Friday, July 31, 2009

Economic Analysis of Drug Research and the 12 year protection provision

In the course of crafting economic analysis of research/innovation markets, economists often make serious errors of the following kind: failure to investigate incentives in detail; failure to set a valid bar of comparison; mischaracterization of the market itself; and failure to account for the dynamic institutional relationships between researchers and the firms that become their direct clients. Such is the case with the most recent inclusion of a 12 year data exclusivity rule for new biotechnology drugs in the new House Healthcare Package, HR 3200.


My starting point for research into this topic is Proper Duration of Data Exclusivity for Generic Biologics by Economist Alex M. Brill of the American Enterprise Institute.

The most important observations relating to HR 3200 are the following:

1. The drugs in question are cutting edge biologics, an important but quite small segment of the pharma market. They are estimated, by 2012, to have a total global market of $6 billion. The 2008 revenue of the pharmaceutical industry as a whole is more than $600 billion, with a high concentration of revenues and profits in a few drugs: Lipitor (Cholesterol - $14.3 billion), Advair/Seretide (Asthma - $6.1 billion), and Plavix/Iscover (Thrombotic events - $6 billion). Source: Wikpedia

2. As a corrolary to (1), if a political tradeoff that leads to a diminished economic result for the small biologics segment also secures an improved result for the larger non-biologic segment, the sheer difference in scale makes a net benefit very likely. Furthermore, HR 3200 does contain such provisions: A ban on schemes where generic manufactureres recieve payoffs from brand manufacturers in exchange for delaying generic production (backed by the FTC) , and drug price controls (pg 787-797 ; tenative about what this will look like and what its real effect will be). So, political concerns may render the economic analysis moot.

3. Data exclusivity rules differ from patent protections in the following way: Both can effectively grant monopoly status to a drug manufacturer for a period of many years, but patent protection is granted at the time of filing, before the trial period of the drug, and only patent protection can be challenged in courts. The current patent protection lasts 20 years, of which only a portion can typically be used for monopoly production. In comparison, the entire period of data exclusivity is given to monopoly production, without similar uncertainties of legal challenge (Brill, 7). For this reason, any calculation of profitability under a patent scheme should hold a fortiori for data exclusivity.

4. Brill's paper proceeds with a break-even analysis, reaching a conclusion that the break-even point is 9 years for a 7 year data exclusivity window. His paper is largely a response to a paper written earlier in 2008 by Grabowski that did similar analysis, but concluded that the break-even point is between 12.9 and 16.2 years, given a different set of exclusivity assumptions.

My response:

How did we get locked into a debate on the level of innovation? Are we tacitly assuming that the essential question is how to maximize dollar profits associated with innovation?

Specifically, I'm posing this question because this attitude places all of the incentive to innovate into the dollar profit category, which is pure fantasy. Aside from dollar profits, innovation carries a mystique that implies prestige, free press coverage, political clout, and a place in the history books. Even were there no rules or laws in place granting temporary monopoly, there would still be a strong motivation for companies to innovate. Though it is convenient to express the motivations of a company as dollar profits, it is actually a misapplication of theory to associate dollar profits with the firm motivational concept of profit. Firms are motivated to maximize a profit function that takes a set of objectives as input and associates each one with an approximate dollar value. Not all of them need be sources of future literal dollar profit - doing so takes significant cultural factors out of the economic function.

Much innovation is done by nonprofit or educational institutions, hereafter referred to as non-corporate research. In their case, prestige is the single significant motivating factor, and monopoly production power has no bearing on this prestige.

If we further assume that high healthcare costs have no drag effect on the economy, and that innovation is our goal, we will still reach the same policy conclusion as Brill or Grabowski. Whenever the dollar profit incentive declines, the total quantity of research will necessarily decline - because lower corporate profits mean a downward income distribution and lower tax receipts, which in turn mean less funding for non-corporate research. Therefore, we should choose a degree of monopolization that helps guarantee against potential losses in order to encourage innovation.

However, we can take a different approach and say that some potential innovation should be sacrificed for lower drug costs. In this case, considering that drug costs are about 10% of the healthcare system's costs, and given that 69% of all perscriptions are generic, and that generic sales are 20% of all sales ($58.5 of $286.5 billion), we can compute the generic savings. First, if none of these drugs were generic, the total cost of medications would be $735.5 billion (257% cost). If all brand name drugs were replaced by generics today, the total cost of all medications would be 84.8 billion (30% cost). Roughly speaking, were we to reduce the monopoly protections by 50% in America, we would save 35%.

Of course, this is the exact type of trade that is considered immoral in the American ethic. It is a trade away of innovation, therefore a trade away of potential life saving future treatments. Suddenly the policy maker is choosing between dollars and human lives. But there is a lingering quality of life question - how many more people could afford medications, how many more people could avoid financial hardship under such a regime?

If we posit that the economy in general will do better when all healthcare costs are lower, we can still include a variety of attitudes toward protective monopoly. Though the direct, analytical impact of reducing noncompete periods is negative on innovation, a comprehensive policy which significantly reduces healthcare costs could still feature this and very easily be positive to innovation, provided it helps build a sufficiently stronger economy. Higher tax revenues could then be put toward publicly funded research. In effect, our attitude toward healthcare as a whole shifts the balance of research between public and private - a good national healthcare system would put research squarely into the universities rather than private companies, a result that is both good and bad.

I will not join the chorus of voices who denounce the waste and trickery associated with corporate research. The degree to which corporations get away with bad stuff is not a result of any manichean scheme where the corporations themselves are bad. Our society has a class of people who are raised with a goal of making profit - these are the business people, who graduate from business schools and do not have the time nor the obligation to study social justice. It is a failure of regulation when companies get away with bad things. Private research does offer many nice benefits to our society, but we can't look the other way or give them excessive powers of privacy.

Where a non-corporate researcher can get away with essentially doing nothing for decades, the private researcher is more likely to be brought to account by the very profit-oriented business people that are absent from the academic sphere. But while the corporate researcher can develop a drug that is substantially identical to his previous drug and be paid handsomely for it, the non-corporate researcher will hear the ridicule of his critical thinking and prestige-oriented colleagues. This dynamic is the central question in the character of drug innovation in America. At least in this sector of healthcare, and I suspect in others as well, it reveals the case that we have a failure primarily of oversight, both in academic and corporate research. The nature of common abuses is different in both systems, but these abuses are there.

For publicly funded research, there should be funding for pure science and also funding for development of medicine, but it is wrong to systematically dedicate money earmarked for medicine to research that only furthers pure science. Admittedly, the distinction between science for science's sake and for the public good is nuanced and at times difficult. When agencies review and approve grants, agency policy can have severe impacts on the nature of research and the careers of individual researchers. Congress and the relevant agency branches should work to ensure that it is the public good that is served before science. As backwards and anti-scientific as that sounds, it is a reflection of the importance of social welfare as a separate value from the furtherment of science. For the most part, funding will serve many laboratories that contribute to both. When making the tough calls, though, the goal should be to provide money to laboratories that promise realistic benefits to the public before laboratories that only promise to explore possibilities. Separarate funding should be dedicated to the furthering of science! Defrrauding the public is not a prerequisite for stable funding of science!

For corporate research, the key is oversight. Corporations that engage in a variety of unscrupulous practices do so because they know they can get away with it. By a permutation of Gresham's law, this becomes the industry standard over time. It is better to nip these trends in the bud. Laws about information exclusivity need to be formulated so that they cannot be gamed by skilled businesses. All studies of effectiveness should be public, and companies should be required to market their most effective drugs. This is the only way to prevent companies from rolling out drugs, especially biologics, of progressive efficacy in a series rather than simply immediately marketing their most effective one. It is clear where the public good is in this case.

As far as drug costs are concerned, one should ask who the highest paid employee of your local supermarket is. You will find that it is the pharmacist. He is paid well because the drug markup is huge. It is often even larger for generics. As economies become more localized under new city design regimes, the oligopolies of nearby stores may have even more opportunity to pursue these markups. As we embrace changes to healthcare, we might become less interested in small drug price differences between nearby stores, giving license for further markups. For these reasons, it seems to me that regulation at this stage will be essential as well.

In conclusion

The future of American healthcare is probably not going to be much different from healthcare in America today. We will take corrective action only when the system itself is threatened (as it is right now) but we will maintain the same essential character for our healthcare system. The uniquely high costs and waste inherent in the system might be eliminated incrementially but definitely not all at once, even though it is possible to do it all at once with a leap of faith.

No matter how one chooses to restrict generics in the drug market, the effects of such a rule cannot be particularly significant to the general cost problem. I have outlined a variety of ways to address the problem without changing the length of exclusivity periods. Both public and private funding structures for research should be improved. General healthcare reform should consider costs because of their economic and quality of life impact. Other parts of the distribution and production structure should be analyzed, and cost control measures at the retail level should be considered. This alone may allow us to realize a 35% cost reduction, the same as if we took away all dollar incentive for private research.

And if you are curious, because no news agency published the bill number, here is the horse's mouth:
HR 3200

Wednesday, July 22, 2009

Too many Gates

So we have the Bill Gates, Microsoft Overlord:

And now we have the Robert Gates, Military Overlord:

Finally we have the Henry Louis Gates, Harvard Professor arrested for trying to break into his own house: