Vaccine licensing

ARGUMENT

By Michael Spence, Commissioner, GCPPP, May 12th 2021

Of the two approaches — IP rights suspension, as supported by the Biden administration, or compulsory licensing — mandatory licensing is preferable because it acknowledges that the creator and producer of the drug or vaccine is entitled to a return, and so has less potential effect on future incentives to create and produce.

At this juncture in the pandemic, the big question before the World Trade Organization (WTO), the World Health Organization (WHO), and all global leaders is whether vaccine production and delivery can be ramped up quickly enough to allow a large majority of people around the world to be vaccinated relatively soon – the next year perhaps.  Lying behind that question is whether and under what circumstances it is appropriate to suspend domestic and internationally agreed intellectual property rights.  The matter is being discussed in the WTO right now, and the Biden administration’s surprise expression of support for suspension on May 5th has exposed a rift between western governments over the issue.

Many lines have been written about this, urging positive action, motivated mainly by the urgency.  Most would agree that if there ever is any set of conditions that justify this kind of action, the COVID pandemic would meet them.  Millions of lives threatened ought to trigger our shared sense of humanity.  In addition, there is a public good aspect to this: it is not a huge exaggeration to say that no one is safe until everyone is safe.  So there is from a national point of view an element of self-interest.

It is important to get this approximately right which means finding a way to act, while not doing so in a way that produces adverse or unintended consequences that could impair responses to future crises of this type.  Virtually no one thinks this is the last pandemic that will occur.

There are a number of issues that need attention.  Let me address them and discuss each briefly in what follows.

Is the proposal to suspend Intellectual Property (IP) rights, or is it to mandate compulsory licensing?  The difference is that the latter means to suspend the right of a company not to license, but the company retains its IP rights and the right to make a return from them.  In which case, we also need to define what is the appropriate royalty rate.

Of the two approaches, mandatory licensing is preferable because it acknowledges that the creator and producer of the drug or vaccine is entitled to a return, and so has less potential effect on future incentives to create and produce. Henceforth, I will therefore focus on that approach, and will also consider the important question of price.

Thinking mandatory licensing through

A first key variable concerns exactly what IP is being licensed. There is the chemical/biological composition of the drug itself, but also the technology embedded in a scaled-up production process.  They are not the same.  To ramp up global production, in many cases you will need both.  But proprietary production technology is not necessarily drug-specific: effective mandatory licensing of both types of IP may therefore have the potential to affect the production of other drugs.  This raises questions of fairness and the rate of return on investment by the original producers.  In addition, transferring production technology is not always that easy.

A second key variable is manufacturing capacity.  How much is there now, assuming IP is transferred, but also now much is needed, and how fast can it be built, with assurance of high-quality output?  Cutting a long story short, if the IP transfer issue can be resolved, then manufacturing and distribution become the binding constraints – except for one other variable – price.

This issue of price sounds simple, but isn’t.  Public health experts and policy makers generally have taken the view, correctly, that charging the vaccinated is a bad idea, because it runs counter to the objective of vaccinating everyone.  But in this case the customers are primarily governments or multilateral institutions.  So, there are at least two prices to be determined. One is the mandated royalty paid to the original producers who developed the vaccine.  Presumably this is paid by the licensees, that is companies.  Then there is the price paid by governments or multilaterals for the vaccine, to those licensees.  Note that the licensees may not be located in the country of the purchases.  In fact, this is inevitable, because not every country will be home to a vaccine manufacturer.

One wants to preserve the incentives for the major drug companies to invest heavily and rapidly in the next crisis as they did in this one.  And these are risky investments.  The royalties in the aggregate need to be set to produce substantial returns for the successful producers, and also a return on IP embedded in manufacturing technology.  Some may argue that the return to the successful vaccine producers is already high from sales to developed countries.  That’s fine if true, and means that the royalties for production in and for the developing world can be relatively low.  This is a question of fact and has to be sorted out mainly in the WTO.  The principles however are clear.  In a global crisis like this, the return on vaccine development should not be inappropriately low nor should it be astronomical.

Regardless of whether vaccines get to lower income developing countries by direct sales from the producers or via mandatory licensing of manufacturing, there is an issue of price as there was in prior epidemics, like HIV/AIDS.  Affordability means starkly different things across the development spectrum. Probably the fairest way to think about this is to base prices on the per capita income of the country whose government is buying the vaccines.  Aid agencies and non-profits can further subsidize depending on their mission.  This approach involves what economists call price discrimination: it sounds worse than it is, especially when as a poor country the discrimination is in your favor.

But it does have a potential problem:  it opens the possibility that somewhat unscrupulous entrepreneurs and governments may game the system, via trans-shipping from low-price countries to higher priced ones.  A better system is for an international institution like the UN, to negotiate for and buy large quantities of vaccines for sale/distribution to countries below a certain income level. COVAX, a partnership among the World Health Organization, the Global Vaccine Alliance, and the Coalition for Epidemic Preparedness Innovations, set up in 2020, is intended to do this, with funding from a range of advanced countries.  It is a good idea and should be retained.  It is had made progress in acquiring and distributing vaccines, but it is underfunded.  In addition, with a global shortage of vaccines (really the manufacturing and licensing bottlenecks), vaccine nationalism thus far has restricted the available vaccine supply to COVAX as well as developing countries, generally.  Realistically countries where vaccines are developed will always meet their needs first.  The only real solution globally is very rapid scaling up of manufacturing capacity.

Policies need also to pay attention to the investors in vaccine development. In this case, it included governments, prominently the US government as well as those of Germany and the UK, and non-profit organizations like the Bill and Melinda Gates Foundation.  These entities enter the development process primarily to increase the incentives for pharma companies to commit resources and to do it quickly.  At least some of these investments were undertaken with a view to a rapid global vaccine program, and it seems to have worked well. It therefore seems reasonable that part of the return on these public or quasi-public investments should be the condition that mandatory licensing to ensure global distribution be accepted on fair terms.

Policy makers and general public need to be conscious of the difference between ex ante and ex post returns to investment, in other words between forecast or potential returns, and actual returns.  We tend to see the ex-post returns and they can be pretty high. But this takes no account of the risks. The ex-ante return is the ex-post return multiplied by the probability of success, and for risky investments is therefore much lower. In the case of COVID vaccines, plenty of companies have invested in creation and development that has failed.

For that reason, the ex-ante number is a better measure of the incentive for companies to undertake the investment.  If policy responses ignore this distinction and take action to suppress the ex-post returns for successful companies excessively, then the ex-ante returns will be too low for everyone.   There is a well-known proverb, allegedly of Italian origin, that starts out “Fool me once…”  We don’t want to win the battle and lose the war.

Two final points.  Critical decisions like this should not be made unanimously, where everyone has a veto. It is a prescription for delay and inaction.  Instead, we need a responsible broadly representative body like the UN to declare a global emergency, which should then trigger pre-negotiated arrangements.  Negotiating global manufacturing and IP choices in the middle of a pandemic is not ideal. For this pandemic we are where we are, but this is a classic example of lack of prior preparation in terms of systems. This can be, and needs to be, sorted out for the future.

And last, it is clear, whatever arrangements are made with respect to IP and licensing, that there remains a large and urgent peak load problem in manufacturing created by the pandemic, that is, by a huge and largely unpredictable surge in demand.  Peak load capacity is expensive because it is underused most of the time.  On the other hand, when it isn’t there, the alternative is longer rollouts and that too has high costs in terms of lives lost, economic disruption, and global cohesion.  Since experts assure us this isn’t the last time we will face this kind of pandemic, we need to think about this and make the tradeoffs in advance.  The private sector cannot solve this problem.  If there is a global public interest in carrying excess manufacturing capacity, then a way will need to be found for governments in the aggregate to pay for it.