The Economics of Drug Development: Pricing and Innovation in a Changing Market.

• Author: Garthwaite, Craig

Pricing and competition in pharmaceutical markets is an area of great debate and controversy, much of which stems from the fact that patent protection allows firms to charge high prices for potentially life-saving treatments. In the absence of patents, other firms would be attracted by the large profits earned by incumbent firms and enter the market. Such entry would likely raise current period welfare by reducing prices and increasing access to valuable medications.

However, society enacts regulations that prohibit this entry in pharmaceuticals and other intellectual property-dependent markets, allowing high price-cost margins to exist for a period of time. Policymakers accept the reduced output from higher prices in order to provide appropriate incentives for firms to make large fixed-cost investments in new products. That is, there is an implicit tradeoff in which some degree of current welfare is sacrificed in order to ensure strong incentives for future innovation.

A body of research supports this tradeoff, showing a robust relationship between expected profitability of pharmaceutical products and investment in research and development. (1) The tradeoff is not intended to be permanent. After a period of time, patented products are meant to face additional competition that decreases prices, either through the introduction of therapeutic substitutes that engage in "brand-brand" competition that has a moderate effect on prices, or from post-patent generic competition, which drives prices even lower. The degree and nature of the eventual competition is dictated by a combination of policies and market forces.

The parameters of the complicated tradeoff between static and dynamic efficiencies, such as the length and strength of patents, are intended to provide the incentives for an optimal amount of innovation. As a result, these parameters are inherently context-specific, and as the market for developing and selling pharmaceuticals changes, policymakers should reevaluate the fundamentals of the tradeoff. For example, factors that decrease the costs of developing products--such as less stringent clinical research requirements--or those that meaningfully increase potential revenues--such as large-scale increases in prescription drug coverage or the ability to develop products targeting particularly deadly diseases--could support shorter or weaker patent protection. In contrast, factors that increase the difficulty and/or length of the development process--such as targeting diseases where demonstrating efficacy is more difficult--would support stronger or longer patent protections.

Given the dependence of the development of pharmaceutical products on the existing body of scientific knowledge, scientific advancements likely will affect the optimality of the tradeoff between access today and innovation tomorrow. In partnership with various co-authors across a series of papers, I have investigated how changes in the development process of pharmaceuticals impact the economics of drug development, pricing, and innovation.

One strand of research examines changes in the ability of firms to create products targeting small and specific patient populations--products that are often paired with diagnostic tests indicating the product's likely efficacy in an individual. Broadly speaking, these types of drugs are part of the evolving world of precision medicine. The ability of firms to develop such products is more than simply a scientific advancement or curiosity. A pharmaceutical market involving products targeting small patient populations has vastly different economic fundamentals than those that prevailed when the parameters of our existing intellectual property system were developed. This mismatch between public policy and the current reality of drug development has implications for both optimal policy and firm strategies.

In a recent paper, Amitabh Chandra, Ariel Dora Stern, and I examine the degree to which the market is increasingly focusing on R&D activities related to precision medicines, and discuss the economic implications of such a shift in the product mixture. (2) We first use data from the Cortellis Competitive Intelligence Clinical Trials Database (Cortellis), which is compiled by Clarivate (and formerly by Thomson Reuters) and contains all registered clinical trials from two dozen international clinical trial registries. Importantly for our purposes, these data contain detailed descriptions of the trials including the use and specific role of any biomarkers. At a high level, a biomarker is "a defined characteristic that is measured as an indicator of normal biological processes, pathogenic processes, or responses to an exposure or intervention, including therapeutic interventions,"--that is, measurable features of a patient. (3)

Biomarkers can serve a variety of purposes in a clinical trial. Some, but not all, of these purposes may relate to precision medicine. For...