Why patent rights should be respected – Politicsweb, 12 November 2014

Jasson Urbach warns that a weak patent regime can act as a significant deterrent for innovative companies seeking to invest.

Protected Patents Protect Patients and Promote Prosperity

The Department of Trade and Industry (DTI) aims to turn patent law on its head by vastly increasing the scope for compulsory licensing and introducing an examination system for all patent applications. It claims these changes will bring down medicine prices and stimulate a local generics industry, but neither rationale is convincing.  In addition, South Africa lacks the resources for an examination system. The proposals also contradict other government policies aimed at promoting innovation, and overlook far more important obstacles to good healthcare in the public service. Overall, the DTI's plan to reduce patent protection is a short-sighted strategy that will deter local innovation and further diminish South Africa's attractiveness to direct investors.

Patents and innovation

Intellectual property (IP) rights play an integral role in promoting and fostering innovation. Patent laws are particularly important because they give innovators an exclusive right to exploit their inventions for 20 years, protecting them against unauthorised copying of their products in this period. Once this ‘window of opportunity' to capitalise on an invention comes to an end, the product falls into the public domain. Individuals and companies are then allowed to copy it and derive financial benefit from it.

Patents over medicines

Patents are particularly important to the multinational pharmaceutical companies largely responsible for developing antiretrovirals (ARVs) and a host of other medicines. This is because the discovery and development of a new drug is a long, complicated and expensive process that generally involves thousands of people and consumes many resources.

The average cost to research and develop every successful drug has recently been estimated at between $800m and $1bn: equivalent to between R8bn and R10bn. These figures include the costs of thousands of failed attempts. In general, for every 5 000 to 10 000 compounds that enter the research and development (R&D) pipeline, only one is likely to be successful in the end. Moreover, only three in ten new products, on average, generate revenues equal to or greater than average industry R&D costs. Against this background, patent protections are necessary to incentivise innovator companies to bring new drugs to market.

In addition, no drug in practice enjoys a 20-year patent term. Typically, it takes a decade to take a molecule through testing and regulatory approval - a process which begins only after a patent has been granted, as no company will invest in an unpatented molecule. Most drugs, therefore, have an effective patent term of approximately ten years. Given the huge amount of investment required to bring a drug to market, this window of opportunity does not leave companies much time to earn adequate returns on their investments.

Part of the problem is the time needed to obtain regulatory approval for the sale and use of medicines. This is a systemic issue that affects pharmaceutical patent holders in all countries, both developed and developing. However, the problem is particularly severe in South Africa, where it can take up to five years for the Medicines Control Council to register a medicine. Again, this means that pharmaceutical companies are unlikely to benefit from the 20 years of protection to which their patents are entitled in principle.

The United States seeks to counter such problems by extending patent terms for up to five years to compensate for delays in the granting of patents or in the regulatory approval process. However, the Department of Trade and Industry (DTI) in South Africa is determined not to allow a similar reform. This was made clear in the Draft National Policy on Intellectual Property (the Draft Policy) which it published in September 2013 and plans soon to enact into law (see the preceding article and @Liberty 14/2014).

However, the DTI's refusal to follow the US lead in sanctioning such a reform is the least worrying of its proposed policy shifts. Far more serious are its proposals to bring about a vast increase in the compulsory licensing of patented inventions and introduce a patent examination system that South Africa lacks the resources to implement.

Compulsory licensing

Compulsory licensing is a practice that allows competitors to copy patented medicines and other inventions at a fraction of the cost and without obtaining permission from the patent holder, even though the patent has not yet expired.

South Africa's Patents Act already makes provision for the granting of compulsory licences in limited circumstances: for example, if an abuse of patent rights has been proven in a court of law. However, the DTI wants to make it easy for competitors to obtain compulsory licences in wide-ranging circumstances. It also wants to limit the royalties payable to patent holders in return to, say, 3% of the price of the copied products, which will often be too little to compensate the patent holder for his costly R&D (see @Liberty 14/2014).

The DTI claims this proposal will help reduce drug prices and foster the development of a vibrant local pharmaceutical industry able to meet the country's need for cheap ARVs and other medicines. However, neither rationale is convincing.

Medicine prices

Though the Government claims a need to force down prices through compulsory licensing, it already substantially controls the prices of medicines through the ‘single exit price' it introduced in 2004.

The health minister at that time, Manto Tshabalala-Msimang, initially planned to impose a blanket 50% cut in ex-factory medicine prices, as set out in the industry ‘blue book' of drug prices. However, in the face of industry objections, the regulations introduced in 2004 instead stipulated that medicines could be sold only at a ‘single exit price'. This was to be based on aggregate prices in the previous year and had to be the same for all customers. In addition, this single exit price could not be increased without the minister's consent.

In 2006 the minister finally approved a 5.2% increase in the single exit price, but this was not enough to compensate companies for significantly higher input costs resulting from rand weakness (most medicines are imported) and rising inflation. A further increase of 6.5% was allowed in 2008 but was again too little to compensate for higher costs.

This pattern has persisted. In 2014, moreover, though the pricing committee appointed by the minister recommended an increase of almost 9%, health minister Dr Aaron Motsoaledi instead stipulated a 5.8% price increase as the maximum allowed. Again, this is too little to compensate for increased production costs.

Perversely, the single exit price also bars negotiations by private sector purchasers on price discounts for bulk orders. If given the opportunity, pharmaceutical companies, like most other firms, would be willing to negotiate price reductions for bulk orders. This would be a normal commercial arrangement offering mutual benefit to both parties. But the single exit price for a particular drug has to be the same for all private sector customers, regardless of the surrounding circumstances, and so prohibits any discounts to them.

A declining pharmaceutical industry

The DTI's attempt to use compulsory licensing to stimulate the growth of a generics manufacturing industry is misguided in itself. It also ignores the extent to which previous government interventions have already contributed to a significant decline in the local pharmaceutical sector.

In 2007 a study conducted on behalf of the Presidency found that 35 pharmaceutical factories in South Africa had shut down since 1994. The DTI identifies ‘competition from low-cost countries', such as China and India, as a key factor in this decline, while mergers between global multinationals have clearly played a part as well. Also relevant, however, are the Government's own policy interventions in the health sector. Its price controls over medicines have been particularly damaging, an analyst at Frost & Sullivan describing them as ‘disgraceful' and a major deterrent to doing business in the country.

If the DTI's Draft Policy is translated into law, the resulting abrogation of patent rights will become a further major barrier to investment in South Africa - and especially so for the innovator pharmaceutical companies whose new medicines provide the product pipeline on which all generics manufacturers depend.

In addition, undermining patent rights will do nothing to overcome the many other factors that make it difficult for South African manufacturers to compete internationally. These range from electricity shortages to poor skills and productivity, prolonged and often violent strikes, inadequate transport logistics, and high input costs of various kinds.

Substantive examination

The DTI claims that South Africa's current ‘depository' system for patent applications makes for the granting of weak and ‘frivolous' patents - and allows pharmaceutical companies to ‘evergreen' or artificially extend their patents over their most profitable medicines beyond the normal 20-year term (see @Liberty 14/2015).

The ‘evergreening' allegation

Health activists commonly accuse patent holders of making minor variations to existing drugs in order to ‘extend' patent terms on an undeserved basis. However, this allegation is unfounded, as patents cannot be extended under the current rules.

A patent lasts for a maximum period of 20 years. After that time, a drug goes into the public domain and competitors are free to copy and financially benefit from the sale of the copied drug. Often, within that 20-year period, the company that holds the patent will discover a better way to make the medicine, or a new way of delivering it, or a means to reduce the pill burden, and so on. The innovator company must then file an entirely new patent application based on this new invention or process.

If the innovator company is granted a new patent on the basis of a reformulated drug, this is because the reformation is, in fact, a novel invention and meets the requirements for inventiveness. Critics of supposed ‘evergreening' may claim that the new patent is simply an ‘extension' of a patent on an older drug, but this is not so. There can be no ‘extension' in law, as the maximum period for any one patent is 20 years. Moreover, generic companies are free to produce the older version of a drug as soon as the original patent expires.

South Africa's limited resources

South Africa lacks the technical, administrative, and financial resources for an examination system, which even developed nations find difficult to implement. Moreover, the country used to have such a system but was forced to abandon it in 1978 - when its current Patents Act was adopted - because its skills were too limited.

According to Judge Louis Harms, a former judge president of the Supreme Court of Appeal: ‘[South Africa] used to have an examination system, but had to abolish it because we never had the people to do [the job]. It's highly specialised. You need [a person who is both] a scientist and a lawyer, and will [also] do the job at a government salary.'

International experience shows that it takes a patent examiner approximately three days to deal with one patent application. Since roughly 7 500 patent applications are filed in South Africa each year, this suggests a need for at least 110 patent examiners. Yet the DTI seems to believe it will be able to get by with the 20 graduates it plans to appoint as patent examiners from April 2015.

Multinational corporations with experience of applying for patents in a large number of countries with examination systems will find it relatively easy to comply with the new rules, for they are already well versed in the procedures and have the resources to navigate the requirements. By contrast, local companies lack this experience and will require significant time and resources to  get to grips with the process. The burden of the change will thus fall particularly heavily on small and medium-sized companies.

The depository system also works well in practice, which the DTI and other critics tend to overlook. Says Rowan Joseph, an intellectual property lawyer based in Cape Town: ‘The absence of patent examination in South Africa sounds bizarre, but it actually works because the examination system is the same throughout the world.' Hence, if an invention has been patented in the United Kingdom, under the examination system in operation there, it will undoubtedly qualify to be patented in South Africa as well. Given the fact that virtually all developed economies have examination systems and most patents registered in South Africa come from developed countries, there is little need for South Africa to duplicate the procedures in operation elsewhere.

Moving toward a substantive search and examination system may sound like a good idea in principle but in practice it will lead to long delays, while the inevitably higher costs will frustrate the entry of local innovators. For a country such as South Africa, which suffers from a lack of both financial and human resources, a depository system is far more appropriate.

Conflicting policies

The Draft Policy also contradicts various other government policies intended to promote innovation. The Government is well aware that R&D helps stimulate industrial and economic growth, and thus has various incentive programmes to encourage this. Ironically, two of them are administered by the DTI - which is simultaneously acting against innovation via the Draft Policy - while a third is available through the Department of Science and Technology.

The latter department has also been quick to seek patents to protect its own R&D. In 2012, for example, when South African researchers at the University of Cape Town, working in collaboration with the Medicines for Malaria Venture (MMV), achieved a major breakthrough in identifying a new malaria drug candidate, they quickly patented the compound. As the minister of science and technology, Naledi Pandor, pointed out, her department had invested R25-million in the research project and wanted to reap the benefit of its expenditure.

The same thinking underpins the Intellectual Property Rights From Publicly Funded Research and Development Act of 2008, which was brought into operation in 2010. This statute seeks to ensure that ‘intellectual property emanating from publicly funded research and development is...protected...and commercialised', and that ‘human ingenuity and creativity are acknowledged and rewarded'. It also aims to ‘provide incentives' to state-funded research institutions, such as the Council for Scientific and Industrial Research, to ‘reward them for proactively securing protection for intellectual property and...generally promoting innovation'.

In other words, when the Government's ‘own' money is at stake and it wants to ensure a return on its investment, it sees the value of IP rights and does the same as researchers and companies elsewhere - it seeks patents to protect its innovations.

IP, innovation, and investment

The International Chamber of Commerce - the largest and most representative business organisation in the world - sums up the case for effective patent protection, saying: ‘The protection of IP stimulates international trade, creates a favourable environment for foreign direct investment, and encourages innovation, transfer of technology, and the development of local industry, all of which are essential for sustainable economic growth.'

There is also a positive and statistically significant relationship between IP rights and foreign direct investment (FDI), trade, R&D, and patent applications. Says Douglas Lippoldt, formerly a senior economist and policy analyst with the Organisation for Economic Co-operation and Development (OECD): ‘A country that enhances its IP regime may attract additional knowledge-intensive product imports otherwise unavailable on the domestic market, or it may attract inflows of foreign direct investment. In either case, international technology transfer is likely to flow as a consequence.'

A key factor in the success and rapid growth of newly industrialised countries such as Hong Kong, Taiwan, Korea and Singapore was their adoption of market-friendly policies which protected both physical property and IP rights. In the early stages of their development, they tended to adopt IP laws but not enforce them consistently. However, they soon realised that they needed to intensify IP enforcement to gain respectability among foreign governments and investors, stimulate domestic innovation, and avoid retaliatory measures by aggrieved countries and companies.

The case of Singapore is instructive. In 1960 Singapore had GDP per capita (measured in real US$ terms) of $2 530 compared to South Africa's $3 395. By 1970 Singapore's GDP per capita, at $4 857, had marginally overtaken South Africa's at $4 781. But by 2013 Singapore had GDP per capita of $36 898, whereas South Africa's GDP per capita was a paltry $5 916.

Singapore's life expectancy at birth is also now more than 20 years longer than that in South Africa - 82 years as opposed to 60. The reason Singaporeans can expect to live long and prosperous lives has much to do with its stable regulatory environment and the fact that it respects property rights, including IP rights.

Conclusion

The DTI's Draft Policy focuses on the supposed need to save lives by bringing down the price of patented and imported pharmaceuticals. However, the policy shifts it seeks will not be limited to the health sector or to foreign companies. Instead, they will extend to inventions of every kind. They will also bear most heavily on local inventors, rather than multinational corporations.

Within the health sector, the charge that patents act as a major barrier to access to medicines diverts attention from far more important obstacles to good health care. These include poor management in many public hospitals and clinics, where even such basics as adequate hygiene are frequently neglected.

In addition, some 98% of the drugs contained on a list of essential medicines compiled by the World Health Organization (WHO) are already off-patent. The Government should thus focus on ensuring the availability and adequate use of these medicines in the public healthcare service, where drug stock-outs are increasingly common. 

Another simple reform - which would further increase access to essential medicines through a simple stroke of the legislative pen - would be to remove Value Added Tax (VAT) on all pharmaceutical products. South Africa has already eliminated import tariffs on medicines, which has helped to contain costs. But it continues to levy VAT (at the standard rate of 14%) on all pharmaceutical products sold in the private sector, even though this makes prices higher than they would otherwise be.

Charging VAT on medicines is counterproductive. If the Government wants to promote access to health care, it should not impose this tax on people who are often the most vulnerable members of society. Taxes on medicines are highly regressive and severely penalise the marginalised. Removing VAT on medicines would be politically popular and easy to achieve.

The DTI's proposals overlook these vital issues. If carried into law, they will also penalise innovative pharmaceutical companies by denying them an adequate return on their substantial R&D investments. Yet without R&D into innovative medicines, generics manufacturers would soon have little new material to copy. This would have dire consequences for all South Africans, regardless of their socio-economic status.

Within the wider economy, each and every individual or company that may want to capitalise on inventions needs effective patent protection. This is also an essential prerequisite to attract innovative companies to invest within the country.

To date, South Africa has a proud record in upholding patent rights - a record which has generally been lacking elsewhere on the African continent. This has helped it to attract a high level of foreign investment and contributed to the development of local industry. It has also helped South Africans gain access to some of the world's most advanced goods and services, allowing all of us to become wealthier and healthier.

Business decisions to invest in foreign countries are complex and take into account a wide variety of factors, from energy availability and labour laws to the independence of the judiciary and the size of domestic markets. Robust and effective patent protection is thus not enough in itself to attract FDI - but a weak patent regime can act as a significant deterrent for innovative companies seeking to earn a return on their investments.

Moreover, in the vast majority of countries across the globe, standards of patent and IP protection are improving. Reducing patent protection in South Africa is a short-sighted and inappropriate strategy that will further reduce the country's competitive advantages and diminish its attractiveness as a viable investment destination.

Jasson Urbach is a director of the Free Market Foundation.

This article first appeared in @Liberty, the policy bulletin of the IRR.

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