Dean Baker's post on why the U.S. government should confiscate the Tamiflu patent is all well and good (read Tyler Cowen's rejoinder too), and his rant on the evils of the pharmaceutical industry well-warranted, but the real action's all in this old paper he wrote on alternatives to our present method of financing drug innovation. Why doesn't the current patent system—which allows drug companies to sell their little pills for 300-400 percent above the competitive market price in order to recoup their "research" investment—work very well? Here:

[T]here are very good reasons - well known to all economists -- for preferring that drugs be sold in a competitive market with the price approximating the marginal cost of production. The gap between price and marginal costs under the current system of patent supported research leads to large and rapidly growing distortions. This includes denying drugs to patients who could afford them if they were sold at their marginal cost, the distortions also include the tens of billions of dollars spent each year on promoting drugs.

Even more serious is the incentive that monopoly pricing provides firms to conceal or misrepresent research findings. Finally, a large gap between price and marginal cost will inevitably lead to the production of unauthorized versions of patent protected drugs. While these unauthorized versions make drugs available at a lower costs to patients, their quality cannot be ensured since illegal markets are unregulated.

All very real problems, these, and one can note that this sort of protectionism matters much, much more than the various trade barriers people get agitated about. Now obviously we can't just junk the patent system; companies need some incentive to invest in research. But sure we can think of alternatives that work better. Baker lists a couple, including Dennis Kucinich's proposal to get rid of drug patents and steer about $25 billion in taxpayer money—about what Big Pharma claims to spend on research—to government-backed research organizations, similar to the current NIH or the research universities of yore, and socialize drug research. (He lists some other, less drastic, and very clever alternatives too.) More on that in a bit, but the point here is that any financing alternative will have to achieve four main things:

1) provide incentives for pursuing "useful" research
2) minimize the possibility that market distortions will create incentives to pursue less useful lines of research
3) minimize the risk that political interference will direct research spending to less useful ends
4) minimize the incentive to suppress research findings

Obviously it's tricky to decide what is and isn't "useful" research—who decides? the "market"? the government? the dying children lobby?—but the current patent system certainly does badly on the last three counts. Drug companies presently have greater financial incentives to cater their research towards balding, impotent, overweight suburban males rather than look into, say, innovative malaria treatments for the Third World. The patent system also gives drug companies incentives to pursue "me-too" drugs and reap the monetary rewards—see Marcia Angell on this—as well as to suppress any inconvenient research findings.

Now if the government decided to sponsor research directly, as Kucinich proposed, it could avoid many of these problems—2) and 4) especially—but, of course, there's the possibility that politicians could start mucking around with where the research dollars go. Think the reigning First Church of Dennis Hastert would approve one cent for developing new contraceptives? Me neither. And under Kucinich's plan, private research companies could use the legalized graft system in this country to win contracts unduly. On the other hand, to some extent this problem already exists—current research at the NIH is subject to political pressures, and since drug companies often depend to a large extent on government Medicare purchases to profit from their patents, innovation already depends on lobbying, to some extent.

So... What Is to Be Done? In my opinion, the pharmaceutical industry as it stands still does good work, and I don't think full-blown socialism is called for just yet. No, I much prefer creeping socialism. Right now most government research money goes towards basic research, rather than the development and testing of new drugs. Why not steer a couple billion this way, as a test to see if the government can do drug innovation on its own? In the meantime, draconian regulation to crack down on some of the worst excesses of the current system: i.e., force drug companies to open its books; regulate advertising; free the FDA from Big Pharma's tentacles; make the approval of new drugs contingent on improvements over existing drugs (right now, new drugs merely need to be better than placebos to be approved). We can be reasonable people.