Sophia Barthel, Emory University
According to a 2019 CDC report, over 2.8 million antimicrobial-resistant infections occur each year in the US, resulting in over 35,000 deaths. As Emory University ethnobotanist Dr. Cassandra Quave notes, we are facing a “double crisis” in the battle against superbugs: the failure of traditional antibiotics and our failure to incentivize the discovery and development of alternatives. Antimicrobial resistance serves as just one example of mortality that could be avoided through increased pharmaceutical innovation. However, the research and development process for new pharmaceuticals is highly costly (often upwards of $1.2 billion), and only 12% of drugs entering clinical trials are approved by the Food and Drug Administration (FDA) and make it to market. This risk associated with developing new drugs can negatively impact the likelihood that pharmaceutical companies will invest in research and development.
While developing new drugs is crucial for public health, there is a tension between incentivizing innovation (i.e., profit for pharmaceutical companies) and ensuring life-saving drugs are affordable. Pharmaceutical price gouging has drawn the public’s ire in recent years. Moreover, US spending on prescription drugs increased more than tenfold between 1980 and 2018, due in large part to the fact that drug prices in the US are 2.3 times higher than those present in other OECD countries on average. Thus, it is imperative that policymakers balance the incentive for pharmaceutical companies to invent new drugs with ensuring those drugs are affordable and accessible.
Market exclusivity protection is the primary driver of revenue for pharmaceutical firms. Because the marginal cost of drug production is low and the process of drug approval by the FDA is highly public, competitors could easily replicate other firms’ innovations if they were not protected by patents. These pharmaceutical patents are issued at the time of drug discovery rather than when the drugs actually reach the market, meaning that there is a period of time when firms are not earning profits but are still subject to the timeline of the patent. Therefore, one potential policy to incentivize firms to invest in research and development could be to “start the clock” of patents at drug commercialization, which would result in increased expected returns for firms that undertake new drug discoveries. While this policy would make it more likely for firms to invest in long-term research, an extension on patent protection could come at the expense of consumers, who may have to pay higher prices. The introduction of generic drugs after patent expiration can lead prices to decrease to 55% of the prices of brand-name drugs. By excluding competition from generics, extended patents would lead to decreased consumer welfare and potentially result in over-innovation, since pharmaceutical firms could capture too much of the surplus resulting from market exclusivity.
Rather than increasing a firm’s expected returns to innovation, policies aiming to spur research and development should aim to decrease the cost barriers to drug discovery. There is a strong consensus that pharmaceutical innovation is stimulated when firms receive reimbursement for research costs (i.e., through tax credits, tax deductions, or direct public funding). A traditional model for a firm’s decision to innovate would predict that a company will invest until expected revenue is at least equal to the expected cost of development. However, it has also been found that firms base their decision to innovate in part upon the amount of cash they have on hand at a given moment, implying that firms’ risk aversion is dependent upon their current net worth rather than merely their prospective profit.
This finding means that direct subsidies to firms early on in the research process have the potential to reduce the uncertainty associated with risky projects, making firms more willing to pursue the development of truly novel drugs that may be less likely to receive FDA approval. Thus, a positive shock to a firm’s net worth could encourage investment in radical innovation, rather than merely the development of functionally similar pharmaceuticals with slight changes or improvements (often termed “me-too” drugs). Furthermore, transitioning away from large, late-stage grants (in particular those provided to old, well-established firms) in favor of several small, early-stage grants to younger firms just entering the market has been shown to positively impact patenting and innovation rates. It is particularly crucial to support smaller companies that may otherwise be financially constrained, as these firms can provide competition against larger players and drive them to invest in cutting-edge research.
However, policies advocating for increases in targeted pharmaceutical funding do not entirely avoid losses to consumer welfare. While government financial support avoids the drawback of higher prices that would have resulted from extended patents, these costs are reallocated in the form of higher taxes. Nevertheless, over the past 10 years, nearly half of the novel drugs approved by the FDA were developed as a result of publicly-funded research and development, demonstrating the crucial impact of communal support. As economists, we know that there is no such thing as a “free lunch”—if a policy includes financial incentives, the money must come from somewhere. Given the role of novel pharmaceuticals as a public good and the evidence demonstrating the positive impact of early stage-funding, it makes sense for firms’ incentives to be derived from collective support rather than high drug prices.