Reverse settlements, part 2: drug company profits

In my second post, I want  continue my discussion of reverse settlements.  Recall that the basic argument against reverse settlements is that they extend the duration of a pioneer drug company’s patent beyond what it might expected to be if there were no settlement.  (Elhauge and Krueger (Texas Law Review, 2012) have a nice description of the settlement process that yields this result.  For now I will take it as given.)  In my first post I questioned whether drug patents reduce total welfare.  In this post I question whether extending drug patents raise producer welfare at the expense of consumer welfare.  I will argue that the profits pioneer drug companies make under patents overstate producer surplus.  Producer surplus depends on not competition in the drug market but rather on how competitive the market for research and development for the drug was.  But we have little evidence on how competitive that market is.  It is possible that that market is perfectly competitive, in which case, in expectation, drug companies are making no supra-competitive profits.  No such profits would mean no excessive producer surplus, and no antitrust concern, even with its consumer surplus focus.

At the risk of being repetitive (and thereby pedantic), let me restate the conventional tradeoff when setting patent duration, but from the perspective of producer versus consumer surplus as conventional antitrust analysis sees it.  An innovator – in drugs or another product – gets a patent if they come up with a valuable innovation.  This patent allows the innovator to charge a high (monopoly) price and thereby earn supra-competitive profits.  These profits are treated as producer surplus (though I will question that).  The high producer surplus comes at the cost of low consumer surplus.  This is partly because surplus is a zero sum game: total surplus is either consumer surplus or producer surplus.  This partly because the high prices that generate high producer surplus reduce total surplus by pricing consumers out of the market (ignoring my first post on reverse settlements).  When a patent ends, competition starts and the market price of the previously patented drug falls.  This increases consumer surplus, at the expense of producer surplus.  If total sales also rise, total surplus also rises, which also favors consumers.  Thus the duration of a patent determines how long producers enjoy high producer surplus and when high consumer begins.

Given this background, it is possible to see why antitrust law cares about the duration of patents.  Antitrust law and antitrust authorities – for distributional reasons it appears to me – favor consumer surplus over producer surplus; I will take this preference as given.  The more quickly a patent ends, the sooner consumers start earning higher surplus.  For this reason, antitrust law is opposed to reverse settlements if they increase the expected duration of patents.

The problem with this logic is that the producer surplus created by patents is not fully producer surplus.  The purpose of this producer surplus is to encourage innovation.  In the absence of innovation, consumers would be worse off because they would not have the innovation required to generate high consumer surplus once patents expire.  Thus, antitrust law should not judge producer surplus in the patent setting the same as it is in the non-patent setting.  It should not be judged against a baseline of zero-producer surplus.  Instead, it should be judged against a baseline of innovation with shorter patents.  If patent duration is shortened, consumers will obtain less innovation and less consumer surplus.  That reduced consumer surplus should be subtracted from producer surplus observed due to patents and credited as consumer surplus.  (If this were not the case, antitrust law would want to eliminate all patents!).

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Twitter Round-Up (1/20-1/26)

By Casey Thomson

Though simply the consequence of bad translation, the story of the Harvard geneticist George Church looking for a woman to act as surrogate for a Neanderthal clone shocked the internet bioethics world. A look at the problems with this hypothetical situation is just one of the components of this week’s Twitter Round-Up.

  • Frank Pasquale (@FrankPasquale) linked to an opinion piece discussing the reasoning behind the United States’ place in the world rankings of life expectancy at different stages of life. The news is a big hit to ideas of American exceptionalism: according to a report by the National Research Council and the Institute of Medicine, Americans have a substantially higher death rate for those younger than 50 as compared to Western Europeans, Canadians, Japanese, and Australians, but once they reach the age of 80, they have some of the longest life expectancies globally. (1/20)
  • Arthur Caplan (@ArthurCaplan) shared his article on why Neanderthal cloning is a bad idea, both in terms of safety and in terms of avoiding cruelty. (1/22)
  • Arthur Caplan (@ArthurCaplan) posted a news story on the reopening of bird flu experimental procedures for vaccine creation. Caplan was quoted in the article as stating: “I have no issue with restarting the research but some issue with where they are going to publish it and where they present it because bad guys can use it too.” (1/23)
  • Daniel Goldberg (@prof_goldberg) included an evaluation as to the medical disparities occurring in Colorado, particularly between races. The article emphasized in its conclusion that the existence of the disparities themselves is quite clear, but discussion on how to erase such differences is noticeably absent. (1/23)
  • Michelle Meyer (@MichelleNMeyer) retweeted a post that attempted to quantifiably compare the quality of care in Medicare options, namely whether Medicare Advantage plans 1) will eventually shortchange patients by skipping out on care quality because of profit motive or 2) have incentives to improve care quality because of the newly implemented systematic quality monitoring, where poor ratings impact them financially. The author found that most existing data makes the second theory more compelling, though the amount of data regarding the subject in general is largely lacking. (1/24)
  • Michelle Meyer (@MichelleNMeyer) also shared a link to an explanation of the intricacies of “personalized regulation” in medicine, which aims to preserve patient choice in an era leaning more and more towards paternalistic medical oversight. Understanding that patients may choose to make rational decisions that diverge from the community or committee consensus is key towards improving medical care to better reflect patient wants, and rights. (1/24)
  • Arthur Caplan (@ArthurCaplan) included a story on the large imbalance in misconduct reports in research between the genders. Men overwhelmingly led the charge, with only nine women out of the 72 faculty members who committed research misconduct. (1/24)
  • Michelle Meyer (@MichelleNMeyer) additionally shared a letter written by the Editor of The Hastings Center’s Bioethics Forum on the reasoning behind publication of a controversial article on the social pressures leading to obesity. The letter calls for the importance of recognizing that publication means that an article contributes to the larger debate on an issue, though does not affirm that the publication medium agrees with the views espoused within; it also encouraged responses to the ideas of the article. (1/25)
  • Stephen Latham (@StephenLatham) posted a video link from Comedy Central on the perils of WebMD and vegetarianism. (1/25)

Note: As mentioned in previous posts, retweeting should not be considered as an endorsement of or agreement with the content of the original tweet.

Petrie-Flom Interns’ Weekly Round-Up: 1/19-1/25

By Hyeongsu Park and Kathy Wang

A different perspective on reverse settlements

Before I begin my initial post, I want to thank Holly for inviting me to post on this blog.

I want to take up reverse settlements in litigation over pharmaceutical patents.  Circuits are divided on how to treat these settlements under antitrust law (Elhauge & Krueger, Texas L. Rev., 91:283, 285, 2012).  The Supreme Court has decided to take this the topic up this term; it will hear oral arguments in Federal Trade Commission v. Watson Pharmaceuticals on March 25, 2013.  However, this is a topic about which I believe the legal literature has lagged substantially behind the health economics literature.  As a result, I think the conventional (legal) views of such settlements get the economics of pharmaceutical patents and innovation wrong.  (That does not mean they are getting the law wrong. Although the law in this area is highly unsettled, the goal of the law may not coincide with economic prudence.  I am commenting primarily about economic prudence.)

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