CHAPTER 12 INTRO
The pharmaceutical industry got its start in 1899, when Bayer, a German chemical company, introduced a painkiller called aspirin. * Today, the pharmaceutical industry is massive but tightly regulated. This industry is an ideal setting to study both the economics of innovation and the economics of regulation.
The Life Cycle of a Drug Find chemical compound that might treat a disease: trial and error, rational drug design > US pharmaceutical industry in 1970 tested over 700,000 substances in animals of which only about a thousand were promising enough to pass into human trials *Then, test it on animals to show it is not toxic * Then, test on humans in three phases > Phase 1: low dose to health individuals (~2 years) > Phase 2: dose to unhealthy individuals (~2 years) > Phase 3: test effectiveness in preventing disease or medical conditions (~3-4 years)
Get approved for sale by FDA or similar body * Once the drug is approved for sale, the drug company has a temporary legal monopoly protected by a patent (17 years in the US) * This is the company's chance to recoup the millions of dollars spent on testing * After that time is up, other companies can produce the same drug cheaply and profits decrease sharply
Drug Development Drug development is costly: * Hard to find a promising chemical in the first place > Only 21.5% of drugs that enter Phase I pass to Phase III > The while process can cost $500 million or more to bring a drug to the point of approval The costs of developing new drugs have risen dramatically over time
Success Rate by Phase
100%
71%
Success rate 31% 21.5% II III 0 4 6 8 Year
Figure 12.1.Cumulative success rate of drugs entering the three clinical FDA approval phases.Phase durations are approximate. Source: DiMasi et al. (2003). Copyright (2003), with permission from Elsevier.
How do we induce companies to make costly investments? Patents
Patent: government-sanctioned monopoly on a limited market, usually for one specific idea, algorithm, or product. Patents are typically awarded to the first person or firm that invents a new technology. Patents create a legal monopoly and hence the opportunity for monopoly profits. In practice, only the top 30% of drugs pay for themselves.
500
450 (millions of dollars) 400 350 300 250 200 Revenues from drug sales 150 100 50
Average R&D cos
3
8
0
Deciles
* Pharmaceutical R&D expenditures would have fallen 64% without patent protection, compared to just 8% in other industries.
How Strong Should Patents Be?
A
Rate of innovation
Patent strength
Downside of Patents > Customers have to pay monopoly prices for a longer period > Less incentive for further innovation by same company > Legal barriers to subsequent innovation by another company * But if patents are too weak, there is no incentive to develop new drugs!
Patents in Developing Countries * Low-income countries think about this tradeoff differently > Monopoly prices weigh more heav