Do U.S. consumers support world pharmaceutical innovation?

Kevin Drum seems to have the facts on his side in criticizing Andrew Sullivan’s claim that the side-effect of lower pharmaceutical prices in Europe has been less drug development by European firms. But I don’t think Sullivan posed the right question in the first place.

Where a drug is invented doesn’t really matter much. A company that invents a drug in Europe still gets much of its profit from the American market. So the question is, what would be the effect on innovation of squeezing down on pharmaceutical prices in the U.S.?

My first guess is that it would slow things down. If both Wyeth and Novartis have to consider that their next blockbuster drug is going to bring in less revenue, the probability that Drug X will be that blockbuster has to be higher in order to justify spending the money to find out. That means some good prospects get overlooked; presumably not forever, but for now. If every country tries to free-ride by making sure that its consumers don’t pay their share of the cost of innovation, it figures that there will be less innovation. Maybe that’s not right; maybe drug companies, faced with a somewhat less creamy American cash cow, would be able to negotiate up prices in Europe and Asia. (That’s Kevin’s guess.)

But one or the other is going to have to happen, or some combination. It’s not the case that reduced prices can come out of pharmaceutical-company profits; those firms have to raise capital in the same market as everyone else, and their risk-adjusted returns on equity aren’t out of line with those of other companies. (Pfizer’s market capitalization is just shy of $200 billion, which is something less than two months’ worth of U.S. health-care expenditure.)

So it’s true, to some extent, that the U.S. is effectively cross-subsidizing pharmaceutical consumption in other countries, either by sparing them higher prices or by keeping up the pace of innovation. At minimum, that means that the “Canada spends less on health care than we do for equivalent results; therefore they’re more efficient” comparisons need to be adjusted for the cross-subsidy. If I’m right that some of the impact of lower prices would be on innovation, then we need to budget some public R&D funds (as grants, as prizes, or as patent buy-outs) to make up for that loss.

Ending the telephone monopoly was a great thing. Losing Bell Labs, not so much. Of course, for a tiny fraction of what breaking up Ma Bell saved consumers, the government could have supported Bell Labs in style, perhaps via a small dedicated tax on telecommunications services. But that tiny fraction never got spent, and instead we wrecked an institution that did spectacular work for half a century and which it would now be virtually impossible to re-create. That’s not a mistake we want to repeat.