Are we ‘freeloading’ on US innovation?

President Trump’s letter to 17 pharmaceutical companies yesterday claims that “Other nations have been freeloading on U.S. innovation for far too long”. This view, and his response to it, has potentially seismic implications. His grievance is understandable, but his approach is disastrous. Here is why, and what we should do instead.

There was a lot going on in the US yesterday, so you would be forgiven for having missed something of potentially seismic importance.

The President of the United States has asked drugs companies to sell drugs to US consumers at a price no-higher than they sell elsewhere. (This is known as the Most Favoured Nation principle, and President Trump signed an Executive Order about it on May 12, 2025).

Why is this important?

That sounds innocuous enough: but it goes to the heart of how innovation is funded, with implications far beyond pharmaceuticals (though the implications in this sector are important enough).

This is a corner of political economy that is not much discussed or well understood, so here is little explantion of why it is important.

Pharmaceuticals are a text-book case of a product that people value enormously, which have huge fixed costs (R&D costs are typically more than $1bn for a new drug) and very low marginal costs (a few cents, if that, for each pill).

If firms do not recover their R&D costs, they will stop doing R&D. These products are hugely valuable to society. So it is important that someone pays for the R&D. Who should that be? If the consumer is going to pay, should everyone pay the same price above marginal cost, or should firms charge some consumers more than other?

I explained the economics of this in a blog post here more than 20 years ago. (I am feeling old.) I believe that analysis is still correct. The conclusion then, and now, is that complete price discrimination by firms is economically optimal in this case. In other words, firms should be able to charge more to people who are willing and able to pay more. This enables firms to recover their R&D costs, without reducing access to innovations for potential consumers on low incomes.

If the firms make excess profits as a result of capturing so much of the economic surplus, you can redistribute away from them by taxing their profits.

President Trump has ordered firms to stop doing that. He wants US consumers to pay no more than consumers in other developed countries. He says that other nations have been ‘freeloading’ on US innovation. He wants everyone to pay the same price.

This is potentially seismic for three reasons.

First, sharing technology with poorer countries is one of the most valuable forms of development cooperation. (Angus Deaton makes this point convincingly in Chapter 8 of The Great Escape). Without diffusion of technology, poorer countries have no chance of catching up with rich countries. Without technological catch-up, inequality between countries and communities will grow without limit.

Second, more and more of the economy is characterised by high fixed costs and low marginal costs. The most egregious current example is AI. The fixed costs are orders of magnitude larger than pharmaceuticals, and the marginal costs are negligible. If AI turns out to be as valuable as some people say, then excluding people on low incomes from accessing it will turn out to be a very big deal indeed. But apart from AI, most of the information economy in which we now live has big fixed costs and low marginal costs – so we need price discrimination if people on low incomes are to access things like software, weather forecasts, energy, agricultural innovations, medical diagnostics, communications, entertainment, travel and so on.

Third, if there is a single price for these products, nobody will develop technologies that benefit primarily people on low incomes. That is, bluntly, why we spend 10x more on cures for baldness than we do on cures for malaria, and why we still do not have cheap effective vaccines against malaria, dengue fever, or tuberculosis. Only through price discrimination can firms recover enough money to cover their R&D costs.

In short, if we pay for R&D by charging above marginal cost, then without price discrimination, the gap between rich and poor will continue to grow, with no mechanism for catch-up. Inequality will grow without limit.

What should we do instead?

I do understand why President Trump feels aggrieved, on behalf of Americans, that they are paying more than other citizens for pharmaceuticals that have often been developed in the US.

He says in his letter to Eli Lilly (full text is below):

Other nations have been freeloading on US innovation for far too long.

That’s a big claim, and potentially hugely important, well beyond pharmaceuticals, for the reasons given above.

Here are four things we can do.

First, cut the costs of R&D. A lot of the cost is tied up in complex intellectual property and licensing laws, and (in the case of medicines) costly regulation. We would all be better off if we could find ways to streamline this (for example, by removing patent thickets).

Second, fund R&D in other ways. Patents are not the only, nor often the best, way for society to pay for successful innovation. There are lots of alternatives, such as Advance Market Commitments, prizes, patent buyouts, public R&D funding, etc. Here is a longer piece about that. We need a smarter toolkit for which tools to use, when, and how.

Third, recover excess profits from firms through tax. This may require international cooperation on corporate taxation, but we need that anyway. That is a better way of redistributing the producer surplus than regulating prices.

Fourth, increase R&D by other developed countries. That way, Americans will benefit from other countries’ innovations as much as we benefit from innovation that they finance.