Genetically modified organisms and patenting.

U.S. Supreme Court judgment in Bowman v. Monsanto. The spread of genetic modification of plants has generated two types of controversies. The first is whether they are a threat to the environment and a danger to those who consume them. The second is whether the individual or institution that made the modification can be permitted to take and enforce a patent on them. In an important judgment, Bowman v. Monsanto, The United States Supreme Court affirmed the right of Monsanto to enforce the patent on its genetically modified soybean seeds.1. Biological questions are not considered beyond quoting the cautionary assessment of Richard Dawkins, a renowned evolutionary biologist and prolific author: I am undecided about the politics of GM foods, torn between the potential benefits to agriculture on the one hand and precautionary instincts on the other. But one argument that I havent heard before is worth a brief mention. Today we curse the way our predecessors introduced species of animals into alien lands just for fun of it. . . . It is interesting to wonder whether taxonomists of future may regret the way our generation messed around with genomes: . . . Actually I doubt it, but perhaps the point is at least worth raising, in the precautionary spirit. The whole point of the precautionary principle, after all, is to avoid future repercussions of choices and actions that may not be obviously dangerou s now.2. In conferring limited rights to innovators under patents the authorities seek a balance between providing financial encouragement to innovators and limiting the burden to consumers from higher prices. The rest of the article analyzes step by step the challenge in meeting these conflicting goals. The basic logic behind granting of patents can be illustrated by a simple example.3. The research and development (R&D) cost of a new product is $1 million. The average cost of production which includes returns on capital needed to satisfy the shareholders or partners of the firm is assumed to be constant and equal to $100. Since shareholders or partners have claims for residual income in excess of the cost of production, a higher price will increase their returns. Here lies the dilemma. A price of $100 generates enough revenue to cover the cost of production but leaves no balance to recover $1 million invested in R&D. If price exceeds $100, the higher returns will invite new investors into the industry and the increased output will put pressure on the price. If the innovator is able to prevent entry of other firms, then consumers will end up paying the higher price even after the firm has earned back the R&D expenses and, from economic point of view, it is an excess burden on consumers. Patent laws are designed to give a temporary monopoly to the producer to enable him/her to recover the cost of development and then open the market for competition. Currently the life of a patent is 20 years.4. 1

The price of a product in the market moves to a level at which the quantity demanded equals the quantity supplied. Under monopoly, the firm can control the output or price and the market will determine the price or sales respectively.5. The monopolist will use this relationship to choose the output that maximizes his profit. To revert to the numerical example, the patentee produces 10,000 units and the market price is $105. In the twenty year period he recovers the R & D cost (5 x 10,000 x 20 = $1 million). Such fairy tales seldom if ever occur in the real world. If the demand for the product is price insensitive, the monopolist can charge a price that exceeds what is needed to recover R&D costs. At a price of $110, he earns $2 million during the life of the patent. On the other hand, the incentive to develop new products depends not on the actual R&D costs of a successful project but on the expenses the innovator expects to incur before developing a new and marketable product. If only one in two projects succeeds on the average and each costs $1 million, then the expected cost of developing a successful product is $2 million. The uncertainty of the innovation process will make the innovator risk averse and he will invest on development only if the expected income is even higher than $2 million.6. Once patent is granted, the law must to determine the rights of the patentee after the sale of the product. The principle of product exhaustion states that patentee has no right over the product after an authorized sale.7. Copyright laws play a role in promoting literature as patent laws does in encouraging innovation. A comparison brings out the limitation of rights imposed by both set of laws. One who has purchased the book at full price from the publisher or authorized bookseller cannot be restricted from selling it to another at a discounted price. The market for discounted price provides a choice for potential buyers to buy a new book at full price or used book at discounted price. On the same principle, anyone who has legally purchased a patented product can resell the product. The existence of second hand market whether in books or products reduces the monopoly power conferred on the original producer by the copyright or patent law. The product exhaustion provides another means to balance incentives for the producer with protection of the user and the practice is enshrined in Supreme Court judgments. Can a manufacturer who holds the patent circumvent the product exhaustion rule by licensing the product instead of an outright sale and place restrictions on the buyer? What if the buyer sells the product to another who restores the product to a condition identical to new one? Mallinckrodt has a devise that allowed hospitals to load and dispense a radioactive spray for diagnostic purposes. It sold the product with a label restricting the buyer to one use only. Mediport offered to sanitize the product and sell it back to the hospitals at a discount. In Mallinckrodt v. Mediport, the United States Court of Appeals of the Federal Circuit went against case laws on product exhaustion and ruled that, as long as no price fixing was involved, the patentee can put restrictions on use after sale. The Supreme Court in Quanta Computer v. LG Electronics without addressing the earlier ruling on the Circuit Court pushed back on the conditional sale argument. The opinion of legal commentators is that Supreme Court by neither confirming nor rejecting

Circuit Court created a degree of uncertainty on the legal standing of the product exhaustion doctrine.8. Monsanto producer an herbicide Roundup that is effective in killing broad-leaf weeds that hurt commercial crops. On the downside it also damages the crop. To get around this limitation, Monsanto developed and patented genetically engineered seeds that are Roundup Ready and resist the herbicide. Farmers who buy the seeds from Monsanto or its licensees can sell the crop to grain elevators, agricultural processors or consumers but cannot use part of it to plant the next crop. Farmer Vernon Bowman brought soybean seeds for many years from a licensee of Monsanto, planted all of it and sold the entire crop to a grain elevator. For the second crop each year which is riskier, Bowman adopted a strategy. He brought soybean from the grain elevator which had mixed his crop with those of others and planted them. He guessed correctly that most of the seeds will be Roundup Ready and he sprayed the crop with Roundup. Though some plants died, the harvest was enough to make this more profitable than buying seeds from Monsanto at premium price. Bowman argues that he planted the seeds as agreed and sold the crop to an elevator. Once it is done, he claimed, Monsanto has no control on what is done with the soybeans. He also argued that it is in the nature of seeds to multiply and he did not infringe the patent by creating identical copies of a patented product.9. Justice Kagan who delivered the Supreme Court judgment rejected Bowmans argument. He pointed out that by law elevators can sell soybeans to consumers or agricultural processers but not to farmers as seeds, that no other farmer has brought soybeans from elevators for use as seeds, and that the seeds did not spontaneously burst into crop. Bowman took deliberate acts to make the soybean purchased from the elevator to grow in his fields and make exact copies of a patented product. Hence he infringed the patent. However the judgment also stated: Our holding today is limitedaddressing the situation before us, rather than every one involving a self-replicating product. We recognize that such inventions are becoming ever more prevalent, complex, and diverse. In another case, the articles self -replication might occur outside the purchasers control. Or it might be a necessary but incidental step in using the item for another purpose. . . . We need not address here whether or how the doctrine of patent exhaustion would apply in such circumstances.10. Also left open is the question whether all self-duplicating organisms should be patented. In Europe and India, there is open opposition to consuming genetically modified food. Biological implications of genetic modification cannot be separated from its economic consequences. The green revolution that increased food supply faster than growth in population has leveled off and food shortage is becoming a possibility once again. While the critics focus on the precautionary instinct mentioned by Richard Dawkins, should not equal weight be given to his judgment that he doubt it that we will regret the introduction of genetically modified crops? 3

Footnotes:
1. 2. 3.

http://www.supremecourt.gov/opinions/12pdf/11-796_c07d.pdf Richard Dawkins, The greatest show on earth (New York: Free Press, 2009), pp.304-5.

To focus on the effect of patent on incentives and price, stringent assumptions were made about production technology and financing of the firm.
4.

For a readable discussion of the economic justification for patents see, http://www.scribd.com/doc/98551849/Opportunities-and-Choices, pp. 97-99.
5.

The relation between price and output in a monopolistic market is discussed in: http://www.scribd.com/doc/98551849/Opportunities-and-Choices, pp.88-91.
6.

The high cost of innovation is at the center of the controversy over drug prices. Pharmaceutical firms argue that the low success rate in pharmaceutical research and the high cost of each project requires them to set high prices for new medications. Critics doubt the claim and, argue that even if it is true it is due to lack of control of the innovation process. Some countries, with India on the lead, argue that life-saving medications should be affordable even to patients who cannot afford the risk-weighted prices charged by western pharmaceuticals. Their laws allow generic manufactures to get a license to manufacture the drug for sales within the nation. Drug companies complain that, if many nations adopt such policies, then introduction of new drugs will taper off. They argue that the state and not they are responsible for providing affordable health care to the citizens. For a statistical study that defends the prices of drug see: Joseph A. DiMasi, Ronald W. Hansen and Henry G. Grabowski, The price of innovation: new estimates of drug development costs, Journal of Health Economics 22 (2003): 151-185. For the current debate about licensing generics, Financial Times, Patents and precedents, May 16, 2013. P.6.
7.

Jeremy N. Sheff, Self-replicating technologies, Stanford Technology Law Review 16 (2013). Pp.229-256. Downloadable from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2184589. Section on patent exhaustion: Pp. 232-235. For a shorter review of the patent issues written before the Supreme Court judgment, see http://www.patentlyo.com/patent/2012/04/self-replicating-technologies.html .
8.

http://en.wikipedia.org/wiki/Mallinckrodt,_Inc._v._Medipart,_Inc.; also Sheff (footnote 7) and http://www.jmripl.com.php5-10.dfw1-2.websitetestlink.com/articles/LaFuze5.pdf

9. 10

The thrust of the argument is that the Circuit Court ruling in Mallinckrodt v Medipart is not applicable here. . http://www.supremecourt.gov/opinions/12pdf/11-796_c07d.pdf p.10

Rama V. Ramachandran
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