Sovaldi: Risk vs Uncertainty, Innovation vs Facilitation, and How Patents and Ownership Don’t Differentiate Them

(This is an extension of my previous two posts on Sovaldi, particularly the second one.)

Piracy is simply the free market saying, “Your markup is ridiculous.”

As Nassim Nicholas Taleb mentions in his books The Black Swan and Fooled By Randomness, there’s a difference between risk and uncertainty. I’m sure I’m going to butcher the distinction, but roughly speaking, risk is the more or less finite quantity you know you may loose if a bet goes badly. Uncertainty is the unknown behind probability estimations – the degree to which your estimations are just wrong – and how wrong. Uncertainty is open-ended. Risk is supposed to be a tangible, calculable quantity. I’m uncertain if a meteor will destroy the Earth in some time period, but if one does, I can estimate the value at risk of this happening (by saying this, I do not mean to defend the historical use of VAR in finance).

When Gilead’s vice president Gregg Alton says,

“Those who are bold and go out and innovate like this and take the risk — there needs to be more of a reward on that. Otherwise, it would be very difficult for people to make that investment.”

he is actually mixing risk and uncertainty, and innovation vs facilitiation, in a socially destructive way. Pharmasset, the company that developed Sovaldi, was bought by Gilead in January, 2012 for $11.2 billion, as the results of clinical trials of Sovaldi crystallized, was the organization that worked through the uncertainty of real innovation. When they started working to produce the RNA polymerase inhibitor of the hepatitis C virus, they didn’t know they would be successful at all. It took years of preemptive effort to realize success. At the end of that process, Pharmasset had produced something new and unique for our society – a new cultural asset that should last as long as humans maintain knowledge. And it is an asset that will likely continue to benefit our culture long after the current 175+ million people who current have hepatitis C are cured or, effectively, die waiting for the financing to obtain treatment. The employees and shareholders of Pharmasset were compensated, in addition to the salaries and wages they’d already been paid, $11.2 billion for this work. I don’t know how much of that ended up back in the hands of venture capitalists who were merely financiers – not innovators, but I imagine it’s a significant chunk. Still, since I believe such venture capitalists redirect their earnings to funding more innovative start-ups, I really don’t begrudge anyone in this $11.2 billion payout (well, besides the few that very probably gained a lot more than they earned – but I believe this is the least of our problems in this series of events).

When Gilead purchased Pharmasset, Sovaldi was in final clinical trials. It’s effectiveness was largely known. The final trials seek to illuminate optimum dosing, treatment duration, dosing of the cooperative drugs interferon and ribavirin, and get a handle on side-effects (so far, Sovaldi seems to have few if any side-effects, since as far as is currently known or disclosed, it’s only apparent effect is to inhibit the particular variant of RNA polymerase present in hepatitis C viruses).

So what did Gilead have to do between the time it purchased Pharmasset and the time the FDA provided expedited approval for Sovaldi? It had to complete the clinical trials (these would have been completed anyway, of course). It surely did a lot of legal hand-wringing on liability considerations. It surely spend several (over-priced) millions on people who ushered the drug through the FDA process. A few million were surely paid to ramp up production processes and branding, etc. But in all of this, was there any uncertainty? Relatively speaking, no. By the time much of this money was spent, the knowledge that they could either sell their work to another pharma-giant or obtain remuneration for their work through selling the drug themselves was essentially guaranteed. And that’s just looking at it from the perspective of the corporation. The actual people within Gilead were already paid throughout the process. Even if Gilead suddenly, mysteriously collapsed, much of their personal gains would already be locked-in (even the $11.2 billion paid for Pharmasset was partially financed by banks, not Gilead).

The point is that the purpose of innovation – and the reason we ought to remunerate it – is to offset the risks associated with the uncertainty of working on an innovation, especially when it takes years to develop the innovation. What Gilead did was not innovation. It wasn’t even unique. Any pharma-giant would have been happy to do it, and more than capable of doing it. The work they’ve done adds essentially zero to the cultural wealth of the human race. Yet they want to extort as much as $150 billion from the human race for “taking the risk” of doing whatever it is they think they are doing for us.

But we didn’t ask them to do that for us. They volunteered! Suppose Merck had bid $10 billion for Pharmasset, and Gilead won the bidding by offering $11.2 billion. By doing so, Gilead proactively volunteered to do what it has now done over the intervening 27 months (or so). In effect, Merck would have been saying, “I’ll do it for $10 billion…?”And Gilead said, “Hmmm. No, we’ll do it for the extra interest costs on $1.2 billion more than Merck is willing to volunteer.” If Gilead now finds their work so onerous that they can’t bring themselves to do it for anything less than $150 billion, I offer up advice to them of, “Go fuck yourselves!”

In the Gilded Age of Robber Barons, we gradually formed the FTC to regulate – and block, if perceived necessary – firms from using public law and physical realities to create what we call a monopoly. But what, exactly, is a monopoly – the bad parts, anyway? At it’s core, the part that makes a monopoly economically and culturally destructive is using the social constructs of ownership and/or patents to set the price of some good far higher than the mark-up the rest of society is customarily charging for most other goods. This is why we perceive “monopoly rents” as “unfair” – the monopolist is asserting that they deserve much more profits than the rest of society is offering.

This isn’t the way monopolies are typically presented, but just consider: Gilead is saying they somehow need or deserve a markup of 41900%. This bugs us because in our current economy, typical markups (of all services – not just the markup on the final product cost) run from 10% to, say, 2000%, with the distribution heavily skewed to the 10%-200% range. Getting everyone to increase their markups to something of the same order as Gilead’s in a free-market economy is virtually impossible due to the phenomenon John Nash described as an Equilibrium. Thus, we feel powerless to retaliate against Gilead in the way we would really like to – the way a “free-market” is supposed to retaliate against elaborate prices – by using counter-pricing to either “extort” a more reasonable price, or indirectly finance a competitive product. Since we can’t coordinate this level of action, we feel this nebulous unfairness about markups like Gilead’s. We may even refer to it as “anti-social” or just “immoral.” But at it’s core, the only problem with such a markup is the fact that we’re unable to change all other markups to match Gilead’s (or the futility of doing so, since if we actually could do that, society would likely find itself in an endless markup-war, upward markup spiral (downward moral spiral)).

This is a paradox of free markets. We’re all “free” to set prices of products we “own” however we want – except that this is an illusion. We aren’t actually “free” to do that at all. Our freedom to set prices is dictated to us by the reality of the number of alternative products – or alternative “pricing paths” – such as piracy or legal retaliation.

That’s where the FTC comes in. One way we deal with monopolists is to use the apparatus of government to implement a socially coordinated legal retaliation – to get past our social Nash Equilibrium that may otherwise leave us all frustrated but powerless to respond. Another path is to fund an alternative drug and then “force” (wait, I thought the market was “free”?) Gilead to lower their price (or make no sales). Along this line, Gilead’s pricing is in-effect saying that they either:

  1. believe it is extremely unlikely anyone will find (or there even exists) any other hepatitis C virus RNA polymerase inhibitors, so they can charge whatever they want
  2. believe other companies are on the verge of bringing other hepatitis C virus RNA polymerase inhibitors to market very soon, so they need to recoup their $11.2 billion very quickly (unlikely)
  3. believe in setting their price so high that they implicitly foster the development of piracy

#1 and #3 are not mutually exclusive, of course, and #3 is inevitable, given the price Gilead is charging. The only question is whether Gilead was consciously choosing to foster piracy of their product? I think we can assume they aren’t that dumb. Therefore, we should also assume that Gilead plans to use the patent and legal system to suppress pirated copies of their drug from being available, and enable themselves to charge the 41900% markup. I can imagine they may even complain about their legal expenses. They might even try to take action against Americans who fly to India to buy the treatment there at the “low thousands” price they plan to offer the less wealthy nations.

Well, I would propose our legal system explain to Gilead that it isn’t in the business of policing the market. This would, actually, be the non-judicial-activism proposal. Piracy is simply the free market saying, “Your markup is ridiculous.” Gilead could subvert piracy by simply offering the product at a competitive price – or selling their ownership of that product to another company that is willing to market the product at a competitive price. In effect, when piracy takes the form of selling the equivalent product at a much lower price (as opposed to misrepresentation of a brand name, or misrepresenting equivalence) the only reason piracy exists – and is perceived as a “problem” – is because the firm or person complaining about the piracy overpaid for ownership rights. The “free-market” solution would, actually, be to cut your losses and move on, not use the courts and law to try to make up for your past purchasing error.

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About stormculture

In pursuit of reality.
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