Lucy Xiaolu Wang on the Medicines Patent Pool

Patent pools are agreements by multiple patent owners to license related patents for a fixed price. The net welfare effect of patent pools is theoretically ambiguous: they can reduce numerous transaction costs, but they also can impose anti-competitive costs (due to collusive price-fixing) and costs to future innovation (due to terms requiring pool members to license future technologies back to the pool). In prior posts, I've described work by Ryan Lampe and Petra Moser suggesting that the first U.S. patent pool—on sewing machine technologies—deterred innovation, and work by Rob Merges and Mike Mattioli suggesting that the savings from two high tech pools are enormous, and that those concerned with pools thus have a high burden to show that the costs outweigh these benefits. More recently, Mattioli has reviewed the complex empirical literature on patent pools.

Economics Ph.D. student Lucy Xiaolu Wang has a very interesting new paper to add to this literature, which I believe is the first empirical study of a biomedical patent pool: Global Drug Diffusion and Innovation with a Patent Pool: The Case of HIV Drug Cocktails. Wang examines the Medicines Patent Pool (MPP), a UN-backed nonprofit that bundles patents for HIV drugs and other medicines and licenses these patents for generic sales in developing countries, with rates that are typically no more than 5% of revenues. For many diseases, including HIV/AIDS, the standard treatment requires daily consumption of multiple compounds owned by different firms with numerous patents. Such situations can benefit from a patent pool for the diffusion of drugs and the creation of single-pill once-daily drug cocktails. She uses a difference-in-differences method to study the effect of the MPP on both static and dynamic welfare and finds enormous social benefits.

On static welfare, she concludes that the MPP increases generic drug purchases in developing countries. She uses "the arguably exogenous variation in the timing of when a drug is included in the pool"—which "is not determined by demand side factors such as HIV prevalence and death rates"—to conclude that adding a drug to the MPP for a given country "increases generic drug share by about seven percentage points in that country." She reports that the results are stronger in countries where drugs are patented (with patent thickets) and are robust to alternative specifications or definitions of counterfactual groups.

On dynamic welfare, Wang concludes that the MPP increases follow-on innovation. "Once a compound enters the pool, new clinical trials increase for drugs that include the compound and more firms participate in these trials," resulting in more new drug product approvals, particularly generic versions of single-pill drug cocktails. And this increase in R&D comes from both pool insiders and outsiders. She finds that outsiders primarily increase innovation for new and better uses of existing compounds, and insiders reallocate resources for pre-market trials and new compound development.

Under these estimations, the net social benefit is substantial. Wang uses a simple structural model and estimates that the MPP for licensing HIV drug patents increased consumer surplus by $700–1400 million and producer surplus by up to $181 million over the first seven years of its establishment, greatly exceeding the pool's $33 million total operating cost over the same period. Of course, estimating counterfactuals from natural experiments is always fraught with challenges. But as an initial effort to understand the net benefits and costs of the MPP, this seems like an important contribution that is worth the attention of legal scholars working in the patent pool area.

Do Patent Laws Affect the Location of R&D?

One of the common complaints about weakening patent protection is that it causes reduced R&D in the country with weakened protection. I've always been skeptical of this claim in the modern era, because one can develop anywhere and import into a location with better protection. As a result, one would expect that patent protection is unrelated to R&D offshoring.

In a draft article called Offshoring Patent Law, Gregory Day (Georgia Business) and Steven Udick (Skiermont Derby LLP) consider this question. Their article is forthcoming in the Washington Law Review and a draft is on SSRN. Here is the abstract:

Legislators and industry leaders claim that patent strength in the United States has declined, causing firms to innovate in foreign countries. However, scholarship has largely dismissed the theory that foreign patents have any effect on where firms invent, considering that patent law is bound by strict territorial limitations (as a result, one cannot strengthen their patent protection by innovating abroad). In essence, then, industry leaders are deeply divided from scholarship about whether innovative firms seek out jurisdictions offering stronger patent rights, affecting the rate of innovation.

To resolve this puzzle, we offer a novel theory of patent rights — which we empirically test — to dispel the positions taken by both scholarship and industry leaders. Since technology is generally developed in one country, the innovation process exposes the typical inventor to infringement claims only in that jurisdiction. In turn, we demonstrate that inventors have powerful, counterintuitive incentives to develop technology where patent rights are weaker and enforcement is cheaper. Given that it typically costs more to defend a patent infringement claim in the United States than to lose one in another country (the cost to litigate a patent in the United States averages around $3.5 million and royalty awards have surpassed $2.5 billion), our empirical research contributes to the theoretical understanding of patent rights by shedding new light on the important, yet largely dismissed, dimension of where innovation takes place.

We received invaluable support from international research organizations and patent attorneys working for top-tier law firms. Notably, the Global IP Project, which is a multinational research group spearheaded by the leading global intellectual property (“IP”) law firm, Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, as well as Darts-ip, an international organization dedicated to the study of global IP litigation, provided proprietary data, enabling us to explore whether firms optimize value by placing research and innovation in countries with “better” patent laws. To verify our models, we interviewed notable patent attorneys practicing in the United States, Europe, and Asia.

The primary takeaway from their approach is that not only might the strength of the laws matter, but also the costs of defense. To tell this story, they use Marvell as an example, but that was actually a rare case where the R&D and sales process itself constituted infringement to trigger worldwide sales. I would expect that companies can usually design in the U.S., send designs overseas (see Microsoft v. AT&T), and ship from there. Thus, the more important complaint is that patent enforcement causes manufacturing to move offshore, not R&D.

That said, the article performs a regression on R&D and several variables that might affect R&D like tax rates and human capital density, and finds that costs of defense and damages awards are negatively correlated with R&D, while strength of enforcement is positively correlated. This is all reasonable enough, but I'm concerned that the empirical model is incomplete. Though the word "cost" appears dozens of times in the article, not once is it mentioned with respect to the cost of R&D. Might the reason R&D gets offshored be that it's cheaper? And could cheaper R&D also correlate with lower enforcement of IP? My guess is yes, based on the studies I've read over the years. I would have liked to have seen some analysis and discussion of this point.

While I think this is an interesting paper, I think that the model is underdeveloped in two ways. The first is the focus on costs in only half of the equation. The second is the neglect of trade secret enforcement. Unlike patent law, trade secret laws can affect R&D in the country in which the R&D takes place because the developer can lose value without ever selling into that country. Studies by Lippoldt and Schultz and also by Png demonstrate this pretty well.

For those interested in this topic, I recommend this article, and I recommend a contrast with Bilir, Patent Laws, Product Life-Cycle Lengths, and Multinational Activity, in the American Economic Review. Bilir develops a similar model, but bases it on location of companies (which covers some of the manufacturing issues), and considers the life-cycle of R&D (long term v. short term protection) as well as trade secrets. Bilir does not directly consider costs of defense, so it would be interesting to see how that notion from this new article would overlay onto Bilir.