Haggling for a Patent: What a Government Would Have to Pay for Prescription Drug Patents

In previous papers (Guell, R. and Fischbaum, M. The Milbank Quarterly 1995; 73: 2 and Applied Economics Letters in press), we established that the allocative inefficiency in the prescription drug industry is so pervasive that some remedy is warranted. In the first paper, we estimated a lower bound on this inefficiency at approximately $3 billion, with an upper bound of approximately $30 billion; all on total industry sales of approximately $50 billion. In the second paper, on a narrower set of drugs for which sales were $8 billion, we more precisely estimated this dead weight loss to be $5 billion. From this we showed that a system could exist whereby a government would purchase a drug patent from a willing seller, freely distribute it and reap significant efficiency benefits. In those papers we considered the possibility that the innovating firm would not want to relinquish the patent, but we assumed that they would be indifferent between being paid the expected net present value of future monopoly profits and reaping those uncertain profits over time. While that may be the case, a more likely scenario would be that a negotiation would take place. In the current paper I show the bargaining range that would exist under different risk preference assumptions and show that this range widens as each side becomes more risk averse and narrows if the government threatens to use its power of eminent domain. Lastly, I acknowledge the risk of firms ‘capturing’ the government agents doing the negotiation. To conclude, I present the circumstances under which the proposed agency would likely improve societal welfare and contrast that with the circumstances where the presently inefficient system would be made more so by government intervention. © 1997 by John Wiley & Sons, Ltd.