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Innovation, patents, and trickle-down economics

  • Published at 09:59 pm January 27th, 2018
Innovation, patents, and trickle-down economics
It sounds ridiculous, but there is a new drug treatment in the market that will cost $850,000 per treatment for a single patien. That’s the price of Spark Therapeutics’ break-through new product Luxturna, which treats a rare kind of blindness using gene therapy. But how can anyone justify that sort of price? Does it really cost that much to produce the drug for one treatment? That answer is no; it is actually rather cheap to produce. But it did cost billions of dollars – yes, really, billions – to develop this one drug, which, at the expiry of the patent, will become very much cheaper. This is one of those areas where trickle-down economics really works.

Research and development

New drugs are an example of a public good, in that, they require a huge amount of initial expenditure that no private firm would bother with under free-market conditions.
Just about every technology has started as the play-thing of the rich, or has been exclusive to them, until the one thing that market capitalism is very effective at swings into action -- making things cheap.
It costs billions to come up with the idea of a new drug, test it, then get it through the process of gaining a licence to sell it. There are also many drugs which get part of the way and then fail, these have to be paid for as well, somehow. But once all of that work has been done, it is very cheap to copy that drug. This poses something of a problem. Who will pay those billions to research and develop a new product if someone can just then copy it and make money selling it for cheaper? How can anyone make money out of developing new drugs if they can’t stop people from copying?


Our answer – perhaps not the very best one but one that does work – is that the people who do that development work get an exclusive licence to sell the new drug for some period of time. This is usually referred to as a patent and they last 20 years. After that, anyone can copy the drug and sell it. So, what we do is give people a monopoly for the life of that patent in order that they can at least try to make their money back from the development process. As I said, it might not be a perfect system but it is one that works to at least an extent. People do develop new drugs given such patents, after all. As for the price, that’s easy enough. There are only some 1,000 people a year in the US who might benefit from the treatment, not all of whom will qualify. So the market is relatively small in terms of number of consumers. Companies have 10 years (usually, drug licensing comes half way through the patent term) to make their billions back, which means the price has to be quite steep, although there will be many schemes for certain people to receive low-cost treatments.


After the patent runs out, anyone can make the drug and sell it, and since the production cost is relatively low, generic manufacturers will pour into the market and the price will collapse. This is, as I say, an example of trickle-down economics actually working. Normally, the phrase “trickle-down economics” is used as an insult to make fun of the idea that if we don’t tax the rich then that money will somehow trickle down to the rest of us (which never happens). But in the development of new products, it’s an idea that actually does work. Just about every technology has started as the play-thing of the rich, or has been exclusive to them, until the one thing that market capitalism is very effective at swings into action -- making things cheap. I’m old enough to have been already an adult when the first mobile phone call was made in England. The handset cost more than many used cars I’ve had over the years, airtime was $2 a minute. Today, you and I, less than a lifetime later, can get a phone and near unlimited annual access for less than $100. The phone is very much better too – including internet access which that first one most certainly did not. That’s an example of trickle-down. The same was true of cars – the first models were on the roads in the 1890s, by 1920 Henry Ford had made the Model T something that the average worker or farmer could well afford. Well, the average American worker, that is. A microwave cost thousands in 1950s dollars when it first came out; computers used to be massive machines only the very largest corporations could afford; which brings us back to our smartphones, each of which is more powerful than the computers than the Apollo Project used to get to the moon!

What about equity?

It’s also true that it all seems most unfair; that those few Americans with good insurance will be able to get an $850,000 treatment to save their sight when there are people going blind for lack of something simple like Vitamin A in their diet. It’s even possibly true that the patent system isn’t the right way to deal with this basic problem, how do we compensate people for the development work which can then so easily be copied? But there’s no doubt at all that some system has to be used to do this and patents have that one great benefit in that they visibly do work, they do achieve that goal. They make trickle-down economics work. What is currently some play-thing of only the very rich will be, in one or two decades, a standard part of the medical treatment available to us all. But without that initial patent period during which some people are hugely benefited but some others are temporarily deprived, the product wouldn’t exist at all. The fact that, eventually, the drug will be affordable to all, is worth the initial sacrifice; that is, equity issues get balanced out over time. This is so much so that Hal Varian, Google’s chief economist, tells us that predicting the future is rather simple. What is only for the rich these days will, in a decade, be a middle class commonplace and, in two, be available to all. That is, trickle-down economics works as long as we define it correctly in the first place.   Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.