Reaching for mediocrity: Competition and stagnation in pharmaceutical innovation

Abstract

Patents might incentivize invention but they do not guarantee firms will invest in projects that maximize social utility. We model how risk-neutral firms' ability to obtain substantial private returns on marginal new technologies causes them to "reach for mediocrity" by investing in socially-suboptimal projects, even in the presence of competition and new entrants. Focusing primarily on pharmaceutical innovation, we analyze various policy interventions to solve this underinvestment problem. In particular, we describe a new approach to patents-a value-based patent system, which ties patent protection to the underlying invention's social value-and show how it incentivizes socially-optimal innovation.