COVID-19 - Insights from Innovation Economists

23 April 2020

Written by Dominic Foray and Gaétan de Rassenfosse, College of Management of Technology, Ecole Polytechnique Fédérale de Lausanne (EPFL)

The present article provides the take of innovation economists on the current pandemic.

It offers a reading of current real-world developments using economic reasoning and relying on existing economic research.

The article is based on an extensive paper entitled “COVID-19: Insights from Innovation Economists,” which has been written by a collective of scholars primarily associated to the College of Management of Technology at EPFL, under the supervision of Profs Dominique Foray and Gaétan de Rassenfosse.

What follows is a selection of thoughts about one critical root cause of the crisis and some short-term innovation policy responses dealing with this cause that can be observed these days.

1 - Failures on the market for vaccine research as one important cause of the crisis

Since the pioneering works by Richard Nelson and Kenneth Arrow in the early sixties, economists have developed a framework to explain the systemic underinvestment in R&D, which is an obvious cause of the current pandemic crisis. The reasons for underinvestment in vaccine R&D include an insufficient demand for vaccines in normal times (Kremer and Snyder, 2015) as well as the very characteristics of R&D as an economic activity.

For a long time now, economists have shown that the production of new knowledge through R&D entails significant positive externalities that are difficult to capture by the private innovator. They have shown that this gap, sometimes very large, between social and private rates of return to inventions result in significant underinvestment in R&D. This situation leads to less inventions and discoveries than what is socially desirable. This argument is not specific to vaccines R&D, but it applies very strongly to this field (Kremer, 2000).

Furthermore, vaccine is subject to a time consistency problem. It is characterized by high fixed costs for research but relatively low cost of manufacturing. Once vaccines are produced, governments are in a strong position to obtain vaccines at a price that will cover manufacturing cost, not R&D cost. Since potential inventors anticipate this problem, they invest less in research than they would otherwise. All these reasons explain why private developers lack incentives to pursue research on socially valuable projects in the vaccine industry. As a matter of fact, few companies are active in this domain. Novartis’ large vaccine division was sold to GSK in 2014 because it was incurring losses, leaving only five major players on the vaccine market, namely GSK, Merck, Sanofi, Pfizer and Novavax. 

These reasons provide a strong case for government support and interventions. But if the world as a whole would be better off with public support for R&D, this is not necessarily true for countries taken individually. Indeed, national governments are interested in maximizing domestic welfare, not global welfare. Yet, vaccine R&D is a global public good: once the vaccine has been invented, it becomes a commodity to which global access is open. In practice, that means that each country has an incentive to freeride on research financed by foreign countries. This global perspective weakens the incentives for national governments to invest in vaccine R&D.

Today, vaccine developers are working with unprecedented speed since the first genome sequence of the SARS-CoV-2 was released in January. Opportunely, market failures for vaccine consumption have dissipated for SARS-CoV-2. Millions, if not billions, of people demand access to it, and a significant fraction of consumers are willing to pay a higher price than the manufacturing cost. Furthermore, most market failures related to R&D have been solved thanks to governments large injection of research money. Competition across countries to be the first to have access to new vaccines also mitigates the free rider problem and strengthens R&D incentives.

2 - Short term STI policy reaction: Is there an optimal investment level in SARS-COV-2 research?

The case for investing in research to prevent pandemic outbreaks may have been strong. However, now that a pandemic is upon us, and given the many demands on the public purse, is it wise to invest large amounts in COVID-19 research? For example, the NIH alone has received $1.8 billion

How many scientists, medical researchers and pharmaceutical companies should switch their efforts towards SARS-CoV-2 prevention, treatment or mitigation? In the short run, only a subset of researchers have the right human capital to advance the knowledge frontier in any specific area. While more research on the ‘elasticity of science’ with respect to targeted funding is needed, work by Kyle Myers (forthcoming) suggests that switching costs of science are large. Human capital is not the only barrier: good research ideas may also be scarce. In a world of scarce ideas, increasing funding invariably leads to diminishing returns. That is, the most promising ideas are explored first and the productivity of additional researchers is lower since they must work on less promising ideas (see also Bloom et al., 2020). Finally, the unmet medical needs of yesterday have not gone away and pharmaceutical innovation for all sorts of other diseases is still needed, calling for a cautious reallocation of research efforts.

The previous considerations suggest that reallocating vast amounts of funding to SARS-CoV-2-related research could be wasteful. However, they should also be taken with caution. The scarcity of ideas may be a factor, but the current virus has not been the focus of research for a long time. Therefore, we may be far from diminishing returns kicking in. As far as the human capital constraint is concerned, this may be mitigated by the fact that a wide range of innovations could be useful to fight COVID-19, from vaccines, drugs and medical equipment to innovation in testing. Immunologists may work on vaccine development while microbiologists focus on testing and engineers put their efforts on new protective equipment and ventilators. 

While the optimal level of SARS-CoV-2 public research support is unclear, we believe that in the long term there is a strong case for considerably more support than is presently the case. The discrepancy between the needs and the current level of support is stupendous. The NIH COVID-19 budget may sound large but it represents only 4 percent of the total annual NIH budget. As the pandemic paralyzes the economy of most advanced countries, outside China SARS-CoV-2 clinical trials are less than 1 percent of the total number of clinical trials currently underway. It is likely that we will not see investment in research to fight COVID resulting in major progress in the immediate future. However, given the stakes involved, even minor innovations could be useful and the upside of a breakthrough is massive. It is also possible that innovation in the medium run could be incredibly valuable. In the longer run, policy should aim not just at increasing spending but at increasing the total quantity of inputs that go into the research, and in particular human capital at the right level of skills and knowledge.

3 - Do we need a mission-oriented R&D policy to boost life science innovation?

The current crisis, characterized by the innovation imperative of finding a vaccine very quickly and at any cost, seems to represent a strong case for organizing research and allocating resources under a logic of ‘mission-oriented R&D policy’ (MOR). Archetypal examples of MOR have been the Manhattan Project and the development of penicillin during WWII. Such policies are characterized by a high level of centralization and intentionality (there is a specific and well-defined technology target) and a certain simplicity between the set of agents that are involved: the State is both the funder and the customer and some public agencies are performing the R&D operations. MOR has been mostly deployed in defense and space sectors and has delivered significant results in terms of goal achievement (landing a man on the moon, inventing the atomic bomb) within a rather short time period. MOR seems thus an appropriate approach in any crisis time, when a particular ‘technological fix’ is needed urgently.

This drawback explains why the life sciences ecosystem has never worked under such a MOR principle. Quite the opposite. According to Cockburn et al. (2011): “In contrast to a Manhattan project approach in which a single burst of focused investment yields a single technological fix, life science innovations have been driven by intellectual freedom, scientific openness and opportunities for experimentation and diversity at the level of individuals and institutions, as well as by an intense and pervasive competition throughout the value chain in life science”. Successful life science innovation systems seem to involve freedom to experiment and competition rather than a command-and-control approach.

What we are observing today as a reaction to the pandemic crisis is not really the creation of a new Manhattan Project but rather a proliferation of a wide range of responses by a complex set of institutions and actors. This organization maintains and promotes intellectual freedom, scientific openness and decentralized competition at all stages of the research and product development process. As policy guidance for future crises, how the system is responding now is probably a better solution than what could be organized under a MOR principle, even when a particular public health priority is emerging.

4 - Isn’t the patent system blocking the search for a solution?

The worry that patents may be a barrier in the fight against COVID-19 is a legitimate concern. On the one hand, patent provides a well-known solution to the appropriability problem which is the main cause of the market failure described above. But, on the other hand, a patent is a temporary monopoly right granted to an inventor that allows her to exclude others from using, making and selling the protected invention. Excluding others from using bright ideas may seem counterproductive in present times.

Aware of the blocking power of patents, a couple of patent holders have already given up patent rights or granted free licenses to relevant patents. Individual initiatives of voluntarily sharing patents are a welcome development. To accelerate the trend, proposals such as the Open COVID pledge are emerging. Signatories to the pledge commit to making patents that could be used in ending the COVID-19 pandemic available for free and without encumbrances. Patent pledges have the potential to accelerate innovation by pointing to relevant patents, by offering some legal certainty to follow-on innovators (reinforced by the public commitment of the patent holder to the patent pledge), and by reducing transaction costs (that is, the cost of negotiating and drafting a contract with every potential user of the technology).

The creation of a ‘patent pool’ would be a clear catalyst in the search for a solution, and later vaccine adoption. Patent pools are a collection of patents from different patent holders available in bulk, for free or for a fee. Governments have already called on the WHO for the creation of a SARS-CoV-2 patent pool. Because patents in a pool are available in one place, under clear terms, and generally at a reasonable price, they reduce litigation risks and lead to lower licensing fees and transaction costs among participating firms.

If voluntary contributions fail, governments can step in and force patent holders to share their inventions. Indeed, patent laws of many countries include ‘compulsory licensing’ provisions that allow governments to forcibly license a patented invention when there is a threat to public safety. Some countries have actually reinforced their legislative base to speed up compulsory licensing and generic drug production.

Clearly, the first-best solution would be for private actors to act responsibly by providing broad and affordable access to tests, drugs, and vaccines. Government intervention is certainly an option to consider—if only because the threat of compulsory licensing encourages patent holders to act responsibly. The actual implementation of compulsory licensing is challenging but a real option on the table. 

5 - Conclusion

The immediate lessons in terms of science and innovation policy are rather cruel: lost time cannot be made up when it comes to science and technology. Furthermore, an intense but belated mobilization of resources aimed at specific scientific objectives will not compensate for the inadequacy of private investments and the misguided efforts of public policy that have characterized the recent period regarding vaccine R&D. It seems to us that economic theories such as market failures (and their remedies), the application of concepts such as the elasticity of science as well as the analysis of some key institutions such as the patent system, offer powerful tools for reflecting on STI policy questions that typify times of crisis and great societal challenges. The present article offers an attempt in this direction.

[The views expressed in this article are those of the author(s) and do not necessarily reflect the views of the UNCTAD secretariat]

About the Authors:
  • Dominic Foray is full professor and Chair in Economics and Management of Innovation at EPFL
  • Gaétan de Rassenfosse is Assistant Professor and Chair of Innovation and IP Policy at EPFL