Compulsory Licensing: A Confusion of Arguments
I recently heard a talk by someone who tried to test that prediction by looking at U.S. drug companies that had been required to accept compulsory licensing, usually as one of the conditions of a merger. She had a total of six cases. In only one did there seem to be a visible decrease in future patent applications. She viewed that as at least weak evidence against the "conventional wisdom" that compulsory licensing would reduce innovation.
Her sample size was tiny and the data very noisy, making a conclusion in either direction difficult. But that wasn't the interesting problem with the project.
In four of her six cases, the requirement was for compulsory licensing of a patent that already existed. When I pointed out that there was no reason to expect that to have any effect on future research by that particular drug company, she replied that that wasn't what the drug companies, arguing against compulsory licensing, claimed.
Thinking about it, I believe I know what was going on. There are two entirely different arguments for the same conclusion which look similar enough to be confused. One is the argument that I, or any economist, would make. The other is the argument she was rebutting.
Her argument takes the form "If the drug companies don't have enough money from their past research, they can't afford to finance future research to produce new drugs." That sounds plausible, but it's wrong. If future research looks to be profitable, drug companies don't need to finance it from past profits—that's what capital markets are for. If future research looks unprofitable then, however much money drug companies have from past research, they can find somewhere else to put it. That too is what capital markets are for.
The argument that makes sense to an economist is about incentives, not resources. Anything that makes future research less profitable, such as a policy of compulsory licensing expected to apply to future drugs, means that some projects go from just worth doing to not quite worth doing, reducing the amount of future research. In terms of that argument, four of her six cases are irrelevant, since they involved compulsory licensing of patents that already existed. In only two cases did the requirement apply to future patents. So her sample size was not six but two, and one of the two was the one case where she concluded that the result of the requirement was to eliminate research in the area it covered. Insofar as any conclusion could be drawn from her results, it was the opposite of the conclusion she drew.
The argument she was answering was the wrong one from the standpoint of an economist. But I can easily enough believe that it was the argument, or at least an argument, that the drug companies were making—because while it is economically wrong, it is rhetorically right.
With her argument, the drug companies are claiming that they would like to develop new drugs to save lives, but they just can't do it if compulsory licensing deprives them of the needed resources. That sounds a lot more attractive than saying that, while they could develop new drugs to save lives, they won't unless it is profitable.