Patent Protection and Innovation in Pharma

Viagra doesn’t grow on trees. Neither does Advil, Lipitor, or any of the myriad other drugs that make their way to the market. These biochemical breakthroughs are rooted in human innovations, not magic. Like most other human endeavors, innovation is thought to be encouraged by some pushing and prodding. Align the right incentives, build the proper protections, and human ingenuity might cook up a better pill (or compose a symphony, or invent the hula hoop). But the work of Yi Qian (assistant professor of marketing), published in The Review of Economics and Statistics, calls into question the degree to which innovation can truly be stimulated by the rights and restrictions codified in intellectual property (IP) protections.

Intellectual property rights were a concern long before the World Trade Organization (WTO) and countless other influential acronyms came into being. Many invitees to the 1873 International Exhibition of Inventions in Vienna opted not to participate out of fear that their ideas would be stolen and exploited around the world. Ten years later, the Paris Convention for the Protection of Industrial Property marked the first major treaty intended to develop international protection for intellectual creations. In the same spirit, the World Intellectual Property Organization (WIPO) was established in 1967. It became a specialized agency of the United Nations in 1974 with a mandate to “develop a balanced and accessible international intellectual property system, reward creativity, stimulate innovation, and contribute to economic development while safeguarding the public interest.”

As trademark monitoring was loosened, counterfeiting became easier and authentic companies actually engaged in more innovative practices to differentiate themselves from the counterfeiters.With such a broad, ambitious mandate, WIPO endured its share of political divisions, largely between developed and developing nations. Frustrated by treaty limitations imposed by WIPO’s developing countries, developed countries turned in the 1980s to the General Agreement on Tariffs and Trade (GATT) to establish international IP standards. The Uruguay Round of GATT negotiations from 1986 to 1994 gave birth to the WTO and the enactment of TRIPS (the Agreement on Trade-Related Aspects of Intellectual Property Rights), which outlines many standards for IP regulation.

According to Qian, IP regulation has always been controversial. “One strand of literature argued that patent law was critical for innovation,” she said. “By being promised the awardees of ex post monopoly rights, innovators have more incentive to engage in innovation ex ante.”

“But others refuted that,” she continued. “For example, in today’s world, when life cycles of products can be so short, the long procedure required for patent protection might render products inconsequential. Patent laws could potentially promote excessive litigation, as explained in a 2004 book by Josh Lerner and Adam Jaffe, Innovation and Its Discontents.  In addition, patent laws may even block sequential innovation, which is the building of subsequent inventions upon preceding ones, by fostering high licensing fees.”

In order to explore whether IP policies stimulate technological innovation, Qian focused on one particular type of IP protection: the implementations of pharmaceutical product patent laws in a set of countries from 1980 to1999. With global, annual spending on pharmaceuticals estimated in excess of $600 billion, and with development of an innovative, approved drug estimated to cost in the neighborhood of $1 billion, the pharmaceutical industry provides plenty of opportunity to investigate incentives and barriers to innovation. In 2006 the U.S. Patent and Trademark Office awarded almost 8,000 pharmaceutical-related patents to inventors around the globe, evidence that U.S. patents are among the most sought after in the world.

Hard-to-find data and limited analysis tools have handcuffed much prior research in this area, which is marked by inconclusive studies of single countries. “It’s very difficult to do research on non-OECD countries,” said Qian, referring to the scarcity of consistent, reliable economic data for countries that are not among the thirty relatively developed members of the Organization for Economic Cooperation and Development. Qian gathered data from different databases and used a sampling algorithm to match countries of similar characteristics, which let her draw causal inferences about the effects of national patent policies on domestic innovations. Qian used a novel combination of matched sampling and panel analyses. This approach allowed her to analyze data from ninety-two countries from 1978 to 2002. In the process, she honed in on twenty-six countries that provided an opportunity to analyze a “natural experiment.”

During the 1980s and 1990s, those twenty-six countries passed pharmaceutical patent laws, creating an economic researcher’s dream: a mix of ninety-two countries, twenty-six with brand-new patent laws, others that had already offered such protections, and others that still did not offer such rights. By comparing the amounts and “weights” of U.S. patents issued to each country’s innovators, and by examining time periods both before and after the new laws were passed, Qian was able to tease apart relationships between the presence or absence of patent protections and the amount of resultant innovation. Since not all innovations are created equal, some being more groundbreaking than others, patent weight reflects the degree to which a patent is cited as an influence by subsequent patents.

But such a simple set of comparisons alone could not make a clear case for or against the influence of patent regulations. For example, in addition to differences in the type and timing of patent policies, countries also differed in many other respects—such as their legal traditions, education levels, overall economic capacities, and economic freedoms—all factors that could influence pharmaceutical research and development, innovation, and patenting. Qian had to account for the influence of those features in order to attribute changes in patent awards to changes in IP law. A 70-year old statistic, called Mahalanobis’s distance, allowed her to do just that.

“Matched sampling has been used in various academic fields for a while, particularly in labor economics. But it’s not too frequently used in productivity economics,” said Qian, explaining her use of Mahalanobis matching. “Each country is a point in a multi-dimensional space, with its coordinates reflecting country characteristics such as gross domestic product, education, economic freedom, and the amount of the labor force involved in pharmaceutical production.”

Countries that clustered together in that multivariable space, for example, Denmark, Norway, and Sweden, thus shared a great deal in common on a wide range of innovation-relevant social, economic, and political features. By identifying clusters of similar countries among which the only major difference was the presence, absence, or type of patent regulations, Qian could attribute differences in U.S.-awarded patents to differences in IP regulations. For example, considering again our set of similar Scandinavian countries, Denmark enacted new pharmaceutical patent policies in 1983, while Norway had no such policies at that time, and Sweden already had such policies in place (Table 1).

Table 1: Matching pairs and timing of reforms

Note: Matched with the Mahalanobis method. Each country that implemented domestic pharmaceutical patent protection is matched with two countries as control groups: one country that did not have patent protection prior to the next reference period and one country that had patent protection prior to the reference period. Qian grouped the reforms into four reference periods.

Using this method, Qian came to this simple conclusion: “Patent protection alone is not a sufficient condition for innovation.” Her conclusion is supported by three different measures: U.S.-awarded patents (both raw counts and citation-weighted counts), pharmaceutical exports, and spending on research and development. Those same measures of innovation, however, were enhanced in countries with higher levels of economic development, education, and economic freedom. Qian thus concluded, as others have speculated, that regardless of IP protection some nations simply may not have sufficient innovation potential to take advantage of those protections. Some minimal levels of social, economic, political, and cultural capacity must be in place as the raw materials upon which IP policies may exert some positive influence.

“The patent system has positive contributions, but only in combination with the country’s own innovative potential,” explained Qian.

The positive influences of patent regulation’s can turn sour, however, if not prudently implemented and monitored. Qian noted an “inverted U” shape in the relationship between IP regulation and innovation. Compared to a totally lawless IP environment, increased patent protections nurtured innovative activities—but only up to a certain level. Too much regulation effectively suppressed or extinguished the generation of more and better innovations.

With the ink barely dry on this research, Qian has already begun to dig deeper into the interplay between IP policies and innovation. “Weighted patents only capture major inventions that have been patented in the United States. While these major innovations are interesting to study, I would also like to observe smaller innovations that were only locally successful. I’m extending the research by getting new data on pharmaceuticals in each country.”

Qian recently gained access to a large database of new chemical entity (NCE) developments by thousands of companies worldwide. She has conducted analyses using the number of NCEs in different clinical phases as innovation estimates instead of relying on U.S. patent awards. In another paper Qian studied the impacts and remedies of counterfeits, the flipside of IP rights. She found that as trademark monitoring was loosened, counterfeiting became easier and authentic companies actually engaged in more innovative practices to differentiate themselves from the counterfeiters. This suggests that IP rights law is not always a necessary condition for innovation. The central theme of her new research, however, is to test and propose effective means in combating counterfeits at both the company level and public policy level.

While not likely to put patent attorneys out of work anytime soon, Qian’s research may allow developing and developed nations to reconsider and fine-tune their IP policies. In so doing, nations may encourage more and better ideas and innovations, to benefit people within their own borders and around the world.

Further reading:
Jaffe, Adam, and Josh Lerner. Innovation and Its Discontents. New Jersey: Princeton University Press, 2004.

Maskus, Keith E. (2000). Intellectual Property Rights in the Global Economy. Washington, D.C.: Institute for International Economics.