Pharm-BushWar-7-3REVISED.doc

NEEDS TO CONFORM TO ANNALS RULES "SPECIAL REPORT?"

DRAFT 7/3/04 Revised 7/24/04

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References 604

**THE HIGH PRICE OF PATENTED DRUGS: A POLICY ANALYSIS**

Donald W. Light, Ph.D.

Professor, University of Medicine & Dentistry of New Jersey

Fellow, Center for Bioethics, University of Pennsylvania

Joel Lexchin, M.D.

Associate Professor, School of Health Policy and Management, York
University

The high price of patented drugs in the United States has arisen since
1998 to be an issue of pressing concern to the 70 million people who do
not have insurance for prescriptions, to employers, to state
legislatures trying to cope with Medicaid budgets and state health
benefits, and to many consumer groups.^1^ By the summer of 2000, doing
something to bring the prices down was considered the number one issue
for both Republican and Democratic candidates. REF? The sense of urgency
led to providing partial coverage, but at the same high prices, through
reform of Medicare in 2003. In 2004, both Families USA and AARP issued
reports documenting how much the industry keeps raising its prices, set
as the highest in the world.^2-5^

A novel and worrisome response has been mounted by the pharmaceutical
industry and echoed by high government officials. The argument is that
prices in other industrialized nations are substantially lower because
they do not pay for research and development (R&D).^6^ The price gap is
widening as they lower their prices. Thus, they are 'free-riders' on
Americans, who have to pay for their R&D and who make most of the
important new discoveries. Americans have taken this argument to heart
and are angry about what William Safire called the "foreign rip-off."^7^
Acting on these claims, the Bush administration has been threatening
trade sanctions and using other forms of economic pressure to get these
other countries to raise their prices, extend protections from price
competition and block export of their cheaper drugs. ^8,\ 9^ The goal is
to get other countries to pay as much as Americans do. The implicit
promise is that if other countries pay more, American patients or their
payers can get relief and pay less.^10^ Some Congressmen, however, have
been concerned from the start that this global campaign to erect a new
set of legal barriers to free trade and price competition would harm
American payers and patients. ^9,\ 11-13^

We took these claims as hypotheses to be tested. What is the evidence
that other countries do not pay for their R&D? To what extent are
Americans saddled with paying for the R&D of other countries? Is drug
research suffering, as claimed, and if so, by how much? If prices were
increased, by how much would research for breakthrough drugs increase?
Finally, do the claims made and these questions make economic sense? Do
they reflect the way the pharmaceutical world works?

**No evidence of free riding**

All the evidence we can find indicates that R&D costs for new drugs are
fully paid for in each country as an annual expense. For example,
domestic sales in Canada are reported by 70 pharmaceutical companies to
be about 9 times greater than R&D costs; so they are easily paid for
each year. Audited reports in the UK show that domestic sales just to
the National Health Service are about 6 times R&D costs, fully covered,
with substantial profits after all costs each year. ^14,\ 15^ Huge
export sales (largely to the U.S. at much higher prices) are extra.
William Safire's claim of a "foreign rip-off" as Americans pay for the
world's R&D is contradicted by these facts.^7^

**Price** **gap due to rising prices**

Studies confirm that the gap between U.S. and foreign drug prices has
been widening, but the growing difference is due to pharmaceutical firms
raising their U.S. prices, not to European countries lowering
theirs.^2-5^ As the audited figures from the UK show, drug prices could
be substantially lower and still cover research costs, with healthy
profits as well. Specifically, at prices about 50% lower than in the
United States, pharmaceutical firms devoted more of their domestic sales
to the National Health Service to R&D than did U.S. firms and still
reported profits of more than 15% on those sales before taxes.^14^ The
reason is that the UK has structured its incentives to reward R&D,
guarantee profits and yet hold prices down.

**No evidence of research decline**

There is also no verifiable evidence for the claim that the prices in
other affluent countries are "slowing the process of drug development
worldwide." For example, according to OECD figures, between 1995 and
1999 R&D grew in Germany, the United Kingdom and Canada by 85%, 51% and
46% respectively, compared to 30% in the U.S.^16^ Investments in R&D
have continued to rise steadily since then as well.^17^ Nor can we find
any evidence that these foreign prices "discourage the R&D needed to
develop new products."

**U.S. less innovative, not more**

Contrary to claims of American dominance, the latest data from the
pharmaceutical industry itself show that European research teams have
discovered more major new drugs (new molecular entities) than their
proportional share of global sales, while U.S. teams have discovered
less.^18^ Specifically, the U.S. accounts for just over 49% of world
sales, but it took 50% of global R&D expenditures invested in the U.S.
to discover 45% of the new molecular entities that were launched on the
world market in 2002.^18^ The most objective research on corporate R&D
in the United States reports that just under 12 percent of domestic
sales is devoted to R&D, not the much higher figures cited by industry
leaders.^19^ In Canada, the figure is slightly lower at 10 percent.^20^
In 2000, four other industrialized countries devoted more of their GDP
to R&D for new drugs than the US.^16^ Thus, contrary to what the
administration and the pharmaceutical industry claim, in relative terms
R&D spending outside the U.S. is more intense and more productive than
in the U.S.

**Limited basic research by industry**

The long-standing survey of basic and applied research by the National
Science Foundation (NSF) last calculated that 18% of the total research
and development (R&D) budget for the pharmaceutical industry went to
basic research, to discover breakthough NMEs.^21^ Industry-sponsored
figures based on proprietary data are much higher but cannot be
independently verified.^22^ Given that the NSF survey found that
pharmaceutical firms spend only 11.8 percent of revenues on R&D, this
means only 2.1 percent of revenues goes to discovering new drugs. The
net percent after taxpayer subsidies is even lower. The after-tax cost
of \$1 of R&D expenditures in the U.S. for large companies appears to be
in the range of \$0.53 to \$0.61^23^ This means that net of taxpayers'
contributions, drug companies invest about 1.3 cents of every dollar
paid for their drugs to basic research for "tomorrow's miracles." This
makes good sense, as senior financial writer, Merrill Goozner, describes
in detail.^24^ Basic research takes so long and has so many twists and
frustrations that no company can reasonably invest much in it year after
year. Quite sensibly, the industry monitors the hundreds of basic
science teams around the world and waits until one of them comes up with
a promising breakthrough.

Taxpayers also paid for all \$18 billion in National Institute of Health
funds in 1999, as well as for R&D funds in the Department of Defense and
other public budgets (now about \$30 billion). Most of that money went
for basic research, and public money also supports more than 5000
clinical trials.^25,\ 26^ These figures do not support the industry's
claim that they spend huge sums at high risk to discover the next
generation of breakthrough drugs.

Government protections from normal competition, largely crafted by
industry advocates and lobbyists, are now more than 50 percent greater
than a decade ago.^27^ They reward less risky and cheaper research into
variations on existing drugs, where the mechanism of action, general
effectiveness and safety profile are already known. Most of this applied
and derivative research produces "new" drugs of little or no therapeutic
advantage over existing drugs. Independent review panels plus a major
industry review have concluded that only 10 -- 15 % of "new" drugs
provide a significant therapeutic breakthrough over existing
drugs.^28-30^

As one would expect in a market where sellers can set their prices to
cover research costs and receive special tax treatment, companies have
strong incentives to maximize their research costs. Most of the recent
increase in R&D costs has been in late-stage clinical trials.^22^ They
have become a major vehicle for establishing substantial market share,
and advertising firms are now running clinical trials.^25,\ 31,\ 32^ An
international team of experts estimates that clinical trials could be
done for much less than they are at present.^25^ To summarize, basic R&D
into drugs that provide significant therapeutic advantages is only a
fraction of overall R&D expenditures and total costs could be made much
smaller if clinical trials were not so commercialized.

**The** **Bain Report**

A new report supported by the pharmaceutical industry (the Bain Report)
and reported to millions by AARP^33^ claims to document the "high cost
of Europe's free ride."^34^ Yet the report contains almost no facts and
has no references. It portrays Europe as a "free rider" that will suffer
from less drug innovation and "higher morbidity and mortality from
diseases that could be treated with innovative drugs -- if they were
more readily available in Europe."^30^ No evidence is provided for this
unlikely prediction. Morbidity or mortality are lower in Western Europe
than in the United States. No evidence is provided that therapeutically
beneficial drugs are less available in Europe. The few facts in the
report are contradicted by reputable published reports, including the
report by the European Federation of Pharmaceutical Industries and
Associations.^18^

The Bain report does not mention that proportionately more new major
drugs are being discovered in Europe, nor that most new drugs have
little additional benefits to patients. The Bain report's model claims
to show a negative economic and social impact in Germany as a result of
"free riding", but it presents no data or facts and hides many unlikely
assumptions inside its general graphs. The fact that the countries in
which substantial drug research takes place more than pay for the cost
of research through just domestic sales is ignored.^15,\ 16^ Rather, the
"free rider model" and the report are based on what appears to be a new
premise of industry-sponsored reports: the more drugs people take, the
healthier they will be, and the more they pay for them, the better off a
country will be. The increased prices and profits from the U.S. market
are presented as the ideal. What may be unsustainable are the rising
prices in the United States.

**Free-riding as an economic myth**

**(0r) Economic nonsense and doublespeak**

Physicians, along with patients, are subjected to economic nonsense that
they are unprepared to discern, even though they spend their lives
discriminating between misleading and scientifically grounded symptoms
and diagnoses. Here we outline five economic myths commonly stated as
truths about drugs and five kinds of doublespeak, that is, terms used to
mean their opposite.

First, the entire argument that prices are high because there are high
fixed costs for research contradicts basic economic theory that asserts
that price has nothing to do with fixed costs but is set by the market.
The argument for high prices to cover fixed costs only makes sense if
companies are asking governments to pay for their R&D expenditures as a
social good. In that case, one is calling for society to set prices.
What makes the industry's argument false is to use the claim for a
societal good as a reason to set corporate monopoly prices. It is
effective political rhetoric contradicted by sound economics.

Second, which country discovers more drugs is largely irrelevant to how
the global pharmaceutical markets work. It is effective political
rhetoric that arouses nationalistic feelings but has little to do with
the economics of the global drug market. The industry quickly
capitalizes on new discoveries from any country, tests them in countries
where it is most advantageous and then markets the resultant products
everywhere where it is profitable. It is both remarkable and disturbing
when leading health economists promote either of these arguments that
contradict basic economic theory and the economics of the pharmaceutical
industry.^6^

Third, the claim that prices in most affluent countries do not pay for
research can only be made through unorthodox accounting methods in which
all research costs are written off each year as they occur. Further, R&D
is the heart of the industry, and R&D costs are reduced by tax
deductions and credits; so if anything, they are deducted before
marketing and other costs. If revenues were inadequate, it would make
more sense to conclude they do not cover all marketing costs than
research costs. Global pharmaceutical companies report that they invest
2.5 -- 3.0 times more in marketing, plus advertising and administration
than to research costs.^35^

A fourth myth is buried inside the term "free rider." This term conveys
the image of someone jumping on for a free ride; but in economics it
means the proportional allocation of fixed costs. For example, if some
buyers (Group A) pay \$1 per pill and others (Group B) pay \$2 a pill,
and if they each buy a million pills, then a conventional rule in
financing allocates any large fixed cost proportionately, so that Group
A is paying half as much of the fixed cost as Group B. Group A (e.g.,
Europe) is then said to be "free riding," though the term is both
inaccurate and moralistic. If, however, the fixed costs are only
\$300,000 or 1/10^th^ total revenues for the 2 million pills, then one
could just as easily say that Group A is more than paying for the fixed
costs, while Group B is paying much more than it has to. This is the
flat allocation of fixed costs, and it highlights how much more Group B
(American patients and payers) are paying than is necessary to cover the
fixed costs of corporate research.

The core argument by the Bush administration and the drug industry is
that nations in Group A are "free riders" and should be coerced into
paying \$2 a pill like Group B. But there would also be no "free riding"
if Group B's prices were cut in half to \$1 a pill. Solving the
so-called free rider problem this way makes drugs more affordable and
lowers the ceiling of global prices, while still paying for the fixed
costs of research. The U.S. campaign to raise lower foreign prices
simply makes them less affordable and raises profits even higher for one
of the world's most profitable industries.

A final economic myth lies in the charge that efforts to lower prices
for patented drugs by other countries, and by major employers, unions
and governors within the United States, are "no different than violating
the patent directly" to make cheap copies.^36^ This is a remarkable
statement by a star health economist, because it means that normal
competition, in which large buyers use their buying power to seek better
value, is a criminal act and morally offensive. One might expect hired
lobbyists to argue that normal competition is illegal, but not a
well-trained economist and high government official.

A difficulty in understanding the nature of pharmaceutical policy
doublespeak, using words to mean their opposite. "Competitive
liberalization" appears to mean competitive restrictions, or
liberalization from competition for companies. "Free trade" means
restricted trade, or the ability of drug companies to trade freely at
prices they set. "Free markets" for patented drugs means free from
normal competition, so that the longer competition is delayed, the
"freer" markets are said to be. "Openness" means allowing drug companies
to alter pricing agreements in the domestic markets of other countries.
"Reimportation" refers to global free trade of drugs, but makes it sound
like a bizarre, unnatural act.

# Conclusions

In this analysis, we found no support for any of the five hypotheses, or
claims, on which international pharmaceutical policy is based. Yet
policy makers in Europe and the U.S. appear to have accepted these
claims from industry sources as facts. Current policies, if allowed to
be carried out, will fix prices at the highest levels for wealthy
countries, eliminate price competition, and raise the starting price for
discounting to patients in less affluent countries. Affordability and
access will be harmed both in the United States and in the rest of the
world, with no measurable benefit. Research budgets to discover
"tomorrow's miracles" might increase by their average of 1.3% of
revenues.

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