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7. RALLYING INNOVATION

Published onApr 09, 2020
7. RALLYING INNOVATION
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This chapter is about how we can innovate our way out of this and future crises. Thus, it seems appropriate to begin with, the movie, Mission Impossible 2. Released in 2000, the antagonist is an Australian-based biotech company (Biocyte Pharmaceuticals if you must know) with a rather unique commercialization plan. They have developed a virus, Chimera, that could start a very bad pandemic — it lies dormant for 20 hours before destroying the carrier’s red blood cells. One plan might have been threatening to release the virus and be paid not to do so. But the folks at Biocyte went one step further. They planned to release the virus itself because they had also developed the cure. And, get this, they hold the patent on it. Suffice it to say, I suspect some venture capitalists would call this one ‘fundable.’

The movie plot involved the chase to stop the virus being released but also to secure the cure in case it was. But I wonder, did they have to? The plan was to release the virus and then charge for the cure. Drugs normally, once made available, are easy to copy and so have patents. The plan here was to use the patent to extort world governments to pay up much of global wealth. But herein lies the problem: the patent is granted by those governments. Surely in this situation, they would just invalidate the patent and take the cure?

The point, and you will see that I do have one, is that when it comes to innovations in the face of global pandemics, business as usual for our innovation system is unlikely to apply. The reason is that once an innovation has been created, there are strong pressures to make it freely available and, in the process, push down the return to any R&D that has been conducted. Anticipating this, businesses may not invest in R&D in the first place. And this is not a hypothetical situation.

Such concerns are likely very salient to firms. For example, after Senator Paula Hawkins (R‐FL) asked a major vaccine manufacturer how it could justify charging nearly three times as much to the U.S. government for vaccines as to foreign countries, U.S. manufacturers stopped submitting bids to UNICEF to supply vaccines …. When President Bill Clinton announced his plan to immunize all children against a standard list of diseases in 1993, he said, “I cannot believe that anyone seriously believes that America should manufacture vaccines for the world, sell them cheaper in foreign countries, and immunize fewer kids as a percentage of the population than any nation in this hemisphere but Bolivia and Haiti” …. In the face of such statements, potential risks facing firms seem real.1

It is very unlike that governments around the world are going to accept monopoly pricing for a vaccine developed for COVID-19 that potentially will benefit 7 billion people. For life saving drugs, it is not uncommon for those prices to be in the hundreds of thousands per person. Suffice it to say, for a vaccine intended to be given to a population such as the US, even $10,000 a dose would set the government back $3 trillion. That ain’t gonna happen.

Will governments likely pay a princely sum for a vaccine for COVID-19? Yes. Will it cover the costs and the risks associated with developing and trialing that vaccine? Hopefully. But given the uncertainty amid the crisis, there is a concern that pharmaceutical companies and their researchers do not need to add further uncertainty. Moreover, this isn’t just about the current crisis. Like SARS and H1N1, coronaviruses are probably with us for the foreseeable future and may require annual vaccine development. There are other innovations (e.g., methods to test and anticipate pandemics) that we might finally demand having felt the costs of a global pandemic in the modern era. All of those will be of a public nature with the idea of using them widely. That means that the price for these innovations will be set in negotiation with governments who, we can imagine, are unlikely to be less stingy with public funds for pandemic prevention going forward. Given this, how should we think about an innovation system for what are essentially ideas that will enhance the global public good?

Why traditional innovation incentives won’t cut it

The usual way we try to encourage innovation in a market economy is to reward the innovator with intellectual property protection. If you have a new drug, you can secure a patent that gives you the exclusive right to sell it for about fifteen years. In other words, your reward is to make whatever profits you can for a time unimpeded by close competition. That system works pretty well.2 However, the main problem with regard to innovations that will help avoid or stem the effects of a global pandemic is a contradiction — in order for the innovator to receive profits we have to allow the innovator to price in such a way that many will be unable to use the innovation. As our goal is widespread use, this contradiction is prohibitive.

The difficulty for a vaccine maker is that a low price on the vaccine reduces their profits but generates much more value for other firms as the economy recovers. There are clever ideas, however, to help the vaccine maker recover some of this value. Consider this, as told by Matt Levine:

[I]f I ran one of the big index-fund companies, and a pharmaceutical company in my portfolio developed a patented fully effective cure for Covid-19 that it could manufacture cheaply and planned to sell to anyone who could pay $50,000 a dose, I would call that company right up and say “no, you give that pill away for free, because the value to me of Covid-19 going away quickly and the economy recovering—the value to me as an owner of airlines and hotels and chain restaurants and retailers and every other company—is vastly, vastly greater than the value to me of your profits on that pill.”3

This is pretty ingenious.4 If you know you have a COVID-19 vaccine then you know that, when it is released, there will be an economic boom and so you can invest in the stock market on the basis of that information. That should generate a healthy return. Unfortunately, it also requires a very large amount of capital to make the return that would incentivize the innovator. Suffice it to say, relying on stock market processes to fund important innovative endeavors is risky at best.

Given the value on the table, the other option is to ignore the market altogether and have the government offer grants and subsidies to defray the costs of conducting research and development. This has certainly been a hallmark of the system of scientific research conducting in most countries following World War II.5 The challenge is that it is very difficult to evaluate whether grants are being spent in an efficient manner. Consequently, grants tend to be favored where no other sources of funding are available — for instance, for basic research that has no commercial payoff and a high degree of uncertainty — or where there is expertise to evaluate the efficacy of the research program and required expenditures. This latter task, however, is itself not amenable to a quick disbursement of funds. Thus, if there is any urgency, such as lives being lost while research is being conducted, grants are unlikely to be an efficient means of generating innovations.

Advanced market commitments

This has caused economists to consider ways of encouraging innovations that combine the elements of grants with market signals. One approach contemplated was the use of prizes. For centuries, benefactors have announced prizes that would be paid in the event certain inventions were generated. The most famous was the prize for a clock that worked at sea so as to provide a dramatic improvement in navigation by measuring longitude at sea.6

Prizes have the advantage that they are clearly solutions to problems someone believes it would be valuable to solve.7 Thus, they have a market signal embedded in their make-up. The difficulty is that the problems that are usually specified are to achieve some scientific milestone such as proving a mathematical theorem or landing a spacecraft on the moon. These are not necessarily of the class that would require widespread adoption for the global public good. For pandemics and pandemic control, we are talking about inventions whose adoption will impact on billions of people. Thus, quality and workability really matter. They cannot simply be scientific advances. The innovations need to be able to work for their intended function. That is a tougher challenge than any one prize for a significant milestone is likely to achieve.8

To solve these problems and enhance the market test associated with prize-like mechanisms, Michael Kremer proposed the use of advanced market commitments (or AMCs).9 Suppose you are trying to encourage the development and then manufacture of a vaccine. An AMC is a contract without a specific counterparty that a donor/sponsor offers to deliver the intended vaccine. The contract specifies that the provider (as yet unknown) will be guaranteed a certain payment per dose of the vaccine up to a specified number of doses. This serves to set a floor on what the provider might earn because the contract specifies a subsidy for every dose actually purchased. So, a country, for instance, may pay a low price (such as $1) per dose but the provider would receive an additional subsidy (say $15) per dose. Thus, there is a guaranteed payoff for providers but, in return, providers agree to cap the price they charge for the vaccine. Their overall earnings are greater the more doses are actually sold. Obviously, if there are no candidates that pass certain quality standards, the contract is never paid out.

A key feature of AMCs is that they are not compulsory. Recall that why we need AMCs that ‘stick’ for innovations that potentially have high social value is that, in their absence, governments and other donors may claw back on promised returns. Thus, it is important that AMCs are a strong commitment. If AMCs are non-compulsory, this means that any innovator could choose to sell their product at whatever price they choose if they do not accept the AMC. A compulsory AMC only enhances rather than reduces the returns to any R&D investments. The commitment increases the price above what the market would pay and, thus, the AMC contains a prize-like element but only if the vaccine is used by lots of people.

How could AMCs be deployed for pandemic related innovations? It depends on some features of the innovation — specifically, how close current efforts are to a viable product. For innovations that are more ‘technologically distant’ the goal is to encourage more R&D effort and resources. This might be the case for a vaccine that could handle most potential coronaviruses as opposed to the specific virus that is currently spreading. The challenge in designing the AMC is setting a price that will induce that R&D effort. This will be an easier task if that price encourages multiple simultaneous attempts to pursue the innovation. At the same time, however, AMC designers will want to ensure that innovators’ payoffs are sensitive to how well their products work so they push innovation towards products that are likely to be more effective. Thus, even though the price might be set ex ante, to encourage that effort and align incentives, AMCs for technologically distant innovations will likely remove the floor (in terms of sales guarantees) to give innovators more ‘skin in the game.’

Writing this, as I am, in the midst of a pandemic, it is reasonable to expect that much of the innovative effort will be focused on products that are much closer to market. An example of this might be vaccines to deal with the current strains of coronavirus or innovations to dramatically improve and reduce the costs associated with testing and treatment. In that situation, there are likely to be a number of candidate prospects in the pipeline and so the chief constraint is not riskier R&D but instead undertaking trials and then building capacity to bring these products to market. An AMC designer faces a challenge as they would not have accurate information regarding the costs of those activities even if they know they are potentially substantial. The good news is that they have better information regarding precisely what the potential prospects can achieve.

In setting the per unit price for the AMC, for a technologically close product, the designer has to refrain from setting a very low price — even though that may save on overall costs to those using the innovation — and err on the side of a higher price so that the necessary capacity investments actually are made.10 As there is likely urgency in getting products to market quickly, you would not want to skimp on payments and risk insufficient capacity. Again, this highlights the importance of the AMC’s role as a commitment because, having built capacity, there will be pressures to reduce price. The AMC needs to guard against those pressures.

One thing that can take the pressure off prices in this situation is if the AMC can guarantee a certain level of sales for the product. After all, the innovator will be making investments depending on the overall return. Thus, they will be happy to trade-off price with quantity so long as the total revenue (that is, price times quantity) does not change. This is a luxury AMC designers have when setting terms of a technologically close product as they have a much better sense of the overall level of demand for that product.

A relatively technologically close AMC has recently been undertaken to produce a pneumococcal conjugate vaccine specifically targeting developing countries where 700,000 children are estimated to die from the disease each year. Five countries and the Gates Foundation put up $1.5 billion for an AMC in 2007 and it was launched in 2009. Businesses would compete for a contract to supply the vaccine over a ten-year period with a price capped at $3.50 per dose (much lower than prices paid in developed countries) and a subsidy from the AMC of another $3.50 per dose.11 In 2010, pharmaceutical companies GSK and Pfizer committed to each supply 30 million doses annually (a substantial fraction of the total need of 200 million). This vaccination campaign appears broadly successful although we can never be completely sure what would have happened in the AMC’s absence. Experience tells us that it would have likely been very little.

More Failure, Please!

Thus far, the discussion here has focused on why business as usual in terms of market and private rewards for innovation are unlikely to be suitable for pandemic related innovations. However, there is also a sense in which governments, in particular, need to abandon business as usual that often accompanies their own funding on research and development — an adversity to failure.

The innovation challenge is so potentially large that it is very important that we pursue as many different paths as possible. In a sense, there may be very important scientific and innovation directions out there which each have very unclear and hard to understand potential payoffs. In other words, there is considerable uncertainty. The classic example was the development of the Spitfire fighter plane by the British just before World War II. The plane was faster and more maneuverable than anything before and had seemed implausible when it received funding in the 1930s. Winston Churchill opposed it. However, it arguably was instrumental in protecting Britain from invasion as Churchill would later endorse.12

Given that the payoffs can potentially be very high, this suggests that we should be more comfortable pursuing riskier and potentially unconventional scientific approaches. In other words, there is a broad need for a portfolio approach to innovation — spreading our options widely — so as to better understand which paths might prove to be feasible.

The takeaway here is that governments and donors should not be afraid of casting their net very widely and not just funding moonshots but also loon-shots.13

A New Manhattan Project

In the midst of World War II, Franklin D. Roosevelt authorized the creation of a highly funded project to build the first nuclear bomb. The Manhattan Project was a stunning success. It brought together a workforce of 129,000 including a large concentration of scientists (3 of whom had won and 3 of whom would later win Nobel prizes) at a cost of what today would be $23 billion to the New Mexico desert and, in three years, had built a working weapon. To be sure, that weapon would create a decades long existential crisis for the whole of humanity causing fear and sowing mistrust that continues to this very day, but right now we can marvel at the fact that the project met all of its KPIs and ended World War II in relatively short order.

It is not a stretch to suggest that both managing the current COVID-19 pandemic (with tests, anti-virals and a vaccine) along with coming up with innovations to more effectively manage future pandemics, a project well in excess of the scale of the Manhattan Project, is warranted. Based on the potential future economic cost alone, there is an easy rate of return justification. What is more, unlike the Manhattan Project, this would not have to be conducted with secrecy and, indeed, there would be considerable merit to precisely the opposite in terms of openness.

This is not the place to scope out what that potentially massive endeavor would look like. However, I can list here some key features that should be considered as part of it:

International cooperation: all of these efforts are in terms of contributing to a global public good. The challenge will be to find mechanisms that distribute the costs of achieving these goals in a workable and sustained manner.

Regulatory audit: each country should pursue a major regulatory audit to ensure that there are no unnecessary impediments to being able to innovate and then to adopt new promising technologies. The COVID-19 crisis has already led to a relaxing of some regulatory rules specifically regarding approvals for public drug release. For instance, the US Food and Drug Administration has fast tracked various treatments and vaccine trials.

Patent pools: there is merit to pooling together patents associated with COVID-19 and other future pandemic threats. A patent pool is an agreement between patent holders to licensing terms for patents between them. By agreeing to these, it is easier to combine innovations together to build products and services.14 An example of this emerged during the COVID-19 crisis when a patented HIV therapy, Kaletra, was potentially promising as a treatment for COVID-19. The patent holder, Abbie, announced it would not defend its patent rights.15 Suffice it to say, a more formalized agreement before the fact regarding licensing would remove frictions even further.

Expert review boards: The research involved will likely be pursued amongst many promising paths. This happened with the Manhattan Project where two different bomb designs were pursued in parallel. To organize these competing streams, expert review boards will likely need to be constituted on an on-going basis. This could assist in the allocation of funds, the highlighting of impediments, the evaluation of project quality and the design of AMCs.

If there is one thing a crisis of this magnitude should tell us is that there is room to do better. The funding for innovation for medical research is a fraction of that devoted to other threats — notably national security. Our experience in 2020 suggests that our attention has been mis-focused.

Footnotes
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Comments
6
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Robert Owen: In Thailand, where I live, Viagara is available cheaply in a form known as Kamagra. The Thai government believed the cost of Viagara was prohibitive and hindered many Thai people from enjoying their life to the fullest. As a result the government authorised the manufacture and sale of the generic form even while patents were restricting its sale globally. Viagara costs about 200 baht a tablet, as a comparison a shop worker and many other lower paid workers only earns about 300 baht a day - the minimum wage in Bangkok is 215 baht a day. Kamagra is available for 25 baht a tablet. How the Thai government worked its way around patent laws I do not know.
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Robert Owen: The development of vaccines is similar. Today, there are real concerns about the emergence of resistant strains of pathogens like TB. New antibiotics are urgently needed yet drug companies are not prepared to fund research into the development of new antibiotics. If a new “wonder“ vaccine was discovered and manufactured, doctors would not use it except as a last resort when all other treatments have failed. Doctors would, understandably, keep the vaccine in very limited use until all other treatment options had failed as they would not want pathogens to gain resistance to this drug as well. The economic result for a pharmaceutical company is that the costs associated with developing vaccines will not be recuperated in the near future, maybe not at all. Maybe there are no undiscovered “wonder“ vaccines out there, but thanks to “the market“ we may never know.
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William Janeway: Also see my Doing Capitalism in the Innovation Economy, pp. 352-7 on “efficiency as the enemy of innovation.”
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Krishna Ravi Srinivas: See my recent publications on this 1) Science, Technology and Innovation and the Challenge of Epidemichttp://ris.org.in/newsletter/diary/2020/Covid%2019%20III/pdf/Krishna%20Ravi%20Srinivas.pdf2) Intellectual Property Rights and Innovation in the Times of Corona Epidemic - Policy Brief 89, April 2020https://www.researchgate.net/publication/340941016_Intellectual_Property_Rights_and_Innovation_in_the_Times_of_Corona_Epidemic_-_Policy_Brief_89
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Peter Rigsbee: Was this acronym defined? I had to look it up.
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Roger Bohn: You mean AVERSE (opposed to, dislike) not ADVERSE (an unfavorable outcome). , So “their averseness to failure”. Or just “their avoidance of failure.”
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Roger Bohn: ?? Medical research such as “war on cancer” is an academic-medical industry boondoggle. It pursues patentable high cost treatments, not effective low cost health-improving innovations. Case in point is low research on infectious diseases, as you know. The “mis focused” is certainly correct.