Are Patents and Intellectual Property Necessary Components of an Economy?

I apologize for my hiatus. I have been extremely busy on a project for work that has consumed about 75% or more of my time lately. I appreciate you, my faithful readers, sticking with me.

If you’re a fan of economics, you won’t be disappointed today. In response to the news of Martin Shkreli buying the patent to produce the AIDS medication, Daraprim and promptly jacking up the price, I was asked by a friend on Facebook to comment from a Libertarian perspective.

I immediately identified the problem as being the patent. The fact that the government allows this guy to operate a monopoly is what allows him to get away with this.

If there was no patent and the price rose this high naturally, then that would be an indication that there was a shortage of supply in the market. This would signal producers to create more supply. In this particular case, some other pharmaceutical company would create their own version of the drug and compete with this guy, thus eating his lunch if he tries to stubbornly keep his prices higher. Even then, the price might still stay naturally high if demand continues to outweigh supply until more and more companies produce more of the drug and the price eventually comes down.

Of course that cannot happen in this case, because the government has created artificial barriers to enter this market in the form of the patent which makes actually it illegal to produce more of the same thing and FDA screening which requires a lengthy and expensive red tape process to get your product approved by the government before it can be deployed to the market.

So the true bad actor here is the government. Shkreli himself may indeed be a bad actor, but he’s only able to succeed at acting badly because of the environment that the government created, much the same way that Al Capone was only able to succeed at his bad acting because of prohibition.

The funny thing is, when I posted this analysis, my friend objected. His objection?

Don’t get me wrong- intellectual property (and especially copyright) policy in the U.S. is obscene as is… But it also exists for a reason.

Without it… Joe spends years of his life and millions of dollars researching the production and effects of a chemical that solves a particular problem.

I then, nearly overnight, buy a single quantity of this chemical, analyze and replicate it. My costs being significantly lower, I sell it at a fraction of the price, forcing him out of business (in order to compete, he has to eat his development costs, and may never be able to turn a profit at all).

The overhead in creating something is ALWAYS higher than the overhead in copying it…

The irony here is that his objection to my analysis that the government causes this problem by outlawing the practice of poaching products (I’m not sure if that’s a real economic term or not, but I will use it for this article and define it to mean the act of reverse engineering a product for the purpose of bringing an alternate to the market as competition) – which clearly needs to happen in this case – is that without patents, products would be poached!

Despite several attempts to explain that this is a good thing by going over sound economic praxeological analysis of this issue including what prices actually are (in which I tried to dispel the notion that prices are determined by production cost and argue that patents shield innovators from risk causing them to make bad investments in things that may not actually be viable products) he remained firm in his faith that

Price may be set by the market, but if the price is lower than the cost, the product won’t ever get made in the first place.

The cost, in the case of drugs, is cost of development PLUS cost of manufacture. Cost of development is MASSIVE, but only has to be paid by whoever does it first.

With patents, the developer has a massive advantage, because he doesn’t have to worry about competition for a year or few.
Without them, that advantage moves from the developer to EVERYONE BUT the developer…

Without patents, the price will always be lower than the cost, thus, successful businessmen will NEVER innovate, because it’s NEVER worth it, in the cost-benefit analysis.

Thus, your free market stagnates.

[…]

Patents exist to provide an extra benefit that might temporarily outweigh that cost. Stripping them away doesn’t free up entrepreneurs to innovate at will… it takes away one of the few reasons to invest (unless they can afford to throw money away on a guaranteed loser, and are doing it for feel-good reasons).

So what do I say to this? Is he right? Would poor old Hypothetical Joe be at the mercy of the sharks in the market if he didn’t have a patent to protect him? Continue reading Are Patents and Intellectual Property Necessary Components of an Economy?