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I can't see this working at all.

R&D is an incredibly risky proposition. The drug company I worked for had a success rate of 0.69%. That is, less than one drug that ever entered formal testing in animals, ever made it to market. Note, all the work done up to the point of testing it in animals is a tiny fraction of the overall cost of getting a drug approved.

So combine those two issues. You have an investment that requires huge amounts of capital, typically in the several hundred million dollar range (to get a drug approved). You also have a very low chance of a positive result. What does this mean when you are trying to raise capital? A very large pay out.

If you reduced the return on this investment by 80%+ (which is what you'd do if you added a 5 to 10% royalty to the current generic prices), you'd have all that capital moving to investments with much better risk/return profiles.

I don't have the source available, but I remember reading that of the drug that are approved, only 1/3 of them actually ever make a profit for the company overall. It's the massive blockbusters like Lipitor that not only pay for all the R&D that failed, but also all those drugs that didn't fail, but didn't even break even.

It actually sounds like you are saying that drugs are NOT that expensive to develop. The high failure stage is cheap ("tiny fraction of the cost"), bringing it to market is expensive but this happens once efficacy and safety are more certain?

This would be quite a common misunderstanding, and imply that we should focus on reducing these latter-stage costs rather than treating drugs as a special case that really need patents. Can you elaborate?

I should clarify. The costs of getting a drug into animal testing are relatively low (in the millions of dollars), however, the failure rate beyond that stage is still very high (~90% failure rate) as are the costs.

You are correct in saying that efforts to reduce the costs of failure are paramount to R&D companies. In fact it is a huge focus right now. However, the requirements for approval are growing in size, so it's somewhat of a one-step forward, two-steps back deal.

Thanks for the clarification (and no thanks for the utterly bizarre downvote, whoever that was - wtf?).

Based on your experience, is it the companies themselves who can get these later costs down, or is it entirely dependent on outside parties (regulators - only reduceable by lobbying)?

In the context of the patent debate, it would make more sense for government to grant monopolies/patents where its own policies introduce the costs. Even if these costs do not decrease, because of e.g. public safety, this may actually be quite a nice criterion for things that should get protection.

Right now what is happening is that companies are shifting their R&D efforts towards diseases that have relatively low regulatory barriers. The best example is the shift out of diseases like diabetes (treatments are relatively effective, so safety standards are very high) into diseases like cancer (where treatment options are poor and safety standards are relatively low because patients die so quickly).

In the future I think it will be a combination of new technologies that allow drug makers to prove efficacy and safety in a more cost effective way. I also think regulators will soften their hard-line stance on safety (in some areas). The FDA has already started to do this. Instead of saying "that drug isn't proven safe" they are saying "that drug has been proven safe, but it helps a lot so maybe we'll allow the drug company to sell it to a few patients until we get more data".

The current drug patent system isn't the best way to incentivise R&D investment, but all the other options out there seem worse right now. You are correct, however, in saying that the costs associated with drug approval are often external to the company (the FDA). So when you pay $300/month for a new drug, a lot of what you're paying for is an assurance of efficacy and safety (and the gov't agency that assures it's done right).

What about creating a system of income-based drug pricing? If done correctly, this wouldn't even hurt profits... it would maximize them. And, everyone gets treated. Win/win.

Note that pharma companies already try to do this (because price discrimination does maximize profits), but they break pricing down by country. Countries with low per-capita income are charged less. But this neglects low-income people living in high per-capita income countries like the US; just because you live in the US does not mean you can afford the highest price. A pricing system based on individual incomes would solve this.

Furthermore, individualized pricing would help to limit the offshoring of jobs. Consider that an auto worker in the US has to pay the full US price for medication, but an auto worker in China only has to pay the price in China, which is undoubtedly lower. Therefore, the current system of nation-based pricing distorts economic incentives and unnecessarily encourages the offshoring of jobs. But a system of individual income-based pricing would correct this, and make US auto workers more competitive with their foreign competition.

Another thought would be to give the government the option to purchase drug patents from industry at some fixed multiplier of research costs and profits during the lifespan of the patent. That way if the public thought that it was truly in the public good for a drug to be available, people could campaign on the promise of purchasing certain patents.

Strictly speaking, we have that option - the multiplier of profits, &c., is just a matter of what the market will bear, however.

I'm talking about more formalized than that. For example, suppose that we had a model that would typically return double what a drug would (modelling for inflation and opportunity cost), but that the pharmaceutical company was obligated to sell the patent at that price. Furthermore, suppose that this model was tweaked to generally return 20% more to the pharma company than holding the drug for the length of the patent.

Now the voting public could say that a drug was important enough that it should be funded via tax dollars.