Health

The Failure of Pharmaceutical R&D: High Drug Costs (3/4)

In previous posts (part 1-the health gap & part 2-current responses) I pointed out that the basic reason for the failure of pharmaceutical R&D was a lack of markets in the developing world. However, current responses are inadequate to address the gap. As I argue here, there are other systemic problems that inhibit market incentives from working, not just in the developing world but even in the developed world.

To understand my objections, one must question the basic premise of the industry - that drug development is risky and requires high returns - something the developing world cannot provide. Is that true?

The True Cost of Drug Development
It is a known fact that prescription drug prices in the west are extremely high, and have been increasing exponentially over recent years. The pharmaceutical industry takes great pains to explain that these increases are justified in order to:

1. Cover high drug development costs
2. Justify the high risk involved in drug development
3. and, enable further investments in R&D

There is no doubt that drug development costs have increased. A 2001 study by Tufts University, concluded that drug development costs that year were approximately $802 million, compared to $231 million in 1987. This implied a 2.5 times increase in inflation-adjusted terms.

But is drug development really that expensive? There is no dearth of critics who question the industry’s figures:

• These figures include the cost of research on drugs that do not reach the market – a factor that makes drug development risky. Critics have pointed out, however, that most of the new drugs developed and approved are not fundamentally different but only minor modifications of existing compounds. The cumulative drug development of most pharmaceutical pipelines should, therefore, be less risky and less expensive than a sample would suggest.
• The Tufts study included in its cost calculations the opportunity cost of investments in drug development. However, as James Love of CPTech, a fervent anti-patent critic points out, this is akin to saying the cost of a car is the price you pay, plus the interest payments (i.e. the perceived cost is actually lower than the actual cost).
• It is also a fact that a significant portion of basic research is funded not by big pharma, but by the government. In the USA this is often done through the NIH. The result then is to reduce the overall risk in drug development.
• Finally, it is often pointed out that while R&D is expensive, it is not the biggest component of big pharma’s expenses. On the contrary, the component that has increased the most is marketing and administration. In 2001, the top 9 US companies spent 11% of sales on R&D, compared to 27% on marketing and administration. Since 1995, the number of R&D jobs has remained static, while the number of marketing jobs has increased by 60%.

It is reasonable to assume drug development has become more expensive with higher costs of clinical trials and greater regulatory requirements. However, these counter-points suggest that the industry’s figures should be taken with a healthy dose of skepticism. While drug development is expensive, it alone cannot account for the sky-high price of medicines.

Faulty Pillars of Innovation: Patents and Profits
To find out why prices remain high, one must question the basic model of the pharmaceutical industry, which is based on two pillars - patent protection and high profits from high-risk investments.

The patent system, it is argued, generates innovation. Drug companies invest money in R&D, but expect appropriately high returns. The patent system makes these returns possible by giving companies an exclusive right to market a drug for a limited time. At present, the TRIPS agreement provides patent protection for 20 years. While this may appear to be long, one must consider that it takes 10-15 years to get a drug approved, leaving 5-10 years to market it.

However, the patent system has several other mechanisms to extend the basic protection. For instance, companies can file for a new patent if they modify a drug slightly, or if they prove a new use for an old drug. Therefore, a particularly good antibiotic can, with some modifications become extremely good for another condition, and be marketed exclusively as such for another 20 years.

The second pillar drug companies base their model on is high profits, which are seen as a natural outcome of high-risk investments in drug development. However, given that as public companies all pharmaceutical companies must show profits, there can be a tradeoff between innovation and profits. Given such pressure, it is hardly surprising that big pharma does not invest in malaria or TB drugs that will yield little.

Combine these two facts - a patent system that encourages modifications rather than new drug development, and a capitalist mindset that maximizes profits even at the cost of innovation - and the implications for R&D are obvious. Companies are encouraged to invest not in new drug development, but in enhancing existing drugs. Faced with a choice between a high-risk investment that takes 10-15 years for returns, and a low risk investment that generates lower, but still significant returns in 5 years, companies will clearly take the latter option.

There is evidence this is happening. In 2002, the FDA approved 78 drugs. Only 17 of these contained new active ingredients. Seven drugs were improvements over older drugs, while the remaining seventy-one were marginal variations of existing drugs.

The patent system, as it stands, therefore, has become a hurdle to the very innovation it is supposed to encourage. And the high profits the industry achieves also hinder innovation, because innovation requires risk, which can lead to volatility - something not welcomed by the stock markets.

There is one final factor that keeps drug prices high - a perception among society that they should be - and because they can be, given the purchasing power of the developed world. A sustained and highly successful PR campaign by the industry has led us to believe that drug development is more costly or risky than it is. And to support that myth, we grant big pharma a monopoly, without regulating the price. As any economics student will tell you, a monopoly will charge premium pricing.

Further Reading

• The Price of Innovation: New Estimates of Drug Development Costs. The Tufts Centre Study of costs of drug development (J.A. DiMasi et al. / Journal of Health Economics 22 (2003) 151–185).
• Editorial: New Estimates of Drug Development. Analysis and comments on the Tufts Centre study mentioned above. Read this instead of the full report (Journal of Health Economics 22 (2003) 325–330).

© 2006 The Discomfort Zone.