- This chapter is adapted from an article published in The World Economy: The Americas 24(6): 779-95.
Perhaps the most critical task currently facing the global economy is devising mechanisms that encourage research aimed at finding treatments for diseases that are common in impoverished nations and that achieve widespread international distribution of those treatments at sufficiently low costs to be effective and affordable. This issue has achieved prominence by virtue of the severe epidemic of HIV, which almost inevitably leads to the onset of AIDS, in Sub-Saharan Africa and, increasingly, in South Asia and Southeast Asia.
HIV/AIDS is not the only disease that plagues poor nations; malaria, tuberculosis (TB), and other maladies are equally lethal and debilitating. Indeed, HIV/AIDS is unusual in that strong incentives for pharmaceutical companies to develop treatments for sufferers in high-income economies have resulted in medicines that effectively permit patients to function well for many years before onset of the disease. In that regard, the current debate is about how best to transfer these medicines to poor countries. In contrast, virtually no research and development Page 208 (R&D) efforts are aimed at producing new treatments for malaria or TB. This situation arises largely because those who suffer are overwhelmingly poor and cannot afford medicines in sufficient quantities to cover R&D costs. The problem is accentuated by weak patent protection in potential markets, further reducing the willingness of pharmaceutical enterprises to develop new drugs and vaccines.
In economic terms, under the current system, the incentives to achieve efficient dynamic and static provision of medicines are grossly inadequate in the face of massive poverty. Two programs have been advanced in recent years to address the problem; these programs are considerably at odds with each other. On the one hand, the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) within the World Trade Organization (WTO) requires member countries to grant and enforce patents for new pharmaceutical products (Maskus 2000a; Gorlin 1999). More precisely, developers of new drugs have enjoyed exclusive marketing rights (EMRs) to all WTO members since January, 1995. Although product patents are not required until 2005 in the least developed countries, EMRs provide similar protection. Various economic studies suggest that this new regime could raise prices of new drugs markedly in developing countries (Fink 2000; Lanjouw 1998; Subramanian 1995; Watal 1999), though substantial uncertainty remains on this point.1 Thus, some possibility exists that patents will raise incentives for R&D in these neglected diseases (Lanjouw 1998). However, this policy shift does nothing directly to increase the incomes of patients, who would, if anything, become less able to afford new medicines.2
Conversely, considerable pressure has mounted on pharmaceutical companies to provide their drugs at marginal production cost (or less) to poor countries. Several firms have responded, such as Merck & Co., Bristol-Myers Squibb Co., GlaxoSmithKline PLC, and Abbott Laboratories. For example, Merck & Co. recently announced it would reduce the prices of two AIDS-controlling drugs in Africa by 40 to 55 percent, adding to sharp price cuts announced in 2000 (Wall Street Journal 2001a). Abbott announced that it would sell its two AIDS drugs, Norvir and Kaletra, at a price that would earn the company no profit (Wall Street Journal 2001b). To some degree, these actions are a competitive response to offers by two Indian producers of generic AIDS drugs, Cipla Ltd. and Hetero Drugs Ltd., to provide medicines at even lower prices. As we note in the next section, however, even at these prices, the drugs may be beyond the reach of most patients.
The research-intensive pharmaceutical firms that invented these drugs have three concerns about a low-cost distribution program. First, provision at marginal cost or lower adds nothing to firms' ability to cover the fixed costs of R&D. Second, although they may be willing to circulate their medicines cheaply, the firms are anxious to retain the exclusive distribution rights inherent in patents and EMRs. Indeed, this preference to forestall generic competition was the root of the Page 209 recent lawsuit raised by 39 drug makers in South Africa aimed at striking down that country's 1997 Medicines and Related Substances Control Act (Wall Street Journal 2001c).
Third, and perhaps most significantly, original drug developers worry that the availability of far cheaper treatments in poor countries could erode their price-setting power in rich countries. This erosion could happen directly through unauthorized parallel trade in drugs or indirectly through political pressure mounted by patients and insurance companies on health authorities to require significant price reductions. Because the vast bulk of returns to R&D are realized in the European Union (EU), the United States, and other industrial nations, pharmaceutical companies argue that such price spillovers would significantly hamper their incentives to develop new treatments.3
Control over patent rights in AIDS treatments is now before the WTO in a dispute raised by the United States against Brazil in February 2001. Under article 71 of Brazil's 1997 Patent Act, foreign firms must manufacture patented drugs within Brazil before three years have elapsed from patent grant. Failure to meet these working requirements could result in an order by the Brazilian Health Ministry to local firms to manufacture generic substitutes, a threat that currently faces makers of the AIDS drugs efavirenz (Merck & Co.) and nelfinavir (Roche) (New York Times 2001b). TRIPS appears to restrict considerably Brazil's ability to enforce working requirements. Thus, this case could set an important precedent concerning the ability of countries to limit private rights to exploit patents.
Putting these elements together, we see that drug development and distribution involve tradeoffs that implicate important principles underlying protection of intellectual property rights (IPRs). There is a strong global public interest in providing sufficient incentives for the continual development of new medical treatments for diseases that afflict the poor. Within the intellectual property system, these incentives stem largely from exclusive production and distribution rights provided by EMRs and patents. However, such rights may be inadequate for meeting the needs of extremely poor patients, who do not have enough income to purchase new medical treatments, even at low prices.
Furthermore, such rights are national or territorial in scope, meaning that governments may choose their own regimes concerning whether rights holders can prevent parallel trade.4 Indeed, TRIPS affirms that countries have the authority to decide whether exclusive rights are exhausted at national borders. The threat that products may be shipped from lower-priced countries to higher-priced countries reduces the enthusiasm of rights holders to supply them at low cost.
The current system generates numerous undesirable outcomes. First, there are not enough incentives to develop new treatments for endemic diseases in impoverished markets. The resulting high rates of infection and contagion impose external costs on Page 210 others both within and across borders, in part because of lower productivity. Surely, the industrial economies suffer some costs from slower growth in the afflicted countries. In this sense, development and provision of effective drugs is a global public good.
Second, demands that drugs be provided at marginal cost in some countries force patients in higher-priced countries to accept a disproportionate share of the burden of financing R&D cost recovery. Put another way, patients in lower-priced nations effectively free ride on the pricing systems of the United States and other industrial nations. In fact, the free riding has at least two dimensions. In addition to the low prices in poor countries, price controls in Canada, Europe, and elsewhere mean that patients in those nations provide limited contributions to recovering fixed R&D costs.5 In that context, U.S. patients and insurance companies bear the brunt of paying for R&D and any losses associated with distribution programs abroad. Thus, neither pharmaceutical companies nor their patients may be expected to embrace the costs of distribution and development.
Third, pharmaceutical firms chronically undersupply the medicinal needs of poor countries, partly because of limited exclusivity in rights, including the need to restrain parallel trade.
These problems point squarely to the need for further public involvement in encouraging new drugs and in procuring and distributing medicines. In this chapter, we set out a proposal for addressing the fundamental problems in a manner that is least disruptive to the international system of IPRs. First, it increases public assistance or public health budgets in the rich countries to fund purchases by a body such as the World Health Organization (WHO) of exclusive licenses to distribute selected medicines in poor countries. The license fees should be sufficient to cover all or a substantial portion of fixed R&D costs, thereby establishing a strong incentive for pharmaceutical and vaccine firms to produce new treatments. In terms of distributing these products in poor markets, the WHO would be free to do so at a per unit price less than its marginal private costs in recognition of the external benefits from improved health status. Finally, each country or region that avails itself of this program...