The Price of Innovation

January 22, 2020

Photo by Leslie Walker

The United States pays more for prescription drugs than any other country in the world. But whenever politicians propose lowering those prices, industry leaders claim it would harm innovation and the development of new breakthrough treatments. Can we lower prices and retain innovation?

Listen to the full episode below, read the transcript or scroll down for more information.

The Basics

Prescription drug prices* in the United States have been rising faster than in other countries for the past two decades. While most other countries regulate drug prices in some way, the United States does not in any meaningful way. Lowering drug prices has bipartisan support from voters and policymakers, and both Democratic and Republican leaders proposed legislative fixes in 2019. Proposals to reduce drug prices are regularly met with a warning from the pharmaceutical industry that lowering prices would lead to less innovation* and fewer new breakthrough treatments in the future. *Note: By prices, we mean the total revenue manufacturers make from their drugs, not just what consumers pay out of pocket. And by innovation, we mean the process of developing new drugs and bringing them to market.

By the Numbers:
Drug Prices in the U.S.

$ 0
billion spent on prescription drugs in 2018¹
0 %
of total U.S. health spending attributed to retail prescription drugs¹
0 %
of people in the U.S. report not taking medication as prescribed because of cost²
  1. Centers for Medicare and Medicaid Services
  2. Kaiser Family Foundation, March 2019 

By the Numbers:
Drug Development in the U.S.

0 %
of new drugs in 2018 were patented by small biotech firms¹
$ 0
billion reported spent on research & development by PhRMA members²

1 in 10

odds of a drug making it from clinical trials to market³

  1. The Changing Landscape of Research and Development, IQVIA, 2019
  2. PhRMA Annual Member Survey, 2019
  3. Clinical Development Success Rates 2006-2015; BIO, Biomedtracker, Amplion; 2016

The Evidence: The Relationship Between Drug Prices and Innovation

Numerous studies over the past 20 years have found that in various settings, the more potential drug revenue companies can expect, the more they will invest in drug development. For example…
However, research has also shown that those newly developed drugs did not always represent truly breakthrough treatments or cures. For example…
We have no specific evidence on what would happen if expected future profits were lowered because that has not happened to date in the U.S.
  • Many believe lower potential returns would dissuade venture capitalists from backing the biotech startups responsible for developing the majority of new drugs. Venture capitalists’ investments in pharma have tripled in the past decade.⁴
  • Estimates vary widely over how many new drugs would be lost under proposed price regulations (from 8⁵ to several hundred⁶), but no estimates can predict how truly innovative those "lost drugs" would have been.
  1. Amy Finkelstein, Static and Dynamic Effects of Health Policy: Evidence from the Vaccine Industry, Quarterly Journal of Economics, 2004.
  2. Margaret E. Blume-Kohout and Neeraj Sood, Market Size and Innovation: Effects of Medicare Part D on Pharmaceutical Research and Development, Journal of Public Economics, 2013
  3. David Dranove, Craig Garthwaite and Manuel Hermosilla; Pharmaceutical Profits and the Social Value of Innovation; National Bureau of Economic Research; 2014
  4. PitchBook analysis
  5. Congressional Budget Office Analysis of H.R. 3, 2019
  6. House Drug Pricing Bill Could Keep 100 Lifesaving Drugs from American Patients, White House, 2019

The Tradeoffs: Price Regulation vs. Innovation

Lowering drug prices would increase people’s ability to access medications today, but it will likely also reduce the number of new drugs introduced over the next few decades. However, it is impossible to know how innovative and life-changing those drugs would be. Previous moments of increased investment in drug development produced some breakthrough treatments along with many that did not offer significant improvements over existing options. Some argue that regulating drug prices based on their value — how much clinical benefit they offer relative to existing treatments — could lower prices while retaining the financial incentive for truly innovative treatments. While this would likely lead to mostly lower prices in the U.S., it could result in some drugs becoming more expensive and others potentially not being covered at all even though they could help some patients.

From Lab Bench to Bedside: How an Idea Becomes a Drug

At the core of the argument over how drug prices will impact innovation is the process of researching and developing new treatments. The graphic below demonstrates a common (though not universal) path that an idea must follow to become a prescription drug. Estimates of the cost of the complete process range from several hundred millions to billions of dollars, and many drug ideas fail at every step of the process.

Drug discovery often starts with research conducted at primarily government-funded university labs.

Promising ideas or compounds form the basis of biotech startups, often funded by venture capitalists, which support continued research and development.

Large pharmaceutical companies acquire the most promising biotech startups in order to get products through clinical trials and to market.

Potential drugs are put through human clinical trials to test their safety, effectiveness and increased benefit relative to existing treatments.

A small number of medications are approved by the FDA and released to the market each year. Novel drugs receive exclusive patents, allowing companies to charge high prices upfront.

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Episode Resources

Drug Price-Innovation Relationship:

Pharmaceutical Profits and the Social Value of Innovation; David Dranove, Craig Garthwaite and Manuel Hermosilla; National Bureau of Economic Research; 2014

Market Size and Innovation: Effects of Medicare Part D on Pharmaceutical Research and Development, Margaret E. Blume-Kohout and Neeraj Sood, Journal of Public Economics, 2013

Static and Dynamic Effects of Health Policy: Evidence from the Vaccine Industry, Amy Finkelstein, Quarterly Journal of Economics, 2004

Role of Venture Capital in Drug Development

The Changing Landscape of Research and Development, IQVIA, 2019

U.S. Drug Prices Compared to Other Countries

“The True Story of America’s Sky-High Prescription Drug Prices,” Sarah Kliff, Vox, 2018

Paying for Prescription Drugs Around the World: Why Is the U.S. an Outlier? Dana O. Sarnak, David Squires and Shawn Bishop; The Commonwealth Fund; 2017 

Episode Credits

Guests: Chaitan Khosla, Director of Stanford ChEM-H
Craig Garthwaite, Associate Professor of Strategy, Kellogg School of Management at Northwestern University
Stacie Dusetzina, Associate Professor of Health Policy, Vanderbilt University

Original music composed by Ty Citerman; additional music by Blue Dot Sessions, Bacon and OnlyMeith

This episode was reported and produced by Ryan Levi and Victoria Stern. It was mixed by Ryan Levi.

Additional thanks to:
Rachel Sachs, Dan Paterson, Paul Hastings, Sarah Dykstra, Michelle Arkin, Michael Carrier, Nicholas Bagley, Richard Frank, Ariel Dora Stern, Brian Smokler, Bill Edwards, Kristen Samuelson, Paul Ruest, the Tradeoffs Advisory Board…

…and our stellar staff!