Health Care: Access Versus Innovation in Pharmaceuticals

To some participants in the debate over health care reform, increasing access to existing drugs is a moral imperative. In their view, pharmaceutical innovators enjoy the fruits of patent protection, while sick people — especially those without health insurance — cannot afford the drugs they need. Nor can they wait years for patents to expire and lower—cost generics to become available. People need drugs, and they need them now.

Michael Moore is asking us to take a longer view. As part of his ongoing research on innovation in the pharmaceutical industry, Moore and his colleagues Edward Snyder and James Hughes are developing a dynamic model for quantifying the net benefits to all consumers of immediately eliminating patent protection in the pharmaceutical market. Their conclusion: The benefits of increased access to generics are potentially far outweighed by the costs of decreased returns for pharmaceutical R&D, which society depends on to yield the next breakthrough compounds.

Intellectual property protection necessarily involves a tradeoff. Patents, which temporarily limit competition on the pricing dimension, allow inventors to charge a price in excess of marginal production costs. Health care consumers ask why prices need to be so high. Once a drug is discovered and developed, high prices lead in their view to near—term inefficiencies. Patent protection is crucial, however, for allowing competition on the innovation dimension: According to current estimates, drug innovators spend hundreds of millions of dollars in R&D for each new compound that survives the regulatory process and makes it to the market. In the absence of protection, the discovery and development process would not work. Given the time it takes for the few drugs that actually turn out to be clinically viable to get to the market, typically only a fraction (often less than half) of the nominal patent life remains to recover those investment costs. Without patent protection, inventive people would have little economic incentive to generate new ideas.

What, then, is the appropriate balance between access and innovation, asks Moore, a principal at Chicago Partners (a subsidiary of Navigant Consulting), who has long studied health care economics and policy. When Moore and his colleagues began researching the welfare economics of pharmaceutical innovation, they turned to a then—current example: Napster, the Internet service that allowed consumers to exchange music files without payment to copyright holders. Artists and recording companies argued that this practice would ultimately stem the flow of new music. In 2001, the courts agreed, finding that Napster had violated artists' and music distributors' copyright protection, and it was ordered to cease operations.

What if pharmaceuticals were "Napsterized"? What would be the effects on consumers if existing and future patent rights were eliminated, with no compensation to the patent holders? In modeling this extreme policy experiment, Moore and his colleagues have begun to quantify both the static welfare benefits (the consumer welfare from greater access to existing drugs) and the dynamic welfare benefits (the consumer welfare from the prospective flow of new drugs). In this analysis, they have used basic economic principles and established facts from the published literature on the economics of the pharmaceutical industry: that increases in competition from generic drugs reduce expected revenues, which decreases expected profitability from new inventions, which decreases R&D investment and, in turn, lowers the rate of innovation.

In preliminary work, Moore and his colleagues concluded that the lifetime present—value costs of lost future innovation would be $2.5 trillion. It is this benchmark against which benefits of increased current access must be measured. In preliminary analyses, these benefits appear to be relatively small: with broad insurance coverage for health care and pharmaceuticals, the adverse effects on current welfare of the pricing of patented drugs are mitigated. By subsidizing the purchase of drugs to consumers, insurance can and does protect static consumer welfare without compromising the returns to innovation, increasing access to drugs while allowing companies to maintain the pricing levels that will generate returns that motivate the development of new compounds.

What does this mean for the current health care debate in the United States? "Stop and think before granting increased access to generics," Moore says. "The people who might benefit from greater access are those who are alive right now, particularly the uninsured. They can have very loud voices. But let's not forget future generations, who have no direct voice in the political process. They will need a stream of breakthrough drugs, too, and that means that we must protect the economic incentives for innovation and maintain high levels of R&D investment." According to Moore, trying to solve problems that are due to potential limitations in markets for health insurance by eliminating dynamic competition in the pharmaceutical markets might be good politics, but it is bad policy.