The entire U.S. patent system needs serious repair, but the most broken thing about it is the way we patent prescription drugs. Federal and state governments spend billions of dollars on basic medical research, and the resulting science winds up informing (at least indirectly) the development of blockbuster pharmaceuticals. But our patent system then grants drug companies the exclusive right to sell their innovations without "generic" competition for years. Big Pharma points out that such patents are necessary because without them it can't recoup the massive costs of creating new products. Meanwhile, there are some classes of drugs that the world desperately needs—new lines of antibiotics, for example, or treatments for tropical, emerging, and rare diseases—but that the current system, dependent on blockbusters, doesn't readily produce. The incentives are out of whack.

There's another solution to this problem—a way to directly fund the drugs we're not getting and avoid the high cost of artificial monopolies. Let's take a page from some of our deep-pocketed philanthropists, who have used competitions to rejuvenate space technology (the X Prizes), mathematics (the Millennium Prize), and more. Instead of granting patents, the government should offer lump-sum payouts.

History shows this is not such a heretical idea. Indeed, stimulating innovation through prizes is actually as old as patent law. In the 1750s, Britain's Royal Society of Arts offered what it called premiums, rewards for solutions to pressing technical or commercial problems: Spinning wheels, mechanical telegraphs, naval construction, and brocade weaving were all "premium" inventions. Although the winners got a handsome prize in return—in total, the RSA paid out tens of millions in today's dollars—the solutions could not be patented. This meant that other people could adapt and improve on them.

Prizes create a kind of artificial economic system that maintains most of the key advantages of the free market. They create incentives and competition, and they diversify the number of minds working on the problem. But the prizes eliminate wasteful spending, since they are rewarded only when genuine solutions have been achieved. And when combined with limits on patent monopolies, prizes can ensure that those innovations will flow more readily through the society at large.

>Prizes can ensure that those innovations will flow more readily through the society at large.

Right now, most of the marquee prize-backed challenges are still funded by philanthropists or the nonprofit sector. But governments have begun to get involved. The Obama administration's Open Government Initiative has created more than 150 challenges, everything from developing new fuel scrubbers for the Air Force to a Healthy App contest sponsored by the surgeon general.

Because they are targeted explicitly at individuals or groups who are not on the government's payroll, state-funded challenges offer a way around the traditional complaints about government bureaucracy. The problems may be defined by government insiders or politicians, but the solutions arise from the edges of the network, not the center. A prize system widens and diversifies the web of collaboration, encouraging scientists and entrepreneurs to make a contribution, even if they have no direct connection to the authorities in Washington.

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So how can this mechanism solve the prescription drug crisis? Either by redirecting research money or appropriating new health care funding, we could offer billions of dollars of prize money for new pharmaceutical innovations. And we could mandate that the prizewinners share their innovations open-source-style, forgoing any attempt to patent their discoveries. Last year, U.S. senator Bernie Sanders of Vermont introduced two bills along these lines: the Medical Innovation Prize Fund Act and the Prize Fund for HIV/AIDS Act. By creating an outlandish award for a successful product—a treatment for HIV/AIDS could win billions of dollars—Sanders seeks to increase the number of organizations attacking the problem. And by mandating that the innovators not block generic versions of their drugs, these laws would allow still more organizations to enhance and refine those discoveries.

Sanders is the most left-wing member of the Senate, but it's essential to note that his approach breaks from the mirrored alternatives of Big Capitalism and Big Government. The state isn't trying to come up with breakthrough drugs or even to make direct decisions on which firms to back. Instead, the bills try to use government dollars—and publicity—to widen the network involved in solving these crucial problems and to make it easier to share the solutions that emerge. In our current system, government patents allow marketplace victors to profit for years at others' expense. A prize-based system would allow everyone to win.

Steven Johnson (@stevenbjohnson) is the author of the new book Future Perfect (Riverhead Books), from which this essay is adapted.