Abbott Laboratories (NYSE:ABT) is making a high-stakes stand on drug pricing in a dispute that threatens to make hostages out of the pharmaceutical industry and its investors.

The drug manufacturer is embroiled in controversy for increasing the price of its HIV drug, Norvir, by 400% at the end of last year. Consumer groups have assailed the hike, staging protests and drawing media attention. The private insurer Aetna (NYSE:AET) later briefly pursued a lawsuit against Abbott, and then abruptly withdrew its case, stating it intended to "discuss" the pricing change with the drug manufacturer.

The federal government has become involved in the imbroglio's latest and most crucial phase. Several senators have called for an antitrust investigation. More ominously, in an unprecedented step, the National Institutes of Health has launched hearings to determine if Abbott will be permitted to retain its patent for the medicine.

Abbott has zealously defended its position, asserting that the higher price better reflects the going rate for protease inhibitors, the drug class to which Norvir belongs. The company also notes that the new price tag will mostly impact private insurers, since government programs will pay the pre-hike price and poor patients will receive the medicine for free.

New era
Abbott's regard for less privileged citizens is admirable, but its reasoning may fall flat, at least when it comes to swaying public opinion. At one time, concern over higher drug prices may have been confined to the impact such hikes would have on the poor and the uninsured. But that bygone era has yielded to a time in which middle- and even upper-class citizens worry about health insurance, and companies fret about their ability to continue to provide coverage for their employees.

A recent meeting of the Detroit Regional Chamber's Mackinac Policy Conference put this new reality into sharp focus. Speaking at the conference, General Motors (NYSE:GM) Chairman Richard Wagoner referred to surging health-care costs as a national crisis and voiced his concern that the U.S. could lose entire industries unless costs are contained. Wagoner cited rising prescription drug prices as a major driver in the health-care trend and called on the federal government to move to reform the system. GM itself has taken a number of steps to rein in its outlays on drugs, including raising co-pays for its employees and retirees.

Not surprisingly, Pfizer (NYSE:PFE) Chairman Henry McKinnell, who also attended the meeting, disputed Wagoner's assessment of the role of drug prices in health-care trends, although he did support Wagoner's idea for a bipartisan government panel to investigate the health-care system. Still, it would be hard for McKinnell to argue that GM's drug bill, which amounted to $1.3 billion in 2003, is not a significant burden. And as GM is the largest private provider of health care nationwide, its opinions can't be ignored.

Investors' fear and uncertainty
With so many pointing fingers at drug costs, the pharmaceutical industry has become a whipping boy of sorts for some politicians and consumer groups. Calls for the quick fix of drug reimportation are often accompanied by denunciations of the drug makers. Incidents such as GlaxoSmithKline's (NYSE:GSK) recent troubles with New York Attorney General Eliot Spitzer once would have been treated as isolated events, but they may now add fuel to the fire of hostility toward the industry as a whole.

In part due to this trend, an element of uncertainty seems to have crept into major drug stocks. In light of the controversy, it's understandable that Abbott's stock is down about 1.6% year-to-date. More telling, though, is that despite its solid portfolio, dominant market position, and relatively consistent earnings performance, market leader Pfizer has also seen its shares decline slightly so far this year. This is even more notable considering that drug stocks are typically considered good "defensive" plays in an environment where interest rates are expected to rise, as is forecast in the U.S.

Abbott's risky move
Adding to the investor wariness is the game of brinkmanship that Abbott is now playing with Norvir. What makes the dispute unnerving is that it has prompted the federal government to dust off a never-enforced provision of an obscure law. The Bayh-Dole Act of 1980 was designed to promote the transfer of technology developed with federal funds from academia to private industry. But as Dr. Peter Arno, professor of epidemiology and social medicine at the Albert Einstein College of Medicine, and Michael Davis, professor of law at Cleveland State University College of Law, have written, Bayh-Dole also gives the federal government "march-in" power on patents that arise from federal funding. This power allows the federal government to strip away such patents from their private holders, if the government determines the invention in question is not being provided to the public at a reasonable price.

Abbott received a $3.5 million federal grant for research into protease inhibitors. The firm then spent more than $300 million to develop Norvir. That the company bore most of the burden and took on most of the risk related to the drug is unquestionable. But this does not really matter. What does is that Abbott's unflinching stance on Norvir has released a specter that will probably haunt the pharmaceutical industry for some time.

The problem is that the federal government's influence on the pharmaceutical sector potentially reaches far and wide. Arno and Davis estimate that the federal funds constituted 42% of total health-related research and development spending in 1999, while private industry contributed 55%. With this level of spending, the government probably could lay claim to the patents behind a vast number of drugs now in private hands.

Where does it end?
Right now, the government does not seem to be disposed to a wholesale evisceration of drug patent rights. Abbott will probably keep its claim on Norvir. Still, the episode could be the harbinger of a new era of patent challenges. And someday, the powers that be may be more inclined to radical action.

The pharmaceutical industry, for better or for worse, occupies a unique position in American society, serving both public health and private shareholders. When the Medicare drug benefit takes effect, the public health role will be pushed further to the forefront. This may require pharmaceutical concerns to engage in a difficult balancing game, although in past circumstances the industry has succeeded in meeting the needs of both groups. The Norvir price hike may seem to be in the near-term interests of Abbott shareholders. But over the long haul, failing to find some compromise on drug pricing could be disastrous for Abbott and the pharmaceutical sector.

Fool contributor Brian Gorman is a freelance writer living in Chicago, Ill. He does not own shares of any companies mentioned here. The Motley Fool is investors writing for investors.