Sunday, October 16, 2005

If economics were an honest profession...

In comments to this Marginal Revolution post Dean Baker writes
If economics were an honest profession, we would have hundreds of papers that compared the efficiency of patent financing of prescription drug research with other mechanisms (e.g. direct public financing, as with NIH, or prize funds). The basic arithmetic does not look good for patents. In the U.S., patent monopolies raise annual prescription drug expenditures by approximately $150 billion above what they would be if drugs were sold in a competitive market. For this $150 billion, the industry tells us that we get about $25 billion in research, roughly two-thirds of which goes to develop copycat drugs. In other words, we spend an additional $150 billion a year in higher drug prices to get about $9 billion in research on breakthrough drugs.

Where does the rest of the money go? The largest comnponent [sic]is the marketing campaigns that allow drug companies to maximize the value of their patent monopolies. While providing information is beneficial, providing misleading information and in some cases outright lies is not a social good. Of course, in some cases marketing includes various forms of kickbacks or bribes to doctors who prescribe certain drugs.

When it comes to trade tariffs on imported clothes or shoes, economists go nuts over intervention in a free market. But for some reason, economists don't consider patent monopolies on drugs, which can raise prices by several thousand percent above their competitive market price, a topic worth their time.
Some attack neo-classical economics because the logic of theory doesn't follow, or isn't as satisfactory as you may want (it's tautologous, basically). But Baker objects to economics here because of the topics it chooses to study. I want to believe that Baker is right, but I have yet to understand what it is that drives deep innovation: a corporate environment where you aren't supposed to "waste" resources, yet you also have to deliver measurable results every so often (because of monitoring costs) which precludes wild and wacky research; or a university or public sector environment where once you have a grant or a lab you don't have deliver measurable results (though you do if you want future grants you do), but you're allowed to be as interesting as you want. Which downside is worse: requiring a measurable product, or not requiring a product? This isn't rhetorical; I genuinely do not know what set of incentives line up best to foster creativity -- and then a product.


Blogger henry said...

Baker's ultimate point is disingenuous. Economists aren't doing research on things that are accepted as conventional wisdom. The conventional wisdom on trade tariffs is that they are bad because trade is mutually beneficial. The conventional wisdom on drug patents is that they are good because they allow for development of new drugs. It's not that economists are always pro-free-market and in situations where economists advocate government intervention they are suddenly dishonest. Basic economic theory recommends some intervention, as in the case of drug patents.

9:45 AM  
Blogger Isaac said...

Baker's argument is that the emphasis of economics -- the conventional wisdom of economics -- is generally towards policies that favor corporations: government intervention to help companies, free markets to help companies. This isn't necessarily a bad thing: growth is driven by business, after all. His claim is that the patent regime is un-necessary to generate innovation, that there are better ways. You might dispute that, but you have to make the argument. I agree that economic theory recommends some intervention in the drug market, but it can't specify a specific intervention that is best under all institutional regimes and all informational asymmetries. He claims that the regime we've chosen, while from the set of possible regimes allowed by theory, is not the ideal one. Further, it just happens to be one that benefits companies, whereas there might be others that don't.

2:31 PM  
Blogger Tom Bozzo said...

Baker also takes this on at MaxSpeak.

To offer a slightly different gloss on Baker's comment, I don't think he's disputing the conventional wisdom as such. Implicit in the comment, after all, is the CW that patent regimes trade off some deadweight losses due to the temporary monopolies for "more innovation" than the market w/o patents would provide. Baker is just asking one of the basic questions of applied economics: what are the benefits and what are the costs.

In health economists' defense, there is a problem here that it's next to impossible to get reliable (public) data on economic costs of drug R&D, though if Baker is right as to the relative magnitudes of the costs and benfits, it is something of a scandal.

I happen to think, as Baker implies in the MaxSpeak post, that some esp. left-of-center economists' advocacy of "free market" positions (e.g., on trade issues) at best strains the applicability of the Hicks-Kaldor-Pareto criterion, but that's a topic for another day.

3:27 PM  
Blogger henry said...


If that is Baker's argument (what you wrote is a bit more general than I picked up on), I would disagree. The conventional wisdom seems to be that one should *avoid* rents or profits: they are usually wasteful, as in the case of monopoly. The conventional wisdom is that you break up or regulate monopolies. Obviously this is not slanted towards corporations, since the goal of a corporation is to make a profit. Patents are an exception, but not an exception unjustified by the theory.

I'm not making an argument that patents are the best way to foster drug development. What I do have a problem with is that Baker seems to be implying that the patent case is an inconsistency in the conventional wisdom of economics. The standard theory justifies patents as much as it justifies free trade.


Again, I don't mean to fault Baker for asking whether patents are the best solution. I think that it probably is a question that needs to be asked.

6:35 PM  
Blogger Isaac said...


Ah, by CW are we referring to the analytical method, or the position on a given issue? I think you can maintain the claim that the CW of the economics profession on patent is that the trade-off is worth it; and no one would dispute (or certainly no one in this comment thread) the fact that weighing costs and benefits is the ideal method in this case. Baker is arguing that the conclusion in this particular case is wrong, and should be investigated further. He's not disputing the method. Moreover, he'd claim that there are other cases where economists mis-weigh costs and benefits in favor of corporations (for example free trade...).

I see your point about the economist's view on monopoly power. I think what Baker is getting at is a question of emphasis: why do economists care more about certain inefficiencies than others; which, given that it's a question of shading is rather hard to discuss analytically.


7:59 PM  
Blogger henry said...

By "conventional wisdom" I am referring to the position on the issue. The part of Baker's argument I object to is this:

1) Standard theory is that price should equal marginal cost.
2) Price does not equal marginal cost in the case of patents.
3) But the conventional wisdom is that patents are good.
4) The standard theory is not being applied consistently.
5) Ergo, corruption!

I would argue that (1) is false, that in cases where a first-best world is not achievable (charge marginal cost and get all the medicine you want), the second-best may involve a situation where price doesn't equal marginal cost. In the case of trade, the first-best world is achievable through free trade.

Of course this is just in the *standard theory* without any complications. The conventional wisdom is more or less derived from Intermediate Microeconomics applications of the standard theory. I don't think this is necessarily the best way to form an opinion. I think that economists tend to work on things that there isn't an answer for, even if that answer isn't totally fleshed out. But I don't think it's dishonest.

8:29 AM  
Blogger Tom Bozzo said...

Henry: I don't agree that (1) is Baker's starting point. CW on patents is that there is a quid pro quo -- incremental innovation to society in return for permitting innovators to collect temporary monopoly profits -- that makes the system worthwhile in principle. Then he assesses the terms of the deal, and makes a not unpersuasive case that the deal is raw. That is, the argument is:

1. Patents are supposed to trade off the bad of creating monopolies for the greater good of encouraging innovation.
2. It's an empirical question as to whether this works out for any market, depending on the actual costs and benefits.
3. A back of the envelope calculation suggests that costs exceed the benefits by so much in pharmaceuticals that it's not at all clear that drug patenting is the superior "second best" system for encouraging innovation.
4. Economists should be a lot more interested in refining (3) than they seem to be.

11:53 AM  
Blogger henry said...


I do agree that he has a point regarding the cost/benefit analysis. Where he starts talking about my (1) is here:

When it comes to trade tariffs on imported clothes or shoes, economists go nuts over intervention in a free market. But for some reason, economists don't consider patent monopolies on drugs, which can raise prices by several thousand percent above their competitive market price, a topic worth their time.

There is more in the MaxSpeak post you cite:

The Holy Grail in economics is that price should equal marginal cost. Yet, drug patents lead to situations where prices are hugely out of line with marginal cost, in some cases by a factor of 100 or more.


The $220 billion question (current U.S. spending on prescription drugs) is where are the economists? Remember, economists are people that get high blood pressure from 10 percent tariffs on shoes or pants. When Bush put a temporary tariff on steel imports that maxed out at 30 percent, economists all over the country became apoplectic. So why is the economics profession overwhelmingly silent about drug patents, which are the equivalent of tariffs of 300 percent on average, and affect a product that is much more important to our economy and our health?

This is separate from the argument about costs and benefits. Here he is saying, "Economists always want P = MC, thus they are dishonest if they don't advocate P = MC in every situation."

For the record, I am all for looking into whether patents are the best way of stimulating inventiveness of all types.

11:45 AM  
Blogger Tom Bozzo said...

I'd agree that Baker could have been more precise with his language. But I read what he's saying is that the goal is to achieve what I characterize as #1 with minimal (but almost surely non-zero) markups over marginal cost that yield the desired level of innovation -- now, I'm admittedly giving Baker somewhat of the benefit of the doubt, as he is a PhD holder from a reputable school, on this point. So the issue isn't necessarily that the markups aren't zero, but rather that they're so large that economists (who go ape over small distortions elsewhere) ought to consider whether they're efficiently small.

Clearly, we don't disagree as to the bottom line, so I'll leave it at that.

2:59 PM  

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