The Invention of an Investment Incentive for Pharmaceutical Innovation

• Published date: 01 December 2012
• Date: 01 December 2012
• DOI: http://doi.org/10.1111/jwip.12001
• Author: Shamnad Basheer

The Journal of World Intellectual Property (2012) Vol. 15, no. 5–6, pp. 305–364

doi: 10.1111/jwip.12001

The Invention of an Investment Incentive

for Pharmaceutical Innovation

Shamnad Basheer

West Bengal National University of Juridical Sciences

Pharmaceutical drugs are often hailed as the poster child for the propositionthat patents foster accelerated rates

of innovation.This sentiment stems, in large part, from the belief that pharmaceutical research and development

(R&D) entails significant costs and resources. I argue that if the role of the patent regime is one of fostering

higher amounts of investment in the R&D process,it is better served by a direct investment protection regime,

where the protection does not depend upon whether or not the underlying idea behind the drug is “new” and

“inventive”,two central tenets of patent law.Rather, anydrug that successfully makes it past the regulatory filter

ought to be entitled to protection, since its discovery and development entail significant investment and risk.

Owing to the sub-optimality of the current patent regime in protecting intensive pharmaceutical R&D

investments from free riders, I propose a comprehensive investment protection regime that helps recoup all

investments incurred during the drug discovery and development process. Though similar to existing data

protection regimes in some respects, it differs in others. Firstly, it enables a recovery of all R&D costs, and

not only costs associated with clinical trials. Secondly, unlike patentsand data exclusivity, which offer uniform

periods of protection, it rewards investments in a proportionate manner, wherein drug originators are entitled

to protection against free riders only until such time as they recoup their specific investments and earn a rate of

return on investment dependent inter alia on the health value of the drug.

I consider a pure marketexclusivity based investment protection regime but note thatit is likely to foster exces-

sive pricing and subject the market to the dictates of a single firm. In the alternative, I consider a compensatory

liability model based on a novelcost sharing methodology, where follow-onentrants are free to manufacture the

drug, but must pay a reasonable amount of compensation to the originator.Lastly, I consider a reimbursement

model, where the costs of drug discovery and development arereimbursed through public funding and prizes.

Once it is appreciatedthat the function of investment protection is better addressed through a separateregime,

the pressure on patents to fulfil a role for which it is not intrinsically suited, abates. This point is an important

one to appreciate, as the conflation between patent protection and investment protection has caused many to

argue for a dilution of the patentabilitythreshold.

Keywords innovation; patent; pharmaceutical; TRIPS

Most developed nations resortto two key legal instruments to incentivize pharmaceutical innovation,

namely patents and data exclusivity. In this article, I investigate the optimality of these legal regimes

to foster pharmaceutical innovation.Finding that they suffer serious shortcomings, I propose a novel

investment protection regime.

As far back as 1976, a commentator noted that “[w]ithout patents, the return from investment

in pharmaceutical research and development would fall to zero, and private companies would no

longer engage in research and development” (Schwartzman, 1976).

This sentiment continues unabated till this day, and even those that question the general nexus

between patents and innovation admit that the pharmaceutical industry is an exception (Roin, 2009;

Landes and Posner, 2003, p. 316).1Illustratively, Bessen and Meurer, two of the most vocal critics of

the patent system, note that “(i)n some industries, such as pharmaceuticals, patents provide strong

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Shamnad Basheer The Invention of an Investment Incentive

positive incentives to invest in innovation. But in many other industries, perhaps most, patents fail

to perform like property and they may actually discourage innovation” (Bessen and Meurer, 2008a,

p. 19; Bessen and Meurer, 2008b).

While this statement may hold true at a general level, I take issue with the underlying sentiment

that patents serve as optimal investment inducing instruments. I argue that if the role of the patent

system is conceptualized as one of fostering higher levels of investment into the pharmaceutical

research and development (R&D) process, this function is more optimally achieved through a direct

investment protection regime that does not depend on compliance with traditional patentability

criteria such as “novelty” and “inventive step” (Barton, 2003).2

In other words, a regime that grants comprehensive market exclusivity to new drugs against free

riders until such time as the investment in the discovery and development of that drug is recouped

is preferable to a patent regime. I elaborate upon such a regime in the ensuing parts. This regime

draws in some ways from existing regulatory data exclusivity regimes, which protect investment

costs incurred in the course of generating regulatory data through clinical trials, that is, “safety”

and “efficacy” data, which are required to be submitted to a drug regulatory authority to procure

marketing approval (Mossinghoff, 1999). This regulatory data generation accounts for a major part

of drug discovery and development costs (DiMasi et al., 2003, p. 165). Countries such as the United

States and the European Union countries (hereinafter “EU”) protectthe investments underlying this

data generation by granting a fixed term of marketexclusivity, during which time no competitor can

rely on the data submitted by the drug originator.

However, while a data exclusivity regime could be considered an explicit investment protection

tool and is therefore more optimal than a patent regime on this count, it suffers from certain

shortcomings. Firstly, it provides for a uniform period of protection, sans any consideration of the

specific investment made per drug or the health impact of a drug. Secondly, it only accounts for the

costs incurred during the clinical trial process and excludes significant investments made at the drug

discovery and pre-clinical stages.

I advocate a comprehensive, yet calibrated investment protection regime that grants protection

from free riders who threaten to disrupt the market share of the drug originator with a largely

“similar” drug molecule, until such time as the investments are recouped along with a rate of return

on the investment that broadly tallies with the cost of capital (CoC) and is commensurate with the

health impact of the drug (hereafter referred to as an “appropriate rate of return”).

I first consider a standard market exclusivity model, and note its advantages and disadvantages.

In the alternative, I consider a compensatory liability regime, which eschews any kind of market

exclusivity, leaving the drug originator with the mere right to claim reasonable compensation from

follow-on entrants.3I propose a new frameworkfor assessing fair compensation in this regard. I then

consider a reimbursement model, where the costs of R&D are reimbursed through public funding

and/or prizes.

Once it is appreciated that the function of investment protection is better addressed through

a separate regime, the pressure on patents to fulfil a role for which it is not intrinsically suited,

abates. This point is an important one to appreciate,as the conflation between patent protection and

investment protection has caused many to argue for a dilution of the patentability threshold.4

Contribution

The key contribution of this article is in demonstrating that a comprehensive investment protection

regime is far more optimal than the current patent and data exclusivity regimes in protecting the

significant investments in drug discovery and development.

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The Journal of World IntellectualProperty (2012) Vol. 15, no. 5–6

The Invention of an Investment Incentive Shamnad Basheer

Although scholars have highlighted the limitations of the patent regime in supporting pharma-

ceutical innovationin an optimal manner, none haveproposed a comprehensive investmentprotection

regime, as that proposed in this article. Even those that focus on investment protection advocate the

use of the data exclusivity regime. This article demonstrates the limitations of the data exclusivity

regime,the most obvious of which is that the protection is tied to the submission of regulatorydata and

is meant to cover only those costs incurred during clinical trials. More importantly, data exclusivity

regimes offer uniform periods of protection,which may either under-compensate or over-compensate

the drug originator.

Lastly, the article considers a novel compensatory liability model in order to thwart potential

abuses of the granted monopoly by drug originators who price drugs excessively and/or fail to

supply the market adequately. Under such a model, drug originators do not have exclusive rights

over their drugs; rather, follow-on innovators can enter the market and compete, upon the payment

of reasonable compensation to the drug originator. The article proposes a novel methodology of

computing compensation, whereby a reasonable amount, which balances the interests of both the

drug originator and the follow-onmanufacturer, is to be paid. The compensation methodology takes

into account the global nature of pharmaceutical innovation and the international market for drugs.

Par ts

The article proceeds as follows.

The section entitled “Drug Discovery and Development: An Overview” outlines the framework

for pharmaceutical R&D in order to help appreciate the intensive nature of investments and risks

underlying pharmaceutical innovation.

The section entitled “Patents,Innovation and Investment Protection”explores the role of patents

in pharmaceutical innovation and points out why the regime is sub-optimal from the point of view

of protecting investments.

The section entitled “Data Exclusivity and Pharmaceutical Innovation” discusses the data ex-

clusivity regime (as prevalent in the United States and EU) and its nexus with pharmaceutical

innovation.

The section entitled “Investment Protection Regime” outlines a comprehensive “investment

protection” regime,under which drug originators are granted market exclusivity fora certain number

of years after the drug has been approved. This period of protection is not a uniform one, but is

based on the time taken by drug originators to recover the costs incurred in relation to each drug, as

also an appropriate rateof return on investment based on the “health impact” of the drug, measured

through existing metrics such as quality-adjusted life years (QALYs)and disability-adjusted life years

(DALYs).5Such a calibratedprotection regime is more optimal from a policy perspective, as it avoids

over-compensating or under-compensating drug originators. Most importantly, it helps prevent the

proliferation of “me too” drugs6through a process commonly referred to as evergreening.7

Owing to the potential dangers associated with market exclusivity, I also consider a compulsory

licencing/compensatory liability regime, where the drug originator is not vested with exclusive rights

over the relevant drug market. Rather, any follow-on generic competitor may enter the market upon

the payment of equitable remuneration. I propose a novel compensatory methodology, taking into

account the costs of drug discovery and development and the relative market shares of the originator

and the follow-on generic entrant(s).

Lastly, I consider a reimbursement model as an alternative investment protection instrument,

where the costs of R&D are reimbursed through public funding and/or prizes.

In the section entitled “Patents, Upstream Inventions and Incentives”, I note that despite the

sub-optimality of the patent regime, member states cannot dispense with it, owing to the existence

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