Drug Companies’ Elusive Profits

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What is the incentive to develop new drugs? What should it be?

Those were the two questions emerging out of a book published and launched last week by the American Enterprise Institute (AEI) in Washington, DC.

The book, Innovation and Technology Adoption in Health Care Markets, was written by Anupam B. Jena and Tomas J. Philipson, both from the University of Chicago. “Cost effectiveness analysis may reduce incentives to develop new drugs. Drug firms may have too low incentives to develop new drugs,” they said in a joint statement.

They also said that a low share may mean less-than-optimal investment in new drug development, and suggested that there may be alternative payment systems that provide the correct incentives but at low shares of the costs.

It is still unclear, however, what the correct level of investment in new drug development would be. “Drug firms receive only a small share of the total value to society of new drug development. A low share of the value means less than optimal investment in new drug development,” the two said.

They argued that firm profits are inversely related to cost-effective measures, and that by emphasizing consumer surplus, cost effectiveness analysis would lower profits to drug firms, particularly in the arena of HIV/Aids. “Put together, our results suggest that if the new HIV/Aids therapies are representative of other health technologies the lack of appropriation of social surplus by innovators raises serious concerns about adherence to cost-effective analysis,” the authors said.

And they added: “Despite the high prices of many therapies such as the new HIV drugs, patients and health plans may be getting too good a deal in the short run, which hurts future patients in the long run by leading to lower rates of technological progress.”

The Federal Trade Commission’s Christopher Adams and AEI’s John E. Calfee suggested that it might be necessary for the World Health Organization (WHO), the United Nations (UN) and the Bill Gates Foundation to supplement government efforts around the world to respond to the issues raised in this book.

Jesse Masai is an intern at the American Journalism Center, a training program run by Accuracy in Media and Accuracy in Academia.