacturers manage to minimize the impact of tariffs. The gist of the piece is that the tariffs led to very few jobs in the United States, but instead cause companies to spend lots of time gaming the system. We would presumably rather see them spend their time trying to design better products and production techniques.
While this a very interesting piece, that is written in reference to Donald Trump's latest and future rounds of tariffs, it would be interesting to see a similar piece in reference to patent monopolies, especially in the case of prescription drugs. While the tariffs discussed in the piece range from 7 percent to 27 percent, in the case of prescription drugs, patent protection often raises the price by a factor of 100 or even more. This is equivalent to tariffs of 10,000 percent. The vast majority of drugs would sell for ten to twenty dollars per prescription in a free market, instead of the hundreds or thousands of dollars that are charged as a result of patent protection.
Patents have a purpose (as does all protection), providing an incentive for researching new drugs. But there are other mechanisms for financing research (see chapter 5 of Rigged and this paper). To have a basis for assessing the merits of the different systems we need to know the costs they imply.
In the case of patent monopolies, these costs are enormous. The NYT piece goes through the efforts companies will go through to avoid tariffs of 20 percent — think of the efforts that people can and do go through to avoid patent monopolies that are equivalent to tariffs of 1000 percent.
The most obvious is buying drugs from overseas. In some cases, this is a fine solution, apart from the inconvenience. The drugs disbursed by pharmacies in Canada and West Europe meet the same sort of safety standards as our drugs. However, in some cases, people deal with less reputable distributors who might ship drugs from countries with less adequate safety precautions. In these cases, people may suffer serious harm and not be effectively treated. In other words, the cost of patent protection on drugs is some people's health and even lives. Even when they do get drugs from reliable distributors the time involved can often be a health issue.
Patients and doctors will also try to game insurers, who want to avoid paying for expensive drugs. In some cases, this may mean that a doctor prescribes a drug for a condition the patient does not have so that the insurer will cover the treatment. This could lead to problems for a patient later since their medical records will be incorrect.
Patients also spend lots of time shopping around for cheaper prices, since monopoly pricing leads to large variations by source. It is probably not a good thing that cancer patients or people with heart conditions, drive around for hours (or a family member) to be able to get prescriptions at an affordable price. This would not happen if the drugs sold for their free market price.
And, we have a whole industry, pharmacy benefit managers, that is set up as an intermediary between drug companies and insurers and hospitals. This is a needless source of waste which would not exist if new drugs were sold for $20 or $30 per prescription in a free market.
The monopoly also encourages drug companies to engage in rent-seeking behavior. First and foremost this means misrepresenting the safety and effectiveness of their drugs in order to maximize their monopoly profits. Since the drug companies have access to their data, and no one else does, they are able to get away with these sorts of misrepresentations to a very large extent. It helps that, with their monopoly rents, they can pay off prominent researchers and doctors to promote their products.
The drug companies can also pay off politicians to support favored treatment for drugs in public programs like Medicare and Medicaid. In fact, they can and do pay them off to require private insurers to pay excessive prices for drugs of little value.
And, patent monopolies distort the research process itself. Drug companies will often spend large amounts of money developing drugs that essentially duplicate existing drugs, with the hope of getting a portion of the patent rents. While it is generally of some benefit to have multiple potential treatments for a condition (some people may react poorly to a specific drug), in general, research money would be better spent on developing drugs for conditions where there is no effective treatment.
Drug companies also commonly make payoffs to generics to keep them from entering their market when their patent has expired. They also will file patents of dubious validity as a way to discourage new entrants. There is a fundamental asymmetry in any legal battle between a brand manufacturer and a generic. The brand manufacturer is fighting to sell the drug at the monopoly price whereas the generic company is looking to sell the drug at the free market price. In this context, the brand manufacturer has an enormous advantage since they have so much more at stake.
Anyhow, it is good to see the NYT writing about the waste that results from ill-considered tariffs. It would be great if it would run a piece that talked about the hugely greater waste that results from patent protection in the prescription industry, a sector of the economy that now accounts for 2.2 percent of GDP or $440 billion a year.
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Reposted from CEPR
