Should we move from patents to prizes?

An interesting article by Charles Silver and David A. Hyman argues that we should do away with patents for pharmaceuticals and move to a prize based system.  They write in Vox:

A well-designed prize regime would lower drug prices by eliminating drug monopolies, yet it would also create the necessary incentives for innovation, including incentives to develop so-called “orphan” drugs (for diseases that afflict relatively few people).

The prize system could also be tailored to encourage drug companies to test the efficacy of old drugs for new uses. Finally, a prize regime would place the costs of drug innovation on budget, where they would be borne by all taxpayers rather than just by consumers who happen to need drugs (and their insurers).

Prizes are attractive on a theoretical since they can drive drug costs down to marginal costs (which increases demand and short-run social surplus) while still compensating innovators for the risk taken (making these dynamically efficient).

Implementing a prize-based reimbursement system in practice, however, is much more challenging.  As I wrote way back in 2006 in my “Prizes or patents” post:

Prizes work only if we know exactly which innovation society needs; this limits their scope.  For instance, it would have been impossible ex ante to have had a prize for the inventor of the cell phone, since no one had conceived of the concept before it was actually developed.

Also, using prizes has large informational demands.  How large should the prize be?  It must be high enough to induce researchers to search for cures, but setting a prize too high would use up valuable funds which could be used in other arenas.  How does one determine if a drug is a me-too drug or not?  If a vaccine provides immunity to AIDS for 50% of cases, would this development merit the full prize?  If not, how large should the prize be?  What if the vaccine was only 10%, or 1% or 0.1% effective?

Further, the value of any particular treatment is likely not known at drug launch.  For instance, let us say that a clinical trial for a cancer drug shows that it reduces mortality by half over an 1 year period.  However, we don’t know how well the drug will work in the long run.  If we continue to see mortality falling by half many years out, the drug clearly is more valuable than another one where mortality differences narrow over time.   Prizes would need to be structured in such a way that evidence on treatment value evolved, the prize payment would need to evolve over time as well.

Prizes are also problematic as they may add uncertainty, decrease investment and limit choice. Consider the case where 3 pharmaceutical firms are in a race to develop a new treatment.  Currently, if all three companies discover effective treatments around the same time, they can all can compete to get some sales and it may even be the case that some drugs are better for certain subgroups and others are better for other subgroups.   Under prizes, if the first one is the one to get the prize, then the investment risk becomes very high. Investors required return on investment may need to be much higher than is currently the case to justify this added risk.  Further, the advent of ‘me too’ drugs which may have some beneficial effect for certain patient populations, would be unlikely to occur if the prize were no longer available to them.

In short, prizes may be an attractive way to stimulate R&D where little is occurring, but it is unlikely that prizes could ever effectively replace the current patent system.

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