“Prize-Grants” or Patents for Pharmaceutical Innovation?

Over at the American Enterprise Institute’s online magazine, Arnold Kling has proposed “prize-grants” in favor of patents for pharmaceutical research. Kling dislikes patents:

Patents have always been a problematic way to promote innovation. They raise prices of products far above marginal cost. They impose legal costs involved in obtaining, attacking, and defending patents. They provide an artificially high incentive to develop substitute products that devalue the patented invention. They create an artificial disincentive to develop complementary products, because the high price of the patented product limits its market penetration, adversely affecting would-be product complements.

These drawbacks are well recognized, and a better alternative would certainly be most welcome. The question is: Can there be a better alternative? Kling’s “prize-grant” has the features of both a prize and a patent:

The prize-grant would differ from an ordinary prize in the following ways:

• The criteria for winning the prize would typically be first suggested by the researchers, with funding institutions then assigning a value for the prize, prior to the research.
• Prizes often would be for incremental achievements, not just for spectacular accomplishments.
• Large pharmaceutical companies and other private firms would be just as eligible as nonprofit researchers to receive prize-grants.

We can think of the current intellectual-property regime in medical research as a grant-prize approach in which the prize is a patent. However, prize-grants differ from patents in the following ways:

• The prize for a successful result is specified by the funding institution. With a patent, the value of the prize is determined in part by patient demand but also by the purchasing rules of insurance companies and governments, by legal jousting, and by gaming of the system.
• Useful research that does not result in a patentable product gets rewarded under prize-grants, whereas under the patent system such research does not get rewarded.
• Regardless of the outcome of the research undertaken in pursuit of a prize-grant, findings would be immediately placed in the public domain. In contrast, patents set a term of monopoly on the use of information, during which the prices of patented products can be set far above production cost.

It is a very interesting idea, which I hope Professor Kling continues to develop. By way of constructive criticism, here are some obstacles that need to be overcome:

• How to determine the value of the prize-grant? If the funder is a passive responder with a limited budget, it needs some rule by which to prioritize. There is no way to determine, before the invention is on the market, what it will be worth. That is the great (often unsung) virtue of patents: They do not guarantee one penny of profit. The market determines the value of the product, and its ownership can be traded in the capital market during its entire life-cycle, giving continuous signals to other innovators.

• This is related to the problem of “incremental innovation,” which I have always thought exceedingly difficult to reward by prizes. Prizes have succeeded when they are given out for “big kahunas.” The most exciting modern prizes are likely those put forward by X Prize Foundation. One of its prizes is “a $30 million competition for the first privately funded team to send a robot to the moon, travel 500 meters and transmit video, images and data back to the Earth.” This is an outcome with two attributes: It is remarkably huge; and it can be independently verified without much quibbling, even by non-experts. It is easy to see how prize-grants for incremental pharmaceutical innovation (e.g., another painkiller) could become bogged down in disagreement, no matter how well specified the outcomes are when the prize is announced.

• Kling also cites Peter Huber’s excellent new book, The Cure in The Code, as evidence that the clinical trials and other hoops through which pharmaceutical innovators must jump are harmful to innovation. However, these are mostly erected by the Food and Drug Administration, not patent law. The two intersect in U.S. law, but only because Congress says so. The FDA itself needs significant reform to stop impeding innovation.

On the other hand, there would be a great benefit to a system like that promoted by Kling, which Kling himself does not describe. Pharmaceutical enterprises are corporate bureaucracies that blend R&D functions with sales and marketing, regulatory affairs, government relations, and other non-research functions. Licensing can overcome some of the managerial diseconomies of scope in such an organization. However, if there were a new system of pharmaceutical innovation that would allow more specialization in R&D versus other functions, that would be an exceedingly beneficial public-policy achievement.