Category: Economics

All over the world, new pharmaceuticals are developed more or less the same way. Governments and foundations spend money on fundamental research on diseases, but once a specific molecule has been identified - and sometimes long before that - the focus shifts to the private sector.

A pharmaceutical company puts its own money first into animal trials, then into human safety studies, then into small-scale efficacy trials, and finally into the big, expensive “Phase III” trials required to obtain approval from FDA or its equivalents elsewhere. About 80-90% of the time, the compound turns out to be a loser.

In the minority of cases in which the drug actually gets approved, the average time-lag between starting work and getting it on the market is most of a decade. Since the pharma business is risky, the cost of capital is high. That’s the justification Big Pharma offers for the price-gouging that patent protection allows: if the payoff isn’t there, the R&D won’t get done.

If you’re going to risk millions of dollars that costs you 10% per year on a longshot, the payoff if it hits needs to be very large. So pharmaceutical companies focus on “blockbuster” drugs: those with potential revenues of more than $1B/yr. That means drugs that (1) have to be taken frequently - ideally, every day for a lifetime - and (2) deal with the diseases of people with good health insurance.

None of this makes anything but a twisted sort of sense. It leads to not enough new drugs and to excessive drug pricing. In particular, it leads to the absurd situation where there’s an obvious social need to develop a drug but no economic mechanism for doing so. Today’s big example is a Zika vaccine, but the same is true of antibiotics and of innovative pain-relief formulations (e.g., pain-appropriate dosages of buprenorphine, opiate-and-antagonist combinations) with less addiction risk.

There are lots of proposals for fixing the whole system: my personal favorite is to at least partially replace patent protection with large cash prizes as the incentive for bringing new drugs through the approval process. (Since the U.S. federal government winds up bearing much of the cost of pharmaceuticals anyway - through Medicare and Medicaid, through VA health, through health coverage for its own military and non-military employees and their dependents, and finally through the tax deduction for employee health benefits - it could write some very big checks and still come out ahead, if the result was marginal-cost pricing for the drugs themselves.)

But in the meantime, there’s something much simpler. If drug development were financed at Treasury rates rather than at the pharmaceutical-company cost of capital, lots of socially important projects that aren’t financially attractive now would become attractive. That could be done by creating a publicly-owned pharma R&D firm to get socially needed drugs through the FDA process and license the resulting patents to generic drug manufacturers, or by lending the money at concessionary rates to current phama outfits to develop drugs serving identified needs and then sell them at controlled prices.

Of course the details matter - the details always matter - but in this case almost any set of details would leave us much better off than we are now.

Footnote

There’s a broader issue here: Right now, the whole world is eager to lend money to the U.S. Treasury, and as a result we can now borrow money for 30-year terms at 2.2% nominal. If our political system can just get out of its fixation on deficits and debt, we ought to be borrowing some of that money and investing it in things with good long-term returns: not just drug development, but R&D more generally (especially, I would say, basic science), infrastructure, and education.

One side effect would be to boost final demand, kicking the economy out of the slow growth that has been so marked since the beginning of the Great Recession.  There’s not much wrong with this country that ten years of tight labor markets couldn’t cure.