The pharmaceutical industry has suffered some serious blues in the past 18 months: HIV-positive Africans and old ladies in wheelchairs have cursed it; newspapers have challenged its accounting; stocks have plummeted. The recession, war in Afghanistan, and terrorism around the world may have caused Americans plenty of stress and headaches, but investors, at least, are reaching for the bottles without the childproof caps. In the past year, shares in the Dow Jones breweries-and-distilleries index are up 25 percent; shares in the pharmaceuticals index, meanwhile, are down 25 percent.

And the industry deserves it. For years it has squeezed consumers the world over, endlessly arguing that it needs its huge profits in order to invest in new, lifesaving innovations. But while that might once have been true, lately the industry hasn't been innovating at its past rate--and that's probably the main reason investors have started to back off. According to a May report by the nonprofit National Institute for Health Care Management (nihcm), the pharmaceutical industry has been producing a much higher percentage of "me too" drugs and far fewer truly innovative ones over the past decade. Most damningly, the report shows that the number of drug applications the Food and Drug Administration (FDA) puts on a priority track (because they appear "to represent an advance over available therapy") has shrunk dramatically relative to the number put on a standard track (because they appear "to have therapeutic qualities similar to those of an already marketed drug").

If the nihcm report doesn't convince you, just turn on your television and note which drugs are being marketed most aggressively. Ads for Celebrex may imply that it will enable arthritics to jump rope, but the drug actually relieves pain no better than basic ibuprofen; its principal supposed benefit is causing fewer ulcers, but the FDA recently rejected even that claim. Clarinex is a differently packaged version of Claritin, which is of questionable efficacy in the first place and is sold over the counter abroad for vastly less. Promoted as though it must be some sort of elixir, the ubiquitous "purple pill," Nexium, is essentially AstraZeneca's old heartburn drug Prilosec with a minor chemical twist that allowed the company to extend its patent. (Perhaps not coincidentally researchers have found that purple is a particularly good pill color for inducing placebo effects.)

The Pharmaceutical Research and Manufacturers of America (PhRMA), the drug industry's powerful lobbying group, disputes the claim that it's innovating less than in the past, and it calls the nihcm study politically motivated because health insurance plans critical of PhRMA's high prices support the organization. "Maybe they are right; maybe they are wrong. But it appears that they had a desire to reach a certain conclusion," says Michael Friedman, who currently runs PhRMA's Office for Biomedical Preparedness. The organization also wrote a rebuttal to the nihcm report that dismissed the "priority" and "standard" designations as an FDA "management tool" based on incomplete information about a drug's potential.

But just because something is a management tool doesn't mean it doesn't convey useful information. According to Jane Henney, the most recent FDA commissioner, the nihcm data are not only very useful; they actually understate the reality. That's because in the early years that nihcm analyzed, the FDA put far fewer drugs on the "priority track" because it could only grant that categorization to potential lifesavers.

Everyone should hope the pharmaceutical industry gets its groove back. And it might--particularly if heavy investments in research on the human genome start paying dividends. But for now the industry seems caught in a cycle that stifles the thing it should want most: innovation.

The cliche of the moment is that pharmaceutical companies have picked the low-hanging fruit, developing drugs that interact with the limited number of enzymes and molecules that we already understand and have thoroughly modeled. For example, Lipitor, the best-selling drug in the world last year, lowers cholesterol by acting upon a molecule that scientists had studied for years.

But people have always mourned the loss of the lowhanging fruit--and then smart and innovative folks built taller ladders. The tools and computational abilities available to drug companies today dwarf those that companies employed to develop the blockbusters that fueled the 1990s boom. Scientists now have access to the human genome and a vastly increased understanding of everything from gene expression to organ physiology as well as extraordinarily powerful computing and modeling capabilities. In many ways, discovery should be easier and cheaper now than ever before.

A better explanation for the pharmaceutical slump is a shift in priorities toward marketing, particularly since the FDA first allowed companies to directly target consumers five years ago. According to data collected by Alan Sager, a professor at the Boston University School of Public Health, the number of research and development (R&D) employees at companies making patented drugs declined slightly between 1995 and 2000, while the number of people working in marketing shot up 59 percent. "Drug companies trumpet the value of breakthrough research, but they seem to be devoting far fewer resources than their press releases suggest," says Sager.

Moreover, drug companies have learned that when they can't create a new drug to treat an existing illness, they can create a new illness to treat with existing drugs. GlaxoSmithKline's multimillion-dollar promotion of anxiety disorder as a pernicious national problem enabled the company to make billions more selling Paxil--a drug most experts believe is needed by only a small fraction of the people who take it. Unimed is busy pushing the idea that there's a national problem called male menopause--a problem that just happens to be treatable by a testosterone gel the company makes. The gel is currently FDA-approved for men with rare--and thus relatively unprofitable--problems such as underdeveloped testes.

But even this shift toward marketing doesn't fully explain the decline in pharmaceutical innovation. Just because companies are now able to sell flotsam doesn't mean that they wouldn't rather be selling gold. The problem is the absence of truly innovative drugs, such as Viagra or Prozac, in current drug company pipelines. And the explanation for that might well come from the supposed fount of American innovation: our patent system.

The last decade has witnessed an explosion in patent awards to pharmaceutical companies, with the number of biotechnology patents granted annually increasing by about 500 percent in the past 15 years. Last year GlaxoSmithKline was awarded 229 patents. Aventis has been granted an average of 301 patents over the past five years, according to Technology Review's annual patent scorecard.

The explosion has a couple of causes. One is simply growth in the field, but another is that companies have found they can significantly extend patents through various legal maneuvers--from agreeing to test on children (Congress passed this law to create incentives for companies to perform separate tests on kids) to filing new patent applications on old drugs about to lose their protection. By slightly tweaking Prilosec into Nexium, AstraZeneca got several years of additional protection for a hot-selling prescription drug. "Companies today have found that the return on investment for legal tactics is a lot higher than the return on investment for R&D," says Sharon Levine, the associate executive director of the HMO Kaiser Permanente. "Consumers today are paying an inordinate premium under the guise of the creating the stream of innovation in the future. But it's actually funding lawyers."

Even more important, the patent morass may be blocking new lines of research altogether. Every time a company wants to pursue research on a certain biological process, or even the individual genes involved, it has to find out who owns the patents and the price of a license, if one is even available. Last year Peter Ringrose, then the chief scientific officer at Bristol Myers Squibb, told The New York Times that there were "more than 50 proteins possibly involved in cancer that the company was not working on because the patent holders either would not allow it or were demanding unreasonable royalties." Rebecca Eisenberg, a law professor at the University of Michigan, has called this the "tragedy of the anti-commons," with companies and universities grabbing property that should remain in the public domain.

The key distinction is between "upstream" and "downstream" patents. Downstream patents cover final products, such as actual drugs. Upstream patents cover the various components used to make these final products. For many years companies and, particularly, universities freely granted access to upstream patents. For example, when researchers at Stanford and Berkeley came up with a technique for combining DNA from different species in the mid-'70s, they patented their discovery and licensed it out cheaply to anyone who wanted it--a major source of the boom in modern molecular biology.

In the past 20 years, however, Congress has repeatedly passed legislation encouraging biological patents, beginning with the Bayh-Dole Act of 1980--which enables universities to pursue patents--in the hope that it would give them incentives to commercialize their products. The results have been predictable. In late June, for example, Harvard and MIT joined a suit to try to stop Eli Lilly from manufacturing drugs for osteoporosis and sepsis that the universities say infringe on a 15-year-old patent. The companies Incyte and Invitrogen recently found themselves in a legal battle over patents leased from Stanford--patents that both companies would probably have been free to use under the old patent system.

If universities have tied themselves to the cycle, cheekily known as "patent or perish," companies have been still more aggressive about staking--and defending--claims to cellular parts and processes. Two years ago Chiron Corporation stopped hepatitis C vaccine research at four other companies by refusing to license one of its patents. Recently, as the result of work by the National Institutes of Health (NIH), Human Genome Sciences (HGS) learned that a receptor it had previously patented was actually an important pathway for HIV to enter cells. The result: HGS can now stop competitors' aids research. The U.S. Patent Office has recently made this sort of serendipitous patent use harder, but it can't take away patents already granted.

Companies naturally claim that patents such as HGS's don't hinder research since companies can buy or work around licenses. But that's not convincing. "Unquestionably, progress in science is linked to communication among scientists," says David Lipman, head of the National Center for Biotechnology Information at NIH. "If a growing fraction of research funds are being invested in generating information that is being kept proprietary, then it stands to reason that this would impact on the rate of development of truly novel drugs."

Moreover, biology is moving in the direction of increased integration. One of the brightest current research fields is "systems biology," which hopes to move science from analyzing single cells or proteins to understanding the integrated actions of whole systems. Science Magazine just devoted an issue to the field, and Eli Lilly will soon open a giant center for systems biology in Singapore. But studying systems won't work very well if every component is tied up. At the very least, it will take an awful lot of time and an awful lot of lawyers to resolve the gridlock.

The best thing for the pharmaceutical industry would probably be to maintain its strong protection over downstream products while opening access for upstream products. While it may not say this openly, the industry has implicitly supported this by funding public efforts to gather data upstream. For example, five companies are supporting the work of Alfred Gilman, who is trying to build a complete online model of cellular signaling that could dramatically speed drug development while keeping all the data in the public domain.

But most people in the industry rarely voice this view, in large part because they fear that any change to the patent system would bring uncertainty and confusion: The laws are extremely complex right now, but they work reasonably well from the point of view of the industry. Why mix things up and risk unintended consequences? "If you try to make industrial policy decisions, you risk producing bad outcomes that you can't correct until too late," says Lee Bendekgey, the general counsel for Incyte.

Another reason drug companies aren't talking about loosening restrictions on upstream patents is that they are so focused on fighting off legislative efforts by generic-drug developers to weaken their downstream patent protection. And it's much easier to argue that "patents support innovation" than to try to explain that some patents are good for innovation while others are bad.

There is at least one industry voice in favor of opening up licenses, though: Alfred Roach, chairman of a small company called American Biogenetic Services. Roach believes firmly in end-product patent protection, but he thinks that patents often "put an artificial tourniquet on the flow of a new discovery"--a belief informed by his own company's inability a few years back to get a license it needed in order to do work on hepatitis A--and has called for a law requiring patent holders to license their inventions to others at reasonable prices. A former boxer, Roach flies into a rage when asked why the industry doesn't automatically grant licenses at fair prices. "Why not try to share your information with all the different scientists out there for a fair price?" he asks.

Roach probably won't win though. The pharmaceutical industry has perhaps the most powerful lobby in Washington, employing at least 20 former members of Congress, top staffers from the Clinton administration, and the wife of the Senate majority leader. In fact, PhRMA has just added top health care aides from the staffs of John McCain and Bill Frist to its team of sluggers. That may be enough to quash reasonable reforms--even ones that would help the industry do the one thing that everyone wants: produce new, innovative drugs that can save lives.