Innovation or InNOvation? Drug Development in Low-Income Countries

I. INTRODUCTION

In 1995, all World Trade Organization (WTO) member countries were required to strengthen their intellectual property standards under the Agreement on Trade-Related Intellectual Property Standards (TRIPS). TRIPS mandated that all signed countries recognize and enforce product patents in all fields of technology (most notably in pharmaceuticals), and launched a global trend toward stronger intellectual property rights. TRIPS and post-TRIPS era trade-based intellectual property (IP) agreements are incredibly contentious, and the debate over IP legislation has profound effects on international policy-making: uniform IP legislation has large economic, political, and social costs associated with its implementation because it almost certainly results in higher drug prices. Supporters of strong IP laws argue that patent protections incentivize innovation, while opponents argue that these innovations hurt countries with large generic pharmaceutical production [see Maskus (2000)]. 

This study explores the basis of these claims. I use country-level data on U.S. pharmaceutical patent application filings and an industry-specific index of patent strength to test if strengthened IP reforms increase a country’s innovative activity. The passage of comprehensive IP laws like TRIPS creates a natural experiment to test the economic impact of IP protections. Particularly, I examine the effect of these reforms on patenting activity in countries’ with the highest generic pharmaceutical manufacturing output, since these countries are likely most affected by the reduced copying capabilities resulting from reform. I find economically and statistically significant evidence to suggest that IP reform stimulates domestic innovation. When subject to all controls and confined to a ten-year time period following reform, I find generic-producing countries increase innovative activity by an additional 85 patents per year relative to other countries. This effect suggests that IP reforms induce former drug copiers to become drug innovators, though this result only meaningfully occurs in high income countries.

II. LIT REVIEW

A substantial amount of research has been devoted to the innovative power of patent protection. In theory, patent protection grants exclusive rights to innovators to allow them to recoup the costs of their expensive and high-risk R&D investments, thereby increasing their incentives to innovate. Prior literature seems to support this theory, but only for the rich. Kumar (1996) finds that stronger IP laws are associated with an increase in U.S. R&D intensity for drugs and treatments that exclusively benefit more developed countries. Kumar’s findings suggest that innovation is likely to occur in countries and for countries that are capable of paying a higher price. Similarly, Kyle and McGahan (2009) solely find an increase in clinical trials following increased IP protection for drugs that treat diseases that affect high income countries. The closest such literature comes to finding a positive innovative effect for developing countries is through a “transfer of technology” argument: stronger patent laws attract foreign direct investments and help increase the innovative potential of developing economies (see Branstetter, Fisman, and Foley [2006]). 

It is unsurprising that these innovations occur almost exclusively in wealthier nations given substantial evidence that pharmaceutical innovation closely follows estimated market size. Grabowski, Vernon, and DiMasi (2002) show that a drug’s return on investment exhibits a corresponding response in pharmaceutical R&D expenditures. Dubois, De Mouzon, Scott-Morton, and Seabright (2015) use data on global revenues of pharmaceutical products, worldwide mortality from specific diseases, and GDP to estimate the impact of market size on the global release of new molecular entities. They find an elasticity of innovation to market size of 0.25, suggesting that an average of $2.5 billion is required in additional revenue to support the invention of one new chemical entity. In other words, we find that the positive benefits of patent strength go to richer countries because the payoff from innovating for richer countries is substantially higher. It is therefore understandable that existing research almost exclusively focuses on pharmaceutical innovation among developed countries, because this is where we’re likely to see patents have the most substantial innovative effect.

A small body of research attempts to extract insights about the relationship between domestic innovation and national patent laws via case studies. Particularly, Simonetti et al. (2007) explores the impact of TRIPS implementation on the Indian pharmaceutical industry, finding that the Indian pharmaceutical industry benefited from IP reform as a consequence of its strong pre-TRIPS technological capabilities. Simonetti et al. offer a compelling argument for the effect of patent protections on domestic new drug innovation, but are limited in scope due to the study’s case study nature. Qian (2007) offers broader evidence by assessing the effect of pharmaceutical patent protection on U.S. patent awards in a panel of 92 countries from 1978-2002, but finds no statistically significant relationship. Qian does however find significant effects on patent awards in the interaction between economic freedom and patent implementation, suggesting that countries with higher economic freedoms benefit from greater patent reform.

 Qian’s analysis helps inform the basic empirical framework for this study.  Like this study, Qian leverages the exogenous nature of TRIPS implementation to quantify the effect of IP reforms on innovation. I also use similar variables and covariates that Qian found to have a significant effect on patent awards. In addition to updating Qian’s results to the year 2017 and properly accounting for the timeframe of a country’s most significant pharmaceutical IP reform, this paper adds to existing empirical literature by isolating the effect of TRIPS-era IP reforms among the world’s largest pharmaceutical generic producers, where we expect IP reforms to take the most effect since these countries are least incentivized to sign onto these reforms. By using panel data on 102 countries over a thirty-two year timeframe, I assess the impact of IP reform on two measures of innovation: number of total U.S. patent applications and the number of “small entity” U.S. patent applications. Small entities are a particularly important outcome variable because they help control for cross-country variation in the innovative potential of pharmaceutical producers, since these innovations are small-scale and thus similarly-funded across countries. Previous literature has not explored the impact of IP law on small entity innovation.

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