Alex Tabarrok says today that pharmaceutical companies are undervalued because "pharmaceutical innovations earn only a fraction of the value that they create." For this reason, he opposes the Medicare price controls in the Inflation Reduction Act.
Trying to quantify innovation is hard. Instead, let's just look at profitability:
Pharma is the most profitable major industry group in the world, earning nearly double the amount of most other industries. The only one that's close is software, which has even more enviable production costs (zero) than pharma.
My view is that it's hopeless to try to quantify things like innovation or value to humanity. Penicillin and birth control didn't earn their inventors a penny. Instead, simply look at financial returns when there's true competition. This tells you that the average competitive large company has earnings that are about 8% of revenue. In the pharma industry it's 14%.
Real competition instead of artificial (and unpredictable) patent rights would be the best thing for the pharmaceutical market. Failing that, price controls seem pretty reasonable for an industry that takes very profitable advantage of its favored status.
"pharmaceutical innovations earn only a fraction of the value that they create"
Even if true, Big Pharma doesn't really develop innovations. Researchers in universities and associated biotech startups (generally directly or indirectly funded largely if not entirely by government grants) are the ones that discover new drugs and medical devices. Big Pharma's expertise and role is to scoop up stuff from that innovative environment, take it through clinical trials, and then scale up manufacturing and delivery.
I don't doubt that running a big pharmaceutical company is difficult and complicated, but they ain't innovation engines deserving of increased profits simply because medicine is useful stuff.
Put another way: since Big Pharma is neither the source nor the engine of biotech innovation, reducing their profits (slightly!) will not have a real impact on the level of innovation in biotech.
And guess who funded that university research? Mostly grants came from the U.S. government. In the mid 80’s Senators Bob Dole and Birch Bayh sponsored and got passed a law that allowed the advances made with government grants to be taken private for free. Essentially no strings attached.
We, the public, get to pay for them twice. first in the basic research phase and second when the new “innovative” approach is marketed. Not a bad system for big Pharma. Negotiation is long overdue.
We pay more for health care and medications than anywhere else in the world, by far. Our outcomes meanwhile are middle of the pack. Millions are uninsured. Something is radically wrong.
"A recent study by the Biotechnology Innovation Organization of clinical success rates in advancing drugs to market between 2006 and 2015 found that only 9.6% of drugs entering phase I clinical testing will reach the market." So its a 90% failure rate.
"As general rule of thumb, the average cost of phase 1, 2, and 3 clinical trials across therapeutic areas is $4, 13, and 20 million respectively." This of course does not include the approximately $100 to $250 million it costs to get the average drug to a phase 1 trial (figure given verbally at a pharma conference).
Price setting by the government might work, but it will be tricky to accomplish....
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6609997/#:~:text=A%20recent%20study%20by%20the,fail%2C%20respectively%20(4).
So, uh, what's your point?
ScentOfViolets - since you seem to always 'love' my perspective I will respond. Given the math I shared, combined with time value of money, public company expectations etc, a public pharma company likely has to earn something like $2 billion, over the life of the drug, on a successful drug.
1. I suspect price controls would not likely work under the math I highlighted.
2. With price controls does pharma reduce investments in research? I would think so.
3. Yes a company would accept lower returns IF the government accepted more of the downside. Once you control the price, why not take over the whole process (see notcynicalenough ) ?
Of course, as I am sure you will suggest, I could be wrong. Then again, I feel pretty comfortable with my evaluation of the situation.
You don't understand what 'profit' is, do you? Otherwise you'd know that the '90% failure rate' has already been factored in.
So tell me, why did you think yearly profits didn't include those costs? Seriously. I really want to know. Because the only answer I can think of is that you are really, really stupid.
Well, I can think of another answer. But that one makes you look bad.
So what? If the risk is huge (and 90% failure isn't - that's roughly the failure rate for new restaurants in the first 5 years) then one solution would be Dean Baker's: the government should fund drug development all the way through human trials and put the patents in the public domain.
NotCynicalEnough - "90% failure isn't - that's roughly the failure rate for new restaurants in the first 5 years)"
I say your restaurant example is a great illustration of the problem. Try going out to the capital markets and raise several hundred million dollars for a restaurant concept. Especially a restaurant with capped profit potential. hmmmm
Individual companies are not going to proceed with research and testing (very expensive) based on benefit to society, but primarily on the basis of return on capital. That is presumably best measured by things like earnings/price rather than profitability, but anyway it takes no account of externalities. Return on capital is what is normally meant if a company is considered "undervalued".
But if you want to go by value to society rather than value in the market, then probably the government would have to decide what the value will be, and what to spend research and testing money on. Allowing pharmaceuticals to charge whatever they want as long as they hold patents is not going to prioritize value to society over return on capital.
What does Kevin mean by "real competition"? Without patents pharmaceuticals would not attract enough capital for the extensive research and testing costs - or at least that is the argument for patents. One solution is for the government to do research and testing and then turn over production to what is now the generic market, but that would bypass the miraculous influence of the invisible hand of the free market in deciding what should be produced.
This statement: "Real competition instead of artificial (and unpredictable) patent rights would be the best thing for the pharmaceutical market." is baffling and wrong. The comment that pharma is not the source of innovation is even worse.
It's unclear how deep your naivete goes, but are you saying that the existence of patents is itself evidence that there is no real competition? So the effort that goes into discovering, testing, optimizing therapeutics, then repeating these efforts in humans, is incredibly resource intensive and requires thousands of highly-trained people for years. There is a set of pharma companies called 'generics' that solely exist to copy the end result of company 1's work and sell it at minimal revenue over cost (competition!). The time-limited patents are how a company justifies the expense of making a drug, so there is a return on investment before the generic companies step in. Other innovator companies work on the same problems trying to make their own innovative therapeutics for the same diseases (competition!). It fails more often than it works. There are problems in the system, but this fundamental set up (with patents) is not it. Such blase ignorance should be backed up if you think there's an argument.
On the pharma/biotech "lack of innovation" thing - again, it's just insanely ignorant. I understand most people don't "get" science, but good lord. If you want to take a drug that some research professor made up with his students, good luck. That's the start of the process, not the end. Universities make early discoveries. Professional drug developers make drugs.
There may be some ways to lower drug costs, but these overly-confident, wildly ignorant, statements on competition!, patents!, innovation! are not going to help anyone get a cure for their currently-untreatable disease.
Maybe it's not the best use of your time to post on a blog whose owner is so blatantly naive, surely your posting skills are better used elsewhere.
All that said, there's no way this is actually true: "software, which has even more enviable production costs (zero)".
+1
And pharma companies spend significantly more on marketing than research
https://www.ahip.org/news/articles/new-study-in-the-midst-of-covid-19-crisis-7-out-of-10-big-pharma-companies-spent-more-on-sales-and-marketing-than-r-d
And really, why SHOULD "someone get a cure for their currently untreatable disease"? Or more properly, why should they feel that it is their due? We are all just DNA replication machines, exactly as are all other living organisms. We exist to propagate a compound that somehow learned to replicate itself and then set about developing a means by which to "house" the process.
So your "big brain" with all its kow-towing to monopolists is, in the final analysis, meaningless and futile, like all brains. We like Kevin here; that's why we read his blog. Don't piss us off with your "I know better than your friend" bullshit.
As has been noted elsewhere Big Pharma spends an awful lot on marketing and promotion. And there's no question that they are among the most profitable industries in the world. Moreover, you sound a little naive, indeed childish , when you brush aside all the scientific research done as "something a professor made up with his students". Good lord. So, it's possible that non stop TV ads, 20 year drug patents and multiple billionaires in corporate Pharma, including say . the Sackler family, is evidence that we haven't achieved the best of all possible worlds in bringing very useful drugs to the public.
Nice disease you've got there, it'd be a shame if nobody could make a profit off it.
Patents mean that the price is not set by market competition. The company is protected by the use of govt power to make sure that no one makes generics while the patent is in force. So in the past pharma has made good profits by pricing drugs based upon R&D costs, production costs and some expected profits. It's worked very well for the pharma industry.
However, some bright marketing type said "let's change how we price the new Hep C drugs". They decided to base it on what it would cost to continue treating a pt if they didnt have those drugs. That let them set prices much, much higher. Note that we had not done this for other life saving drugs like antibiotics, and if we did they would also have cost a fortune.
For lack of a better way to describe it we had a kind fo social contract. We will provide patents so that you can be sure your drugs will make lots of money and you can continue to make new ones. In return we ask that you not set those prices at obscene levels. Then they found a way to justify obscene prices.
Steve
Presumably though all the patent means is there is a 17-odd year delay before the drug goes generic and presumably cheap. In the meantime, the rich people are the test subjects for long-term efficacy and effects.
It might be interesting, if feasible, to look at profitability of pharmaceuticals covered by current patents as compared to off-patent pharmaceuticals; the latter group should see real competition.
However, as the recent fuss over the Epipen and the pharma bros. indicates, even off-patent products don't always see real competition. In those cases, one might ask why there is a lack of competition.
It's partly the effect of the big pharmacy chains which have pretty much become a du- or triopoly, depending where you put Wal-Mart. They don't want to have the mess of procuring, distributing, and storing two versions of an ephinephrine injection device. When they all decide on the same one, competitors shrivel and blow away.
The retail pharmacies LIKE high prices for essential drugs. They just tack their usual 25% markup on a higher base price. What's not to like?
The usual conservative argument that allowing the US government to negotiate pharmaceutical prices would reduce the pharma companies' ability to innovate ignores fundamental economic principles. The medicine market doesn't exist in a void -- there are multitudes of buyers on the world market, and the negotiations of one buyer, especially one the size of the US government, affects the prices attainable by the others. If the US can bargain down the prices it pays, that will drive the pharma companies to raise the prices they demand from the other buyers, just as the unusually high prices we now pay make possible the lower prices paid by the other buyers.
Or they will just have to accept lower margins.
I haven't seen anybody point this out yet, so I will: Alex Tabarok is yet another idiot in the mould of Tyler Cowen, Et al., and why Kevin gives these mediocre at best (the evidence returns a much harsher verdict) 'public intellectuals' any attention whatsoever is beyond me.
"look at financial returns when there's true competition"
And then we look at utilities which have a guaranteed rate of return.
But... point taken.
Earlier this year..
Just How Dangerous Are India’s Generic Drugs? Very
https://www.washingtonpost.com/business/2023/04/04/big-pharma-india-s-drug-industry-needs-a-major-overhaul/82e12a36-d31e-11ed-ac8b-cd7da05168e9_story.html
That’s what cheap drugs cost.
Why are drug prices higher in the US than any other rich country?
Why can't we pass a law that says you can't sell a drug here for more than 125% or 150% of the G7 average?
Today, you try and sell a drug in the UK and they offer you $4 a pill. You take the deal because you make $3.75 on each pill you sell. BUT if selling to the UK at $4 means that you have to reduce the price in the US from $15 a pill to $6 a pill then the drug company will push back.
Right now, the US is subsidizing the rest of the G7 on drug prices. If we linked domestic prices to international prices then we would be subsidizing countries like the UK a little less.
The obvious way to make drugs is the US more affordable is to allow all purchasers to force price competition. Right now the largest purchasers (the government) are price takers and not allowed to force competition. This is still the case for most drugs even after Biden's bill opening up competition a a few drugs.