The Coming Bust of the Knowledge Economy

Steven Weber of the University of California at Berkeley argued that the production system for knowledge goods is undergoing not just a dramatic technological change but also a shift in mindset that is fueling a economic revolution. This shift has already occurred in the music industry. The melt-down of the telecommunications industry illustrates the magnitude of the risk. And the software and pharmaceuticals industries are next to face the threat. As illustrated by the open-source software movement, this new system reverses the traditional notion of intellectual property protection from a right-to-exclude to a right-to-distribute. While the change may increase innovation and productivity, it threatens to undermine, in a Schumpeterian fashion of creative destruction, current investments and the profitability of the existing industries.

The discussion focused on a number of points raised by Professor Weber’s presentation.
Much of the discussion centered on the possibility of an open-source type research process in the pharmaceutical industry. Given the high level of human risk and the resulting regulatory controls in pharmaceuticals, the process would be different. As health care in general moves to a much more personalized and information-intensive activity, broader issues of information regulation – including intellectual property rights – are likely to emerge.

The speaker at this policy forum was Steven Weber of UC Berkeley and the Berkeley Roundtable on the International Economy (BRIE). A leading expert in risk analysis and forecasting, Dr. Weber is Associate Professor of Political Science at UC Berkeley and directs the MacArthur Program on Multilateral Governance at Berkeley’s Institute of International Studies. At BRIE, his research focuses on the political and social change in the knowledge-based economy and the political economy of globalization. Professor Weber actively consults with major corporations, non-profits and government agencies. His latest book, The Success of Open Source, will be published this Fall.

He was introduced by Dr. Kent Hughes, Director of the Project on America and the Global Economy at the Woodrow Wilson Center.

Professor Weber began with 4 propositions:

  1. Open-source software is remaking the economics of a significant piece of the information processing industry;
  2. Open source is not just a sui generis phenomenon, but a more general illustration of how new production processes arise in complex knowledge goods;
  3. These new production processes are shifting where value-added is found in the production chain, turning highly expensive goods into commodities, and challenging current notions of what is “proprietary” (to the extent that he predicted that proprietary operating system software would become an old-fashioned, “quaint” notion in as soon as ten years); and
  4. While this process of Schumpeterian creative destruction leads to economic progress, the shift has political as well as economic and technological implications.

Professor Weber cautioned that this evolution entails risks that must be defined and prepared for, the largest being the destruction of business models that largely depend on provincial and antiquated notions of what is proprietary and can be controlled. The repercussions for these business models are substantial: the destruction of huge amounts of invested capital and stock valuation. Those heavily vested in these models will “fight tooth and nail” to halt these economic and technological changes.

Telecom and music

The background and justification for these propositions can be found in the recent history of the telecommunications and music industries and in the current situation of the software and pharmaceutical industries.

A difficult but inevitable truth is that there is no viable business model that guarantees the return of IT stocks in general to their valuations before the bursting of the technology bubble. Some companies over-invested in the 1990s and are left with unused capacity and a significant burden of debt. For instance, telecom companies invested heavily in network capabilities just as the Internet began to replace them. Some of these same companies and others built out huge amounts of bandwidth on the erroneous assumption that there would be enough content and demand to justify such a huge supply. Substantial capital was borrowed to build cable and fiber-optic bandwidth that are now, at most, an inexpensive commodity.

Other industries are still struggling to adapt to the digital revolution. The music industry faces a substantial decline in CD sales and revenue. Unlike the “meltdown” in the telecommunications industry, Professor Weber believe that the music industry faces a “corrosive loss of legitimacy and confidence.”

Professor Weber argues that it is not just a dramatic technological change but rather a shift in mindset that fuels economic revolutions. He reminded the audience that Peter Drucker argued in the nineties that new ideas, not a fascination with technology, fuel economic growth. Drucker compared the nineties to the Industrial Revolution where it was not the steam engine but major innovations in the organization of factories, corporations, daily newspapers, and trade unions that led to rapid growth during and after that period.

Napster, a relatively simple piece of technology, profoundly changed how people thought about the music industry by making the record companies’ business model transparent to their end users/customers. Professor Weber asked 150 students in one of his classes last year if it was legitimate to pay for music. Only three students (the slightly older ones) raised their hands. He believed that this was a mind shift that would not easily be changed.

Professor Weber felt that intellectual property politics led to legally inconsistent and problematic solutions in the Napster case. Under the non-circumvention clause of the Digital Millennium Copyright Act (DMCA), it is not only illegal to break an electronic lock on a protected digital good, it is also illegal (with few exceptions) to build a software tool that can be used to open an electronic lock, regardless of the builder’s intentions. As a result, technologies posing any threat to the copyright regime are being constrained instead of punishing conduct in violation of copyright law.

This preemptive law undermines a major source of innovation for the economy to protect the $12 billion dollar music industry. More fundamentally troubling, it gives more protection to a single piece of intellectual property (in this case a song) than it currently gives to much more personal information such as information encoded in one’s DNA. He argued that while another song might be written at any time, once someone’s DNA has been decoded and made public, the harm that might be done is irrevocable.

Professor Weber also referred to a proposal by Pam Samuelson (UC Berkeley) and the Electronic Frontier Foundation that would levy a tax on hard drives or broadband connections and distribute the tax-generated funds to copyright holders as compensation for file-sharing. He considered this to be a “bizarre, stunningly inefficient, and dysfunctional,” idea.

Software and pharmaceuticals

Professor Weber then went on to discuss the new threats to software and pharmaceuticals. The software and pharmaceuticals industries are both fundamental to the knowledge economy. The debate on the current IPR regime revolves around the breathtaking evolution of software and its related products and services. Meanwhile, the pharmaceuticals industry represents a large percentage of the U.S. GDP and exports and also has the potential to dramatically affect society with groundbreaking treatments for cancer and other life-threatening illnesses. Still, Professor Weber maintains that it is a “strange and discomforting time” to be involved with either industry.

Professor Weber has detected two distinct views on the future direction in both industries, but especially in the IT sector. Many people optimistically believe that the current declines in stock prices are temporary setbacks and that the markets will return to their mid-nineties positions after a few years, but without an equity bubble that proved to be a distorting distraction. The second theory, which Professor Weber agrees with, is that the current economic condition is a major period of industrial reorganization that will fundamentally change the way the markets value these industries.

The software industry represents about two and a half percent of U.S. GDP. Although the whole IT sector was affected by the bubble economy of the 1990s, Professor Weber distinguished between the grossly overvalued dot com companies and less irrational over valuations of traditional software companies that create products with a measurable value for their investors and consumers.

The challenge in the IT world comes from open-source software. Open source is a fundamentally different kind of production process for complex knowledge goods. It has three basic characteristics:

  • the source code that allows people to understand and modify what the software is doing is distributed freely with the software;
  • anyone can redistribute the software without paying royalties to the author of that software; and
  • anyone can modify the software and distribute that software under the same terms.

Open-source software is working under and thus pioneering a fundamentally different IPR regime that is directly opposite of the proprietary software companies’ strategies. It is characterized by an owner’s “right to distribute, not to exclude” under only one condition: other users cannot be constrained in how they alter the code. It is the exact opposite of the current IPR regime: “the core notion” holding together the existing proprietary software model and justifying its valuations is that the software code’s owner can rightfully exclude others according to its own terms. At a basic level, open-source software turns expensive, protected, service-intensive products into commodities. Since the computer code is open and inexpensive, it also broadens the system maintenance market. According to Professor Weber, “open-source software is not just a fluke. It is a fundamentally different kind of production process for complex knowledge goods.”

Professor Weber strongly emphasized that this new form of production means new sources of value, but it also means the destruction of old monopoly rents. Companies such as Microsoft, Oracle, and Sun are thus directly challenged by the open-source method of software creation. For example, about forty percent of businesses have overwhelmingly turned to Linux software on inexpensive Intel chips to run the same kinds and magnitude of operations as they would on much more costly Sun software and chips. Apache, an open-source software program that runs Internet servers, owns 65 percent of the server market. Linux also now runs supercomputer clusters, thereby cutting high-performance computing costs by 30 to 50 percent. Globis is an open-source software program that utilizes the entire Internet’s computational ability to solve problems. TiVo, Sharp PDAs, and household goods are either using or will soon use Linux. Open source is turning what used to be very expensive and highly protected, service intensive products, into commodities – and the market around these commodities is becoming significantly more competitive.

Professor Weber maintained that this actually helps the IT industry because of the fast rate of hardware development and the slow rate of software development. Increasing the rate of innovation and development in software technology would have a disproportionately huge impact on both the IT sector and the entire economy.

Open source has the potential to dramatically remake the software industry because of both its adaptability and its measurable success in the market in the way that Napster altered the music business. More significantly, whereas Napster was simply a distribution system for an existing product, open-source software is a free-standing production system that overturns the existing rules of intellectual property.” The change is significant for not only software companies. For example, in many industries, such as banking, companies invested their resources in capital-intensive, proprietary, specialized software that is the basis of their competitive strategy and therefore of their market valuation. The availability of non-proprietary, less expensive open-source alternatives nay cause their companies’ valuations to plummet. The results would be the bursting of another financial bubble created by the overvaluation of proprietary software.

Professor Weber also discussed what he viewed as a politically and conceptually fragile IPR regime behind the pharmaceutical and biotechnology industries. Conceptually, the success of open-source software undercuts the argument that the patent system is the only way to insure investment in innovative activity. There are also well-known problems with the patent system, including inefficiency of patent pools and the use of patenting as a business strategy for litigation rather than innovation.

Politically, Professor Weber believes that these companies face a number of challenges:

  • The visibility of their business model, as in the music business, foreshadows public pressure and perhaps ultimately, structural changes. Current medicines target a very limited set of human genes while the human genome project’s progress allows for possibly groundbreaking medical treatments that will require public-private and intra-industry collaboration and expansion. Even in the U.S., the pharmaceutical industry’s current business model and reputation do not have the legitimacy and support to obtain and sustain such partnerships;
  • The current debate in developing countries over the price and availability of drugs will soon begin in developed countries. He pointed out that differential pricing for Africa will lead to pushes for lower drug prices for lower income individuals in the U.S. as well;
  • He also foresees drug companies being targeted as villains of public health problems, with some parts of the pharmaceutical industry even being compared to the tobacco industry;
  • With the September 11, 2001 attacks, the anthrax scare, the U.S. government’s threat to take Cipro off patent, and the possibility of a SARS-like outbreak somewhere in the U.S., the pharmaceutical industries can no longer rely on the federal government’s protection for their intellectual property rights.

The pharmaceutical companies typically focus on the development of one or two major drugs. This results in the constant threat of a “biotech bomb” where stock prices collapse as soon as a key drug fails to secure FDA approval or does not prove as effective as initially expected.

Professor Weber pointed out that many people in the pharmaceutical industry, while aware of these problems, fear severe repercussions from Wall Street should they be the first to seek a new business model. The result will not be a melt down, like in telecom, but rather a possible corrosive loss of confidence, as in the music industry.

Public policy

Professor Weber believes there is good news, bad news, and contingent news in this situation. The bad news is that the technology companies will not return to the same high valuations of the nineties. He believes that the IT industry faces a period of persistent lower growth and that negative financial shocks will continue, leaving policymakers with difficult choices:

  • Pension funds must find different places to invest the capital they had previously put in the technology and pharmaceutical industries;
  • Technology outsourcing to India, China, Taiwan, and other countries will become a target for protectionist policies. At the same time, outsourcing will raise national security concerns. Unlike before, technology companies have been politically mobilized;
  • Government-funded research and development in technology from homeland security initiatives will have a disproportionate impact on technology trajectories in areas that were previously driven by the consumer sector (e.g. wireless networking, ubiquitous sensors, distributed supercomputing).

The good news, Professor Weber believes, comes from the opening of new opportunities. The creation of commodity infrastructures build the foundations upon which new industries can grow. The famous example is that of the railroads and Sears. The over-capacity which resulted in price decline in the railroads allowed the creation of a new value chain when someone figured out that they could now afford to ship goods to consumers who purchased them out of a catalog. IBM is moving decisively in this direction with its embrace of open source and its transition to becoming a global services company. Likewise, Professor Weber expects to see the emergence of service providers in the pharmaceuticals industry, perhaps following the approach of a cosmetics company that successfully provides specific products to targeted segments of the population.

The contingent news is that policymakers can either encourage or hinder this process. Professor Weber discouraged “buying time for systems that do not degrade gracefully.” He argued against desperation leading to “defensive, rigid, and inefficient” actions such as the hard drive tax proposed by the Electronic Frontier Foundation, eternal copyright, and the non-circumvention clause of the DMCA.

Professor Weber believes that the government must inevitably subsidize the reconstruction of these industries not because of their size, but because they are too essential to the infrastructure of a modern economy. A good federal subsidy strategy will permit experiments in unlicensed space (ex: Wifi) and simultaneously, give clear boundaries for areas that require regulation in the interests of society (ex: public safety communications bandwidth). The government also needs to find a solution to the problem of “first-mover disadvantage” whereby those who try to move to a new model are financially punished for writing off the old investments. At some point, the government must stop protecting the direct stakeholders and accept the reality of industry losses.

Finally, Professor Weber concluded with the admonition we are still very very early in the evolution of industries like software and pharmaceuticals/biotech. These are not even close to being mature industries. We must never forget that fact as we think and talk about policy in these areas.

Dr. Kenan Jarboe, President of Athena Alliance, moderated the Q&A session. He began by noting a change in one of the political and policy dimensions, specifically the protection of monopolies. Other analysts, notably Rob Atkinson of the Progressive Policy Institute, have made the point that many old monopolies are attempting to protect themselves from changes brought about by new information technologies – i.e. certain groups like realtors, wine stores trying to protect themselves from web-based competition. Yet, Professor Weber seems to be saying that the new industries – such as software – have matured enough that there is a danger that they will seek protection from new forms of economic activities, such as open-source.

The previous Athena/Wilson discussion with Kurt Ramin brought up the issues of how R&D costs are to be accounted for and of how accounting rules might affect outsourcing of R&D. Under the new International Accounting Standards Board (IASB) rules, development costs – once a demonstrable product has been created – are considered an asset and must be capitalized. In the U.S., all R&D costs must be expensed. There are benefits both ways – more expensing means lower profits but also lower taxes. Under both rules, if you buy a patent from outside, it can be capitalized (thus lowering your expense) whereas if you spend the money in-house it must all be expenses. There was some discussion about whether in the case of pharmaceuticals (where much of the R&D is already done outside) this would lead to further outsourcing of R&D. But, according to Professor Weber’s analysis, this type of outsourcing only works if there is a strong IPR regime where you can buy the rights.

Professor Weber responded to the question of possible changes in pharmaceutical R&D by noting that the industry’s strength is in production, marketing and managing the regulatory process. In R&D, their strength is in managing the risks about the scientific enterprise. Small biotech firms are now operating as the de-facto R&D arms of the large pharmaceutical companies. That structure could be put at risk by both changes in accounting rules and IPR – creating the inability to buy R&D in a way that it could be protected. While profoundly altering the industry structure, this could also open up the next level of innovation. Partial findings by biotech firms might be open to development by the next generation of pharmaceutical companies in new ways that can be customized for new markets. It leads to the service model of pharmaceutical companies mentioned earlier. The question is, how the new business model can be sustainable? In the current system the biotech firm sustains its cash flow by selling its latest findings. It is unclear how this would work in a different system.

Jarboe pointed out that this might become even more problematic if the biotech industry moves to a financial model of raising funds through securitization of its IP, rather than through venture capital. What happens if accounting and IPR rules move in the directions of increasing the risk at the same time that the financial model is moving to use securitization to reduce the risk?

Professor Weber noted that the result might be pharmaceutical companies bringing R&D back inside the company — not necessarily because of the ability to own the knowledge, but rather that the internal knowledge and insight about that product would give a short-term marketing advantage. The situation may be analogous to the consumer electronics industry of late 1980 and early 1990’s where control over the basic commodity technology gave companies a short-term development and marketing advantage – at least until the next innovation came along.

Dr. Catherine Mann of the Institute for International Economics raised a note of concern about comparing the computer/software and pharmaceutical industries. The R&D process is very different. The time-to-market is very different. A three to four month advantage makes a difference in computer chips; it doesn’t in pharmaceuticals where there is a long clinical trial period. The difference is in the network externalities. IT has high network externalities; pharmaceuticals, with maybe the exception of HIV/AIDS drugs, have little network externalities.

Both industries operate under international IPR rules, specifically the trade-related aspects of intellectual property rights (TRIPS) agreement as part of the World Trade Organization – which are one size fits all rules. These international rules constrain what national governments can do with their public policy in this area.

Finally much of the discussion has been on the micro-level. The real concern should be on how changes in the business model, the price of the product, and how it is used in the economy affect the performance of the macro-economy and jobs. Is the cost of this disruptive change from the standpoint of the financial markets large enough to cause macroeconomic effects?

Professor Weber commented that the time differences between software and pharmaceuticals are important points. The difference holds for drugs in the narrow sense. But in the larger area that includes medical devices and genetically modified food organisms, the time to market issue is much shorter. And the trend is toward the two industries becoming much more similar rather than diverging.

On the macro-economic issue, the question is how to look at the situation. From a purely macro perspective, value shifts from one part of the economy to another are part of normal economic evolution. Some people are hurt; some are helped. However, the shifts can have real macro-economic effects. For example, the concern over Microsoft stems from the fact that it accounts for half the market valuation of the software sector. If that valuation is the result of an IP valuation bubble even in just that one company, the bursting of that bubble may have large spin-off effects on the entire sector and the whole economy.

Nor is it clear that a new business model that is being created will return the same monopoly rents – just to a different set of economic actors. There may be a similar industry concentration in a commodity software industry, but the valuations might be much less than in the old proprietary software model. The result is a destruction of the old system of monopoly rents. This may be good from the macro-economic perspective that monopoly rents are bad. But the transition process can be extremely painful.

As Kent Hughes then pointed out, monopoly rents are what supposedly drive the innovation process. The process is one of a series of monopoly rents which are eroded over time and replaced by new monopoly rents (due to new innovations).

One participant noted that the cost of innovation in IT is relatively low – with the open-source process actual enhancing the capacity for innovation. In the biotech industry, R&D is a capital-intensive activity. In a commodity industry, resources are not available to carry out capital-intensive activities. A shift of pharmaceuticals and biotech to a commodity-type industry would therefore have a large macro impact on the innovation system.

Another participant stated that he was less concerned about IT and more concerned about pharmaceuticals. In IT there already is an alternative source of innovation and technology in the open-source movement. In pharmaceuticals, there is no such alternative source of innovation. That gives the pharmaceutical industry an enormous source of political strength for protecting IP in the sector.

Professor Weber commented that the cost of innovation is important, but not as normally thought of. The cost of innovation in pharmaceuticals is largely a function of the regulatory environment. Take the situation in the larger life-sciences industry – specifically the case of genetically modified seeds. Currently, a farmer buys seeds that are tied to a specific pesticide, such as Monsanto’s “Round-Up.” Imagine a different IP regime where farmers buy a genetic sequence licensed under something like the open-source general public license. They also buy tools to modify that sequence and compile them into seeds customized for their particular fields. They could also redistribute those seeds to others with similar types of fields. They could hire companies for specific services (pesticides, herbicides, fertilizer, irrigation) around that specific configuration of the customized seed and their specific ground characteristics.

In this alternative situation, sources of innovation are very different. Innovation is happening in farmers’ fields with real-time experimentation, rather than in the Monsanto R&D labs. The configuration of value-added is very different – centered more around providing the auxiliary services. The monopoly profits are very different. And the product life-cycle is very different, with products moving in and out of the system very quickly.

As one participant then pointed out, the predicate for this type of system is a relaxed regulatory system. It may be appropriate in some areas, but not in areas of modification of DNA and human health. Such a relaxed regulatory system is unlikely in the biotech areas. Open source is logical in the software area, but not in the biotech area where the consequences of a disastrous outcome, however remote, are enormous.

Professor Weber agreed with this assessment and noted that this is exactly where the discussion needs to focus. Where are the areas where strict regulation is required?

Dr. Jarboe also noted that the line between strict regulation and experimentation is already fuzzy because of the practice by some medical doctors of prescribing drugs, originally approved for one application, to treat conditions for which they were not originally approved. In addition, companies such as IBM are already moving to position themselves to be the information provider for personalized medicine. As the information revolution continues, the regulatory system will be modified and will modify the innovation system in return.

Dr. Mann raised the possibility that rather than pharmaceuticals becoming more like software, software would become more regulated like pharmaceuticals. Certain IT innovations would not be allowed and certain information and information services would be restricted because of issues of homeland security and of privacy. IT services would then become a highly regulated sector.

Professor Weber noted that in this scenario the big IT players become the major interface with the regulatory process – similar to the way that the large pharmaceutical companies manage the FDA regulatory process. This is not an implausible scenario. The pharmaceutical companies then might have a competitive advantage over the IT companies in managing the regulatory process.

Dr. Mann also noted that the pharmaceutical industry is in protectionist mode, the IT industry is not. From a public policy perspective, the IT industry is still very much in an open market position, not even following the “protect the market” stance of the music industry. However, Professor Weber noted that there is a fair amount of protectionism of business models centered on the war over the open source model. For example, Microsoft launches fierce counter attacks every time a local government or country announces that it is going to switch to open source software. While it appears that Microsoft is losing the battle against open source, he expressed a concern over the expansion of this protectionist mindset.

Dr. Jarboe raised a question about where the battles for openness were being fought. Microsoft may be losing the battle to protect operating systems, but other issues are heating up. There is still the issue of business process method patents, where a number of lawsuits will soon reach the courts. There are international efforts to constrain either the use or flow of information. With these other forces pushing toward greater regulation, are the principles behind open source strong enough to push back?

Professor Weber responded that a movement in the IT industry toward a highly regulated and patented system would end up creating more problems. Such an overprotection of the old system would destroy the innovative potential of the industry. The industry may generally understand this – but it also continues to be worried about the opposite scenario where there is no IP protection at all and the industry falls apart.

Dr. Hughes returned to the question of the different nature of the pharmaceutical industry, specifically the role of the public sector. Much of the basic research, and the training of the industry scientist, is paid for by the public sector. If the industry changes to this more open source model, what is the role of the public sector in the R&D process? Does public support research become the source of the pharmaceutical equivalent of LINUX?

Professor Weber responded that much of the innovation already comes out of the public sector and universities. The small biotech firms, at least on the West Coast, are an adjunct to academic work. If market-based funding based on the creation of a proprietary produce is reduced, R&D activity may return more to academic research environments. It would be a different activity, but not necessarily less innovative. Dr. Hughes pointed out it might be analogous to the role that university-based Engineering Research Centers play in the computer industry.

At this point, a participant referenced an EU-US conference at George Washington University earlier this year on open source. At that conference a step-wise model of IPR was proposed (open source escrow plan) whereby a program would become open source after it reached a certain valuation. It was also noted that the general legal discussions of Microsoft in the lawsuits were flawed because they blurred the difference between operating system and applications. The distinction is most important in the creation of new products; open source may be able to improve the process of software creation.

Professor Weber emphasized the problems of innovation and productivity in software – and that certain business models make those problems even greater. Thus, any improvement in the way in which software is created would have huge macro-economic (general public welfare) benefits. Hardware has progressed tremendously; software has not. Improvements in software creation are large sources for new value-added. However, value will be created in different parts of the economy and that shift will be messy and difficult.

The point was also raised about bundling the technology. The industry is beginning to move to a less technology-driven and more user-driven model as it stresses information services over information technology. But the transition to the service model will only occur with a great deal of displacement.

The issue of migration of technology out of the U.S. was raised by another participant. Professor Weber answered that the process was one of dispersion rather than migration. Whether this is a dispersion domestically or internationally may not matter as much as the fact of the dispersion itself. It will become a political issue insofar as it affects the concern over retaining high-wage jobs in the United States.

Dr. Jarboe noted that the whole concept of controlling either migration or dispersion of an information good – which is non-rival and non-excludable – is only possible in strong IPR legal regimes that allow for the information good to be constrained. Otherwise, the information will flow freely of its own accord. The issue becomes one of how to capture the economic rents – by creating a proprietary right, by exploiting first-mover advantages based on the information, or by becoming a service provider building upon a common information base.

Dr. Mann brought up the issue of doing the R&D versus gaining the benefits from that R&D. European pharmaceutical companies are deliberately coming to the U.S. to do their R&D. They believe there is a better climate for R&D here. There are externalities of university arrangements that make it more cost-effective. There is a health care system that will pay more for drugs. Thus, there are lower costs and higher profits for developing the drugs here as opposed to Europe. But, then they take the drugs back to Europe to be sold there. U.S. citizens have essentially paid for all of this – and have reaped the benefits. But the Europeans also get the benefits without paying the costs. Thus, there is a set of economic understructures that influence the international flows of intellectual property.

Professor Weber pointed out that this process describes a mature industry with a relatively slow product development cycle. Most industry profits come from very few drugs. But the industry is likely to change to one where there is a faster rate of innovation.

Dr. Mann asked how this might happen in a political climate where there is a thrust to greater regulation, especially in Europe over Genetically Modified Organisms (GMOs).

Professor Weber responded by saying it would to happen in the U.S. first. But it will still matter where the basic research is done. In order for it not to matter the following would have be true: that the raw information that comes out of the basic research moves simply and quickly across national borders; that the tacit knowledge gained in the research process is not important; that the companies will not try to tie up the information and use it in high profit margins.

Dr. Jarboe pointed out that this is very close to a description of the open-source model whereas the traditional product life cycle model describes a situation where R&D is done in the U.S. first and then sold in Europe. That model changes dramatically if pharmaceuticals moves to an open-source service model where there is an open knowledge base that is customized at the service delivery point.

Dr. Mann pointed out that the customized system describes information-intensive health care delivery as an IT industry. It may not describe the narrow R&D-based product-specific pharmaceuticals/biotech industry. When the IT-driven health care delivery system runs up against restrictions on information, then it becomes closer to the current highly regulated pharmaceuticals model. Under that highly regulated system, it becomes very difficult to operate an open-source model.

Dr. Jarboe speculated about what might happen when the key product is the information – not the pill. What happens when the most important factor is not the economies of scale in making the pill, but getting information about what goes in it to the point of delivery – say, the local pharmacy that can make it on site? It is the regulation of the information, not the product, that becomes the key intervention point.

Dr. Hughes raised the issue of changes in both the IPR and trade regime in pharmaceuticals under an open-source approach to research where companies don’t need to recoup profits by selling overseas, don’t have costs of extensive clinical trials and generic manufactures can sell anywhere. Do we end up with a graduated pricing system – like a differentiated tariff system?

Dr. Mann pointed out that differential pricing is difficult at the pill level because the product can be bought over the Internet, creating a gray-market problem. In such a situation with no IPR protection, the pharmaceuticals industry claims that there would be no research on new drugs. Many of these new drugs will be so-called life-style drugs, which people will be reluctant to do without.

Professor Weber noted that the pricing issue comes about because the business model for producing those drugs is not transparent. People don’t understand why, if a drug costs eight cents to make, they can’t buy it for nine cents.

Dr. Jarboe commented that the same lack of transparency in the music industry is why college students don’t see the need to pay for music. But Professor Weber stated that in the music industry, it is a generational change by a group (students) who have a good understanding of the issues.

Professor Weber went on to comment on the issue of a system that has an innovation regime as its foundation but a greater level of regulation at the delivery point. Such a system could create huge problems for countries facing acute long-term health care issues due to aging populations. The current system has an implicit assumption of a continued high rate of innovation in dealing with issues of chronic care.

Lynn Sha of the Wilson Center raised the question of regulation. Even in areas that are supposedly tightly regulated, there are places/countries where unregulated activities take place. One of the lessons of the open-source model is that it is better to have these activities out in the open where they can be monitored. If the technology is not developed in the open, it will develop on its own without any public guidance.

Professor Weber noted that this points out that regulation is a very difficult with new technologies. It is possible to set up a micro-biology lab for roughly $10,000.

Dr. Jarboe raised the concern that as health care moves into a more information intensive system – and that information is more widely available – the regulatory challenge become greater. It is more and more important that, as this series of discussions has pointed out, we look closely at the new rules in the information age (regulatory, accounting, IPR, etc.) – and that we work hard to get the rules right.

Audio and written summaries of earlier forums in this series are available at the Athena Alliance website at