Prescription drug markets are complex and constantly shifting. To better understand the dynamics of drug development in the industry today, I enlisted the help of Professor Craig Garthwaite, a health economist and professor at the Kellogg School of Management at Northwestern University. Professor Garthwaite’s work on the relationship between drug prices and innovation has been published in the Quarterly Journal of Economics, the New England Journal of Medicine, the Wall Street Journal, and the New York Times. Some of his recent working papers for the National Bureau of Economic Research focus on examining the consequences of the Orphan Drug Act and the intersection of patent protections and precision medicine development. I recently interviewed Professor Garthwaite for The Incidental Economist to shed some light on the economics of how drugs come to market.
Liam Bendicksen (LB): Is it prices or profits that drive innovation?
Professor Garthwaite (CG): When you’re thinking about the price-innovation tradeoff, all you’re trying to do is get back the fixed cost of developing a drug. In many ways, you might be agnostic as to how that comes. But ultimately it’s profits. It’s a matter of asking whether you’re getting back the fixed cost of development.
LB: Is it possible to lower prices for some drugs but increase market size, such as with more favorable drug coverage, such that profits don’t fall much or maybe not at all?
CG: There’s a line of thinking that says higher prices always lead to more profits. We know that’s not true from economics. We also know that’s not true from what drug makers actually do because they don’t set an infinite price. They are thinking about the margin-quantity tradeoff just like any other monopolist.
LB: How does the knowledge that the vast majority of Americans have health insurance affect research and development decisions?
CG: The fact that people are insured means that the optimal price for a product goes up. The price that you charge in a world of insurance is higher than otherwise, and to the extent that that also results in greater returns, you might expect that there would be more products coming to market.
LB: By what process should we take innovation into consideration when contemplating drug regulation, whether in terms of prices or other aspects?
CG: The conversation about pricing is a conversation for either policymakers or insurers about what incentives for innovation in the future they want to provide, taking into account decreased access today. Everything about the way in which we get new products is a policy decision. The market starts with an inherent market failure. The creation of a new drug is the creation of scientific knowledge, which is a public good. So if we want to encourage the production of that public good, we need government intervention. How we do that is by providing market exclusivity either through patents or through FDA market exclusivity. You’re trying to decide how much market exclusivity we want to provide that gives a sufficient amount of welfare for products in the future that makes up for the decrease in consumption today that results from higher prices. If we decrease the return from products today, we’ll get less innovation tomorrow. So the question is whether we want to do that. Do we believe that a lower rate of innovation in exchange for access to drugs is going to be welfare-enhancing?
LB: In a recent interview with The Incidental Economist, Professor Stacie Dusetzina underscored the importance of maximizing value in how we regulate drugs. What are your thoughts on the idea of a policy that could reward truly innovative products? Is that feasible with regulation and if so, how could we go about that?
CG: I think I’d push back a bit more than other people to suggest that truly valuable products get higher returns today compared to drugs that are less valuable. It’s clear that when products provide more unique value, they generate greater returns in the market. But still, our society is unwilling to say no to products that provide even a small amount of incremental advancement. We need to have an honest conversation about how much innovation we’re willing to pay for in society.
LB: What are your thoughts on having an advisory health technology assessment agency in the U.S. that could evaluate the value of drugs for insurance companies and the government?
CG: I’m not sure how much new information that offers to the market. The belief that payers don’t know about the technical characteristics of new products ignores a lot of health technology assessment that happens. It’s not like pharma companies pick a number and payers say ‘oh whatever you say, that’s good.’ So the question is what new information does that actually bring to the market? It’s not fully clear.
LB: What about the niche of comparative cost-effectiveness research, along the lines of what ICER [the Institute for Clinical and Economic Review] is trying to do?
CG: I don’t believe ICER is as independently beneficial as other people might. I think it has a particular point of view. And I have concerns about an organization that was started with the idea of decreasing costs that says it’s going to come up with an independent view of the value of a product.
LB: In your view, what is ICER’s bent? What is their preconceived bias?
CG: If you look at their commentary, their goal is to lower spending on drugs. If you look at their funding, a lot of the funding comes from payer-based foundations or other ideological groups such as the Arnold Foundation. If you look at the academics involved, they often make public comments about the desire to decrease spending on drugs. I think all of those ideas, if they went in the other direction, would be seen as quite questionable as a form of conflict. We would have questions about an ICER that was completely funded by pharmaceutical companies.
LB: Do you think lowering drug spending is necessarily a bad goal?
CG: I think the goal of lowering spending is a bad goal. I think the goal of high-value spending is a good goal. With all healthcare spending, the idea is not that we want to lower spending, the idea is that we want value for money. Even the idea that 18% is ‘too much of GDP to spend on healthcare’ is a misnomer. The idea is that we want to get the best value we can.
LB: To what extent does industry research and development drive innovation? What role does the government play?
CG: I think the government has a very particular role in the development of drugs right now, which is to fund basic science research. I think there they’re solving a market failure. Early-stage research has a lack of ‘appropriability’ that leads to an under-provision of it in the market. It’s quite hard to patent advances in our understanding of basic science, so I think the National Institutes of Health really has a vital role in helping us with those types of basic science advances. On the commercialization side, I think the government has much less of a role. I think we should rely more on the private market there because trying to pick the winners of what is likely to be the right drug development process is a herculean task. Even private firms, the large pharma firms that people think about, have largely stopped investing in early-stage drug development. That has been primarily the domain of small biotech companies, with the goal of those companies being they will sell their product to someone who will take it to market. The fact that private firms have chosen to move away from early-stage development gives me all the more caution that the government is the right body for directing how we want to think about drug development dollars.
LB: How do you think the increasing prevalence of biotech firms and venture capital in the drug development process will affect the market?
CG: It’s reasonable to think that the type of early-stage money that’s currently available for pharma will be a bit more mobile across sectors. We have venture capital firms that fund early-stage development, and those funds are often quite specialized. But the money they’re investing is not their money, it’s the money given to them to try to generate a high return, and the people who are trusting firms with that money can move their funds to a more promising sector if biotech returns go down. The venture capital people in biotech are very interested in developing new cures. I don’t doubt that. I doubt whether the people providing the actual capital are wed to biopharma as a sector, as opposed to looking for where they can maximize their return on investment. So that mobility could be greater now than in the past when big pharma firms dominated research and development.