Socializing Drug Development Costs After FDA Approval is Not Feasible 
By Jeff Lemieux
8/23/2003

People don't like high drug costs, and in a Washington Post op-ed yesterday, economist Burton Weisbrod squarely addressed the core issue:  Do Americans want to pay the high costs of drug development through taxes, or at the pharmacy?  There is no free lunch.  However, Weisbrod's proposal to socialize drug R&D by paying "awards" to drug development firms after FDA approval is highly impractical.

Currently, drug companies in the U.S. price their medicines based on what the market will bear.  They must recoup all of their research and development and capital costs -- for drugs that succeed and for drugs that do not -- through those prices.

Under professor Weisbrod's proposal, taxpayers would pay the research and development costs instead.  The government would pay "massive awards" to drug companies that developed medicines approved by the Food and Drug Administration.  The size of those awards would theoretically cover the firms' R&D costs.  Then, the government would take possession of the patent and grant the right to produce and distribute the drug to generic manufacturers or other qualified firms.

With taxpayers covering the expensive R&D, the price of medicines faced by consumers and health plans would plummet toward the much lower cost of production and distribution.

However, this proposal is not feasible for several reasons.  First, as Weisbrod admits, it would be very difficult for the government to decide how much to "award." 

Governments rarely pay huge hypothetical amounts.  It would be politically difficult (if not impossible) to ask the public to allocate billions of dollars to companies based on economists' estimates of what the market would have paid, had there been a market for drug prices.  Over time, with data on market pricing fading further into the past, how would economists have any idea what consumers would have paid for a medicine?

Since there could be no clear outside determination of how much the government should pay, politicians would take up the fight.  Given the amounts of money involved, these "awards" would be intensely politicized.

Democracies are much more comfortable reimbursing companies for actual costs of producing goods or services in the public interest.  Actual costs can be audited. 

But if actual costs are used, how would firms cover the cost of drugs that did not succeed clinically, or could not be reliably produced in large scale?  Would the government also cover the costs of failures?  If not, innovator firms would be out of luck.  They could not build the cost of failed prescription drugs into the price of other products they might sell without placing themselves at a competitive disadvantage in those markets. 

Ultimately, there is no way for investors in drug or bio-tech firms to reliably estimate how the government might choose the appropriate size of awards in the distant future.  Under the current patent system, they can estimate that market prices will (probably) be in effect, and that if a drug succeeds and is popular, prices can be set (within the patent period) to cover all costs and earn the firm a large profit.  But they will not bet on the possibility of large profits from uncertain government reimbursements.

To keep the drug discovery process alive, the government would have to socialize all research and development from the start.  Firms would apply to the government for research permits.  The government would fund lab work and trials right from concept to FDA approval.

The question is, do we really want to completely socialize the drug discovery process?  Putting the decisions about which drugs should be pursued into the hands of government, and converting the drug discovery industry into government contractors or grantees could create all sorts of unwanted distortions and set back the pace of innovation considerably.  Would economists regard this as the most efficient alternative, both in terms of resource allocation and the likelihood of maintaining a socially appropriate pace of discovery and development?

Second, what would other countries do?  Currently, foreign governments in rich countries usually set the price of drugs below the U.S. market prices, but high enough to cover a decent share of firms' R&D costs.  (Companies generally sell drugs at low prices to poor countries.  But even then, poor country prices sometimes are high enough to make at least a small contribution toward R&D costs.)

But under Weisbrod's proposal, rich countries would almost certainly lower their government-set prices to match the new, ultra-low U.S. prices.  They would be foolish to do otherwise.  If they maintained their current prices (below U.S. market prices but well above production and distribution costs), American companies could profit by shipping U.S drugs abroad.

And we can be sure other rich countries would not set up "award" programs for U.S. firms' R&D costs.

The problems of drug development and pricing are complex.  High drug prices are a real and difficult burden for many Americans.  Professor Weisbrod's proposal helps people understand that drug development costs are not free, and that any solutions involve sacrifices and tradeoffs.  But taxpayer-paid R&D for drugs would almost certainly be more problematic than the current pricing system.  

Links:
Centrists.Org Issue Summary:  Health Costs, Competition, and Chronic Care "Prescription Drug Prices"

Burton A. Weisbrod Solving the Drug Dilemma Washington Post (August 22, 2003)