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.

Background

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:

http://energycommerce.house.gov/
HR 3200

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:

Postponing new content

I've decided to put off adding new content to this blog until after session is over. Legislative Aides are not allowed to have blogs and I don't want to bring anything negative to anybody. Sadly, this means that I effectively have my political voice completely taken away. I hope that one day America will be a different place where the freedom of speech is better protected.

Rolling Reconnect - what it was.

House Bill 2157 ended rolling reconnect and decoupled Oregon from the bonus depreciation business tax break. What more is there to understand? Ok, just kidding. Probably the most laughably incomprehensible lobbying hand out ever was circulated earlier this month by an economics think-tank for the floor vote on the bill. You can read that exact same article here: http://www.ocpp.org/cgi-bin/display.cgi?page=iss20090128stop

I'll try to give you a better description. First, I'll attempt to define some things clearly:

Depreciation: basically the amount that a businesses' machinery, buildings, and other assets lose value every year. Businesses keep records of this as part of their accounting. They have to use formulas that are set by the government, cause the government doesn't want anybody to have any fun.


Tax Credit: a reduction in total tax liability, often expressed as a downward revision in taxable income. In the case of a business, how that business writes its books can give it depreciation tax credits. So, how it does its accounting, and therefore its depreciation calculation, directly affects its taxable income. This is why the IRS audits businesses from time to time, and why the government is all up in businesses' grills.

Some legislators or lobbyists (nobody I worked for was directly involved in this) figured out that the federal stimulus might contain extra tax credits for businesses based on federal formulas for depreciation. The problem was that the fed wasn't just writing it as a tax credit, but actually declaring that these businesses could claim "extra" depreciation. Oregon, by law, used the federal depreciation standard - we were 'automatically coupled to bonus depreciation' to borrow language from the OCPP. Therefore businesses that got a federal tax credit for depreciation would get a second, bonus state depreciation credit. Thus, the federal stimulus would lead to a state level budget shortfall.

So, 2157 ended that, meaning that the businesses only got the federal credit, not the state one too. Oregon businesses must now track depreciation separately for both the federal and state level if the fed chooses to pass a bonus depreciation allowance.

Hope that helps....

Ban Escalators

Today, a little girl had her hand mangled in an escalator at a JC Penney in Anchorage.

Some will assert about this story that it was irresponsible for the mother to leave her child unattended. Others will point their fingers at JC Penney for failing to install modern safety features on the escalator. What I ask is a more profound question.

Why does something such as an escalator even exist? It seems that it is a trade where we expend resources producing a machine that uses power and is dangerous in exchange for the convenience of not having to expend quite as many calories going up and down staircases. Malls use escalators to force patrons to walk past more products and storefronts in search of the one going in the desired direction. Which of these 'benefits' are quantifiable as things that have improved our quality of life? To me, this is just another sad nail in the coffin of the revealed preference model.

Are we serious in our desire to promote a safe, energy efficient society? If so, we should embrace a future where there are no escalators.

Laffer, Revisited

Today, out of boredom, I made a rough, category and assumption driven laffer-type model designed as a kind of test for the future development of my ideas. My goal was to do a careful and component driven model of the Laffer Curve, which uses assumptions of both incentive and savings/investment interaction to predict a threshold beyond which increases in nominal tax rates will reduce revenues. This is not a growth model; it is an equilibrium model. Time is therefore not a factor in the model. We cannot accept arguments regarding the rate of economic growth, inflation, etc.

Every dollar spent is split between savings and demand. Savings is the variety of ways that the dollar is retained for later. This may be a variety of things, ranging from pure investment to stashing, to what amounts to demand increases.

Demand is the ways that money leaves the hands of the individual. Demand has three components: taxes, autonomous spending, and consumer spending.

Returning to the income equation, we have the following: 1 = S + D ; Which when D is analyzed for its savings component gives S + D(S + D(S + D(.... = S + SD + SD^2 + SD^3... which is easily verified to equal 1.

From this we can make an incentive hypothesis. Laffer made one, because without it there would be no Laffer curve. His is simple, and it says that as the tax rate increases, the incentive to produce wealth decreases. Incomes will decrease and therefore so also will marginal tax revenue, creating a parabola. There is a significant problem here, that as tax rates increase we do not know whether incentives will decrease uniformly. It seems to me that they will not, and various criticisms of the Laffer curve simply shift the peak out of symmetry, usually toward the higher tax end.

The meat of my version of this model is to assume that individuals are ambivalent between money spent autonomously and money taken as taxes. Furthermore, diminishment of income should spurn compensatory increases in wages, which would drive up prices, and lead to a certain forced reduction in real autonomous spending. Finally, we assume, as Laffer did, that when incentives are zero, production is zero. There is nothing wrong with the claim, but it is probably impossible to bring such a situation about. In fact, if you consider that the economic models take all of our desires into account, some of us will be raving nationalists and work out of altruism which cannot be effectively taxed to zero. This impossibility opens the door to discontinuity in the graph as tax rates become higher.

I intend to make a model that also explores a second criticism (in a certain sense). We postulate that changing the tax rate changes consumer spending but does not change autonomous spending. Depending on the savings level, the increase in taxes will mostly be taken out of savings, or mostly be taken out of spending, with the equilibrium savings rate being a function of the tax rate. The foreign components are leaks of money out of the economy, making them another key aspect of what the maximum will be. Even though the US savings rate is like 0% I'm going to pretend we have a savings rate of 4%. As a function of the tax rate, the savings rate will decline to zero more or less asymptotically.

So, to start my model, first i find the tax rate. We know that total government revenues for 2006 (a good data year) were 2.2 tril, and the GDP that year was 13.1 tril, giving an effective tax rate of 16.6%. Because the data I can get for autonomous spending includes some uber-right wing assumptions, I'm going to go with what I was looking at when I lived alone. Mine was about 43% of my income (I'm not including taxes in this!), meaning 43 cents out of every dollar went to food, bills, and rent. If I add in my student loans (which I am paying now but were still in their grace period the last time I was employed), the number jumps even higher!

Next, I denote four component demands, each being a function of different variables. These demands have a stimulus effect on the economy that is a constant calculated from econometric data. Dt, the tax generated demand, will be demand generated by government programs. We can expect this to be the highest; one study found that every dollar spent on government programs produces 1.4 times as much stimulus as a dollar spent in the private sector. We know private sector spending, thanks to my handy calculation taken from my own expenses, is divided up about evenly between autonomous and free spending. I will assume that free spending has twice the stimulus effect of autonomous spending. From this, we deduce that autonomous spending would have a constant of about 2/3 and free spending would have a constant of about 4/3. Finally, domestic investment will be a function of savings and will have a constant of 0.9, which is a number I just made up.

Percentage change in the four component demands creates a relative scaling of the GNP. Hence, if the total Dt+Da+Dc+Di were to increase by 10%, the GNP would increase by 10%. This is then multiplied by the linear decrease in output produced by consumption decreases. This is the roughest part of the model, and I would have to do a lot of research to come up with something better.

Finally, everything is multiplied together to get a relative change in revenue, with 100% being our current situation.

So, how does my graph compare to Laffer's?



It is worth noting that the maximum here at 54% is not the nominal tax rate of 54%, or the top tax bracket being at 54%. This is the total of all revenues divided by the GNP. This doesn't have any impact on tax equity; in fact I am tacitly assuming something like a flat tax, and the number might be higher than 54% if most of the income is collected from the rich. So, at the very least, we could double our tax rate in America and expect to gain about 75% more revenue. We can also boldly pursue a much more progressive tax code.

My personal hunch is that if we could reduce autonomous spending in the real economy, it would be a huge economic boost. My favorite plan for this is government land purchases. Ideally, the government could be our landlord. That's one of the biggest disconnects between democracy conceived and implemented. If we control the government, shouldn't it be in control of something?

The Societal Gains of Mass Production

The above graph is an idealized model of the relative gains to production efficiency and relative losses from destruction of traditional lifestyle that accompanies the adoption of varying degrees of mass production of goods.

No society will be at either extreme of this graph. At the left end, there is the society where nothing is mass produced. However, there are always things which are better left done in a uniform or assembly line fashion. Many of these are component goods such as paper; others may require high degrees of quality assurance, such as condoms. At the right end we find a society where all good are produced in factories. Not even so much as dinner in the evening is done by hand. Perhaps in this world all food is cooked and eaten in massive cafeterias with giant industrial ducting sucking air toward a depressingly high ceiling. This, and other meditations, indicate that the marginal loss is least when the first unit of a respective type is introduced, and greatest when the last unit of the other type is removed.

The gains from mass producing any commodity come in the form of efficiency of labor, commonly called productivity. Productivity is good because it means less labor is used to produce a given quantity of goods, meaning that either less work is required in total and therefore more leisure is available to the populace, or more total goods can be produced at a given level of employment, or some combination of the two. Therefore, the society that is more productive will generally have lower levels of employment and greater availability of goods.

The losses from mass producing any given commodity come in the driving of traditional craftsmen (truly craftspersons, but I just don't want to make my writing opaque by using awkward, gender ambiguous language) out of the market. Craftsmen produce goods that are artistically diverse, and therefore create a rich cultural tradition, whereas mass produced goods are by definition homogeneous. Furthermore, a rich cultural tradition provides a context in which individuals are able to express themselves, either through Petit Bourgeoisie or non-commercial expression. Therefore, having a high level of traditional craftsmanship implies that a society will offer artistically diverse products and greater opportunities for individual creativity.

Total consumption bundles are only composed of goods and services. Of the total goods consumed, each good is either mass produced or the work of a craftsman. To a certain degree, movement along the distribution will lead to changes in total goods consumed, with more being consumed as one moves toward complete manufacturing of goods. Now I postulate a bliss point, which is a saturation point where individuals do not desire more goods. Since the consumption curve (not pictured) is smooth, a diminishing marginal propensity to consume as the availability of goods increases is the only means of achieving a bliss point. Assume now that the means of production, affluence and availability of goods are sufficient for the bliss point to fall in the spectrum of mass production pictured. Following along the lines of a typical Keynesian employment argument we see that as new manufacturing jobs are added, demand for goods will not expand sufficiently to maintain a steady level of employment. Therefore, employment levels will go down as expanding mass production increases average productivity, or to put it nicely, more people will enjoy more leisure time (work is not water, after all). If the reader is not satisfied with my argument in this paragraph, a much more detailed argument of a similar character has been made by Karl Marx.

A higher level of total good consumption is generally correlated to higher levels of benefits like adequate nutrition, shelter, and information availability; harms such as environmental destruction and anomie; and indeterminates including personal effects, luxury items, and consumer individuality.

Following my argument two paragraphs ago, we may expect lower employment to accompany high levels of mass production. A lower level of employment is generally correlated to higher levels of leisure time. Though generally accepted, the idea that a person should work at least 40 hours a week can be meaningfully challenged. Work is not inherently virtuous. Leisure has benefits like greater time for childraising, education, and relaxation; harms such as unemployment and criminal mischief; and indeterminates including controversial labor distributions.

Because the production levels of hand crafted goods are low, the diminishing marginal propensity to consume will not significantly affect craftsmen. Craftsmanship, however, does require individual skill. In addition to knowledge of the craft, it also involves business savvy, interpersonal finesse, creativity, and risk taking. Not all individuals will possess such skills, but the degree to which they can be learned is probably high. Communities will not be free from exceptions to this rule of merit, such as rivalries, oppression of individuality, and the like. However, subcultural differences make the negative behavior of other cultures stick out while the negative behavior common to our circles goes unnoticed. Specifically, I reject as completely baseless the belief that poverty and a lack of industrialization have any causative effect on the formation of such negative behaviors in societies. Therefore, a society that features more crafts will be one that rewards excellence, and because of the assumption of learnability, cultivates artisan traditions in order to make such excellence teachable.

A higher level of artisan traditions is generally correlated to benefits like cultural or artistic diversity, and consumer choice; harms such as supply surpluses and shortages, lack of information collection, and lack of documentation; and indeterminates including informal assessments of quality and loss of national identity.

A higher level of rewards for excellence in individuals is generally correlated to benefits like community participation, greater internalization of ethical principles, and higher self esteem; it has no definite harms but does have indeterminates including hypersensitivity to social injustice, overabundance of schools of thought, easy identification of the mediocre, and docility.

It is clear from this graph that craftsmen play an important role in a society. Furthermore, there is cause to believe that in the regulatory environment favored by classical liberalism, mass production is unfairly favored competitively against craftsmanship. It is worth observing here that the regulatory environment is not totally separable from the definitions of concepts in classical economics. Liberalism of markets is both a political and economic stance, and it is synonymous with both the state of regulation that it favors and the economic models that justify it.

An analysis of the effects of the respective approaches reveals that in the case of mass production, classical liberalism gives the results of mass production first to the Capitalist. He is first to recieve adequate shelter, nutrition, education, relaxation time, and even time to properly raise a child. His control of information is best seen in the proliferation of advertising, specifically through the power of corporations to define our very goals in life. The harms of mass production do not affect the Capitalist until the very last. It is the masses that suffer from environmental destruction, anomie, unemployment, and crime.

It is the opposite that is true for the craftsman. As the number of craftsmen in a society increases, few of the benefits accrue directly to the craftsmen. While a certain critical mass of craftsmen may be necessary to build an artisan tradition, this is not generally the case. Certainly, the increases in self-esteem are felt by the craftsman, first and foremost. However, the remainder of the effect that is created is felt by the society as a whole. The fabric of the society itself is woven from the perception by the individuals that the role they are playing is important to the society and therefore allows them a certain degree of control. When the harms associated with traditional craftsmanship are felt, they are felt by the craftsmen themselves, who go out of business when supply is imbalanced, and suffer first for their own lack of documentation.

The interplay between these two is therefore one where a natural subsidy exists for mass production. As each new large-scale business is founded, the entrepreneur never reimburses the remaining craftspeople for the work they have done in producing a stable society that has a docile consumer base of ethical workers, marketable artisan imagery, rich natural resources, low crime, and a healthy community that will attract the necessary skilled foreign workers. As mass production drives the craftspeople out, the social decline is gradual, but very difficult to reverse. Methods and traditions are lost to extinction. It helps least of all that laws and customs that did not evolve with mass production in mind provide security to the capitalist once his act of injustice has come to light.

Any historical example of this process will show how wrong it is to equate the best interest of the individual with that of the society through any simple set of relations. To do so presupposes a set of conditions where interrelations feature symmetric negotiating power. On the contrary, human interrelations are asymmetric, with a symmetry only in the statistical aggregate. The individual who stumbles upon the power to force his costs onto others will on occasion do so, and even if his act is inadvertent, evolutionary effects dictate that eventually such individuals will dominate over others. The only check on this effect, and probably the reason there is justice at all in this world, is that humans have evolved to have an innate sense of fairness. However, our innate ideas are relics of an evolutionary past that predates anything resembling modern industry. It is utter madness to believe that our innate ideas, specifically our concept of fairness, do not have a profound effect on economic markets. We must therefore be weary that new technologies such as mass production do not mislead the heuristic reasoning that creates the average person's concept of justice.

It is also possible that the destruction of traditional methods will almost always precipitate an environmental disaster. In times without modern technology, a community that made such a choice would simply perish with it. Today, we have the power to destroy everything.

So, I guess that is as good an argument as any for a resurgence of crafts movements. I am not advocating the complete abandonment of mass production. Rather, we should recognize that there are positive externalities to be rewarded for crafts, and negative externalities to be taxed with regard to mass production.