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Russell Mokhiber and Robert Weissman wrote a typically informative article on how evil drug companies price gouge consumers and lie about how much it costs them to develop drugs. Lets take a look.

Drug prices in the United States are out of control, and rising.

The reason is that the United States permits pharmaceuticals to be marketed by unregulated monopolies: Patent protection gives the drug companies monopoly control over their products. These companies face neither direct competition, nor price controls.

The idea that drug companies are “unregulated monopolies” is hysterically funny on its face. There are few industries as tightly regulated as the pharmaceutical industry. The Food and Drug Administration exerts a level of control over every aspect of drug discovery, manufacturing and marketing that is matched by few other agencies.

Pharmaceutical firms do have monopolies on new drug compounds for a brief period of time, but then must compete with generics that are all-but identical to the original products — again, a situation faced by few industries within the same time frame as pharmaceuticals.

But what is the reason for the government grant of these patent monopolies (which often extend long beyond the official 20 years, thanks to a variety of Big Pharma “evergreening” tactics to block or delay the introduction of generic competition)?

This is inaccurate. The government does not extend patent protection for drug compounds. What does happen, however, is the FDA extends a period of “market exclusivity” in which it will not approve generic compounds for sale.

Why does the FDA do this? Because most new drug compounds that are brought to market have very little time left in their official patent protection period. As of the late 1980s, FDA drug review took on average 3 years and total drug investigation time up until filing of a New Drug Application was almost 7 years.

If a company patents a drug in 1980, but doesn’t obtain FDA approval until 1990, the 20 year window of patent protection is actually just a 10 year window. If the FDA did not extend “market exclusivity”, drug companies would likely respond by not developing new drug compounds that could not be brought to market in 10 years or so. Neither consumers nor companies would benefit from such a shortsighted policy.

A better policy would be to simply automatically extend the patent period after FDA approval by the number of years a drug spent in development. The main benefit would be transparency and certainty, rather than the current model where neither generic companies nor pharmaceutical companies are ever certain for precisely how long the FDA will continue to grant a manufacturer market exclusivity.

The industry claim of $800 million costs per drug relies on a study from an industry-funded research center at Tufts University in Boston. Tufts researchers supposedly had access to industry data to come up with their figure, but no one else is able to see the underlying data. So if you choose to believe in this number, it is simply a matter of faith.

Mokhiber and Weissman are correct to the extent that the $800 million cost per drug is not the end-all be-all of estimating drug development costs. The study is far more useful than they let on, however, and studies favored by Mokhiber and Weissman suffer from bigger problems.

As for the fact that the industry data is still secret, of course revealing the data would also likely expose trade secrets held by the companies involved in the study. The fact is that the industry gave the Tufts researchers far more open access to their records than any other such study — Mokhiber and Weissman should praise their willingness to be open with the researchers rather than slam the companies for not wanting specific economic data published where their competitors could easily see.

Approximately half of the Tufts-industry estimates are attributed to financing costs, known as opportunity costs of capital. Money invested in drug R&D could have been invested in treasury bonds, say. WHile the bonds would start returning revenues right away, R&D returns are not realized for years, until a drug is discovered, developed, approved and put on the market. So in the Tufts-industry study, a “cost” of development is the forsworn income during the period of development.

This is all true, as far as it goes, but it is not how people normally think about “cost.” As James Love of the Consumer Project on Technology says it, it is the equivalent of saying the cost of a car is not the sticker price, but the sticker price plus interest payments on a car loan.

This may not be how most people normally account for the cost of things, but in the pharmaceutical business it is the only reliable way to measure the true cost of drug development.

What Mokhiber and Weissman leave out is that the pharmaceutical business is one of the most capital-intensive of all industries. This is why, for example, profits from pharmaceutical companies appear to be so high compared to other industries. Mokhiber, Weissman and others generally claim that the industry has such high profits because it is gouging consumers, but in fact such high profits are a direct result of the low capital turnover rate in the pharmaceutical industry (in fact, if pharmaceutical companies had profit levels similar to say, retail store chains, then investors would be foolish to ever invest in the industry).

This is why comparing capital investment in new drug development to a car loan is absurd. Car loans are generally for relatively small amounts (usually well under $100,000), for relatively short periods of time, that result in the transfer of an asset to an individual. With drug development, however, potentially hundreds of millions of dollars must be invested up front for a new compound that may never return a profit and in a best case scenario will only begin returning money 12 to 15 years out. Pharmaceutical firms must, in turn, offer a much higher rate of return in order to attract such capital. Ignoring this, as Mokhiber and Weissman would do, makes no sense at all.

Excacerbating the problem, the researchers may pick an unreasonably high interest rate. They may also set the period for drug development as too long — in the Tufts-industry model, relatively small delays in getting the drug to market lead to big increases in the overall cost.

In fact, even very short delays do cost sizable sums, especially when a drug compound is nearing the end of its patent protection. The pharmaceutical industry spends often exorbitant sums on third party often just to help shave a few months off of the time it takes to get a drug to market. Again, though, this is an opportunity cost and since people don’t buy their new cars based on opportunity costs, this likely isn’t a concern that Mokhiber and Weissman would find legitimate.

Then there’s the not insignificant fact that the case of drugs brought to market without government support is the exception, not the norm. The federal government supports an enormous amount of research, and funds the earliest and riskiest portions of the R&D process: basic research and the earlier phases of clinical trials.

Mokhiber and Weissman are very smart to stick to vague claims that “the federal government supports an enormous amount of research.” In fact the National Institutes of Health spends about $14 billion per year on biomedical research compared to estimates that private pharmaceutical research is somewhere between $24 and $30 billion per year.

Mokhiber and Weissman also conveniently forget to point out that most federal research funding is channeled through universities who in turn reach royalty agreements with pharmaceutical companies for any intellectual property they develop that is subsequently sold for further development to drug firms.

Mokhiber and Weissman are correct that the government largely funds basic research, but imply that once this is taken care of that developing a marketable compound from such research is all but risk free and cheap. In fact taking a drug from basic discovery to finished product is an extremely risky venture as witnessed by the many compounds that appear to be likely wonder drugs but never make it to market due to one problem or another that develops.

Any honest examination of available evidence on the costs of drug development suggests the United States — and most of the rest of the world, thanks to the U.S./industry strong-arming tactics in international trade negotiations, now maintains or soon will adopt U.S.-style patent rules — is massively overcompensation Big Pharma for its work in bringing drugs to market.

. . .

Meaningful reform might include ending the industry’s patent extension tricks, licensing drugs developed with public monies on a nonexclusive basis to permit price-reducing competition (or at least permitting competition where prices are excessive), and considering rollback to the 20-year patent term and the adoption of price controls.

And an honest examination of this sort of proposal suggests that while all of these tactics would indeed lower the costs of current medicines, they would both curtail drug development and likely result in the withdrawal and or/shortages of many drugs that would no longer be profitable.

A quick look at the vaccine market confirms what happens when factors conspire to increase the risk of drug development while simultaneously curtailing the payoff for investors. Both vaccine development and production have largely dried up in the United States. Currently there are shortages of basic vaccines which has become so acute that the way in which children are vaccinated will have to be altered for the next five to 10 years.

Most pharmaceutical companies have simply left the vaccine development market altogether. A few companies still do limited research into vaccines that would be blockbusters — mainly to vaccinate against the few diseases that still plague Western industrialized countries.

Mokhiber and Weissman’s proposals would end up turning the entire pharmaceutical industry into the wasteland that vaccine development and production has become. Drug development would become even further tilted toward home run blockbuster drugs, especially so-called lifestyle drugs and away from drugs that might cost of hundreds of millions of dollars to develop but have a more limited market.

Mokhiber and Weissman would lower drug costs by destroying the pharmaceutical industry. Slowing down the flow of new drug compounds is certainly one way to control drug costs, but hardly a long term winning strategy for continually improving human health prospects.

Source:

Stripping away big pharma’s figleaf. Russell Mokhiber and Robert Weissman, June 13, 2002.