Back to an old argument

The argument? Drug pricing. Hal Pawluk at Tude put together this explanation on BlogCritics of why prescription pharmaceutical prices are so high. If it makes anyone feel better,in the version posted on his own site, he suggests getting back to more of a free-market in drugs.

If you believe that drug prices are so high because of R & D, Big Pharma has done their job. And they're going to be in your pocket for a long, long time.

MYTH: Drug prices need to be as high as they are to pay for research and development.
REALITY: Drug prices are as high as they are to support unconscionable profits, with much of the research paid for by taxpayers.

The big claim by Big Pharma is that it costs $802 million to bring a new drug to market.

It's not true.

The drug industry figure comes from a Tufts University study released in late 2001. There are some major problems with the study (it affects your bank balance so it's worth paying attention):

1. The $802 million included $400 million that had nothing to do with bringing drugs to market. It was an estimate of how much the drug companies could have made by investing in some other way. This is an imaginary number that the drug companies do not pay.
After deduction: $402 million.

2. The remaining $402 million included about $230 million for clinical trials, but many drugs are simply revamps of existing drugs so clinical trials are done on only about 29% of drugs. That cuts the figure to $67 million, and we can deduct another $163 million.
After deduction: $239 million.

3. The US taxpayer pays for 34% of the remainder through a tax deduction drug companies take on R & D. I think encouraging R & D this way is good policy, but it does reduce the cost of bringing the drug to market by $81 million that's paid for by you and other taxpayers, not the drug companies.
After deduction: $158 million - $644 million less than Big Pharma claims.

Multiplying the real cost by a factor of 5 is a lot of "shading," but even the last figure is still higher than the average cost to bring out a new drug: the study was limited to a number of drugs that were developed exclusively within the drug companies.

What's wrong with that?

This: the reality is that the majority of drugs are developed with government support, paid for by American taxpayers:

A National Institutes of Health (NIH) internal document, dated February 2000 and obtained by Public Citizen earlier this year, showed that all the top five selling drugs in 1995 received significant taxpayer backing in the discovery and development phases. Investigations by the Massachusetts Institute of Technology and The Boston Globe also have examined samples of medically important and top-selling drugs and found that a vast majority of drugs in each group received government support. [True Figure of R&D Costs Likely Is 75 Percent Lower]

The explanation for this situation may be grounded in the fact that the Tufts Center for the Study of Drug Development gets 65% of their research funding from drug companies.

So when you hear spokesmen like Dr. Mark B. McClellan, commissioner of the Food & Drug Administration [yeah, I know - he's supposed to be working for us], claim that "the US is is paying the lion's share of the cost of developing drugs" you can believe him.

But remember that we're paying twice: once in government-funded research, and again in drug prices that are much, much higher than in other developed nations.

That's where those "unconscionable profits" come from.

Pharmaceutical prices

This one will have links scattered all over hell and back.

Sebastian Holsclaw, who visits here periodically and DESPERATELY NEEDS TO GET THE RIGHT PERMALINKS INTO HIS RSS FEED gives props to a Corante blog I used to read that is dealing with one of my "favorite" subjects.

Pharmaceutical Prices
Derek Lowe has a number of excellent posts on the problems of drug research. His most recent series focuses on the high cost of research and the difficulty in recovering the costs.
His posts are:

Darn Those R&D Costs Anyway

The Contact Sport of Cost Accounting

More on Prices, High and Otherwise

Drug Prices and Costs--From the Mail

He has one of my very favorite quotes on the subject: "There will be more next week on drug costs and research spending (the mail keeps on coming!), but no matter what, I think we can assume that the two are somehow related."

The strangest thing is that many people act as if drug costs and research spending are at closest, distantly related. I say 'act'. I'm sure that if you cornered them, they would admit that there is some relation between the two. But many people who want to talk about the subject are shockingly incurious about how much other industries spend on 'marketing, advertising and administration'. They aren't interested in investigating the high failure rate of drug companies.

Anyway, if you are interested in such topics, you should read articles by someone who knows. And Derek Lowe's articles are a great place to start.

I linked to the posts that actually say something.
Derek Lowe, in turn, links to Alex Tabarrok at Marginal Revolution:

Firms spend on R&D from the day the development process begins up until the day the drug is approved for marketing which may be a decade or more later. But a dollar spent early in the process could have been earning interest in the bank for years before marketing approval is achieved. Recognizing this, DiMasi et al. calculate the cost of the drug as if all the money had been spent on the day the drug was approved.

Is this unreasonable? Well, suppose you lend me $5000 - how much would you want back in a year, in 2 years, in 10 years? The longer the loan period the more you would expect back when the loan came due, right? This is exactly the same calculation performed by DiMasi et al.

This is a common calculation. It is nonsense because

1. The money was NOT spent all on day the drug was approved
2. Most of the money spent was Federal money

The question is not whether the calculation is accurate. It is whether the calculation has any bearing on reality. See how simple it is when you deal in reality instead of just abstractions?

Mr. Lowe also links to a WSJ rant which may be fairly summed up as:

"Damn those Democrats anyway."

I rarely link to rants per se.

Pharmaceutical prices II

I do this sort of thing because not everyone reads comments and I believe this to be an important discussion.

1. The money was NOT spent all on day the drug was approved
2. Most of the money spent was Federal money

On the first point he says:

You're right, that money wasn't all spent on the day of approval. The point of looking at it that way is, as you doubtless know, to calculate the opportunity costs. The money could have been invested instead of spent - how much would would you have, by approval day, if it had been? People do the same sort of calculations for mortgages and loan payments all the time - imputed interest rates and all that. Are those nonsense as well? If your answer is "yes", do you think you could convince an accountant?

My response, lifted from comments:

You assume they had the money to invest on day one. And why do you stop the calculation on approval day? That's kind of arbitrary. Why not do the calculation over the life of the product? Because it would lead to an entirely different judgment. I'm not saying it's evil, it's simply the way the game is played. For instance, if I (corporately) show $20,000 profit and one expects to make 2% on one's investment, then one values my corporation at $1,000,000 even if I only spent a couple of grand on computers to set it up. Not evil, simply the way the game is played…and has as much bearing on reality as opportunity costs. Exactly as much. At any rate, I might be able to convince an accountant of the validity of doing opportunity cost calculations over the life of the product but it wouldn't be in the best interests of his client so I doubt being able to convince one to actually do it.

This morning I recognized another disagreement with reality in this argument: taxes. I'm not sure is pharmaceutical companies declare opportunity costs as actual expenses or losses, but if they do they don't declare the entire expense or loss incurred in developing a drug. They would if they could, but they don't know the figure so they can only declare what they can calculate. Taking that into account when calculating opportunity cost would lead to a less assailable figure.

As for the second point, that most drugs are developed in government funded research, Derek says:

I was speaking of the money that drug companies spend on drug development. None of it is federal money. It's ours - yep, our ill-gotten profits - and we risk it by paying people like me in the labs, paying for clinical trials, and so on. How do you figure that this is government money, again?

I think my response:

I'll yield your point about it being the pharmaceutical company's money under discussion if you'll yield the point that all drug that were initially developed with public funding should go generic immediately.

…is reasonable if a bit disingenuous. I feel it justified though. And it's a real suggestion. Let corporations have process patents on the ways they've developed to mass produce the drug, but if it was developed in government funded research the drug itself should be in the public domain.

See, I told you!

This harkens back to February and the several discussions on pharmaceutical pricing I had with several pharmaceutical industry types. And as usual, I was right…

REALLY LONG Quote of note:

The most important of these laws is known as the Bayh-Dole Act, after its chief sponsors, Senator Birch Bayh (D-Ind.) and Senator Robert Dole (R-Kans.). Bayh-Dole enabled universities and small businesses to patent discoveries emanating from research sponsored by the National Institutes of Health, the major distributor of tax dollars for medical research, and then to grant exclusive licenses to drug companies. Until then, taxpayer-financed discoveries were in the public domain, available to any company that wanted to use them. But now universities, where most NIH-sponsored work is carried out, can patent and license their discoveries, and charge royalties. Similar legislation permitted the NIH itself to enter into deals with drug companies that would directly transfer NIH discoveries to industry.

Bayh-Dole gave a tremendous boost to the nascent biotechnology industry, as well as to big pharma. Small biotech companies, many of them founded by university researchers to exploit their discoveries, proliferated rapidly. They now ring the major academic research institutions and often carry out the initial phases of drug development, hoping for lucrative deals with big drug companies that can market the new drugs. Usually both academic researchers and their institutions own equity in the biotechnology companies they are involved with. Thus, when a patent held by a university or a small biotech company is eventually licensed to a big drug company, all parties cash in on the public investment in research.

These laws mean that drug companies no longer have to rely on their own research for new drugs, and few of the large ones do. Increasingly, they rely on academia, small biotech startup companies, and the NIH for that.[7] At least a third of drugs marketed by the major drug companies are now licensed from universities or small biotech companies, and these tend to be the most innovative ones.[8] While Bayh-Dole was clearly a bonanza for big pharma and the biotech industry, whether its enactment was a net benefit to the public is arguable.

The Truth About the Drug Companies
By Marcia Angell

…Before its patent ran out, for example, the price of Schering-Plough's top-selling allergy pill, Claritin, was raised thirteen times over five years, for a cumulative increase of more than 50 percent—over four times the rate of general inflation.[2] As a spokeswoman for one company explained, "Price increases are not uncommon in the industry and this allows us to be able to invest in R&D."

…In the past two years, we have started to see, for the first time, the beginnings of public resistance to rapacious pricing and other dubious practices of the pharmaceutical industry. It is mainly because of this resistance that drug companies are now blanketing us with public relations messages. And the magic words, repeated over and over like an incantation, are research, innovation, and American. Research. Innovation. American. It makes a great story.

But while the rhetoric is stirring, it has very little to do with reality. First, research and development (R&D) is a relatively small part of the budgets of the big drug companies—dwarfed by their vast expenditures on marketing and administration, and smaller even than profits. In fact, year after year, for over two decades, this industry has been far and away the most profitable in the United States.

…Second, the pharmaceutical industry is not especially innovative. As hard as it is to believe, only a handful of truly important drugs have been brought to market in recent years, and they were mostly based on taxpayer-funded research at academic institutions, small biotechnology companies, or the National Institutes of Health (NIH). The great majority of "new" drugs are not new at all but merely variations of older drugs already on the market. These are called "me-too" drugs. The idea is to grab a share of an established, lucrative market by producing something very similar to a top-selling drug. For instance, we now have six statins (Mevacor, Lipitor, Zocor, Pravachol, Lescol, and the newest, Crestor) on the market to lower cholesterol, all variants of the first. As Dr. Sharon Levine, associate executive director of the Kaiser Permanente Medical Group, put it,

If I'm a manufacturer and I can change one molecule and get another twenty years of patent rights, and convince physicians to prescribe and consumers to demand the next form of Prilosec, or weekly Prozac instead of daily Prozac, just as my patent expires, then why would I be spending money on a lot less certain endeavor, which is looking for brand-new drugs?

Third, the industry is hardly a model of American free enterprise. To be sure, it is free to decide which drugs to develop (me-too drugs instead of innovative ones, for instance), and it is free to price them as high as the traffic will bear, but it is utterly dependent on government-granted monopolies—in the form of patents and Food and Drug Administration (FDA)–approved exclusive marketing rights.