Two unrelated public controversies — drug costs and music copying — highlight an important economic lesson.
Society benefits when governments grant property rights in intellectual property through patents and copyrights. But the benefits can be costly. Patents and copyrights help society by motivating people to be creative. They hurt society when the artificial monopolies they inherently create bring higher prices and lower quantities.
The challenge for policy makers is to implement systems that maximize benefits to society from innovation, and minimize losses resulting from abusive monopolies. Prescription drug prices and digital music copying demonstrate that this is not easy.
We grant patents for new pharmaceutical compounds to encourage drug companies to develop useful drugs. We give exclusive rights to manufacture or license the production of new drugs for 20 years, the same as for new windshield wiper controls or revolutionary onion slicers.
In practice, the period of patent protection for drugs is effectively much less than 20 years because there usually is a gap of several years between the granting of a patent and initial commercial sales of a drug. Moreover, the 20-year period of patent protection becomes moot for many drugs whenever a preferable substitute is introduced.
Drug manufacturers can charge high prices, however, for those remedies still on patents and not facing good substitutes. They set the price to achieve the combination of quantity sold and price charged that maximizes their profits. So does every other monopolist.
Consumers who have to pay the resulting high prices are understandably angered — particularly if they have low incomes or take several drugs.
Then, there are the international complications. Other countries, particularly small ones with no pharmaceutical industry, have every incentive to use government power to reduce drug costs. Such actions save money for their citizens. Any disincentive to pharmaceutical innovation is small and well hidden from voters.
Canadians are never going to rise up in arms because the pricing policies pursued by their governments are choking off the production of new medicines. But that nation’s lower drug prices infuriate consumers and politicians in the United States. The fury is not directed at Canadian freeloading but rather at pharmaceutical companies for price abuses.
The situation with digitally recorded music is similar in that granting copyrights in recorded music gives record companies the ability to use monopolistic pricing. The fairness of the split of such monopolistic profits between record companies and creative artists also is controversial. In any case, consumers think that getting little change back from a $20 bill for buying one CD is objectionable.
Unlike making substitutes for patented drugs, it is easy to copy digitally recorded music with little loss in quality. File-sharing software such as Napster facilitates unauthorized copying of protected songs, but even when such programs are squelched, copying still occurs.
The recording companies have responded with a variety of legal measures, the most recent of which is a campaign to visibly punish people who made unauthorized downloads of copyrighted songs. The idea is that highly publicized legal judgments against a few copiers will deter others.
What government should do, if anything, to deal with the problem of monopolistic abuses is highly controversial. Some consumer advocates call for government price controls on drugs here in the United States. Others favor shortening the number of years of exclusivity granted by patents and copyrights.
Many consumers want to limit recording companies’ ability to quash services such as Napster or to penalize individuals who make digital copies for their own use. Sen. Norm Coleman (R-Minnesota) recently called for hearings to help ensure that relatively minor copying activities do not result in draconian legal judgments.
Economic theory does not point to any optimal policy here. All economists can do is point out the inherent tradeoffs involved. Shortening years of protection or curbing legal remedies for enforcement of intellectual property rights reduces prices for consumers. But it also reduces incentives for innovation. That is the essential tradeoff.
This is probably one of those times when muddling through is the best course. It would be a mistake to make fundamental changes in our copyright and patent laws, though some reversal of recent repeated extensions of the copyright period would do little harm.
At the same time, courts and regulatory agencies can take discretionary actions here and there to limit monopolistic abuses. Legislative jawboning of the type initiated by Coleman can work if used sparingly and with a minimum of demagoguery.
Technology and institutions change. To those who think that drug and CD prices are the outstanding issues of justice and morality in our time, I would urge some caution. In 20 years, we may barely remember what the fuss was all about.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.